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Monthly Archives: April 2018

After experiencing weakness in February and March, crude oil spiked to three-year highs in April due to geopolitical fears associated with the Syria bombing campaign as well as falling inventories. Earlier today, President Trump tweeted that OPEC was to blame for “artificially Very High!” crude oil prices, which he said are “No good and will not be accepted!” In this piece, we will look at key technical levels and other information relevant for understanding crude oil prices.

Since the summer of 2017, crude oil has been climbing a series of uptrend lines, but broke below one of these lines during the market rout of early-February 2018. WTI crude oil broke above its $66-$67 resistance last week, which is a bullish technical signal if it can be sustained. If WTI crude oil breaks back below this level, however, it would be a bearish sign.WTI Crude Daily

A major reason for skepticism about crude oil’s recent rally is the fact that the “smart money” or commercial futures hedgers currently have their largest short position ever – even larger than before the 2014/2015 crude oil crash. The “smart money” tend to be right at major market turning points. At the same time, the “dumb money” or large, trend-following traders are the most bullish they’ve ever been. There is a very good chance that, when the trend finally changes, there is going to be a violent liquidation sell-off.

WTI Crude Monthly

Similar to WTI crude oil, Brent crude has been climbing a couple uptrend lines as well. The recent breakout over $71 is a bullish sign, but only if it can be sustained; if Brent breaks back below this level, it would give a bearish confirmation signal.

Brent Crude Daily

It is worth watching the U.S. Dollar Index to gain insight into crude oil’s trends (the dollar and crude oil trade inversely). The dollar’s bearish action of the past year is one of the main reasons for the rally in crude oil. The dollar has been falling within a channel pattern and has recently formed a triangle pattern. If the dollar can break out of the channel and triangle pattern to the upside, it would give a bullish confirmation signal for the dollar and a bearish signal for crude oil (or vice versa). The “smart money” or commercial futures hedgers are currently bullish on the dollar; the last several times they’ve positioned in a similar manner, the dollar rallied.

USD Weekly

The euro, which trades inversely with the dollar and is positively correlated with crude oil, is also worth watching to gain insight into crude oil’s likely moves. The “smart money” are quite bearish on the euro, which increases the probability of a pullback in the not-too-distant future. The euro has been rising in a channel pattern and has recently formed a triangle pattern. If the euro breaks down from this channel, it would give a bearish confirmation signal, and would likely put pressure on crude oil (or vice versa).Euro Weekly

There has been a good amount of buzz about falling inventories and the reduction of the oil glut, but this week’s inventories report of 427.6 million barrels is still above average for the past 5 to 10 years. In addition, U.S. oil production continues to surge and recently hit an all-time high of 10.5 million barrels per daily.

For now, the short-term trend in crude oil is up, but traders should keep an eye on the $66-$67 support zone in WTI crude oil and the $71 support in Brent crude oil. If those levels are broken to the downside, then the recent bullish breakout will have proven to be a false breakout. Traders should also keep an eye on which way the U.S. dollar and euro break out from their triangle and channel patterns.

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One of the worst possible outcomes for the U.S. economy, and ultimately for investors, is stagflation. Of course, if you weren’t around in the 60-70’s, there is a reasonably high probability you are not even sure what “stagflation” is. Here is the technical definition:

stagflation – persistent high inflation combined with high unemployment and stagnant demand in a country’s economy.”

How can that happen? Exactly in the way you are witnessing now.

While the current Administration is keen on equalizing trade through tariffs, trade deals, and trade deficit reduction, they have also embarked on a deficit expanding spending spree which has deleterious long-term effects on economic growth. At the same time, the administration is attacking our major trading partners, particularly China, leading to a push to shift away from the U.S. dollar as a reserve currency.

What does all that mean?

Here is the problem with the current trajectory.

  • A weaker dollar leads to higher commodity prices creating cost-push inflation.
  • As fears of inflation infiltrate the markets, interest rates increase which raises borrowing costs.
  • As the dollar weakens, commodity prices rise increasing input cost to manufactures.
  • Higher input costs, borrowing costs, and weaker profits ultimately force corporations to suppress wage growth to protect profits.
  • As wage growth is suppressed, particularly with a heavily indebted consumer, demand falls as higher costs, both product and borrowing costs, cannot be compensated for.
  • As demand falls, companies react by reducing the highest costs to their bottom lines: wages and employment.
  • As profits come under pressure, stock prices fall which negatively impacts the “wealth effect” further curtailing consumptive demand.
  • As the economy slumps into recession, unemployment rise sharply, demand falls, and interest rates decline sharply. 

As I discussed just recently, the bottom 80% of U.S. households are heavily indebted with no wage growth to offset the rising costs in “non-discretionary” spending requirements of rent, utilities, food and healthcare and debt payments.

However, as the dollar weakens, the input costs to manufacturers rise leading to concerns of inflationary pressures which pushes interest rates higher.

The biggest risk to the markets, and investors, is both the current Administrations trade policies, particularly as it relates to China, and the reduction of the Federal Reserve’s balance sheet. Combined, these two represent the largest buyers of U.S. Treasuries which is most inopportune at a time where the fiscal deficit is set to swell creating a surge in U.S. debt issuance. (The chart below is the annual rate of change of foreign holdings of U.S. Treasuries versus the annual change in interest rates.)

Furthermore, this is all occurring at a time when global liquidity is being withdrawn.

The removal of global policy stimulus has naturally come about as the world economy finally managed a couple of quarters of synchronised growth in 2017. But our view is that this growth is tenuous and very late-cycle, particularly in China and the US, as the credit cycle has already turned. And the next challenges for markets are just around the corner.”

While much of the mainstream media continues to promote expectations of a global resurgence in economic growth, there is currently scant evidence of such being the case. Since economic growth is roughly 70% dependent on consumption, then population, wage, and consumer debt growth become key inputs into that equation. Unfortunately, with real wage growth stagnant for the bottom 80%, demographics running in reverse, and consumers extremely leveraged, a sustained surge in economic growth to offset higher interest rates becomes unlikely.

So, to summarize, we have a depreciating dollar policy from the White House, which is inflationary, with the Fed and foreign purchasers of our bonds not keeping pace with burgeoning deficits. With inflation, not generated by economic growth but by a weak dollar instead, pushes interest rates higher, the combination is a deadly one-two punch for the economy. This is an outcome to which the market is currently ill-prepared for.

Just something to think about as you catch up on your weekend reading list.

Economy & Fed


Most Read On RIA

Research / Interesting Reads

“The trick of successful investors is to sell when they want to, not when they have to.” – Seth Klarman

Questions, comments, suggestions – please email me.

“Peter Cook is the author of the ‘Is That True?’ series of articles, which help explain the many statements and theories circulating in the mainstream financial media often presented as “truths.” The motives and psychology of market participants, which drives the difference between truth and partial-truth, are explored.”

The Federal Reserve (Fed) regularly proclaims its decisions on monetary policy are “data dependent.”  More precisely, the Fed uses data as inputs for its economic models, which are thought to describe how the economy functions in the real world.  The complexity of Fed models probably couldn’t be explained in fewer than 50 pages of academic jargon.  But Keynesian economic philosophy, a belief that an economy’s health can be described by the aggregate annual amount of spending (otherwise known as GDP), is foundational to the Fed models.  For 2018, the Federal Open Market Committee (FOMC), which votes on monetary policy, predicts real GDP growth of 2.7%.

The Fed’s regional banks also produce economic research, which can differ from the FOMC’s forecasts.  For example, the Cleveland Fed (CF) also produces an estimate of the upcoming year’s GDP growth, but its model is based on observations of the U.S. Treasury yield curve.  No model can perfectly describe reality, and a potential weakness of CF model is that it is based on a single input; the spread between the yield on the 3-month Treasury bill and the 10-year Treasury bond.

Because the CF model is based on market-based data (not economic data), it is fundamentally different than the FOMC model.  As a result, the difference between the FOMC model and the CF model could be interpreted as a difference between what the FOMC believes and what the market believes.

The CF model is based on 60+ years of historical data between GDP growth and the shape of the yield curve, as shown below.  To achieve the best fit between the data series, the CF model assumes that changes in the spread of the yield curve affect GDP growth one year afterward.  Therefore, the chart below shows the real-time yield spread (orange line) versus GDP growth (blue line) one year later.

The chart below shows the CF model over the past 16 years, which makes it easier to see the changes in the yield curve and GDP growth.  The recent spread of the yield curve produces an estimate of GDP growth for the upcoming year (red line), which has been steady at 1.4% over the past several months.

The FOMC model estimates 2018 GDP growth of 2.7% while the market-based estimate is 1.4%.  So, what is the market seeing that the Fed is missing, or vice versa?  The most likely explanation is the effect of the recent tax cut/reform (TCJA).  The main components of the TCJA were a $200 billion annual tax cut for individuals, plus another $100 billion in additional government spending in 2018.  Keynesian economic theory assumes the total of $300 billion will be spent on items that will increase GDP by 1.5% during 2018 (1.5% equals $300 billion divided by $20 trillion, which is the approximate size of US GDP).

Also, Keynesian theory assumes a multiplier effect for government deficit spending, meaning that the theoretical boost to GDP in 2018 should exceed 1.5%.   But the theoretical multiplier isn’t the same for different types of spending and it isn’t stable over time, so it isn’t a useful concept for this analysis.

Looking at the difference between the FOMC model of 2.7% GDP growth and the CF model of 1.4% growth, the market appears to be saying that the TCJA will have a very little effect on 2018 GDP growth.  How could that be possible?  The market appears to believe that the $200 billion in individual tax cuts will not be spent during 2018; instead, that money will be saved or used to pay down debt, neither of which directly boosts GDP growth in the short-term.

What about the $100 billion in federal deficit spending?  Surely that should create an increase in 2018 GDP growth, under Keynesian assumptions.  It appears the market is no longer driven by Keynesian analysis, because the CF model shows that deficit spending may have very little effect, if any, on GDP growth.

If so, the market’s belief would coincide with the analysis in “Is the U.S. Economy Really Growing?”, which demonstrated a regime change has occurred since 2008.  Before 2008, deficit spending resulted in what Keynesians expected; an increase in GDP that exceeded the amount of deficit spending.  But after 2008, annual increases in federal debt far exceeded annual GDP growth.  The regime change may be the single-most important reason that the Fed has consistently overestimated GDP growth in its forecasts over the past decade.

Does the fact that the Fed has systematically overestimated growth in GDP and inflation over the past decade mean that it will do so in the future?  Not necessarily.  Will the market estimate of 2018 GDP growth be too low?  Again, not necessarily, and for the same reason; the past does not always predict the future.

But there are some clues to which may be more accurate.  The market-based estimate of the CF model incorporates bets by the world’s largest investors to forecast GDP growth (and inflation), and it hasn’t systematically overestimate or underestimated GDP growth over the past decade, as shown in the second chart.  In contrast, the FOMC model incorporates Keynesian assumptions on economic data to forecast GDP growth (and inflation), and it has systematically overestimated GDP growth over the past decade.  When there is a divergence between the two groups, it’s probably a better bet to follow the money, not the academics.


Today, two models that forecast 2018 GDP growth produce substantially different results. The 1.3% difference in GDP growth forecasts (2.7% – 1.4%) is roughly equal to the theoretical fiscal stimulus of the TCJA (1.5%).

The FOMC model is based on Keynesian assumptions that equate a boost in federal deficit spending with an increase in real GDP.  The FOMC model has consistently overestimated GDP growth over the past decade, probably because it has failed to grasp the regime change that has occurred in the relationship between deficit spending and GDP growth.

The CF model is based on the spread of the yield curve and appears to reflect a high degree of skepticism that federal deficit spending will produce a boost to GDP growth.  Over the past decade, it hasn’t systematically overestimated or underestimated GDP growth.

It is possible that GDP growth is 2.0%, and that both models will be incorrect by the same amount.  But probably not.  As we progress through 2018, the results of the models will converge.  The direction in which the convergence occurs will be crucially important to investors.

A few days ago, Neel Kashkari, president of the Minneapolis Fed, told an attendees at an event at Howard University that Wall Street is “forgetting the lessons of the 2008 financial crisis“:

“The shareholders got bailed out. The boards of directors got bailed out. Management got bailed out. So from their perspective, there was no crisis.”

Kashkari, long an advocate of more stringent regulations to rein in major banks, said US labor groups, whose pension funds took major hits during the crisis, may have a role to play in countering the political influence of the nation’s largest banks.

They have been campaigning, fairly successfully, to roll back many of the post-crisis regulations known as Dodd-Frank, which President Donald Trump has vowed to largely repeal.

“We are forgetting the lessons of the 2008 crisis,” Kashkari said. “The bailouts worked too well.”

Financial crises keep happening “because we forget how bad they were,” he added.

What’s the solution? Making banks raise more equity to fund their investment rather than rely so heavily on debt.

“No other industry is levered likely the banking industry,” Kashkari said. “If we double the amount of equity banks have we could go a long way toward resolve the problem that too big to fail banks pose. If it were up to me we’d be increasing banks’ leverage ratio, not decreasing it.”

While I agree with Kashkari that Wall Street is forgetting the lessons of the 2008 financial crisis (and is participating in the development of another dangerous economic bubble), he seems to be absolving the Federal Reserve of its massive responsibility for inflating the mid-2000s U.S. housing and credit bubble as well as the current “Everything Bubble” that I am warning about. Make no mistake: by holding interest rates at artificially low levels and pumping large amounts of liquidity into the financial system, the Fed plays the primary role of creating bubbles – not Wall Street. The Fed is the dog and Wall Street is merely its tail – not the other way around. Of course, Wall Street is guilty for participating in bubbles originally created by the Fed – it takes two to tango.

The chart below shows how relative troughs in the Fed Funds Rate correspond with the formation of disastrous economic bubbles that pop when interest rates rise. The mid-2000s housing bubble inflated because the Fed helped to push mortgage interest rates to very low levels, which led to a borrowing binge that sent housing prices to unsustainable new highs. The U.S. housing bubble would not have occurred if the Fed didn’t meddle and distort borrowing costs and markets. The Fed is making the same mistake once again: though the current “Everything Bubble” hasn’t popped yet, it’s only a matter of time before it does…it’s just math.

Fed Funds Rate

By holding interest rates artificially low, the Fed has been encouraging the growth of the U.S. debt bubble. This debt bubble is significantly larger than it was in 2008, which means that the next downturn is going to be even more powerful, unfortunately.

Financial Leverage

The Fed’s pro-asset inflation policies have helped to push U.S. stock market valuations to 1929 levels. At some point, these valuations will revert back to the mean, as they always do, which will result in a powerful bear market.


The latest Fed-induced asset bubble (which is occurring in stocks, bonds, and some parts of the property market) has helped to boost U.S. household wealth in a manner similar to what occurred during the late-1990s Dot-com bubble and mid-2000s housing bubble. Unfortunately, this “wealth boost” is not a permanent gain or windfall, but a temporary increase until the latest asset bubble inevitably pops.

The latest asset bubble has the IMF worrying too – “IMF Warns of Rising Threats to Global Financial System“:

Threats to the global financial system are rising, with the price of risky assets surging in a manner reminiscent of the years before the global financial crisis, the International Monetary Fund warned.

Downside risks to world financial stability have increased “somewhat” over the past six months, the IMF said Wednesday in the latest edition of its Global Financial Stability Report. “Financial vulnerabilities, which have accumulated during years of extremely low rates and volatility, could make the road ahead bumpy and could put growth at risk,” said the Washington-based fund.

Investors “should not take too much comfort” in the fact there were no major disruptions from the sharp selloff that shook markets in February, the IMF said. “Valuations of risky assets are still stretched, with some late-stage credit cycle dynamics emerging, reminiscent of the pre-crisis period,” it said. “This makes markets exposed to a sharp tightening in financial conditions, which could lead to a sudden unwinding of risk premiums and a repricing of risky assets.”

Prices are frothy across a variety of assets, according to the IMF. Stock prices are high relative to fundamentals around the world, especially in the U.S., the fund said. Corporate bond valuations are also elevated, with signs of overheating in demand for leveraged loans from firms with low credit ratings, it said.

It is disingenuous for the Fed’s Neel Kashkari to place the blame solely on Wall Street for “forgetting the lessons of 2008” when the Fed itself is forgetting those lessons in such an egregious manner. This type of thinking at the Fed is why another massive financial crisis is already baked into the cake.

Please follow or add me on TwitterFacebook, and LinkedIn to stay informed about the most important trading and bubble news as well as my related commentary.

The stock market has been rallying on the surge in global economic growth (recently monikered global synchronized growth) over the past year. The hope, as always, is that growth is finally here to stay. The surge in growth has also given cover to the Federal Reserve, and Central Banks globally, to start reducing the flood of liquidity that has been propping up markets globally since the “financial crisis.”

That optimism has bled over in recent months as improving confidence has pushed leverage back to record levels, investors carry the highest levels of risk assets since the turn of the century, and yield spreads remain near record lows. It certainly seems as “things are as good as they can get.”

But it is when things are “as good as they can get” that we find the rest of the story.

recent report from the Brookings Institute highlights one of the biggest risks to investors currently – global growth.

“The world economy’s growth momentum remains strong but is leveling off as the winds of a trade war, geopolitical risks, domestic political fractures, and debt-related risks loom, with financial markets already reflecting mounting vulnerabilities. The latest update of the Brookings-Financial Times TIGER index provides grounds for optimism about the current state of the world economy matched by some pessimism about the sustainability of the growth momentum.”

This has been a key concern of mine of the last several months. The recent uptick in the U.S. economy has been undeniably the strongest we have seen in the last few years. As Brookings notes:

The U.S. economy remains in robust shape, with growth in GDP, industrial production, and investment holding up well. In tandem with strong consumer confidence and employment growth, wage and inflationary pressures have picked up slightly, although less than would be typical at this stage of the cycle.

The issue, however, is that much of that uptick was attributable to a series of natural disasters in 2017. To wit:

“The Trump Administration has taken a LOT of credit for the recent bumps in economic growth. We have warned this was not only dangerous, credibility-wise, but also an anomaly due to three massive hurricanes and two major wildfires that had the ‘broken window’ fallacy working overtime.”

As shown in the chart below, the ECRI’s index and the Chicago Fed National Activity Index suggests that bump in growth may be waning. Historically, spikes in activity have historically noted peaks in the economic cycle. Such should not be surprising as growth breeds optimism which drives activity. Just remember, everything cycles.

While current optimism is high, it is also fragile.

For investors, when things are “as good as they can get,” that is the point where something has historically gone wrong. It is always an unexpected, unanticipated event that causes a revulsion of risk assets across markets. Currently, there are a host of competing forces at play within the markets and the economy. These competing forces weave a delicate balance that can be easily disrupted creating a reversion in behaviors.

As Brookings notes:

The U.S. is engaged in a perilous macroeconomic experiment, with the injection of a significant fiscal stimulus even as the economy appears to be operating at or above its potential. The Fed is likely to lean hard against potential inflationary pressures as this stimulus plays out. Export growth has been buoyed by a weak dollar and strong external demand, but the U.S. trade deficit has still risen over the past year. The large bilateral trade deficit with China remains a flashpoint, setting in motion trade tensions that could have implications for China, the U.S., and the entire world economy.”

But this isn’t just in the U.S. It is also on a global scale.

“In 2017, the Euro-zone turned in its fastest pace of growth over the last decade. Growth in overall GDP as well as in the manufacturing and services sectors remains solid but has cooled off slightly this year. Centrifugal political forces in many countries, rising global trade frictions, and the withdrawal of monetary stimulus could lay bare some of the unresolved structural problems and tensions in the zone.”

The last point was recently noted by Michael Lebowitz:

“Global central banks’ post-financial crisis monetary policies have collectively been more aggressive than anything witnessed in modern financial history. Over the last ten years, the six largest central banks have printed unprecedented amounts of money to purchase approximately $14 trillion of financial assets as shown below. Before the financial crisis of 2008, the only central bank printing money of any consequence was the Peoples Bank of China (PBoC).”

The central banks’ goals, in general, were threefold:

  • Expand the money supply allowing for the further proliferation of debt, which has sadly become the lifeline of most developed economies.
  • Drive financial asset prices higher to create a wealth effect. This myth is premised on the belief that higher financial asset prices result in greater economic growth as wealth is spread to the masses.
    • “And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”– Ben Bernanke Editorial Washington Post 11/4/2010.
  • Lastly, generate inflation, to help lessen the burden of debt.

QE has forced interest rates downward and lowered interest expenses for all debtors. Simultaneously, it boosted the amount of outstanding debt. The net effect is that the global debt burden has grown on a nominal basis and as a percentage of economic growth since 2008. The debt burden has become even more burdensome.

However, that liquidity support is now being removed.

That extraction of liquidity is potentially already showing up in slower rates of global economic growth. As recently noted by the ECRI:

“Our prediction last year of a global growth downturn was based on our 20-Country Long Leading Index, which, in 2016, foresaw the synchronized global growth upturn that the consensus only started to recognize around the spring of 2017.

With the synchronized global growth upturn in the rearview mirror, the downturn is no longer a forecast, but is now a fact.”

The ECRI goes on to pinpoint the problem facing investors currently which is a “willful blindness” to changes in the economic fabric.

“Still, the groupthink on the synchronized global growth upturn is so pervasive that nobody seemed to notice that South Korea’s GDP contracted in the fourth quarter of 2017, partly due to the biggest drop in its exports in 33 years. And that news came as the country was in the spotlight as host of the winter Olympics.

Because it’s so export-dependent, South Korea is often a canary in the coal mine of global growth. So, when the Asian nation experiences slower growth — let alone negative growth — it’s a yellow flag for the global economy.

The international slowdown is becoming increasingly obvious from the widely followed economic indicators. The most popular U.S. measures seem to present more of a mixed bag. Yet, as we pointed out late last year, the bond market, following the U.S. Short Leading Index, started sniffing out the U.S. slowdown months ago.”

While at the headline, things may seem to “firing on all cylinders,” there are many indicators showing rising “economic stress” such as:

The shift caused by the financial crisis, aging demographics, massive monetary interventions and the structural change in employment has skewed many of behaviors of politicians, central bankers, and investors. We are currently sailing in very unchartered waters where a single unexpected wave could easily capsize the ship. Not just domestically, but on a global scale.

As Brookings concludes:

“The era of growth fueled by macroeconomic stimulus, with no apparent adverse side effects such as high inflation, appears to be drawing to an end. In the absence of deep-rooted reforms to improve productivity, it will be difficult to ratchet up or even sustain high growth in the major economies.”

Mounting public debt in the U.S. and other advanced economies, compounded by unfavorable demographics, and rising external debt levels of some emerging market economies are risk factors that also reduce policy space for responding to shocks.”

There are a multitude of risks on the horizon, from geopolitical, to fiscal to economic which could easily derail growth if policymakers continue to count on the current momentum continuing indefinitely. The dependency on liquidity, interventions, and debt has displaced fiscal policy that could support longer-term economic resilience.

We are at war with ourselves, not China, and the games being played out by Washington to maintain the status quo is slowly creating the next crisis that won’t be fixed with another monetary bailout.

* Adding to my large SPY short
* Downside risk grows relative to upside reward

I have been shorting (on a scale higher) SPDR S&P 500 ETF (SPY) most of the day — adding to an already large short position.

There are a number of factors contributing to this move:

* Narrow market leadership. (We are back to the FAANG — Facebook (FB) , Amazon (AMZN) , Apple (AAPL) , Netflix (NFLX) and Alphabet (GOOGL) — market).
* The continued rise in short term interest rates. (The 2-year U.S. note yield is +1.5 basis points to 2.39%.)
* Seeing more investor complacency (anecdotally in the business media and elsewhere) — after the rally off of the lows.
* The rise in gold looks solid.
* Disappointing action in financials. (Though I continue to buy)

Finally, with S&P cash now at 2705 — the downside risk relative to the upside reward seems to argue in favor of a net short exposure.

Remember, I expect a 2200-2850 trading range for 2018, with a “fair market value” of about 2400.

So according to my calculus, currently, there is about 500 S&P points of downside risk (to the low end of my trading range) and 300 S&P points of risk to “fair market value” — as compared to the upside of only approximately 150 S&P points.

* Add the recent advance in oil stocks and a breakout in commodities as more reasons to be short term bearish


I can add two more factors that are contributing to my short term bearishness:

* Oil stocks have been the leading (non-FANG) sector in the stock market over the last few days/weeks – obviously in response to the rise in crude oil prices. Historically, a market being led by oil stocks is close to a top of what we can characterize as a mature Bull Market.

* As noted by my pal Peter Boockvar this morning, the CRB commodity index has broken out and now sits at the highest level since October, 2015. It’s not only oil – nickel, aluminum and other non-precious metals are rising. Peter also relates that the US ten year inflation breakeven is up by almost 1 basis point – and at the highest level since September, 2014. As noted earlier, the two year US note yield is now over 2.42%.

Caution is advised.

Trade negotiations and threatening global tariff volleys are contributing to significant volatility in the financial markets. Although applicable in many ways, the Smoot-Hawley protectionist act of 1930 is unfairly emphasized as the primary point of reference for understanding current events.

In 1944, an historic agreement was forged amongst global leaders that would shape worldwide commerce for decades. The historical precedence of post-WWII trade dynamics offers a thoughtful framework for understanding why trade negotiations are so challenging. This article uses that period as a means of improving the clarity of our current lens on complex and fast-changing trade dynamics.

The following article was originally published to subscribers of 720Global’s The Unseen. We are now releasing it to the public to provide a glimpse of our coming service, RIA Pro.

Triffin Warned Us

“We are addicted to our reserve currency privilege, which is in fact not a privilege but a curse.”  –James Grant, Grant’s Interest Rate Observer

Folklore states that Robert Johnson went down to the crossroads in Rosedale, Mississippi and made a deal with the devil in which he swapped his soul for musical virtuosity. In 1944, the United States and many nations made a deal at the crossroads in Bretton Woods, New Hampshire. The agreement, forged at a historic meeting of global leaders, has paid enormous economic benefits to the United States, but due to its very nature, has a flawed incongruity with a dear price that must be paid.

In 1960, Robert Triffin brilliantly argued that ever-accumulating trade deficits, the flaw of hosting the reserve currency and the result of Bretton Woods, may help economic growth in the short run but would kill it in the long run. Triffin’s theory, better known as Triffin’s Paradox, is essential to grasp the current economic woes and, more importantly, recognize why the path for future economic growth is far different from that envisioned in 1944.

We believe the financial crisis of 2008 was likely an important warning that years of accumulating deficits and debts associated with maintaining the world’s reserve currency may finally be reaching their tipping point. Despite the last nine years of outsized fiscal spending and unprecedented monetary stimulus, economic growth is well below the pace of recoveries of years past. In fact, as shown below, starting in 2009 the cumulative amount of new federal debt surpassed the cumulative amount of GDP growth going back to 1967. Said differently, if it were not for a significant and consistent federal deficit, GDP would have been negative every year since the 2008 financial crisis.  

Data Courtesy: St. Louis Federal Reserve (FRED) and Baker & Company Advisory Group/Zero Hedge

Bretton Woods and Dollar Hegemony

By decree of the Bretton Woods Agreement of 1944, the U.S. dollar supplanted the British Pound and became the global reserve currency. The agreement assured that a large majority of global trade was to occur in U.S. dollars, regardless of whether or not the United States was involved in such trade. Additionally, it set up a system whereby other nations would peg their currency to the dollar. This arrangement is somewhat akin to the concept of a global currency. This was not surprising, as a few years prior John Maynard Keynes introduced a supranational currency by the name of Bancor.

Within the terms of the historic agreement was a supposed remedy for one of the abuses that countries with reserve currency status typically commit; the ability to run incessant trade and fiscal deficits. The pact established a discipline to discourage such behavior by allowing participating nations the ability to exchange U.S. dollars for gold. In this way, other countries that were accumulating too many dollars, the side effect of American deficits, could exchange their excess dollars for U.S.-held gold. A rising price of gold, indicative of a devaluing U.S. dollar, would be a telltale sign for all nations that America was abusing her privilege.

The agreement began to fray after only 15 years. In 1961, the world’s leading nations established the London Gold Pool with an objective of maintaining the price of gold at $35 an ounce. By manipulating the price of gold, a gauge of the size of U.S. trade deficits was broken and accordingly the incentive to swap dollars for gold was diminished. In 1968, France withdrew from the Gold Pool and demanded large amounts of gold in exchange for dollars. By 1971, President Richard Nixon, fearing the U.S. would lose its gold if others followed France’s lead, suspended the convertibility of dollars into gold. From that point forward, the U.S. dollar was a floating currency without the discipline imposed upon it by gold convertibility. The Bretton Woods Agreement was, for all intents and purposes, annulled.

The following ten years were marked by double-digit inflation, persistent trade deficits, and weak economic growth, all signs that America was abusing its privilege as the reserve currency. Other nations grew increasingly uncomfortable with the dollar’s role as the reserve currency. The first graph below shows that, like clockwork, the U.S. began running annual deficits in 1971. The second graph highlights how inflation picked up markedly after 1971.

By the late-1970’s, to break the back of crippling inflation and remedy the nation’s economic woes, then Chairman of the Federal Reserve Paul Volcker raised interest rates from 5.875% to 20.00%. Although a painful period for the U.S. economy, his actions not only killed inflation and ultimately restored economic stability but, more importantly, satisfied America’s trade partners. The now floating rate dollar regained the integrity and discipline required to be the reserve currency despite lacking the checks and balances imposed upon it by the Bretton Woods Agreement and the gold standard.

As an aside, The Fifteenth of August discussed how Nixon’s “suspension” of the gold window unleashed the Federal Reserve to take full advantage of the dollar’s reserve currency status.

Enter Dr. Triffin

In 1960, 11 years before Nixon’s suspension of gold convertibility and essentially the demise of the Bretton Woods Agreement, Robert Tiffin foresaw this problem in his book Gold and the Dollar Crisis: The Future of Convertibility. According to his logic, the extreme privilege of becoming the world’s reserve currency would eventually carry a heavy penalty for the U.S.  Although initially his thoughts were generally given little consideration, Triffin’s hypothesis was taken seriously enough for him to gain a seat at an obscure congressional hearing of the Joint Economic Committee in December the same year.

What he described in the book, and his later testimony, became known as Triffin’s Paradox. Events have played out largely as he envisioned it. Essentially, he argued that reserve status affords a good percentage of global trade to occur in U.S. dollars. For this to occur the U.S. must supply the world with U.S. dollars.  In other words, to supply the world with dollars, the United States would always have to run a trade deficit whereby the dollar amount of imports exceeds the dollar amount of exports.  Running persistent deficits, the United States would become a debtor nation. The fact that other countries need to hold U.S. dollars as reserves tends to offset the effects of consistent deficits and keeps the dollar stronger than it would have been otherwise.

The arrangement is as follows: Foreign nations accumulate and spend dollars through trade. To manage their economies with minimal financial shocks, they must keep excess dollars on hand. These excess dollars, known as excess reserves, are invested primarily in U.S. denominated investments ranging from bank deposits to U.S. Treasury securities and a wide range of other financial securities. As the global economy expanded and more trade occurred, additional dollars were required. Further, foreign dollar reserves grew and were lent back, in one form or another, to the US economy. This is akin to buying a car with a loan from the automaker. The only difference is that trade-related transactions occurred with increasing frequency, the loans are never paid back, and the deficits accumulate (Spoiler Alert – the auto dealer would have cut the purchaser off well before the debt burden became too onerous).

The world has grown dependent on this arrangement as there are benefits to all parties involved. The U.S. purchases imports with dollars lent to her by the same nations that sold the goods.  Additionally, the need for foreign nations to hold dollars and invest them in the U.S. has resulted in lower U.S. interest rates, which further encourages consumption and at the same time provides relative support for the dollar. For their part, foreign nations benefited as manufacturing shifted away from the United States to their nations. As this occurred, increased demand for their products supported employment and income growth, thus raising the prosperity of their respective citizens.

While it may appear the post-Bretton Woods covenant was a win-win pact, there is a massive cost accruing to everyone involved. The U.S. is mired in economic stagnation due to overwhelming debt burdens and a reliance on record low-interest rates to further spur debt-driven consumption. The rest of the world, on the other hand, is her creditor and on the hook if and when those debts fail to be satisfied. Thus, Triffin’s paradox simply states that with the benefits of the reserve currency also comes an inevitable tipping point or failure.

Looking Forward

The two questions that must be considered are as follows:

  • When can our debts no longer be serviced?
  • When will foreign nations, like the auto dealer, fear such a day and stop lending to us (e., transacting in U.S. dollars and re-cycling those into U.S. securities)?

It is very likely the Great Financial Crisis of 2008 was an omen that America’s debt burden is unsustainable. Further troubling, as shown below, foreign investors have not only stopped adding to their U.S. investments of federal debt but have recently begun reducing them.  This puts additional pressure on the Federal Reserve to make up for this funding gap.

Data Courtesy: St. Louis Federal Reserve (FRED)

Assuming these trends continue, America must contend with an ever growing debt balance that must be serviced. In our opinion, there are two likely end scenarios. Either the resolution of debt imbalances occurs naturally via default on some debt and paying down of other debts or the Federal Reserve continues to “print” the digital dollars required to make up for the lack of funds the debt servicing and repayment requires. Given the Fed has already printed approximately $4 trillion to arrest the slight deleveraging that occurred in 2008, it does not take much imagination to expect this to be their modus operandi in the future. The following graph helps put the scale of money printing in proper historical context.

Data Courtesy: Global Technical Analysis and St. Louis Federal Reserve (FRED)  


In a 2013 interview, Yanis Varoufakis, economist, academic and the Greek Minister of Finance during the most recent Greek debt crisis, mentioned a manuscript that he had recently read.  The document, written in 1974 by Paul Volcker was directed to his then-boss, Secretary of State Henry Kissinger. Volcker stated that the U.S. need not manage its deficit as would be typical. Instead, he opined that it is our job to manage the surplus of other countries.

America’s ability to run deficits and accumulate massive debt balances for over 40 years, while maintaining its role as the global reserve currency, is a testimony to the power of our politicians and central bankers to “manage the surplus of other countries.” The questions to consider are:

  1. How much longer can the United States manage this tall and growing task?
  2. What is the tolerance of foreign holders of U.S. dollars in the face of dollar devaluation?
  3. Is the post-financial crisis “calm” the result of a durable solution or a temporary façade?

If in fact 2008 was a first tremor and signal of the end of this arrangement, then we are in the eye of the storm and future disruptions promise to be more significant and game-changing.

This concept has far-reaching implications well beyond economics and investing. We intend to provide future articles to extend the analysis on this topic and shed further light on how and when Triffin’s paradox may climax. We will also offer investment strategies to protect and grow your wealth during what may be tumultuous times ahead.

Admittedly, she was a seductress.

Who could blame him for falling in love?

I still remember how she glistened in the summer sun.

Hot to the touch.

I was as enamored as he was.

I was young, yet I remember like it was yesterday: “Her” name was “Tammy.”

Heck, I named everything “Tammy.” I had a mad crush on my babysitter.

However, this “Tammy” was a 1969 Mercury Cougar convertible – a black-glazed exterior elegance with cool white leather underneath a rag top.

Great lines and tough to ignore.

Years later, I learned the source of the money to purchase the sporty model was set aside by my mother’s hard-working father who came from Italy and lived in two rooms above a Mulberry Street, New York grocer – also his employer.

I can’t imagine how long it took papa to save $4,000. I’m sure his entire life –a respectable nest egg on his measly wages. I still admire his strong saving discipline.

Before he died, Giuseppe Zappello instructed his daughter:

“This money I leave behind is to be used for Richard’s college education only.”

He wrote his last instructions on crumpled note paper and gave it to mom shortly before his death from pancreatic cancer.

For Grandpa Joe, it was important that I further my education; it was his only request. I know he wasn’t enamored with my father and felt it important to outline how he wanted the money utilized.

Shortly after his death she decided to hand over the money for the purchase of an automobile, taking an action grandpa would have hated.

I’m being kind here. I believe mom probably caused Papa Joe to roll over in his grave.

For years, it bothered me she made this decision; it was troublesome that dad was short-sighted, too. I can’t imagine blowing my daughter’s education fund on a car.

Bad money decisions tied to financial infidelity are not new. Family members can be affected by them for generations; money mindsets forever forged by them.

The National Endowment for Financial Education® (NEFE®) has been tracking financial infidelity for over a decade and the problem continues to be formidable.

The latest findings from a biennial survey conducted by Harris Poll on behalf of NEFE finds two in five (41 percent) of American adults who combine finances with a partner or spouse, admit to committing financial deceptions against their loved one. The survey also finds that three quarters (75 percent) of adults say financial deceit has affected their relationships in some way – Source:

From their latest survey:

Among the reasons survey respondents say they committed financial deceptions in their current or past relationships, over one third (36 percent) say they believe some aspects of their finances should remain private, even from their spouse/partner; a quarter (26 percent) said they had discussed finances with their spouse/partner and they knew they would disapprove; almost one in five (18 percent) were embarrassed/fearful about their finances and didn’t want their spouse/partner to find out; and 16 percent said that while they hadn’t discussed finances with their spouse/partner they feared they would disapprove.

I too have been negligent in the past about following fidelity rules when it comes to sharing my financial decisions with others. To be clear: I will share information however, I’m going to move forward on my decisions as long as no one is hurt financially, and it’s for the good of people I love.

I admit – my money “imprint” is based on mom’s willingness to turn over my college fund to dad just so he can purchase a depreciating asset. Even financial advisers have faulty money scripts. What’s a money script? It’s your financial bloodline, a heated mixture of observation, experience, perception, memory, subconsciously put to action. Occasionally, with negative financial consequences.

I ask:

Why is the definition of financial infidelity so narrow? Why can’t it occur between a parent and a child, friends, an individual’s actions vs. original intentions? Mom failed to follow through on grandpa’s last request. She gave away blood money for a want, not a need which makes it more painful for me to understand. She wasn’t strong enough to say “no” to my father.

Although, I believe a measured dose of financial infidelity can be healthy.

For example, what if mom never told dad about the money earmarked for me? I figured the $4,000 she gave willingly could have been conservatively worth $8,000 by the time I needed it for college. Not a fortune, but it would have helped.

What can you do to avoid money temptation and financial infidelity?

Broaden, outline and then communicate your definition of financial infidelity.

Before marriage, make sure you communicate (write out and share) with your future partner specific actions you would classify as money cheating. I met with a couple recently where the man thought it was money infidelity for his fiancé to pay more than $20 for lunch without communicating with him first. In this case, the couple decided not to wed.

Consider broadening your definition to include those you care about including children. For example, I have clearly explained to my daughter how her college funds are for her, nobody else. Her mom is in agreement with this, too. If your definitions conflict or financial rules established are too restrictive at least it’s all out in the open for discussion.

Keep separate.

It’s important that separate property remain separate property. Assets held in trust should remain separate per the instructions of the grantor. Document each asset you plan to maintain apart from a future spouse. Communicate your intentions but don’t cross boundaries. These assets are yours. Don’t be talked into sharing.

Money earned before marriage should be maintained separately. If single, direct all your earnings into an individual account since wages, salaries and self-employment income will be considered community property in Texas (and other states) once you’re married. At that point, you should halt transfers of money into the account and maintain it as separate property going forward.

Inheritances need to be separate. It’s in your control to share. Or not. Your choice. Consider carefully whether or not sharing an asset with a spouse or future partner was truly the intention of the provider. In other words, think twice. Then think again. If you do decide to share, document the specific assets in question and sign along with the other receiving party.

Segment the cash you require to make daily purchases like lunches, nights out with friends, and clothes. I know a married couple who have agreed-upon “allowances” they direct automatically to separate accounts monthly from their joint account to cover personal expenses.

If additional money is required, they communicate and then jointly approve or disapprove the requests. I found this method effective for record keeping and accountability. It’s also useful to early detect wayward spending patterns.

 Keep together. 

Property purchased during the marriage may be held in joint ownership. A bank, investment account, real estate held jointly is common and advisable if you intend to leave the asset to a spouse upon death. Depending on the size of your joint estate ($5.6 million or more), it’s advisable to seek an estate planning attorney to create trusts that will preserve estate-tax exemptions and outline your intentions for beneficiary distributions years after your death.

 Keep away.

If you establish a custodial account for your child keep in mind that the money placed into it is considered an irrevocable gift. In other words, at age 21, the custodian (you) must turn over the asset to the former minor regardless of how uncertain you are of your child’s maturity level at the time of the transfer.

Custodial accounts are easy to establish which is a reason why they’re appealing. However, once money is deposited, it’s no longer yours. There have been cases where former minors have sued parents when custodial assets haven’t been turned over in a timely basis or were not notified of the accounts.

The lesson here is that assets earmarked for children and other loved ones should be considered solely for their current or future benefit.

Keep your discipline. Strong mental boundaries should be maintained.

Make sure your intentions to keep away are clear to others.

And perhaps you’ll avoid being seduced by Cougars or other large purchases that drive across your path.

This past weekend, I recommended taking action as the market approached our target zone of resistance. To wit:

Nearly a month later, and we are watching the “pathways” play out very close to our “guess.” 

Chart updated through Monday’s close

“More importantly, we continue to trace out the ‘reflexive rally’ path. However, my guess is we are not likely done with this correction process as of yet. From a very short-term perspective, the backdrop has improved to support a continued reflexive rally next week. 

The problem which now arises is the short-term oversold condition, which supported the idea of a “reflexive rally,” has largely been exhausted. Furthermore, the now declining 50-dma, which has also crossed below the 75 and 100-dma as well, suggests that some variation of ‘Option 2’ noted above is likely.

Given the recent rally, and overbought conditions, we are using this rally to follow our basic portfolio management rules. As the market approaches the “neighborhood” of the 100-dma we are:

  • Selling laggards and raising cash.
  • Rebalancing remaining long-equity exposure to comply with portfolio target weightings
  • Rebalancing the total allocation model to comply with target exposure levels.

Note that we are simply rebalancing risks at these levels – not selling everything and going to cash. There is an early “buy signal” combined with the potential for “earnings season” to support asset prices. The goal here is simply to rebalance risks and let the market “confirm” it has re-established its bullish bias.

A Simple Method Of Risk Management

Ben Carlson recently wrote an interesting piece on selling out of the market when it breaks the 200-day moving average (dma). To wit:

“As the legendary hedge fund manager Paul Tudor Jones said:

‘The whole trick to investing is: ‘How do I keep from losing everything?’ If you use the 200-day moving average rule, then you get out. You play defense, and you get out.’

Investors need to be careful about blindly following any indicator that gets them out of the market. There is no guarantee that markets are headed for a crash just because this trend was broken. There are no market timing signals that work every single time, so there’s no telling if the current correction will morph into an all-out bear market.

There are no silver bullets in the stock market. The 200-day moving average will be breached at some point during the next bear market. That’s a given. But it’s not a given that the most recent signal can assure investors a bear market is right around the corner. The majority of the time corrections don’t turn into crashes. History tells us that a false breakdown is a higher-probability event that further deterioration in the markets.”

While there is nothing “incorrect” contained in the article, in my opinion, Ben dismisses the two most important points about the investing and the portfolio management process – capital preservation and time.

The point of using any method of portfolio risk management is to have a strategy, process and discipline to avoid excessive levels of capital destruction over time. Ben is absolutely correct when he states there are no “silver bullets,” but “false positives” from time to time are a relatively small price to pay to avoid the probability of a major “mean reverting event.”

“In fact, the S&P 500 has crossed the 200-day moving average 150 times since 1997. If this were a perfect signal, that would imply 75 separate market corrections.

In reality, in that time, there were only 11 market corrections when stocks fell 10 percent or worse. That means the majority of the time when the S&P 500 went below the 200-day it was a head fake, when investors sold out of the market only to buy back higher.”

Let’s take a closer look.

The chart below is $1000 invested in the S&P 500 in 1997 on a capital appreciation basis only. The reddish line is just a “buy and hold” plot while the blue line is a “switch to cash” when the 200-dma is broken. Even with higher trading costs, the benefit of the strategy is readily apparent.

It’s Not The Method, It’s You

To Ben’s point, what happens to many investors is they get “whipsawed” by short-term volatility. While the signal gets them out, they “fail” to buy back when the signal reverses.

“I just sold out, now I’m supposed to jump back in? What if it crashes again?”

The answers are “yes” and “it doesn’t matter.” That is the just part of the investment strategy. 

But such is incredibly hard to do, which is why the majority of investors fail at investing over time. Adhering to a discipline, any discipline, is hard. Even “buy and hold,” fails when the “pain” exceeds an individuals tolerance for principal loss.

Investing isn’t easy. If it was, everyone would be rich. They aren’t because of the repeated emotional driven investment mistakes over time. This is why every great investor throughout history has had a basic philosophy of “buy low, sell high.”  Of course, you can’t buy low, if you didn’t sell high to begin with?

While there are many sophisticated methods of handling risk within a portfolio, even using a basic method of price analysis, such as a moving average, can be a valuable tool over longer-term holding periods.

Will such a method ALWAYS be right? Absolutely not.

Will such a method keep you from losing large amounts of capital? Absolutely.

Let’s go back further in time. The chart below is WEEKLY data to reduce price volatility and smooth out the signals over time. What becomes readily apparent is that using a basic form of price movement analysis can provide a useful identification of periods when portfolio risk should be REDUCED. Importantly, I did not say risk should be eliminated; just reduced.

Again, I am not implying, suggesting or stating that such signals mean going 100% to cash. What I am suggesting is that when “sell signals” are given it is the time when individuals should perform some basic portfolio risk management such as:

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

By using some measures, fundamental or technical, to reduce portfolio risk by taking profits as prices/valuations rise, or vice versa, the long-term results of avoiding periods of severe capital loss will outweigh missed short-term gains. Small adjustments can have a significant impact over the long run.

This is shown in the chart below. There is always a big difference between market prices and the impact of losses on an actual dollar-based portfolio. By using a simple method to avoid losses, the differential over the long-term on $1000 is quite significant. (Chart below is capitalization only for example purposes.)

As shown in the chart above, this method doesn’t avoid every little twist and turn of the market, and yes, were many “head fakes” along the way. But what it did do was avoid a bulk of the major market reversions and inherent capital destruction.

Yet, despite two major bear market declines, it never ceases to amaze me that investors still believe that somehow they can invest in a portfolio that will capture all of the upside of the market but will protect them from the losses. Despite being a totally unrealistic objective this “fantasy” leads to excessive risk taking in portfolios which ultimately leads to catastrophic losses. Aligning expectations with reality is the key to building a successful portfolio. Implementing a strong investment discipline, and applying risk-management, is what leads to the achievement of those expectations.


Chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk that you realize. Two massive bear markets over the last decade have left many individuals further away from retirement than they ever imagined. Furthermore, all investors lost something far more valuable than money – TIME needed to achieve their goal.

While I have stated this many times before, it is worth reiterating that your portfolio should be built around the things that matter most to you.

  • Capital preservation
  • A rate of return sufficient to keep pace with the rate of inflation.
  • Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4% every year, losses matter)
  • Higher rates of return require an exponential increase in the underlying risk profile. This tends to not work out well.
  • You can replace lost capital – but you can’t replace lost time. Time is a precious commodity that you cannot afford to waste.
  • Portfolios are time-frame specific. If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

In hindsight, it is easy to see that investors should have been out of the market in 2001 and 2008. However, remember just prior to those two major market peaks the Wall Street mantra was the same then, as it is today:

“This time is different.” 

The problem, as always, is trying to determine the difference between a “false positive” and a “valid signal.” By the time you know for sure, it is often too late.

Four years ago, I wrote a piece for Forbes called “This New Libor ‘Scandal’ Will Cause A Terrifying Financial Crisis,” in which I explained that the “real” Libor scandal wasn’t the Libor rigging scandal, but the fact that that Libor interest rates were simply too low for too long, which was helping to fuel dangerous economic bubbles around the world. I was frustrated that, despite all the attention the Libor rigging scandal had received, that almost nobody was paying attention to the even larger crisis that was looming. It’s not that I was trying to minimize or trivialize the Libor rigging scandal; it’s just that I believed that the mainstream financial world was missing the forest for the trees. As I explained, the Libor rigging scandal caused tens of billions of dollars worth of losses, but the eventual popping of global bubbles that formed as a result of ultra-low Libor rates would gut the global economy by trillions of dollars. I still firmly believe that.

“Libor” is an acronym that stands for “London Interbank Offered Rate,” which is an important benchmark interest rate that is used to price loans across the globe. As I explained in 2014:

As the world’s most important benchmark interest rate, approximately $10 trillion worth of loans and $350 trillion worth of derivatives use the Libor as a reference rate. Libor-based corporate loans are very prevalent in emerging economies, which is helping to inflate the emerging markets bubble that I am warning about. In Asia, for example, Libor is used as the reference rate for nearly two-thirds of all large-scale corporate borrowings. Considering this fact, it is no surprise that credit and asset bubbles are ballooning throughout Asia, as my report on Southeast Asia’s bubble has shown.

Like other benchmark interest rates, when the Libor is low, it means that loans are inexpensive, and vice versa. As with the U.S. Fed Funds Rate, Libor rates were cut to record low levels during the 2008-2009 financial crisis in order to encourage more borrowing and concomitant economic growth. Unfortunately, economic booms that are created via central bank manipulation of borrowing costs are typically temporary bubble booms rather than sustainable, organic economic booms. When central banks raise borrowing costs as an economic cycle matures, the growth-driving bubbles pop, leading to a bear market, financial crisis, and recession.

The chart I created in my original Forbes piece shows how historic bubbles formed during periods of low Libor rates (also, low Fed Funds Rates, as the two are highly correlated). What is particularly concerning is the fact that Libor rates have remained at record low levels for a record length of time, which I believe is helping to inflate a global bubble that is more extreme and potentially ruinous than humanity has ever experienced (I’ve named this bubble “The Everything Bubble”).

Libor Bubble

Similar to the U.S. Fed Funds Rate, the Libor has been rising for the last several years as central banks raise interest rates. While rising interest rates haven’t popped the major global bubbles just yet, it’s just a matter of time before they start to bite.


While most economists and financial journalists view the rising Libor as part of a normal business cycle, I’m quite alarmed due to my awareness of just how much our global economic recovery and boom is predicated on ultra-low interest rates. With global debt up 42 percent or over $70 trillion since the Global Financial Crisis, interest rates do not need to rise nearly as high as they were in 2007 and 2008 to cause a massive crisis.

Global DebtThough I am obviously concerned about rising Libor and Fed Funds Rates, I am a realist and pragmatist when it comes to investing and trading; I’m not a “permabear.” As I showed last week, most U.S. stock indices are still in an uptrend despite the volatility of the past several months. This is a time to be a nimble trader with a finger on the “sell” button if and when the primary trend breaks down in a serious way.

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The tech startup boom has been one of the most important and visible economic “growth engines” of the past half-decade. The boom was spurred, in large part, by the success and excitement over Facebook, Uber, Airbnb, and similar companies, which led to a widespread search for the “Next Facebook” or billion dollar “unicorn” company. Unfortunately, the tech startup boom has devolved into a dangerous bubble as a result of record low interest rates and the trillions of dollars worth of liquidity that is sloshing around the globe as a result of central bank quantitative easing (QE) programs.

As an Austrian economist, I believe that central bank manipulation of borrowing costs (typically by holding interest rates too low) creates false signals or “fool’s gold” business and economic booms that trick investors into jumping into “hot” trends, only to lose their shirts when borrowing costs are inevitably increased again. These bad investments are called malinvestments, and occur largely as a result of central bank market distortions rather than organic market forces. I believe that a very high proportion of today’s tech startups will prove to be malinvestments when the current boom turns into a bust.

A recent Wall Street Journal article describes the latest phase of the startup bubble quite well –

SoftBank’s Billions Spur Global Race to Pour Money Into Startups

Silicon Valley Venture Capital Chart

The Silicon Valley money machine is once again in high gear, thanks largely to SoftBank. The conglomerate is injecting billions of dollars into tech, in turn causing deep-pocketed global investors—and some U.S. venture firms—to arm up in response. A record level of late-stage money is flooding in, threatening to keep some startups out of the public markets even longer while heightening concerns that the sector is overvalued.

In recent months, hotly contested companies like ride-hailing service Lyft Inc. and dog-walking app Wag Labs Inc. have received hundreds of millions of dollars more than they sought. Bidding wars are re-emerging, and some once-staid foreign investors are expanding U.S. offices and ditching their ties and suits to court talented entrepreneurs.

“The top companies have as much heat around them as ever and continue to get bid up,” said John Locke, who runs late-stage investing for venture-capital firm Accel Partners.


The big-check bug has spread to U.S. venture-capital firm Sequoia Capital, which is in the process of raising up to $13 billion, including an $8 billion fund for late-stage companies, the largest ever for a U.S. venture-capital firm.

Sequoia was previously content with smaller sums; its largest fund to date is $2 billion. But it made the decision last year to go bigger, seeing an opening to keep investing in companies as they stay private longer and grow larger.

This flood of private investment has heightened concerns it will create a shaky foundation for startups. When money rushes into Silicon Valley, startups historically have overspent by advancing into expensive new markets or battling with competitors in price wars.

“We’re encouraging the excessive use of capital,” Bill Gurley, a partner at Benchmark, said of venture capitalists at a February tech conference. “We’re all doing it because it’s the game on the field.”

Softbank, a Japanese conglomerate, announced in October that it was planning to invest as much as $880 billion into tech startups. At the time of that announcement, I recoiled in horror at the idea of companies “throwing” money into tech startups just because it was a hot, heavily hyped sector:



Sound, long-term business decisions are not made by picking an arbitrary dollar or yen figure and throwing it into a hot sector. This behavior is the hallmark of a liquidity bubble in which there is too much cash clamoring into unprofitable investments. Throwing ever-increasing amounts of cash at unprofitable startups won’t make them profitable – it’s just “throwing good money after bad.” While this is common sense, many business leaders aren’t seeing the obvious because they’re completely drunk on the startup bubble euphoria. I have no doubt that Japan’s Abenomics stimulus plan (in which over $4 trillion worth of new Japanese yen was printed) has played an important role in encouraging Softbank to jump headlong into the tech startup bubble with gobs of cash.

Thanks to the tech sector hype and high tech stock valuations, VCs are looking to cash in on their tech startup investments by going public, just like during the late-1990s Dot-com bubble –

Silicon Valley Venture Capitalists Prepare for an I.P.O. Wave

 Investors, bankers and analysts said they expected a wave of initial public offerings to bring some of the most highly valued and recognizable start-ups to the public market over the next 18 to 24 months — and billions of dollars in returns to their executives and investors. The potential bonanza would follow years of waiting as a few dozen companies amassed valuations without precedent in the private market.

Already, 2018 has gotten off to a fast start. Two of the biggest start-ups still sitting on the sidelines — Dropbox, an online file storage company, and Spotify, the streaming music service based in Sweden — successfully went public over the past month. Tech I.P.O.s have already raised more than $7 billion this year — more than all of 2015 and 2016, and more than half the $13 billion they raised last year, according to the market-data firm Dealogic.

While the mainstream financial world sees the current tech startup boom as a legitimate technology revolution, I see it as a gigantic, liquidity-fueled malinvestment bubble. As the Fed and other central banks remove liquidity as the economic cycle matures, the stock market bubble will burst, which will spill over into tech startups. When the tech startup bubble pops in earnest, I expect thousands, if not tens of thousands, of startups to fold. While the world should have learned from the Dot-com bubble, today’s tech startup bubble proves that we didn’t, so we are doomed to repeat the lesson.

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As we approach “tax day” in the U.S., I wanted to take a moment to revisit the issue of taxes, who pays what, and why the “Tax Cut and Jobs Act” will likely have limited impact on economic growth.

This week, Laura Saunders penned for the WSJ an analysis of “who pays what” under the U.S. progressive tax system. The data she used was from the Tax Policy center which divided about 175 million American households into five income tiers of roughly 65 million people each. This article was widely discussed on radio shows across the country as “clear evidence” recent tax reform was having a “huge effect” on average households and a clear step in “Making America Great Again.”

The reality, however, is far different than the politically driven spin.

First, the data.

“The results show how steeply progressive the U.S. income tax remains. For 2018, households in the top 20% will have income of about $150,000 or more and 52% of total income, about the same as in 2017. But they will pay about 87% of income taxes, up from about 84% last year.”

See, the “rich” are clearly paying more. 

Not really, percentages are very deceiving. If the total amount of revenue being collected is reduced, the purpose of a tax cut, the top 20% can pay LESS in actual dollars, but MORE in terms of percentage. For example:

  • Year 1: Top 20% pays $84 of $100 collected = 84%
  • Year 2: Top 20% pays $78 of $90 collected = 87%

This is how “less” equals “more.” 

So, where is the “less?”

“By contrast, the lower 60% of households, who have income up to about $86,000, receive about 27% of income. As a group, this tier will pay no net federal income tax in 2018 vs. 2% of it last year.”

“Roughly one million households in the top 1% will pay for 43% of income tax, up from 38% in 2017. These filers earn above about $730,000.”

While the “percentage or share” of the total will rise for the top 5%, the total amount of taxes estimated to be collected will fall by more than $1 Trillion for 2018. As Roberton Williams, an income-tax specialist with the Tax Policy Center, noted while the share of taxes paid by the top 5% will rise, the people in the top 5% were the largest beneficiaries of the overhaul’s tax cut, both in dollars and percentages.

Not surprisingly, as I noted previously, income taxes for the bottom 2-tiers of income earners, or roughly 77-million households, will have a negative income tax rate. Why? Because, despite the fact they pay ZERO in income taxes, Congress has chosen to funnel benefits for lower earners through the income tax rather than other channels such as federal programs. Since the recent tax legislation nearly doubled the standard deduction and expanded tax credits, it further lowered the share of income tax for people in those tiers.

The 80/20 Rule

In order for tax cuts to truly be effective, given roughly 70% of the economy is driven by personal consumption, the amount of disposable incomes available to individuals must increase to expand consumption further.

Since more than 80% of income taxes are paid by the top 20%, the reality is tax cuts only have a limited impact on consumption for those individuals as they are already consuming at a level with which they are satisfied.

The real problem is the bottom 80% that pay 20% of the taxes. As I have detailed previously, the vast majority of Americans are living paycheck to paycheck. According to CNN, almost six out of every ten Americans do not have enough money saved to even cover a $500 emergency expense. That lack of savings can be directly attributed to the lack of income growth for those in the bottom 80% of income earners.

So, with 80% of Americans living paycheck-to-paycheck, the need to supplant debt to maintain the standard of living has led to interest payments consuming a bulk of actual disposable income. The chart below shows that beginning in 2000, debt exceeded personal consumption expenditures for the first time in history. Therefore, any tax relief will most likely evaporate into the maintaining the current cost of living and debt service which will have an extremely limited, if any, impact on fostering a higher level of consumption in the economy.

But again, there is a vast difference between the level of indebtedness (per household) for those in the bottom 80% versus those in the top 20%.

The rise in the cost of living has outpaced income growth over the past 14 years. While median household incomes may have grown over the last couple of years, expenses have outpaced that growth significantly. As Stephanie Pomboy recently stated:

” In January, the savings rate went from 2.5% to 3.2% in one month—a massive increase. People look at the headline for spending and acknowledge that it’s not fabulous, but they see it as a sustainable formula for growth that will generate the earnings necessary to validate asset price levels.”

Unfortunately, the headline spending numbers are actually far more disturbing once you dig into “where” consumers are spending their dollars. As Stephanie goes on to state:

“When you go through that kind of detail, you discover that they are buying more because they have to. They are spending more on food, energy, healthcare, housing, all the nondiscretionary stuff, and relying on credit and dis-saving [to pay for it]. Consumers have had to draw down whatever savings they amassed after the crisis and run up credit-card debt to keep up with the basic necessities of life.”

When a bulk of incomes are diverted to areas which must be purchased, there is very little of a “multiplier effect” through the economy and spending on discretionary products or services becomes restricted. This problem is magnified when the Fed hikes short-term interest rates, which increases debt payments, and an Administration engages in a “trade war” which increases prices of purchased goods.

Higher costs and stagnant wages are not a good economic mix.

The Corporate Tax Cut Sham

But this was never actually a “tax cut for the middle-class.”

The entire piece of legislation was a corporate lobby-group inspired “give away” disguised as a piece of tax reform legislation. A total sham.

Why do I say that? Simple.

If the Administration were truly interested in a tax cut for the middle class, every piece of the legislation would have been focused on the nearly 80% of Federal revenue collected from individual income and payroll taxes.

Instead, the bulk of the “tax reform” plan focused on the 8.8% of total Federal revenue collected from corporate taxes. 

“But business owners and CEO’s will use their windfall to boost wages and increase productivity. Right?”

As I showed previously, there is simply no historical evidence to support that claim.

Corporations are thrilled with the bill because corporate tax cuts immediately drop to the bottom lines of the income statement. With revenue growth, as shown below, running at exceptionally weak levels, corporations continue to opt for share buybacks, wage suppression and accounting gimmicks to fuel bottom lines earnings per share. The requirement to meet Wall Street expectations to support share prices is more important to the “C-suite” executives than being benevolent to the working class.

“Not surprisingly, our guess that corporations would utilize the benefits of ‘tax cuts’ to boost bottom line earnings rather than increase wages has turned out to be true. As noted by Axios, in just the first two months of this year companies have already announced over $173 BILLION in stock buybacks.  This is ‘financial engineering gone mad.’” 

The historical evidence provides a very different story than the bill of goods being sold to citizens and investors. There is no historical evidence that cutting corporate tax rates increases economic growth. In fact, as recently noted by Michael Lebowitzthe opposite has been true with high correlation between lower tax rates and slower economic growth. 

With the deficit set to exceed $1 Trillion next year, and every year afterward, the government must borrow money to fund the shortfall. This borrowing effectively crowds out investment that could have funded the real economy.

“Said differently, the money required to fund the government’s deficit cannot be invested in the pursuit of innovation, improving workers skills, or other investments that pay economic dividends in the future. As we have discussed on numerous occasions, productivity growth drives economic growth over the longer term. Therefore, a lack productivity growth slows economic growth and ultimately weighs on corporate earnings.

A second consideration is that the long-term trend lower in the effective corporate tax has also been funded in part with personal tax receipts. In 1947, total personal taxes receipts were about twice that of corporate tax receipts. Currently, they are about four times larger. The current tax reform bill continues this trend as individuals in aggregate will pay more in taxes.

As personal taxes increase, consumers who account for approximately 70% of economic activity, have less money to spend.”


This issue of whether tax cuts lead to economic growth was examined in a 2014 study by William Gale and Andrew Samwick:

“The argument that income tax cuts raise growth is repeated so often that it is sometimes taken as gospel. However, theory, evidence, and simulation studies tell a different and more complicated story. Tax cuts offer the potential to raise economic growth by improving incentives to work, save, and invest. But they also create income effects that reduce the need to engage in productive economic activity, and they may subsidize old capital, which provides windfall gains to asset holders that undermine incentives for new activity.

In addition, tax cuts as a stand-alone policy (that is, not accompanied by spending cuts) will typically raise the federal budget deficit. The increase in the deficit will reduce national saving — and with it, the capital stock owned by Americans and future national income — and raise interest rates, which will negatively affect investment. The net effect of the tax cuts on growth is thus theoretically uncertain and depends on both the structure of the tax cut itself and the timing and structure of its financing.”

Again, the timing is not advantageous, the economic dynamics and the structure of the tax cuts are not self-supporting. As Dr. Lacy Hunt recently noted in his quarterly outlook:

“Considering the current public and private debt overhang, tax reductions are not likely to be as successful as the much larger tax cuts were for Presidents Ronald Reagan and George W. Bush. Gross federal debt now stands at 105.5% of GDP, compared with 31.7% and 57.0%, respectively, when the 1981 and 2002 tax laws were implemented. 

However, if the household and corporate tax reductions and infrastructure tax credits proposed are not financed by other budget offsets, history suggests they will be met with little or no success.

Since the current Administration has chosen to do the exact opposite by massively increasing spending, having no budget offsets, or slowing the rate of growth of either deficits or debts, the success of tax reform to boost economic growth is highly suspect.

Policymakers had the opportunity to pass true, pro-growth, tax reform and show they were serious about our nations fiscal future, they instead opted to continue enriching the top 1% at the expense of empowering the middle class. 

The outcome will be very disappointing.

Mike ‘Wags’ Wagner: ‘You studied the Flash Crash of 2010 and you know that Quant is another word for wild f***ing guess with math.’

Taylor Mason: ‘Quant is another word for systemized ordered thinking represented in an algorithmic approach to trading.’

Mike ‘Wags’ Wagner: ‘Just remember Billy Beane never won a World Series .’ – Billions, A Generation Too Late

My friend Doug Kass made a great point on Wednesday this week:

“General trading activity is now dominated by passive strategies (ETFs) and quant strategies and products (risk parity, volatility trending, etc.).

Active managers (especially of a hedge fund kind) are going the way of dodo birds – they are an endangered species. Failing hedge funds like Bill Ackman’s Pershing Square is becoming more the rule than the exception – and in a lower return market backdrop (accompanied by lower interest rates), the trend from active to passive managers will likely continue and may even accelerate this year.”

He’s right, and there is a huge risk to individual investors embedded in that statement. As JPMorgan noted previously:

Quantitative investing based on computer formulas and trading by machines directly are leaving the traditional stock picker in the dust and now dominating the equity markets.

While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock specific fundamentals. Fundamental discretionary traders’ account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double the share a decade ago.

As long as the algorithms are all trading in a positive direction, there is little to worry about. But the risk happens when something breaks. With derivatives, quantitative fund flows, central bank policy and political developments all contributing to low market volatility, the reversal of any of those dynamics will be problematic.

There are two other problems currently being dismissed to support the “bullish bias.”

The first, is that while investors have been chasing returns in the “can’t lose” market, they have also been piling on leverage in order to increase their return. Negative free cash balances are now at their highest levels in market history.

Yes, margin debt does increase as asset prices rise. However, just as the “leverage” provides the liquidity to push asset prices higher, the reverse is also true.

The second problem, which will be greatly impacted by the leverage issue, is liquidity of ETF’s themselves. As I noted previously:

“The head of the BOE Mark Carney himself has warned about the risk of ‘disorderly unwinding of portfolios’ due to the lack of market liquidity.

‘Market adjustments to date have occurred without significant stress. However, the risk of a sharp and disorderly reversal remains given the compressed credit and liquidity risk premia. As a result, market participants need to be mindful of the risks of diminished market liquidity, asset price discontinuities and contagion across asset markets.’”

When the “robot trading algorithms”  begin to reverse, it will not be a slow and methodical process but rather a stampede with little regard to price, valuation or fundamental measures as the exit will become very narrow.

Importantly, as prices decline it will trigger margin calls which will induce more indiscriminate selling. The forced redemption cycle will cause large spreads between the current bid and ask pricing for ETF’s. As investors are forced to dump positions to meet margin calls, the lack of buyers will form a vacuum causing rapid price declines which leave investors helpless on the sidelines watching years of capital appreciation vanish in moments.

Algo’s were not a predominant part of the market prior to 2008 and, so far, they have behaved themselves by continually “buying the dips.” That support has kept investors complacent and has built the inherent belief “this time is different.”

But therein lies the “risk of the robots.”

What happens when these algo’s reverse course and begin to “sell the rallies” in unison?

I don’t want to be around to find out.

On Wednesday, during the Real Investment Hour, I discussed a recent comment by David Rosenberg regarding “the most important” number, right now.  His answer: 13,000,000.

That is the number of individuals that have entered the financial services industry since the end of the “financial crisis.”

Why is that important? These individuals have only lived in a market supported by repeated rounds of stimulus, low interest rates, QE and a seemingly “can’t lose” market.

Experience is a valuable teacher.

Yesterday, during the Real Investment Hour, I discussed the three components of any investment – safety, liquidity or return. Importantly, as an investor, you can only have 2 of 3 components at any given time. Therefore, determining which components are the most important at any given time is key to the investment decision process.

In December of last year, as Congress voted to pass the “Tax Cut & Jobs Act,” I wrote that without “real and substantive cuts to spending,” the debt and deficits will begin to balloon. At that time, I mapped out the trajectory of the deficit based on the cuts to revenue from lower tax rates and sustained levels of government spending.

Since that writing, the government has now lifted the “debt ceiling” for two years and passed a $1.3 Trillion “omnibus spending bill” to operate the government through the end of September, 2018. Of course, since the government has foregone the required Constitutional process of operating on a budget for the last decade, “continuing resolutions,” or “C.R.s,” will remain the standard operating procedure of managing the country’s finances. This means that spending will continue to grow unchecked into the foreseeable future as C.R.’s increase the previously budgeted spending levels automatically by 8% annually. (Rule of 72 says spending doubles every 9-years) 

The chart below tracks the cumulative increase in “excess” Government spending above revenue collections. Notice the point at which nominal GDP growth stopped rising.

Trillion dollar deficits, of course, are nothing to be excited about as rising debts, and surging deficits, as shown, impede economic growth longer-term as money is diverted from productive investments to debt-service.

While many suggest that “all government spending is good spending,” the reality is that “recycled tax dollars” have a very low, if not negative, “multiplier effect” in the economy. As Dr. Lacy Hunt states:

“The government expenditure multiplier is negative. Based on academic research, the best evidence suggests the multiplier is -0.01, which means that an additional dollar of deficit spending will reduce private GDP by $1.01, resulting in a one-cent decline in real GDP. The deficit spending provides a transitory boost to economic activity, but the initial effect is more than reversed in time. Within no more than three years the economy is worse off on a net basis, with the lagged effects outweighing the initial positive benefit.

Dr. Hunt is absolutely correct when he notes that due to the aging of America, the mandatory components of federal spending will accelerate sharply over the next decade, causing government outlays as a percent of economic activity to move higher. According to the Center On Budget & Policy Prioritiesnearly 75% of every tax dollar goes to non-productive spending. 

As Dr. Hunt concludes:

“The rising unfunded discretionary and mandatory federal spending will increase the size of the federal sector, which according to first-rate econometric evidence will contract economic activity. Two Swedish econometricians (Andreas Bergh and Magnus Henrekson, The Journal of Economic Surveys (2011)), substantiate that there is a ‘significant negative correlation’ between the size of government and economic growth. Specifically, ‘an increase in government size by 10 percentage points is associated with a 0.5% to 1% lower annual growth rate.’ This suggests that if spending increases, the government expenditure multiplier will become more negative over time, serving to confound even more dramatically the policy establishment and the public at large, both of whom appear ready to support increased, but unfunded, federal outlays.”

The evidence is pretty clear.

Trillion Dollar Deficits

The Committee For A Responsible Federal Budget just released the following analysis:

“The Congressional Budget Office (CBO) released its ten-year budget and economic outlook today, showing that recent legislation has made an already challenging fiscal situation much worse. CBO’s report projects that:

  • The budget deficit will near one trillion dollars next year, after which permanent trillion-dollar deficits will emerge and continue indefinitely. Under current law, deficits will rise from $665 billion (3.5 percent of Gross Domestic Product) last year to $1.5 trillion (5.1 percent of GDP) by 2028.
  • As a result of these deficits, debt held by the public will increase by more than $13 trillion over the next decade – from $15.5 trillion today to $28.7 trillion by 2028. Debt as a share of the economy will also rise rapidly, from today’s post-war record of 77 percent of GDP to above 96 percent of GDP by 2028.
  • Cumulative deficits through 2027 are projected to be $1.6 trillion higher than CBO’s last baseline in June 2017. The entirety of this difference is the result of recent legislation, most significantly the 2017 tax law.
  • Spending will increase significantly over the next decade, from 20.8 percent of GDP in 2017 to 23.6 percent by 2028. Revenue will dip from 17.3 percent of GDP in 2017 to 16.5 percent by 2019 before rising to 18.5 percent of GDP by 2028 as numerous temporary tax provisions expire.
  • Deficits and debt would be far higher if Congress extends various temporary policies. Under CBO’s Alternative Fiscal Scenario, where Congress extends expiring tax cuts and continues discretionary spending at its current level, the deficit would eclipse $2.1 trillion in 2028, and debt would reach 105 percent of GDP that year – nearing the record previously set after World War II.

CBO’s latest projections show that recent legislation has made an already challenging fiscal situation much more dire. Under current law, trillion-dollar deficits will return soon and debt will be on course to exceed the size of the economy. Under the Alternative Fiscal Scenario, the country would see the emergence of $2 trillion deficits, and debt would reach an all-time record by 2029.”

This analysis certainly isn’t the policy prescription to “Make America Great Again,” but rather “Make America More Indebted.” 

I encourage you to read the entire analysis by the CRFB, but the bottom line is what we already know, more debt equals less economic growth.

“As a result of this and other effects, CBO estimates real GDP growth of 1.5 to 1.8 percent each year after 2020, with an annual average of 1.8 percent over the 2018-2028 period. This is very similar to the average growth rate projected in June 2017.

Notably, CBO’s projected average growth rate is significantly lower than the roughly 3 percent assumed in the President’s FY 2019 budget. Such rapid levels of growth are far below what others – including the Federal Reserve – have projected; and they are highly unlikely to occur based on available economic evidence. The fact that 3 percent growth could be sustained for two years does not suggest it could be continued indefinitely over the long term.”

As I noted previously, it now requires $3.71 of debt to create $1 of economic growth which will only worsen as the debt continues to expand at the expense of stronger rates of growth.

CBO – Always Wrong

Furthermore, it is highly likely the CBO will be incorrect in their assumptions, as they almost always are, because there are many items the CBO is forced to exclude in its calculations.

First, the CBO’s governing statutes essentially require a distorted view of the finances by not allowing for an accounting of the tax breaks Congress routinely extends. As William Gale from the Tax Policy Institute explained:

“Here’s the bad part:  Under current law, CBO projects that the debt – currently 77 percent as large as annual GDP – will rise to 96 percent of GDP by 2028.  And that’s if Congress does nothing.  If instead, Congress votes to extend expiring tax provisions – such as the many temporary tax cuts in the 2017 tax overhaul – and maintain spending levels enacted in the budget deal (which is called the “current policy” baseline), debt is projected to rise to 105 percent of GDP by 2028, the highest level ever except for one year during World War II (when it was 106 percent).”

So, once you understand what the CBO isn’t allowed to calculate or show, it is not surprising their predictions have consistently overstated reality over time. However, it’s how Congress wants the projections reported so they can continue to ignore their fiscal responsibilities.

This is a big problem which David Stockman, former head of Government Accountability Office, pointed out:

“What that leads to is a veritable fiscal nightmare. Whereas the CBO report already forecasts cumulative deficits of $12.5 trillion during the next decade, you’d get $20 trillion of cumulative deficits if you set aside Rosy Scenario and remove the crooked accounting from the CBO baseline.

In a word, what was a $20 trillion national debt when the Donald arrived in the White House is no longer. Now it’s barreling toward $40 trillion within the next decade.

We have no ideas how much economic carnage that will cause, but we are quite sure it will not make America Great Again.”

However, besides those flaws, the CBO gives no weight to the structural changes which will continue to plague economic growth going forward. The combination of fiscally irresponsible tax cuts combined with:

  • Spending hikes
  • Demographics
  • Surging health care costs
  • Structural employment shifts
  • Technological innovations
  • Globalization
  • Financialization 
  • Global debt

These factors will continue to send the debt to GDP ratios to record levels. The debt, combined with these numerous challenges, will continue to weigh on economic growth, wages and standards of living into the foreseeable future. As a result, incremental tax and policy changes going forward will have a more muted effect on the economy as well.


The CBO’s latest budget projections confirm what we, and the CRFB, have been warning about. The current Administration has taken a path of fiscal irresponsibility which will take an already dismal fiscal situation and made it worse.

While the previous Administration was continually chastised by “conservative” Republicans for running trillion-dollar deficits, the Republicans have now decided trillion dollar deficits are acceptable.

That is simply hypocritical.

Given the flaws in the CBO’s calculations, their current projections of $1 trillion in deficits next year, and exceeding that mark every year after, will likely turn out to be overly optimistic. Even the CBO’s Alternative Fiscal Scenario of $2 trillion deficits over the next decade could turn out worse.

But William Gale summed up the entirety of the problem nicely.

“Here’s the worse part: The conventional comparison is misleading.  The projected budget deficits in the coming decade are essentially ‘full-employment’ deficits. This is significant because, while budget deficits can be helpful in recessions by providing an economic stimulus, there are good reasons we should be retrenching during good economic times, including the one we are in now. In fact, CBO projects that, over the 2018-2028 period, actual and potential GDP will be equal.

As President Kennedy once said ‘the time to repair the roof is when the sun is shining.’  Instead, we are punching more holes in the fiscal roof. 

In order to do an ‘apples to apples’ comparison, we should compare our projected Federal budget deficits to full employment deficits. From 1965-2017, full employment deficits averaged just 2.3 percent of GDP, far lower than either our current deficit or the ones projected for the future. 

The fact that debt and deficits are rising under conditions of full employment suggests a deeper underlying fiscal problem.”

The CBO’s budget projections are a harsh reminder the fiscal largesse that Congress and the Administration lavished on the country in the recent legislation is not a free lunch.

It is just a function of time until the “bill comes due.” 


An article, a reflection of his childhood, The Financial Times’ Berlin Correspondent Tobias Buck recently wrote of Germany’s immutable obsession with saving money. His behind-the-scenes account of piggy banks and children’s decorated money boxes (some, 400 years old), stored in a back shelf of the German Historical Museum stirred the memory dust for some guy in Texas. Me!

The recollection of a husky awkward second-grader at Morris H. Weiss School P.S. 215 in Gravesend, Brooklyn who couldn’t wait until (every) Thursday when a representative from Brooklyn Savings Bank came to collect coin and dollars for FDIC-insured coffers. His name I can’t recall; I do remember feeling the excitement of having my blue-pleather passbook savings book marked by another financial milestone. Stamped with the date and a new (higher) balance. It made me happy.

As a society, we made kids excited about saving money, once. Sure, we spent. When I was a kid I drove my mother crazy because I was only interested in popular name brands of food. I was a sucker for television advertising. For example, I would only eat the bacon with the Indian head profile complete with full headdress, on the front of the package – can’t recall the name now. Of course, it was the most expensive and as a single parent household, mom was on a tight budget.

I still remember catching her placing a less popular bacon in an old package of the brand I liked.  Come to think of it, I think she did this often. I recall on occasion my Lucky Charms not having as many marshmallows. As I age I realize I’m fine with tricking children. Buy the Frosted Flakes, keep the box and replace with the generic brand to save money. Today, less expensive brands are tough to tell apart from the premium ones, anyway. Try it.

But I digress…

Throughout the financial crisis, nations threw fiscal stones at Germany for guarding their budget surpluses like Indiana Jones cradling the Holy Grail. The world demanded Germany spend, spend, spend – get all Keynesian, purchase imports from beleaguered brethren, get their citizens to purchase junk they don’t need. C’mon Germany, we’ll be your best friend if you give Greece a free pass.

Before the Great Recession the sovereign was a magnificent fiscal vacuum. Still is. A juggernaut of an export-oriented economy sucking in the bucks from European nations. Even today, Germany can’t catch a break for their ingrained (it’s in the blood), austerity. Donald Trump, the European Commission, IMF Chief Christine Lagarde beat up on Merkel for her nation’s trade surplus. Recently, Lagarde urged Berlin to increase domestic spending and boost imports, lamenting over the burgeoning account surpluses she claims are partly responsible for the rise of protectionism. Yep. Believe that? Most of the world abhors savers and adores spenders.

On the government and household level, Germany maintains a pristine track record of achieving and maintaining budget surpluses. It’s an obsession to be a saver on the Rhine. No debt on the Danube. Saving money, avoiding debt doesn’t merely affect German pockets, it touches their souls. It exists at the center of who they are. Germans are proud savers.

Per Tobias Buck’s article, the German Historical Museum is hosting a new exhibition called Saving – History of a German Virtue. I mean, how serious can you get? Saving =Virtue. Stock markets are frowned upon, perceived as gambling (they are – sorry, but they are). German savings banks are legally mandated to promote savings especially among children in conjunction with support of local school authorities. Banks provide play money and expose kids early to personal finance basics.

It motivates me to ask: What happened to us in America? When did consumption, especially of things we don’t need, gain sustained importance over saving for tomorrow? Instant gratification is a deep, dangerous affliction. Call it a disease.

In Germany, they’re all about delayed gratification; we’re all about the right now. Is there a middle ground we can agree upon? Where are the passbook savings accounts and the weekly elementary school visits to collect deposits? I remember how the girls back then safety-pinned their filled brown bank-deposit envelopes to their outer garments and dresses. Imagine? I’m dating myself. I get it. Hey, we perceive through personal prisms; who we are, is through experience. What kind of experience about saving are we providing for our children when it comes to saving?

As wage growth deteriorated, seemingly our ability to adjust to the adverse structural condition did, too. After all, those ethereal wage increases were “right around the corner,” until we ran out of corners but decided we were still entitled to maintain a standard of living through credit. Tough decisions needed to be made, especially by Baby Boomers in the early 80s. If they were made, they weren’t passed down effectively.

My belief is Germans from the top down, from government desk to kitchen table, would have acted with alacrity and made uncomfortable decisions to adjust the slightest of imbalance. Perhaps downsizing, or a fiscal priority on increasing the skills of the labor force. Anything but cutting the saving rate. German households save 10% of their disposable income, twice as much the average across the globe, writes Mr. Buck. Amazingly, their saving rate has been stable and unaffected by economic crises and changes in interest rates.

In contrast, in the U.S.

On a somewhat positive note, the U.S. personal saving rate has ticked up to 3.4% as of February. Makes you all warm and fuzzy, doesn’t it?

We are at a crisis level in America. Real (inflation-adjusted) incomes, the personal saving rate and debt are no longer funding basic living standards. It’s time for us to “German up” a bit and take control, make tough decisions within our own households to ‘mind the gap.’

There are pervasive macro-economic charts created by the Fed, posted on their regional websites and plastered all over social media which display how Americans carry less debt than they did a decade ago; how wages are beginning to bust out of a long-term malaise. I’m happy about that. The micro story differs, however as income growth for the bottom 80% of Americans has been left in the dust. The top 20% however, are thriving. Unfortunately, it’s the masses who still need to make massive adjustments to bolster savings.

Per Bankrate’s latest financial security index survey, a majority of Americans can’t raise $1,000 for unexpected expenses (is my German friend Alda, reading? I may need to hit him up for a loan).

From the study:

“A sizable chunk of consumers seemingly haven’t seriously considered what they’d do in case of a crisis. One in 8 would count on reducing spending from other parts of their budget, 6 percent would resort to something else and 4 percent simply don’t know.”

It’s a disparate tale I write – one of virtue overseas, another of domestic heartache.

So, what can we do to become savers?

Begin with the following 5 questions. Write them by hand. Answer them in pen. Go back to them. Be thoughtful and truthful with responses:

  1. What is the motivation for spending on wants vs. needs? Needs are rent, lights, food. You get it. It’s about survival.
  2. How can you go from Needs Squared to Needs Basic? Needs on credit vs. needs paid from household net income. Tough, life-changing decisions required, perhaps. What would the Germans do?
  3. What statement can you create and repeat that will eventually link saving to virtue?
  4. Think Gross Personal Product. Most metrics of economic health are based on consumption; personal consumption comprises 70% of America’s Gross Domestic Product. Through the 60s and 70s, the U.S. personal saving rate rarely fell below 10%. Our ensemble culture or the culture overall has become obsessed with owning more, status through the acquisition of goods and services. In your household, it must be different. The movement must be grassroots, the individual one by one, taking action to shore up their personal and family household balance sheets. Think GPP, not GDP. Nobody is going to bail you out when the economy cycles in reverse. As a matter of fact, when our economy falls into the abyss, it’s we the taxpayers who bear the brunt of the costly, ineffective patchwork that fiscally duct-tapes systems back together.
  5. How can you get the family involved in the creation of “financial virtue-isms?” For example, what mutually agreed upon boundaries can be initiated around spending? How as a family unit, can saving become a virtuous activity? As a parent, I made a big deal of my daughter’s ability to save, even when it came down to three coins in her piggy bank.
  • Saving is ethos for an honorable life.
  • Saving isn’t a chore, it’s part of who you are. Deep. In the soul kind of deep.
  • A living standard stretched by credit will eventually catch up, set you back.
  • Living on household cash flow alone is an honorable goal.
  • Wealth on credit is “Instagram Currency” – Social media appearance fodder, ‘living large,’ for image. “Likes” aren’t gonna pay the bills.
  • No increase in spending without the wages or bonuses to back it up.
  • The errant spending behavior of your parents does not define you.

So, I shared my personal philosophies around saving and spending to get you started.

“Austerity is an integral part of the image that Germans have of themselves – And a characteristic they feel sets them apart from other nations. There’s a deeply ingrained conviction that saving money and avoiding debt is not just a prudent approach to managing your income, but of something deeper.”

– Tobias Buck. The Financial Times.

Americans were savers once.

It’s not too late for our government, corporations and households to embrace similar lessons.

“Instead of relying on central banks as the foundation of my risk mitigation strategy, I plan to remain committed to my absolute return process and discipline.” –Eric Cinnamond

The world’s oldest investment philosophy, buy low and sell high, is not only the most logical but it is also most neglected when it matters.

Outside of the financial markets, we seek deals on everything. We drive past three gas stations to find one that is a nickel cheaper. We shop at the Costco in the next town instead of the grocery store around the corner. We haggle with car dealers for hours to save a few hundred dollars. Juxtaposed to rational consumer behavior, investors frequently take the opposite tack. Interest in buying stocks and many other financial assets tend to rise as prices increase and decline when they get cheaper.

Toilet paper, gasoline, and most other consumer items in which we seek the best price lack potential financial rewards. Said in current jargon they do not provoke FOMO or the “fear of missing out” in us. This condition which preys on hope and greed is a trap that drives investors to pay top dollar for some assets.

It is said that being a contrarian when markets are at major turning points can be lonely. To help those of you currently in this camp we introduce the rationality of professional value investor Eric Cinnamond (EC). In answering questions we posed to him, Eric provides insights into how he thinks about investing as well as the current investment environment. While he may not win a popularity contest, the logic he shares is irrefutable and extremely valuable.

Eric puts out a free investment letter that we consider a must read. His insight into small cap companies and the broader macro messages we can glean from these companies is invaluable. For access to his commentary, please email Eric directly.

Biography- Eric Cinnamond, CFA

Eric Cinnamond, CFA, was most recently a Vice President and Portfolio Manager at River Road Asset Management, LLC. Prior to this, Eric was a Vice President and Lead Portfolio Manager of the small-cap strategy at Intrepid Capital Management Inc. which he joined in 1998. Previous to that he held similar roles at Evergreen Asset Management, Aston Funds – ASTON/River Road Independent Value Fund, and the asset management arm of Wachovia Corporation, formerly First Union National Bank.

Eric is a member of the C.F.A. Institute having received the Chartered Financial Analyst designation in 1996. Eric received an M.B.A. from the University of Florida and a B.B.A. in Finance from the Stetson University.

Q&A – Eric Cinnamond

What is your investment worldview?

EC: “I am a small cap absolute return investor. My goal is to generate attractive positive returns relative to the risk assumed over a full market cycle. To do this, I follow some basic, but historically effective guidelines. First, when getting paid to assume risk, take it. Every cycle I’ve found there are periods when valuations are attractive and investing opportunistically and aggressively is necessary.  Second, do not overpay.

Over the past three market cycles (including the current cycle), equity valuations have reached very expensive levels that, in my opinion, have not properly compensated investors for the risk assumed. In effect, near valuation peaks, future returns are often inadequate, and the potential for permanent losses to capital are elevated. In such periods, instead of staying fully invested, I attempt to avoid large losses by holding cash and waiting for an improved opportunity set. In conclusion, my investment process is flexible, opportunistic, and often requires considerable discipline and patience.”

Compare your style of investing to the more common passive – 60/40 approach.

EC: “Most passive and relative return styles of investing tend to remain fully invested throughout a market cycle. My strategy is much more price and risk sensitive. Valuation, or what I’m paying for an investment, is very important to me. As such, during periods of inflated valuations, my process often requires me to avoid risk and remain patient. Conversely, passive investors with fixed asset allocations often assume market risk throughout the entire market cycle.

During periods of expensive valuations, instead of assuming significant market risk, I’ll assume career risk and incur an opportunity cost. Until the market cycle ends, it isn’t knowable if remaining patient and avoiding overpaying was the right course of action. Over the past two cycles ending in 2000 and 2009, my absolute return approach worked well by allowing me to mitigate losses and eventually invest opportunistically. However, the current cycle (2009-2018) remains intact and remains too early to determine if the absolute return path was correct, in my opinion.”

Can you explain what you mean by “I’ll assume career risk and incur an opportunity cost”?

EC: “The willingness to assume career risk is similar to the willingness to look different from your peers and benchmarks. I have found there were times during my career when it was very important to look differently. In 1999 technology stocks were the largest weights in many of the benchmarks, but were also the most expensive! By avoiding technology stocks in 1999, my relative performance suffered. In fact, in 1999 I was one of the few portfolio managers to lose money. This was quite an achievement, or underachievement, as the Russell 2000 increased 20% in 1999, with the NASDAQ up 85%!

For portfolio managers, large performance dispersions such as these can increase the risk of losing assets under management (AUM) and ultimately, your job. Hence, the term, career risk.

My absolute return process has historically caused me to incur considerable AUM and career risk. As such, I’ve avoided managing money with an emphasis on maximizing AUM. Instead, my goal is focused on achieving an adequate absolute return on investments over a market cycle. If market conditions warrant that I am unable to do that, I’ll sell overvalued equities and raise cash. And in extreme cases (2016), I’m comfortable with $0 AUM or returning capital.

While remaining patient and holding cash is often a necessary part of my process, it is not risk-free. Holding cash can result in significant opportunity cost, especially in sharply rising equity markets. However, during periods of excessive overvaluation, I believe opportunity cost is preferable to overpaying and risking substantial losses to capital. Significant losses resulting from overpaying can be much more damaging to a portfolio, and in some cases, can be permanent. Conversely, opportunity cost is often temporary, and can be quickly recovered once valuations revert and opportunities return.”

How would you characterize current markets and contrast that with a time when you thought them meaningfully different?

EC: “Broadly speaking, this is the most expensive small cap market I’ve ever seen. My possible buy list is trading at over 30x earnings and 2.5x sales. This is very expensive and suggests large potential losses assuming valuations normalize. Most of the businesses I follow are mature small caps with slow to moderate growth rates. They should not command these type of valuations, in my opinion. Although small caps were expensive near the peaks of the past two market cycles, the current environment of overvaluation is much broader. In 1999 there were large pockets of opportunity and undervaluation in small-cap stocks. In 2007 overvaluation was more widespread, but there remained some pockets of value where an absolute return investor could allocate capital. This cycle, overvaluation has become much more widespread. You can see this in many median valuation measures, which are all near or higher than previous market cycle peaks. I often ask, if we can all agree that 2000 and 2008 were bubbles, how can we not agree that current valuations are as well?”

In your opinion, what are the implications of the damage that would occur in the event of a 2000/2008 market collapse? What do you think the odds of that occurring are?

EC: “Given current valuations, an end of the cycle decline similar to 2000 and 2008 is a real possibility. Will the market crash, go higher, or will we have a decade of stagnant markets that allow fundamentals to catch up with price? I don’t know for certain. However, I’m not aware of a market cycle with valuations as high as today’s that did not end with meaningful declines.

I believe the end of the current market cycle, and its resulting losses, will be partially determined by the effectiveness and ability of central banks to respond to declining asset prices. While many investors assume central banks will come to the rescue during the next meaningful market decline, I believe there are significant risks to relying on the Federal Reserve’s “put option.” For example, in an environment with rising inflation, a weakening dollar, and a declining bond market, will central banks be able to bail out markets with another round of asset purchases (QE)? It’s a good question and one I would be asking myself if I was fully invested. Instead of relying on central banks as the foundation of my risk mitigation strategy, I plan to remain committed to my absolute return process and discipline. Currently, that process is keeping me out of the markets until prices and opportunity sets change.”


With a large holding of cash and few opportunities to invest wisely, Eric chose of his own accord to close his fund and return investor capital in 2016. Essentially he deemed that the small-cap market, in which he specializes, offered no value. He is currently patiently watching the market for signs that value will return.

What truly sets Eric apart is his ethical judgment regarding his willingness to assume career risk as opposed to imposing undo market risk on his clients. While most managers go to lengths to rationalize their holdings and are content clipping a paycheck, Eric, in good conscience, could not buy overvalued stocks offering paltry long-term returns (and large downside risk) for his clients.

In time, markets will correct, and valuations will normalize. When this occurs, we have no doubts that Eric will be in a great position to once again manage a portfolio and take advantage of prices that will be on sale. After all, isn’t it low prices we should be chasing?

The stock market volatility over the past several months has everyone scratching their heads while trying to figure out the next major move. Though I still believe that the U.S. stock market is experiencing an unsustainable debt-fueled bubble that will end in a much more powerful bearish move than we’ve experienced this year, I still watch and respect the major trends to avoid fighting the market. In this piece, I will show the major U.S. stock indices and their key levels I believe everyone should keep an eye on.

Despite all of the recent volatility and worrisome headlines, the SP500 still has not broken its uptrend line that started in early-2016, which means that the uptrend is still intact – at least for now. In addition, the index is still above its 2,532 to 2,550 support zone that was formed by the panic lows in February and early-April. If the uptrend line and the support zone is broken in a convincing manner in the weeks or months to come, it would be a concerning development, but that simply hasn’t happened yet.

SP500 WeeklyThough much of the latest market volatility and fear has been focused on the tech sector, the tech-centric Nasdaq Composite Index still hasn’t broken its uptrend line that started in 2016. In addition to the uptrend line, it is important to watch the 6,630 to 6,800 support zone that was formed during the panic sell-offs of the past few months. If the uptrend line and support zone is broken in the future, it would give a bearish confirmation signal.

Nasdaq WeeklyLike the SP500 and Nasdaq Composite Index, the small-cap Russell 2000 is still in a confirmed uptrend because it hasn’t broken its two year-old bullish channel pattern. If this is eventually broken, it would signify a major change of trend.

Russell 2000

Simple trend analyses like the one in this piece help to put confusing financial market cross-currents into perspective. For now, I don’t believe it is time to panic (as a tactical investor or trader). Of course, I am worried about the longer-term picture, but I’m still not seeing major chart damage. As usual, I will keep everyone updated if there is a major new development or change of trend.

Please follow or add me on TwitterFacebook, and LinkedIn to stay informed about the most important trading and bubble news as well as my related commentary.

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via EmailFacebook or Twitter.

In this past weekend’s newsletter, “Bulls Hang On By A Thread,” I suggested a rally was likely due to the short-term oversold conditions that currently existed. To wit:

“For now, we want to give the bulls the benefit of the doubt, but that ‘bit of rope’ is awfully frayed at this juncture. If the market hits our target zone or breaks support, as shown below, we will reduce portfolio ‘risk’ further.”

“My best guess, at the moment, is that ‘someone’ may well try and talk ‘the Donald’ off his aggressive posture over the weekend. If the markets get some ‘relief,’ a rally back to resistance is likely.”

By Monday morning, the catalyst was in place as statements made by Trump over the weekend, which were described as conciliatory, sent the markets rallying early on the hopes a U.S./China trade war could be averted.

However, while the reflex rally was nice, most of the gains were lost by the close as concerns rose of the FBI’s raid of the office of Michael Cohen, Donald Trump’s attorney, searching for communications between Cohen and the President.

The market just can’t catch a break.

More importantly, the failure to break out of the current downtrend channel is rapidly pulling the 50-dma towards a cross of the 100-dma. Such a downside cross will be “just another brick in the wall” for the continuation of the bull market in the short-term. (My apologies to Pink Floyd.)

The good news is that futures are pointing sharply higher this morning and we should have another shot at a rally. If we can hang on to the rally, it should bring us very close to registering a “short-term buy signal.” Such a signal should theoretically provide enough “gas” to the market for a rally back to the 100-dma or even the previous downtrend line.

I highly suggest you use any substantial rally to reduce risk and rebalance portfolios accordingly. 

Why? Because I am going to out on a limb and making a call.

“I think the 9-year old bull market may have ended in February.” 

I could be wrong. Actually, I hope that I am because managing money is far easier when markets are rising.

However, as I was writing the newsletter, there was a moment of clarity as I penned a list of challenges weighing on the economy, and the markets, which are very different from where we were back in 2009 or even in 2016.

“In 2015, the market plunged as Fed Chair Janet Yellen brought QE3 to its conclusion and started hiking interest rates for the first time in 9-years. Again, this correction would likely have been substantially deeper as the Eurozone faced “Brexit” which sent shocks through the market. The well-timed phone calls to the Bank of England and the European Central Bank by then Fed Chairman Yellen, to take over liquidity operations stemmed the decline. Also as opposed to 2000 and 2007, the Fed had only just started its rate-hiking campaign.”

“Today’s market correction is more aligned with the end of a market cycle versus the beginning of one. The market is facing numerous headwinds that did not exist in 2011 or 2015.”

I want to expand and illustrate that list in today’s update.

1) The Federal Reserve continues to hike interest rates on the short-end pressuring the yield-curve flatter which has never ended well for investors.

2) The Federal Reserve, ECB, and other Central Banks are tapering their liquidity operations. While balance sheets globally continue to expand, the rate of growth is beginning to slow. 

3) Economic growth globally has begun to weaken as the boost to the U.S. economy from 3-hurricanes and 2-major wildfires have started to fade.


4) The current Administration is engaging in a “trade war” which potentially impacts various aspects of the economyAs noted by the Heisenberg this past weekend:

“The Trump administration decided to look into the possibility of proposing an additional $100 billion in tariffs on China in retaliation for Beijing’s retaliation”

“The major risk after Thursday evening is that the Trump administration ultimately backs China into a corner by proposing more in tariffs than China imports in U.S. goods. If the U.S. were to up the ante to $150 billion in total tariffs, that would exceed U.S. goods exports to China.

Do you see the problem with that? If not, allow me to quickly explain. It would corner Beijing into going the so-called ‘nuclear route’, and the thing investors need to understand is that China actually has several ‘nuclear’ options, two of which are devaluing the yuan and selling Treasuries.”

5) Valuations remain extremely extended as noted in John Hussman’s latest essay.

“The chart below presents several valuation measures we find most strongly correlated with actual subsequent S&P 500 total returns in market cycles across history. They are presented as percentage deviations from their historical norms. At the January peak, these measures extended about 200% above (three times) historical norms that we associate with average, run-of-the-mill prospects for long-term market returns. No market cycle in history – not even those of recent decades, nor those associated with low interest rates – has ended without taking our most reliable measures of valuation to less than half of their late-January levels.”

“Don’t imagine that a market advance “disproves” concerns about overvaluation. In a steeply overvalued market, further advances typically magnify the losses that follow, ultimately wiping out years, and sometimes more than a decade, of what the market has gained relative to risk-free cash.”

6) Despite the recent turmoil, high-yield spreads remain very compressed which suggests that “fear” has not entered back into the market yet.

7) Interest rates are rising in the areas of the economy that impact consumers directly through variable-rate debt like credit cards. Not surprisingly, rising rates on the short-end are already causing rising delinquency and charge-off rates and falling loan demand. 

8) Price volatility is rising.  Historically, significant increases in weekly point changes have occurred going into, and coming out of, more meaningful market corrections. 

9) Investors are still overly aggressive. Via Bloomberg:

“Perhaps the Markets Message Indicator peak in January will prove only temporary. However, its current warning comes when the indicator is near the peaks of 2000 and 2007,” Paulsen wrote in a note to clients Monday. “That is, it suggests investor confidence and aggressiveness ‘across all financial markets’ is nearly as pronounced today as it was at the last two major stock market tops.”

The same can be seen by investor actions. Via Decision Point

“Note that money has left and continues to trickle out of bear funds. Money market assets remain about the same, so we’re not seeing increased worry or cashing out. In fact, we are seeing money now flowing to bull funds.”

10) Earnings estimates are at a record which leaves plenty of room for disappointment. 

“In fact, Q1 of 2018 has marked the largest increase in the bottom-up EPS estimate during a quarter since FactSet began tracking the quarterly bottom-up EPS estimate in Q2 2002. The previous record for the largest increase in the bottom-up EPS estimate was 4.8%, which occurred in Q2 2004.

“Still, while on the surface, Q1 will be a clear upward outlier, the reality is that most of it (and according to Morgan Stanley, more than all) has already been priced in. Which is a risk because as Reuters reports, while in Q1 corporate America will post its biggest quarterly profit growth in seven years, rising by just over 18% Y/Y…even the smallest disappointments could add to further upset the fragile market.”


The backdrop of the market currently is vastly different than it was during the “taper tantrum” in 2015-2016, or during the corrections following the end of QE1 and QE2.  In those previous cases, the Federal Reserve was directly injecting liquidity and managing expectations of long-term accommodative support. Valuations had been through a fairly significant reversion, and expectations had been extinguished.

None of that support exists currently.

Let me conclude with this quote from John’s recent missive:

“At its core, investment is about valuation. It’s about purchasing a stream of expected future cash flows at a price that’s low enough to result in desirable total returns, at an acceptable level of risk, as those cash flows are delivered over time. The central tools of investment analysis include an understanding of market history, cash flow projection, the extent to which various measures of financial performance can be used as “sufficient statistics” for that very long-term stream of cash flows (which is crucial whenever valuation ratios are used as a shorthand for discounted cash flow analysis), and a command of the basic arithmetic that connects the current price, the future cash flows, and the long-term rate of return.

At its core, speculation is about psychology. It’s about waves of optimism and pessimism that drive fluctuations in price, regardless of valuation. Value investors tend to look down on speculation, particularly extended periods of it. Unfortunately, if a material portion of one’s life must be lived amid episodes of reckless speculation that repeatedly collapse into heaps of ash, one is forced to make a choice. One choice is to imagine that speculation is actually investment, which is what most investors inadvertently do. The other choice is to continue to distinguish speculation from investment, and develop ways to measure and navigate both.

At present, stock market investors are faced with offensively extreme valuations, particularly among the measures best-correlated with actual subsequent market returns across history. Investment merit is absent. Investors largely ignored extreme “overvalued, overbought, overbullish” syndromes through much of the recent half-cycle advance, yet even since 2009, the S&P 500 has lost value, on average, when these syndromes were joined by unfavorable market internals.”

There is a reasonably high possibility, the bull market that started in 2009 has ended. We may not know for a week, a month or even possibly a couple of quarters. Topping processes in markets can take a very long time.

If I am right, the conservative stance and hedges in portfolios will protect capital in the short-term. The reduced volatility allows for a logical approach to further adjustments as the correction becomes more apparent. (The goal is not to be forced into a “panic selling” situation.)

If I am wrong, and the bull market resumes, we simply remove hedges and reallocate equity exposure.

“There is little risk, in managing risk.” 

The end of bull markets can only be verified well after the fact, but therein lies the biggest problem. Waiting for verification requires a greater destruction of capital than we are willing to endure.

As my friend Doug Kass has often written:

“Risk is under-priced, and likely considerably so.” 

“Risk” is simply the function of how much you will lose when you are wrong in your assumptions.

Invest accordingly.