Tag Archives: futures

Investors Are Grossly Underestimating The Fed – RIA Pro UNLOCKED

 If you think the Fed may only lower rates by .50 or even .75, you may be grossly underestimating them.  The following article was posted for RIA Pro subscribers two weeks ago.

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Currently, the December 2019 Fed Funds futures contract implies that the Fed will reduce the Fed Funds rate by nearly 75 basis points (0.75%) by the end of the year. While 75 basis points may seem aggressive, if the Fed does embark on a rate-cutting policy and history proves reliable, we should prepare ourselves for much more.

The prospect of three 25 basis point rate cuts is hard to grasp given that the unemployment rate is at 50-year lows, economic growth has begun to slow only after a period of above-average growth, and inflation remains near the Fed’s 2% goal.  Interest rate markets are looking ahead and collectively expressing deep concerns based on slowing global growth, trade wars, and diminishing fiscal stimulus that propelled the economy over the past two years. Meanwhile, credit spreads and stock market prices imply a recession is not in the cards.

To make sense of the implications stemming from the Fed Funds futures market, it is helpful to assess how well the Fed Funds futures market has predicted Fed Funds rates historically. With this analysis, we can hopefully avoid getting caught flat-footed if the Fed not only lowers rates but lowers them more aggressively than the market implies.

Fed Funds vs. Fed Funds Futures

Before moving ahead, let’s define Fed Funds futures. The futures contracts traded on the Chicago Mercantile Exchange (CME), reflect the daily average Fed Funds interest rate that traders, speculator, and hedgers think will occur for specific one calendar month periods in the future. For instance, the August 2019 contract, trades at 2.03%, implying the market’s belief that the Fed Funds rate will be .37% lower than the current 2.40 % Fed Funds rate. For pricing on all Fed Funds futures contracts, click here.

To analyze the predictive power of Fed Funds futures, we compared the Fed Funds rate in certain months to what was implied by the futures contract for that month six months earlier. The following example helps clarify this concept. The Fed Funds rate averaged 2.39% in May. Six months ago, the May 2019 Fed Funds future contract traded at 2.50%. Therefore, six months ago, the market overestimated the Fed Funds rate for May 2019 by .11%. As an aside, the difference is likely due to the recent change in the Fed’s IOER rate.

It is important to mention that we were surprised by the conclusions drawn from our long term analysis of Fed Funds futures against the prevailing Fed Funds rate in the future.

The graph below tracks the comparative differentials (Fed Funds vs. Fed Fund futures) using the methodology outlined above. The gray rectangular areas represent periods where the Fed was systematically raising or lowering the Fed funds rate (blue line). The difference between Fed Funds and the futures contracts, colored green or red, calculates how much the market over (green) or under (red) estimated what the Fed Funds rate would ultimately be. In this analysis, the term overestimate means Fed Funds futures thought Fed Funds would be higher than it ultimately was. The term underestimate, means the market expectations were lower than what actually transpired.

To further help you understand the analysis we provide two additional graphs below, covering the most recent periods when the Fed was increasing and decreasing the Fed Funds rate.

Data Courtesy Bloomberg

Data Courtesy Bloomberg

Looking at the 2004-2006 rate hike cycle above, we see that the market consistently underestimated (red bars) the pace of Fed Funds rate increases.

Data Courtesy Bloomberg

During the 2007-2009 rate cut cycle, the market consistently thought Fed Funds rates would be higher (green bars) than what truly prevailed.

As shown in the graphs above, the market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully. The dotted lines highlight that the market has underestimated rate cuts by 1% on average, but at times during the last three rate-cutting cycles, market expectations were short by over 2%. The market has underestimated rate increases by about 35 basis points on average.

Summary

If the Fed initiates rate cuts and if the data in the graphs prove prescient, then current estimates for a Fed Funds rate of 1.50% to 1.75% in the spring of 2020 may be well above what we ultimately see. Taking it a step further, it is not farfetched to think that that Fed Funds rate could be back at the zero-bound, or even negative, at some point sooner than anyone can fathom today.

Heading into the financial crisis, it took the Fed 15 months to go from a 5.25% Fed funds rate to zero. Given their sensitivities today, how much faster might they respond to an economic slowdown or financial market dislocation from the current level of 2.25%?

We remind you that equity valuations are at or near record highs, in many cases surpassing those of the roaring 1920s and butting up against those of the late 1990s. If the Fed needs to cut rates aggressively, it will likely be the result of an economy that is heading into an imminent recession if not already in recession. With the double-digit earnings growth trajectory currently implied by equity valuations, a recession would prove extremely damaging to stock prices.

Treasury yields have fallen sharply recently across the entire curve. If the Fed lowers rates and is more aggressive than anyone believes, the likelihood of much lower rates and generous price appreciation for high-quality bondholders should not be underestimated.

The market has a long history of grossly underestimating, in both directions, what the Fed will do. The implications to stocks and bonds can be meaningful. To the extent one is inclined and so moved to exercise prudence, now seems to be a unique opportunity to have a plan and take action when necessary.

Are Fireworks Coming July 31st?

As a portfolio manager and fiduciary, it is vital that we constantly assess the risks to our market and economic forecasts. To better quantify risk we must frequently go a step further and understand where the markets may be neglecting to appreciate risk. While tricky, those that properly detect when the market is offside tend to either protect themselves and/or profit handsomely. It is with contrarian glasses on that we look beyond July 4th and towards July 31st for fireworks.

Through June the stock and bond markets priced in, with near certainty, a 50 basis point rate cut at the July 31, 2019, Federal Reserve FOMC meeting. In doing so, volatility in many markets could surge if the Fed does not follow the market’s lead.

Given this concern, we ask what might cause the Fed to disappoint the markets. We approach the answer from two angles, economic and political.

Economic

On the economic front, there are a growing number of indicators that point to slowing domestic economic growth. The following graph from Arbor shows seven important leading indicators (surveys and outlooks).

While the graph is concerning, hard economic data which tends to lag the survey data graphed above has yet to weaken to the same degree. If the weakening in the indicators graphed above prove to be a false signal or transitory, the Fed might cut rates less than expected or even delay taking policy actions.

A second reason the Fed might delay or not take action would be an increase in inflation expectations. The Fed has been outspoken about the need to bolster inflation expectations which have recently drifted lower. Given that unemployment is at 50 years lows and inflation close to their target, inflation expectations seems to be the rationale the Fed is using to justify action. If inflation expectations were to increase the Fed may not be able to defend reducing rates. The following events could temporarily increase inflation expectations:

  • Weaker dollar due to perceived easy monetary policy.
  • Iran tensions could push oil prices higher.
  • Excessive weather conditions in the Midwest are affecting consumer prices for certain commodities.
  • Tariffs are likely to increase prices paid by businesses and consumers.
  • Fed independence compromised (as discussed in the following paragraph).

Political

Beyond economics, politics is playing a role in the Fed’s thought process. The Fed was set up as an independent organization to insulate monetary policy from the often self-serving demands of the executive and legislative branches. Despite the Fed’s independence, many Presidents have bullied the Fed to take policy actions. Such tactics always occurred behind closed doors with the media and public having little idea that they were occurring.

Currently, President Trump is taking his criticism to the public airways and has gone as far as threatening to demote or fire Chairman Powell. A Fed Chairman has never been fired or demoted, leading many to question whether Trump has the legal authority to do so. The Federal Reserve Act states that the Chairman shall serve his stated term “unless sooner removed for cause by the President.” That sentence opens the door to much uncertainty under this President. The language is even less vague about demotion, which, in our opinion, is more likely.

If the Fed wants to assert its independence from the executive branch, they may be inclined to cut by 25 basis points or possibly not cut at all.  Anything short of a 50 basis point rate cut would inevitably irritate the President and increase the risk that Trump fires or demotes Powell. If such an unprecedented action were to transpire the markets would likely react violently. For more on how certain asset classes might perform in this scenario, please read our article Market Implications for Removing Fed Chair Powell.

Beyond the initial market responses to the news, a greater problem could arise. The peril of openly piercing the veil of independence at the Fed could impair many of the communication tools the Fed uses to influence policy and markets. In turn, the Fed will be limited in their ability to coax or pacify markets when needed.

While this spat may be brushed off as Beltway politics aired for the public in the Twittersphere and media, the consequences are large, and as such we must pay attention to this political soap opera.

Summary

We believe a 50 basis point cut is likely on July 31st and afterward the markets will renew their focus on the next few months and what that may have in store. However, unlike the vast majority, we believe that there are factors that may cause the Fed to sit on their hands. If the Fed disappoints the market, especially if not accompanied by warnings, the July fireworks this year may be coming 27 days late.

Investors Are Grossly Underestimating The Fed

Currently, the December 2019 Fed Funds futures contract implies that the Fed will reduce the Fed Funds rate by nearly 75 basis points (0.75%) by the end of the year. While 75 basis points may seem aggressive, if the Fed does embark on a rate-cutting policy and history proves reliable, we should prepare ourselves for much more.

The prospect of three 25 basis point rate cuts is hard to grasp given that the unemployment rate is at 50-year lows, economic growth has begun to slow only after a period of above-average growth, and inflation remains near the Fed’s 2% goal.  Interest rate markets are looking ahead and collectively expressing deep concerns based on slowing global growth, trade wars, and diminishing fiscal stimulus that propelled the economy over the past two years. Meanwhile, credit spreads and stock market prices imply a recession is not in the cards.

To make sense of the implications stemming from the Fed Funds futures market, it is helpful to assess how well the Fed Funds futures market has predicted Fed Funds rates historically. With this analysis, we can hopefully avoid getting caught flat-footed if the Fed not only lowers rates but lowers them more aggressively than the market implies.

Fed Funds vs. Fed Funds Futures

Before moving ahead, let’s define Fed Funds futures. The futures contracts traded on the Chicago Mercantile Exchange (CME), reflect the daily average Fed Funds interest rate that traders, speculator, and hedgers think will occur for specific one calendar month periods in the future. For instance, the August 2019 contract, trades at 2.03%, implying the market’s belief that the Fed Funds rate will be .37% lower than the current 2.40 % Fed Funds rate. For pricing on all Fed Funds futures contracts, click here.

To analyze the predictive power of Fed Funds futures, we compared the Fed Funds rate in certain months to what was implied by the futures contract for that month six months earlier. The following example helps clarify this concept. The Fed Funds rate averaged 2.39% in May. Six months ago, the May 2019 Fed Funds future contract traded at 2.50%. Therefore, six months ago, the market overestimated the Fed Funds rate for May 2019 by .11%. As an aside, the difference is likely due to the recent change in the Fed’s IOER rate.

It is important to mention that we were surprised by the conclusions drawn from our long term analysis of Fed Funds futures against the prevailing Fed Funds rate in the future.

The graph below tracks the comparative differentials (Fed Funds vs. Fed Fund futures) using the methodology outlined above. The gray rectangular areas represent periods where the Fed was systematically raising or lowering the Fed funds rate (blue line). The difference between Fed Funds and the futures contracts, colored green or red, calculates how much the market over (green) or under (red) estimated what the Fed Funds rate would ultimately be. In this analysis, the term overestimate means Fed Funds futures thought Fed Funds would be higher than it ultimately was. The term underestimate, means the market expectations were lower than what actually transpired.

To further help you understand the analysis we provide two additional graphs below, covering the most recent periods when the Fed was increasing and decreasing the Fed Funds rate.

Data Courtesy Bloomberg

Data Courtesy Bloomberg

Looking at the 2004-2006 rate hike cycle above, we see that the market consistently underestimated (red bars) the pace of Fed Funds rate increases.

Data Courtesy Bloomberg

During the 2007-2009 rate cut cycle, the market consistently thought Fed Funds rates would be higher (green bars) than what truly prevailed.

As shown in the graphs above, the market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully. The dotted lines highlight that the market has underestimated rate cuts by 1% on average, but at times during the last three rate-cutting cycles, market expectations were short by over 2%. The market has underestimated rate increases by about 35 basis points on average.

Summary

If the Fed initiates rate cuts and if the data in the graphs prove prescient, then current estimates for a Fed Funds rate of 1.50% to 1.75% in the spring of 2020 may be well above what we ultimately see. Taking it a step further, it is not farfetched to think that that Fed Funds rate could be back at the zero-bound, or even negative, at some point sooner than anyone can fathom today.

Heading into the financial crisis, it took the Fed 15 months to go from a 5.25% Fed funds rate to zero. Given their sensitivities today, how much faster might they respond to an economic slowdown or financial market dislocation from the current level of 2.25%?

We remind you that equity valuations are at or near record highs, in many cases surpassing those of the roaring 1920s and butting up against those of the late 1990s. If the Fed needs to cut rates aggressively, it will likely be the result of an economy that is heading into an imminent recession if not already in recession. With the double-digit earnings growth trajectory currently implied by equity valuations, a recession would prove extremely damaging to stock prices.

Treasury yields have fallen sharply recently across the entire curve. If the Fed lowers rates and is more aggressive than anyone believes, the likelihood of much lower rates and generous price appreciation for high-quality bondholders should not be underestimated.

The market has a long history of grossly underestimating, in both directions, what the Fed will do. The implications to stocks and bonds can be meaningful. To the extent one is inclined and so moved to exercise prudence, now seems to be a unique opportunity to have a plan and take action when necessary.

As Seen On Forbes: American Farm Bankruptcies Are On The Rise

As seen on Forbes by RealInvestmentAdvice.com’s Jesse Colombo: “Here’s Why More American Farms Are Going Bankrupt.”

A report came out this week showing that U.S. farm bankruptcies are on the rise due to falling agricultural product prices as well as rising interest rates:

The increase in Chapter 12 filings reflects low prices for corn, soybeans, milk and even beef. The situation for most farmers has worsened since June under retaliatory tariffs that have closed the Chinese market for soybeans and damaged exports of milk and pork.

Farmers use Chapter 12 bankruptcy because it combines the simplicity of Chapter 13 bankruptcy — usually used by individuals — and the higher debt levels allowed with Chapter 11 bankruptcy — usually used by corporations. The Chapter 12 process typically allows for repayment of debt over three years.

Mark Miedtke, the president of Citizens State Bank in Hayfield, Minn., said bankruptcy hasn’t reared its head for borrowers in his area of southeast Minnesota, but farmers are struggling.

“Dairy farmers are having the most problems right now,” Miedtke said. “Grain farmers have had low prices for the past three years but high yields have helped them through. We’re just waiting for a turnaround. We’re waiting for the tariff problem to go away.”

This chart shows how farm bankruptcies have been increasing since 2014:

Farm Bankruptcy

Read the full article on Forbes.

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Recession Ahead? Watch Dr. Copper

After selling off this summer, copper has been consolidating over the last couple months and appears to be forming a wedge-type pattern that may indicate another strong move when the metal breaks out from it one way or another. Copper has a reputation for leading the global economy and is known as “the metal with a PhD in economics.” As our Chief Investment Strategist Lance Roberts recently showed, there is a rising risk of a recession, and the financial markets may be starting to price this in.

If copper breaks down from its most recent wedge pattern, it would be a worrisome sign for the global economy. The next price target and support level to watch is the $2.5 per pound support level that came into play over the last couple years.

Copper Daily Chart

The weekly chart below puts the current wedge and support levels into perspective. If copper breaks down from its wedge, the next support to watch is $2.5 and, after that, $2 per pound.

Copper Weekly Chart

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

The “Smart Money” Is Bullish On The Dollar

After a brief post-Presidential election surge in 2016, the U.S. dollar has been in a steady downtrend since early-2017. The dollar’s grind lower has helped to boost non-U.S. currencies as well as commodities prices, which trade inversely with the dollar. Now that the “short-dollar, long everything else” trade has been going on for so long, it has become extremely crowded: the consensus view is that this trade will continue for much longer and even accelerate. On the other hand, the “smart money” are betting heavily on a reversal of this trade, as I will show in this piece.

For the past several months, the U.S. Dollar Index formed a triangle consolidation pattern as it digested the financial market volatility. The index broke out of this triangle pattern today, which is a bullish sign as long as the breakout remains intact (ie., the index remains above the top of the triangle pattern).

USD Daily

The longer-term chart shows how the “smart money” or commercial hedgers (see the green line under chart) have built up a bullish position in the U.S. Dollar Index futures. The last several times the hedgers built similar positions, the Dollar Index has rallied. The dollar’s downtrend since early-2017 has occurred within a channel pattern, and the triangle pattern discussed in the prior chart can be seen within this channel. The Dollar Index needs to break out of both the triangle pattern and the channel pattern in a convincing manner in order to signal the end of the downtrend.USD Weekly

The euro, which trades inversely with the U.S. dollar, formed a similar triangle pattern over the past several months and has broken down from this pattern today. This breakdown is a bearish sign for the euro and a bullish sign for the dollar as long as the euro’s breakdown remains intact (ie., it doesn’t reverse and break back into the triangle pattern).

Euro Daily

The “smart money” or commercial euro futures hedgers have built their largest bearish position in at least a half-decade, which increases the probability of a bearish-euro/bullish-dollar move in the not-too-distant future. The commercial euro futures hedgers have a short position of nearly 200,000 net futures contracts, which is far larger than their relatively bearish position in 2013 and 2014 before the euro weakened sharply against the dollar.

Euro Weekly

The “smart money” or commercial futures hedgers are also bearish on the Japanese yen, which would also be bullish for the dollar if they are proven right. The yen experienced bearish moves the last couple times the commercial hedgers positioned similar to how they are positioned now.Yen Weekly

The “smart money” are currently bearish on the British pound as well and have a strong track record of positioning bearishly ahead of major pound routs over the past half-decade.Pound Weekly

If another wave of dollar strength occurs, it would be very bad news for crude oil and the overall energy sector (crude oil and the dollar trade inversely). The U.S. dollar’s surge in 2014 and 2015 was the trigger for the violent crude oil bust. Even more concerning is the fact that the “smart money” are more bearish on crude oil now than they were immediately before the 2014 oil bust, as I discussed in greater detail last week. While oil’s short-term trend is still up for now and I believe in respecting the trend, there is a very real risk that another violent liquidation sell-off may occur when the trend changes.

WTI Crude Monthly

For now, I believe everyone should keep an eye on the U.S. Dollar Index to see if today’s triangle breakout has legs and if the index can break out of its longer-term channel pattern. While most market participants currently believe that further bearish dollar/bullish commodities action is practically guaranteed, they need to be aware of the tendency for the market to “tip over when everyone gets to one side of the boat.”

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Here’s What To Watch In Crude Oil Right Now

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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The Mind Numbing Spin Of Peter Navarro

“The market is reacting in a way which does not comport with the strength, the unbelievable strength in President Trump’s economy. I mean, everything in this economy is hitting on all cylinders because of President Trump’s economic policies. We’ve cut taxes. That’s stimulating investment in a way which will be noninflationary. That’s going to drive up productivity and wages. That’s all good.” -Peter Navarro

Unfortunately, as much as we would like to believe that Navarro’s comment is a reality, it simply isn’t the case. The chart below shows the 5-year average of wages, real economic growth, and productivity.

Notice that yellow shaded area on the right.  As I wrote previously:

“Following the financial crisis, the Government and the Federal Reserve decided it was prudent to inject more than $33 Trillion in debt-laden injections into the economy believing such would stimulate an economic resurgence. Here is a listing of all the programs.”

If $33 Trillion dollars didn’t “unleash” the U.S. economy, or even change the trends of the prior years, there should be serious doubt that just reducing some outdated regulations, giving corporations a tax cut, and engaging in a “trade war” with China is going to be the fix. But nonetheless, here goes Navarro:

“We’ve got an unleashing, historically, of the energy sector, which is going to drive down costs to the American manufacturers–make them competitive even as it drives down costs to consumers, and allows them to spend more and get more out of their dollar.”

Wait a second.

Read carefully what Navarro said. By unleashing the energy sector the supply of oil will increase, lowering the price of oil, which is an input into manufacturing thereby lowering their costs.

This is a good thing?

Let’s dissect his statement. The decline in energy costs may be beneficial to parts of the economy, but we must remember it is offset because of the drag from the energy sector which loses revenue on each barrel of oil. As we have discussed many times previously, the energy patch is a huge CapEx contributor and also provides some of the highest wage paying jobs. As we found out previously, energy is a much bigger contributor to the health of the economy than not.

However, according to Navarro, the decline in oil alone will make manufacturing more competitive in the global marketplace. If that were true, wouldn’t the U.S. already be a leading competitive manufacturer considering oil has plunged over the last few years from over $100/bbl to the low $30’s? Furthermore, following Navarro’s logic, wages should have skyrocketed.

None of those things happened.

Navarro isn’t done yet.

“In terms of trade policy, by reducing the trade deficit, which is the intent of the president’s fair and reciprocal trade policies, that will add thousands of jobs to this economy; and bring in foreign investment. I mean, when we put the tariffs on solar and washing machines in January, that brought in a flood of new investment.”

We do indeed have a trade deficit because there are 300+ million American’s demanding cheaper foreign goods and services than there are foreigners demanding our exports.

While people rail about the amount of goods that we import, the simple reality is that we “export” our deflation and import “deflation.” We do this so we can buy flat screen televisions for $299 versus $2999 if they were made in America. The simple problem is that American workers demand higher wages, vacation, health care, benefits, leave, etc. all of which increase the costs of goods made in America. Not to mention the additional costs born by goods and services producers to comply with the myriad of regulations from EPA to OSHA. A previous interview of Greg Hayes, CEO of Carrier Industries, made this point very clearly.

So what’s good about Mexico? We have a very talented workforce in Mexico. Wages are obviously significantly lower. About 80% lower on average. But absenteeism runs about 1%. Turnover runs about 2%. Very, very dedicated workforce.

Which is much higher versus America.  And I think that’s just part of these — the jobs, again, are not jobs on an assembly line that people really find all that attractive over the long term.

This leads to the “American Conundrum.” While we believer our “labor” is worth “MORE” than anywhere else in the world, we also want to “buy” cheap products.

In order for that equation to work companies must “export” our “inflation.” This is accomplished by off-shoring labor at substantially lower rates which allows products and services to be provided more cheaply (deflation) to fill American demand. As I wrote yesterday, there is little ability for Americans to absorb the higher costs of goods and services brought about through “tariffs” or other inflationary goals of “balancing trade.”

“The chart below shows is the differential between the standard of living for a family of four adjusted for inflation over time. Beginning in 1990, the combined sources of savings, credit, and incomes were no longer sufficient to fund the widening gap between the sources of money and the cost of living. With surging health care, rent, food, and energy costs, that gap has continued to widen to an unsustainable level which will continue to impede economic rates of growth.”

Of course, while Navarro is optimistic that Trump policies will generate a net creation of a few thousand jobs, such aspirations will fall far short of what is needed to balance the economy.

But honestly, you can’t make up his last statement.

So you wonder–and if I put my old hat on as a financial market analyst, I’m looking at that – this market and the economy and thinking, the smart money will buy on the dips here because the economy is as strong as an ox.”

One chart dispels that notion.

So, be careful taking financial advice from Peter Navarro as well.

But, let me defer to my friend Doug Kass:

“To me, the views that animate Navarro’s policy prescriptions demonstrate his economic illiteracy.

There is no inverse relationship between imports and GDP as Navarro asserts.

In fact, there is a strong positive relationship between changes in trade deficits and changes in GDP.

Both Navarro and Ross are proponents of steel tariffs. As I have mentioned, such tariffs hurt producers that utilize steel products much more than they benefit a smaller population of steel producers. The byproduct of which could be rising steel costs which may ripple throughout the economy.

In reality, the US depends on China – we are in a flat, networked and interconnected global economy:

  1. The Chinese export market is important to the U.S.
  2. China produces low cost goods that benefit American consumers.
  3. China funds our budget deficit, their surplus of savings is imported to the US – squaring the circle. If China stops buying our Treasuries, where do we get funding?

Misguided Policies Continue

For the last 30 years, each Administration, along with the Federal Reserve, have continued to operate under Keynesian monetary and fiscal policies believing the model works. The reality, however, has been that most of the aggregate growth in the economy has been financed by deficit spending, credit expansion and a reduction in savings. In turn, this reduced productive investment in the economy and the output of the economy slowed. As the economy slowed and wages fell the consumer was forced to take on more leverage which also decreased savings. As a result of the increased leverage more of their income was needed to service the debt.

Secondly, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment.

All of these issues have weighed on the overall prosperity of the economy and it citizens. What is most telling is the inability for people like Navarro, and many others, who create monetary and fiscal policies, to realize the problem of trying to “cure a debt problem with more debt.”

This is why the policies that have been enacted previously have all failed, be it “cash for clunkers” to “Quantitative Easing”, because each intervention either dragged future consumption forward or stimulated asset markets. Dragging future consumption forward leaves a “void” in the future that has to be continually filled, and creating an artificial wealth effect decreases savings which could, and should have been, used for productive investment.

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the end result, has been clearly wrong. It hasn’t happened in 30 years.

The Keynesian model died in 1980. It’s time for those driving both monetary and fiscal policy to wake up and smell the burning of the dollar and glance at the massive pile of debts that have accumulated.

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

Weekend Reading: Failing To Plan Is Planning To Fail

Failing To Plan Is Planning To Fail

by Michael Lebowitz, CFA

There is a durable bit of market wisdom that states “volatility begets volatility.” The gist of the saying is that at times the market can be very calm producing little need for investors to worry. Other times sharp market movements produce anxiety that spreads among investors and tends to exaggerate market moves in both directions for a while.

The graph below shows the daily percentage change between intraday highs and lows. Plain to the eye one can see the period of unprecedented calm that prevailed in the markets throughout 2017 as well as the sudden bout of volatility that picked up in earnest in late January.

Sailors pay close attention to weather conditions at all times. Importantly, however, they need to be highly in tune with the warnings that Mother Nature presents. This doesn’t mean they must head to harbor immediately. It does mean however they must have a plan or two top of mind if the conditions continue to worsen.

Protecting your wealth is no different. When the markets get choppy, as they have been, we need to heed the message that conditions have changed. One should not sell everything and run to cash. However, it is imperative one has a strategies and actionable triggers in place in case the volatility continues.

Last weekend, Lance Roberts shared the following graph and commentary:

“Considering all those factors, I begin to layout the “possible” paths the market could take from here. I quickly ran into the problem of there being “too many” potential paths the market could take to make a legible chart for discussion purposes. However, the bulk of the paths took some form of the three I have listed below.”

No one knows where this market is going and if they tell you otherwise, they are lying. We simply remind you the market winds are picking up, it is time to put a plan in place. Fear and anxiety are the enemy of complacent and unprepared investors. Those emotions are the direct result of not having considered and planned for the unexpected. For the investor who exercises the prudence to strategize on the “what if” and keep a close eye on market conditions, the fear of others’ is his opportunity.

Consider this recent period of choppy seas a gift. The market is allowing you time to plan.

“Failing to plan is planning to fail” –Alan Lakein

 

Weekend Reading: The Fed’s Dilemma

The Fed’s Dilemma

The confusion at the Fed continues.

On Wednesday, Jerome Powell justified hiking rates 0.25%, while maintaining their projections of two further hikes this year, by painting an upbeat picture of the U.S. economy.

Such may have been the case in January when the Atlanta Fed sent the current Administration into a “tizzy” with a pronouncement of 5.4% economic growth in the 4th quarter, but not at 1.9% currently. Furthermore, as I discussed just recently:

“Since 1992, as shown below, there have only been 5-other times in which retail sales were negative 3-months in a row (which just occurred). Each time, the subsequent impact on the economy, and the stock market, was not good.”

“So, despite record low jobless claims, retail sales remain exceptionally weak. There are two reasons for this which are continually overlooked, or worse simply ignored, by the mainstream media and economists.

The first is that despite the “longest run of employment growth in U.S. history,” those who are finding jobs continues to grow at a substantially slower pace than the growth rate of the population.”

“Secondly, while tax cuts may provide a temporary boost to after-tax incomes, that income boost is simply being absorbed by higher energy, gasoline, health care and borrowing costs. This is why 80% of Americans continue to live paycheck-to-paycheck and have little saved in the bank.”

The Fed’s dilemma is quite simple.

The Fed must continue to “jawbone” the media and Wall Street as economic growth has continued to remain sluggish. As shown, the Fed continues to remain one of the worst economic forecasters on the planet.

While the Fed is currently “hopeful” of a stronger 2018 and 2019, they are likely once again going to be very disappointed. But in the short-term, they have little choice.

Unwittingly, the Fed has now become co-dependent on the markets. If they acknowledge the risk of weaker economic growth, the subsequent market sell-off would dampen consumer confidence and push economic growth rates lower. With economic growth already running at close to 2% currently, there is very little leeway for the Fed to make a policy error at this juncture.

The Federal Reserve has a very difficult challenge ahead of them with very few options. While increasing interest rates may not “initially” impact asset prices or the economy, it is a far different story to suggest that they won’t. In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest-rate hiking campaign that has not eventually led to a negative outcome.

The Fed understands economic cycles do not last forever, and after nine years of a “pull forward expansion,” it is highly likely we are closer to the next recession than not. From the Fed’s perspective, hiking rates now, even if it causes a market decline and/or recession, is likely the “lesser of two evils.”

Crude Oil Breaks Out, But Will It Last?

For the past several weeks, I’ve been watching triangle patterns form in crude oil after its slide in early-February. Breakouts from triangle patterns often lead to important directional moves, which is why I believe it is worthwhile to pay attention to these formations. Both WTI and Brent crude oil finally broke out of their triangle patterns today due to Middle East tensions and speculation regarding more cuts in Venezuelan output.

Here’s West Texas Intermediate crude oil’s breakout:

WTI Crude Daily

Here’s Brent crude oil’s breakout:

Brent Crude DailyWhile I believe in respecting price trends instead of fighting them, I’m still concerned about the fact that crude oil’s rally of the past two years has been driven by “dumb money” or large speculators, who are more aggressively positioned than they were in the spring of 2014 before the oil crash. At the same time, the “smart money” or commercial hedgers have built their largest short position in history.

WTI Crude Monthly

Last week, I showed that U.S. Treasuries had broken out of triangle patterns of their own. Crude oil’s recent bullish move has been threatening the Treasury breakout (the two markets trade inversely):

30 Year Bond

10 Year Note

The U.S. Dollar Index is worth paying attention to when analyzing the crude oil market. Bullish moves in the dollar are typically bearish for crude oil and other commodities, and vice versa. Today’s bullish crude oil move and breakout is not confirmed by the U.S. Dollar Index, which is up .64 percent today. The U.S. Dollar Index has been trading in a directionless manner for the past two months, but its next major trend is likely to affect crude oil. If the Dollar Index can break above its trading range and downtrend line, it would likely lead to further bullish action (which would hurt crude oil). If the Dollar Index breaks down from its trading range, however, it would likely lead to further bearish action (which would push crude oil higher).

Dollar Daily

The longer-term U.S. Dollar Index chart shows that it is trading in a downward-sloping channel pattern. The dollar will remain in a downtrend as long as it trades within this channel. A breakout from this channel would increase the probability of a rebound, which would hurt crude oil. As I’ve been showing, the “smart money” or commercial hedgers are bullish, while the dumb money are bearish.

Dollar Weekly

This is an admittedly confusing time in the financial markets: correlations are breaking down, many technical breakouts and breakdowns are failing and whip-sawing, and the market is chopping all over the place. For these reasons, I’m not making any short-term market predictions, but just showing key charts that I believe are worth paying attention to. Yes, I believe they must be taken with a healthy grain of salt. I am suspicious of today’s crude oil breakout because it’s not confirmed by the U.S. dollar and because of the large bearish position held by the “smart money.” The smart money are usually right in the end, but it’s not prudent to fight the trend in the short-term. As usual, I will keep everyone posted regarding the recent crude oil and Treasury bond breakouts.

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Weekend Reading: Our Ersatz Economy

Chart of the Day

Today’s chart of the day shows cumulative U.S. GDP growth minus federal debt issuance. Most studies and discussions of U.S. economic growth assume that it’s natural, organic, and sustainable, but the reality is that it’s largely juiced by deficit spending (particularly since the Great Recession). According to Peter Cook, CFA:

The cumulative figures are even more disturbing. From 2008-2017, GDP grew by $5.051 trillion, from $14.55 trillion to $19.74 trillion.  During that same period, the increase in TDO totaled $11.26 trillion.  In other words, for each dollar of deficit spending, the economy grew by less than 50 cents.  Or, put another way, had the federal government not borrowed and spent the $11.263 trillion, GDP today would be significantly smaller than it is.

Cumulative GDP growth less Fed. debt issuance

How much longer can we continue juicing economic growth like this? The U.S. federal debt recently hit $20 trillion and is expected to hit $30 trillion by 2028. Despite what Modern Monetary Theorists (MMTers), Keynesians, and similar schools of thought claim, common sense dictates that the endgame is not far off.

Have Treasury Yields Peaked for 2018? BMO Thinks So (Bloomberg)

Strong Demand For 30Y Paper Shows No Shortage Of Buyers Amid Surge In Issuance (ZeroHedge)

Gundlach Says 10-Year Treasury Above 3% Would Drive Down Stocks (Bloomberg)

SP500 performance around Fed tightening cycles (The Macro Tourist)

Dodd-Frank Rollback Optimism Hands Bank ETFs Record Inflows (Bloomberg)

FANG Rally Is Outpacing the Heyday of the Tech Frenzy (Bloomberg)

Apple is inching towards a $1 trillion valuation (Business Insider)

Buying Stocks Now Is Betting On Buybacks (Forbes)

Record Stock Buybacks at Worst Possible Time (Mike “Mish” Shedlock)

4 Reasons To Sell Tesla Stock (Forbes)

Everything is shrinking at GE except its massive debt (CNN Money)

A Worrying Shift for U.S. Pensions: Retirees Will Soon Outnumber Kids (Bloomberg)

The Coming Pension Crisis – Part I, Part II (Daily Reckoning)

The U.S. Retirement Crisis: The Elderly are Broke (Gold Telegraph)

The stock-market correction may be only half over, if history is any guide (MarketWatch)

JPMorgan Moves Closer to Urging a Rotation Away From Equities (Bloomberg)

Bullish On Oil Because of Trump? Don’t Be! (Mike “Mish” Shedlock)

What Event Will Sink the Stock Market? Yields? Tariffs? Trump? (Mike “Mish” Shedlock)

The Netflix Bubble (Seeking Alpha)


Economy

The U.S. Inflation Scare May Be Over (Bloomberg)

Subdued CPI Disappoints Economic Illiterates (Mike “Mish” Shedlock)

Yield-Curve Flattening Gets New Life After Inflation Fears Subside (Bloomberg)

10 years after the financial crisis, have we learned anything? (CNN Money)

Cramer on 2008 crisis: It could happen again ‘because no one went to jail the first time’ (CNBC)

A Decade After Bear’s Collapse, the Seeds of Instability Are Germinating Again (Wall Street Journal)

U.S. CEO Optimism Hits Record (Bloomberg)

Yield Curve Turns Threatening – Again (DollarCollapse.com)

Fed Admits ‘Yield Curve Collapse Matters’ (ZeroHedge)

It’s Just Starting: Moody’s Warns A Deluge Of Retail Bankruptcies Is Coming (ZeroHedge)

Economist Lacy Hunt: These Conditions Preceded The Last 7 Recessions (Forbes)

Subprime Auto Bonds Caught in Vise of Rising Costs, Bad Loans (Bloomberg)

Goldman, Atlanta Fed Slash Q1 GDP Forecasts Below 2.0% (ZeroHedge)

America’s inflation problem isn’t high wages, it’s high rent (MarketWatch)

Investors “Unconcerned” About Record Corporate Debt (Dollar Collapse.com)

Trillion-Dollar Deficits Far as the Eye Can See (Daily Reckoning)

The Everything Bubble – Waiting For The Pin (David Stockman)

Is The U.S. Economy Really Growing? (Peter Cook, CFA)

Why It’s Right To Warn About A Bubble For 10 Years (Jesse Colombo)

Are U.S. Treasury Bonds Breaking Out? (Jesse Colombo)

BTFD or STFR? (Michael Lebowitz)

Technically Speaking: Chart Of The Year? (Lance Roberts)

March Madness For Investors (Michael Lebowitz)

Is The Dot.Com Bubble Back? (Lance Roberts)

Volatility Is Back (John Coumarianos)