Tag Archives: Negative Rates

Will Monetary or Fiscal Stimulus Turnaround the Next Recession?

A recession is emerging with interest rate curves inverted, the end of the business cycle at hand, world trade falling, and consumers and businesses beginning to pull back on spending.  The question is: will monetary or fiscal stimulus turn around a recession? 

In this post, we find both stimulus alternatives likely to be too weak to have the necessary economic impact to lift the economy out of a recession. Finally, we will identify the key characteristics of a coming recession and the implications for investors.

Our economy is at the nexus of several major economic trends formed over decades that are limiting monetary and fiscal options. The monetary policy of central banks has caused world economies to be abundant in liquidity, yet producing limited growth. Central bankers in Japan and Europe have been trying to revive growth with $17 trillion injections using negative interest rates.  Japan can barely keep its economy growing with an estimate of GDP at .5 % through 2019. The Japanese central bank holds 200 % of GDP in government debt.  The European Central Bank holds 85 % of GDP in debt and uses negative interest rates as well. Germany is in a manufacturing recession with the most recent PMI in manufacturing activity at 47.3 and other European economies contracting toward near-zero GDP growth.  

Lance Roberts notes that the world economy is not running on a solid economic foundation if there is $17 trillion in negative-yielding debt in his blog, Powell Fails, Trump Rails, The Failure of Negative Rates. He questions the ability of negative interest policies to stabilize world economies,

You don’t have $17 Trillion in negative-yielding sovereign debt if there is economic and fiscal stability.”

Negative interest rates and extreme monetary stimulus policies have distorted financial relationships between debt and risk assets. This financial distortion has created a significantly wider gap between the 90 % and the top 1 % in wealth.

Roberts outlines in the six panel chart below how personal income, employment, industrial production, real consumer spending, real wages, and real GDP are all weakening in the U.S.:

Source: RIA – 8/23/19

Trillions of dollars of monetary stimulus have not created prosperity for all. The chart below shows how liquidity fueled a dramatic increase in asset prices while the amount of world GDP per money supply declined by about 25 %:

Sources: The Wall Street Journal, The Daily Shot – 9/23/19

Low interest rates have not driven real growth in wages, productivity, innovation, and services development that create real wealth for the working class. Instead, wealth and income are concentrated in the top 1 %. The concentration of wealth in the top one percent is at the highest level since 1929. The World Inequality Report notes inequality has squeezed the middle class between emerging countries and the U.S. and Europe. The top 1 % has received twice the financial growth benefits as the bottom 50 % since 1980:

Source: World Inequality Lab, Thomas Piketty, Gabriel Zucman et al – 2018

There are several reasons monetary stimulus by itself has not lifted the incomes of the middle class. One of the big causes is that stimulus money has not translated into wage increases for most workers.  U.S. real earnings for men have essentially been flat since 1975, while earnings for women have increased though basically flat since 2000:

Source: U.S. Census Bureau – 9/10/19

If monetary policy is not working, then fiscal investment from private and public sectors is necessary to drive an economic reversal.  But, will the private and public sector sectors have the necessary tools to bring new life to an economy in decline?

Wealth Creation Has Gone to the Private Sector

The last 40 years have seen the rise of private capital worldwide while public capital has declined. In 2015, the value of net public wealth (or public capital) in the US was negative -17% of net national income, while the value of net private wealth (or private capital) was 500% of national income. In comparison to 1970, net public wealth amounted to 36% of national income, while net private wealth was at 326 %.

Source: World Inequality Lab, Thomas Piketty, Gabriel Zucman et al – 2018

Essentially, world banks and governments have built monetary and fiscal economic systems that increased private wealth at the expense of public wealthThe lack of public capital makes the creation of public goods and services nearly impossible. The development of public goods and services like basic research and development, education and health services are necessary for an economic rebound. The economy will need a huge stimulus ‘lifting’ program and yet the capital necessary to do the job is in the private sector where private individuals make investment allocation decisions.  

Why is building high levels of private capital a problem?  Because, as we have discussed, private wealth is now concentrated in the top 1 %, while 70 % of U.S GDP is dependent on consumer spending.  The 90 % have been working for stagnant wages for decades, right along with diminishing GDP growth.  There is a direct correlation between wealth creation for all the people and GDP growth.

Corporations Are Not In A Position to Invest

Some corporations certainly have invested in their businesses, people, and technology.  The issue is the majority of corporations are now financially strapped.  Many corporate executives have made profit allocation decisions to pay themselves and their stockholders well at the expense of workers, their communities and the economy. 

S & P 500 corporations are paying out more cash than they are taking in, creating a cash flow crunch at a – 15 % rate (that’s right they are burning cash) to maintain stock buyback and dividend levels:

Source: Real Investment Advice

Sources: Compustat, Factset, Goldman Sachs – 7/25/19

In 2018 stock buybacks at $1.01 trillion were at the highest level they have ever been since buybacks were allowed under the 1982 SEC safe harbor provision decision. It is interesting to consider where our economy would be today if corporations spent the money they were wasting on boosting stock prices and instead invested in long term value creation.  One trillion dollars invested in raising wages, research, and development, cutting prices, employee education, and reducing health care premiums would have made a significant impact lifting the financial position of millions. This year stock buybacks have fallen back slightly as debt loads increase and sales fall:

Source: Dow Jones – 7/2019

Many corporations with tight cash flows have borrowed to purchase shares, pay dividends and keep their stock price elevated causing corporate debt to hit new highs as a percentage of GDP (note recessions followed three peaks):

Source: Federal Reserve Bank of Dallas – 3/6/2019

Corporate debt has ballooned to 46 % of GDP totaling $5.7 trillion in 2018 versus $2.2 trillion in 2008.  While the bulk of these nonfinancial corporate bonds have been investment grade, many bond covenants have become weaker as corporations seek more funding. Some bondholders may find their investment not as secure as they thought resulting in significantly less than 100 % return of principal at maturity.

In a recession, corporate sales fall, cash flow goes negative, high debt payments become hard to make, employees are laid off and management tries to hold on.  Only a select set of major corporations have cash hoards to ride out a recession, and others may be able obtain loans at steep interest rates, if at all.  Other companies may try going to the stock market which will be problematic with low valuations.  Plus, investors will be reluctant to buy stock in negative cash flow companies.

Thus, most corporations will be hard pressed to invest the billions of dollars necessary to turnaround a recession. Instead, they will be just trying to keep the doors open, the lights on, and maintain staffing levels to hold on until the day sales stop falling and finally turn up.

Public Sector is Also Tapped Out

In past recessions, federal policy makers have turned to fiscal policy – public spending on infrastructure projects, research development, training, corporate partnerships, and public services to revive the economy.  When the 2008 financial crisis was at its peak the Bush administration, followed by the Obama government pumped fiscal stimulus of $983 billion in spending over four years on roads, bridges, airports, and other projects. The Fed funds interest rate before the recession was at 5.25 % at the peak allowing lower rates to have plenty of impact. Today, with rates at 1.75-2.00 %, the impact will be negligible. In 2008, it was the combined massive injection of monetary and fiscal stimulus that created a V-shaped recession with the economy back on a path to recovery in 18 months. It was not monetary policy alone that moved the economy forward.  However, the recession caused lasting financial damage to wealth of millions. Many retirement portfolios lost 40 – 60 % of their value, millions of homeowners lost their homes, thousands of workers were laid off late in their careers and unable to find comparable jobs.  The Great Recession changed many people’s lives permanently, yet it was relatively short-lived compared to the Great Depression.

As noted in the chart above, public sector wealth has actually moved to negative levels in the U.S. at – 17 % of national income.  Our federal government is running a $1 trillion deficit per year.  In 2007, the federal government debt level was at 39 % of GDP. The Congressional Budget Office projects that by 2028 the Federal deficit will be at 100 % of GDP

Source: CBO – 4/9/19

We are at a different time economically than 2008. Today with Federal debt is over 100% of GDP and expected to grow rapidly. The Feds balance sheet is still excessive and they formally stopped reducing the size (QT).  In a recession federal policymakers will likely make spending cuts to keep the deficit from going exponential. Policy makers will be limited by the twin deficits of $22.0 trillion national debt and ongoing deficits of $1+ trillion a year, eroding investor confidence in U.S. bonds. The problem is the political consensus for fiscal stimulus in 2008 – 2009 does not exist today, and it will probably be even worse after the 2020 election. Our cultural, social and political fabric is so frayed as a result of decades of divisive politics it is likely to take years to sort out during a recession. Our political leaders will be fixing the politics of our country while searching for intelligent stimulus solutions to be developed, agreed upon and implemented.

What Will the Next Recession Look Like?

We don’t know when the next recession will come. Yet, present trends do tell us what the structure of a recession might look like, as a deep U- shaped, slow recovery measured in years not months:

  • Corporations Short of Cash – Corporations already strapped are short on cash, will lay off workers, pull back spending, and are stuck paying off huge debts instead of investing.
  • Federal Government Spending Cuts – The federal government caught with falling revenues from corporations and individuals, is forced to make deep cuts first in discretionary spending and then social services and transfer funding programs. The reduction of transfer programs will drive slower consumer spending.
  • Consumers Pull Back Spending – Consumers will be forced to tighten budgets, pay off expensive car loans and student debt, and for those laid off seeking work anywhere they can find a job.
  • World Trade Declines – World trade will not be a source of rebuilding sales growth as a result of the China – US trade war, and tariffs with Europe and Japan.  We expect no trade deal or a small deal with the majority of tariffs to stay in place. In other words, just reversing some tariffs will not be enough to restart sales. New buyer – seller relationships are already set, closing sales channels to US companies. New country alliances are already in place, leaving the US closed out of emerging high growth markets.  A successor Trans Pacific Partnership (TPP) agreement with Japan and eleven other countries was signed in March, 2018 without the US. China is negotiating a new agreement with the EU. EU and China trade totals 365 billion euros per year. China is working with a federation of African countries to gain favorable trade access to their markets.
  • ­Pension Payments in Jeopardy – Workers dependent on corporate and public pensions may see their benefits cut from pensions, which are poorly funded today with markets at all-time highs. GE just announced freezing pensions for 20,000 employees, the harbinger of a possible trend that will  reduce consumer spending
  • Investment Environment Uncertain – Uncertainty in investments will be extremely high, ‘get rich quick’ schemes will flourish as they did in 2008 – 2009 and 2000.
  • Fed Implements Low Rates & QE – The Fed is likely to implement very low interest rates (though not negative rates), and QE with liquidity in abundance but the economy will have low inflation, and declining GDP feeling like the Japanese economic stasis – ‘locked in irons’.

Implications for Investors

The following recommendations are intended for consideration just prior or during a recession with a sharp decline in the markets, not necessarily for today’s markets.

Cash – It is crucial to maintain a significant cash hoard so you can purchase corporate stocks when they cheapen. The SPX could decline by 40 – 50 % or more when the economy is in recession.  Yet, good values in some stocks will be available.  At the 1500 level, there is an excellent opportunity to make good long term growth and value investments based on sound research.

CDs – as Will Rogers noted during the Depression, “I’m more interested in Return of my Capital than Return on my Capital”, a prudent investor should be too.  CDs are FDIC insured while offering lower interest rates than other investments. Importantly, they provide return of capital and allow you to sleep at night.

Bonds – U.S. Treasuries certainly provide safety, return of principal, and during a recession will provide better overall returns than high-risk equity investments. Corporate bonds may come under greater scrutiny by investors even for so-called ‘blue chips’ like General Electric. The firm is falling on hard times with $156 billion in debt. GE is seeking business direction and selling off assets. The major conglomerate’s bonds have declined in value by 2.5 % last year with their rating dropped to BBB. Now with new management the price of GE bonds is climbing up slightly.

Utilities – are regulated to have a profit.  While they may see declining revenues due to less energy use by corporations and individuals, they still will pay dividends to shareholders as they did in 2008.  Consumer staple companies are likely to be cash flow strained; most did not pay dividends to investors during the 2008 – 2009 recession. REITs need to be evaluated on a company by company basis to determine how secure their cash streams are from leases. During the 2008 – 2009 downturn, some REITs stopped paying dividends due to declining revenues from lease defaults.

Growth & Value Equities– invest in new sectors that have government support or emerging demand based on social trends like climate change: renewables, water, carbon emission recovery, environmental cleanup. From our Navigating A Two Block Trade World – US and China post, we noted possible investments in bridge companies between the two trade blocks; services, and countries that act as bridges like Australia. Look for firms with good cash positions to ride out the recession, companies in new markets with sales generated by innovations, or problem solving products that require spending by customers.  For example, seniors will have to spend money on health services. Companies serving an increasingly aging population with innovative low cost health solutions are likely to see good demand and sales growth.

The intelligent investor will do well to ‘hope for the best, but plan for the worst’ in terms of portfolio management in a coming recession.  Asking hard questions of financial product executives and doing your own research will likely be keys to survival.

In the end, Americans have always pulled together, solved problems, and moved ahead toward an even better future. After a reversion to the mean in the capital markets and an economic recession things will improve.  A reversion in social and culture values is likely to happen in parallel to the financial reversion. The complacency, greed, and selfishness that drove the present economic extremes will give way to a new appreciation of values like self-sacrifice, service, fairness, fair wages and benefits for workers, and creation of a renewed economy that creates financial opportunities for all, not just the few.

Patrick Hill is the Editor of The Progressive Ensign, https://theprogressiveensign.com/ writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica and Okta to provide investment and economic insights. Twitter: @PatrickHill1677.

What is Bill Dudley Thinking?

On August 27, 2019, Bill Dudley, former Chief Economist for Goldman Sachs and President of the Federal Reserve Bank of New York from 2009-2018, published a stunning editorial in Bloomberg (LINK). After reading the article numerous times, there are a few noteworthy observations worth discussing.

Dudley’s Myopic View

Before we dissect Bill Dudley’s opinions and try to understand his motivations, consider the article’s subtitle- “The central bank should refuse to play along with an economic disaster in the making.”

There is little doubt that Trump’s hard stance on trade and the seemingly impetuous use of tariffs and harsh Twitter commentary presents new challenges for economic growth. Global trade has slowed and manufacturers are retrenching to limit their risks.

Whether the trade war is or will be an “economic disaster” as Dudley says, is up for debate. What is remarkable about this comment is the lack of understanding of the economic instability prior to the trade war and how it got to that point.   

As we have discussed on numerous occasions, the Fed has used excessive monetary policy over the last decade to promote economic growth. Dudley and the Fed fail to recognize that their actions have led to rampant speculation in the financial markets, encouraged significant uses of debt for nonproductive purposes, and have fueled the wealth and income divergences. More concerning, their actions have reduced the natural economic growth rate of the country for years and possibly decades to come. Dudley and colleagues arranged the tinder for what will inevitably be an economic disaster. Trump may or may not be the spark.

Dudley sets up his article with a leading question-“This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?”

He answers, in part, by saying that, based on the Fed’s obligations and “conventional wisdom”, the Fed should respond to economic weakness due to the trade war by “adjusting monetary policy accordingly.” Historically, the Fed has changed policy to counter outside, non-economic factors.

Dudley, however, takes a different tack and asks if easier Fed policy would encourage “the President to escalate the trade war further.” This is where the editorial gets political. He goes on to state his case for the Fed taking a hard line and not adjust monetary policy if the trade war negatively affects economic activity. Dudley believes that by doing nothing, the Fed would:

  • Discourage further trade war escalation
  • Reinforce the Fed’s independence
  • Preserve much needed “ammunition”, as there is little room to cut rates

In the next paragraph, he stresses Trump’s attacks on Chairman Powell and provides more reasoning for the Fed to leave policy alone. Dudley believes the Fed, by not adjusting monetary policy to offset the effects of the trade war in progress, would send a clear signal to the President that he bears the risks of a recession and losing an election. The Fed, thereby, would not be complicit.  

Before going on, we think it’s appropriate to re-emphasize that the next recession will be amplified due to Fed actions over the last ten years. Bernanke should never have extended extraordinary measures beyond the first round of quantitative easing, and Janet Yellen had ample opportunities to raise interest rates and reduce the Fed’s balance sheet during her tenure. Trying to place all of the blame on the current President, or anyone else for that matter, may work in the media and even the populace but it does not line up with the facts.

Dudley’s Summary

Dudley concludes with a stunning and politically motivated statement- “There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”   

Dudley is essentially imploring Powell to base monetary policy on the coming election. If Fed independence is what Dudley cherishes, he certainly did not do the Fed any favors. This implicates elites like Dudley, one of the “Davos Men,” who think they know better than the collective decisions of people engaged in free-market exchanges. It also makes him guilty of an effort to manipulate an election.


Here is an important question. Is this editorial solely Dudley’s thoughts, or was Jerome Powell and the Fed involved in any way?  The Fed has already come out against the article, but in Washington, nothing is ever that clear cut.

If the editorial was in some way subsidized or suggested by Powell, the implications of the Fed going after the President will call into question their independence in the future. No matter how deeply improper that is, it certainly leaves open the question of whether or not people are justified in those efforts. In the same way that no Fed official should ever be viewed as complicit, no President should impose his will from the bully pulpit of the Presidency to influence monetary policy.

From an investment perspective, this is not good. The markets have benefited from a Fed that has promoted asset price inflation and sought to convince us that the economic cycle is dead. Despite sky-high valuations, investors tend to believe that these valuations are fair and that the Fed will always be there as a reliable safety net.

We do not know how this saga will end, but we do know that if confidence in the Fed is compromised, investors will likely vote with their feet.

Caroline’s Summary

We leave you with some thoughts on the subject from Caroline Baum of MarketWatch:

“It is hard to fathom what Dudley was thinking in advocating such an off-the-wall idea of factoring political outcomes into policy decisions. The Fed has a dual mandate from Congress to promote maximum employment and price stability. There is nothing in that mandate, or in the Federal Reserve Act, about influencing election outcomes. Nothing in there either about being part of “the Resistance” to this president.

That would be a dangerous expansion of Federal Reserve’s operating framework.”

The Mechanics of Absurdity

Over the past few decades, the central banks, including the Federal Reserve (Fed), have relied increasingly on interest rates to help modify economic growth. Interest rate management is their tool of choice because it can be effective and because central banks regulate the supply of money, which directly effects the cost to borrow it. Lower interest rates incentivize borrowers to take on debt and consume while dis-incentivizing savings.

Regrettably, a growing consequence of favoring lower than normal interest rates for prolonged periods is that consumers, companies, and nations grow increasingly indebted as a percentage of their respective income. In many cases, consumption is pulled from the future to the present day. Accordingly, less consumption is needed in the future and a larger portion of income and wealth must be devoted to servicing the accumulated debt as opposed to productive ventures which would otherwise generate income to help pay off the debt.

Today, interest rates are at historically low levels around the globe. Interest rates are negative in Japan and throughout much of Europe. In this article, we expound on the themes laid out in Negative is the New Subprime, to discuss the mechanics of negative-yielding debt as well as the current mindset of investors that invest in negative-yielding debt.

Is invest the right word in describing an asset that when held to maturity guarantees a loss of capital?

Negative Yield Mechanics

Negative yields are not only bestowed upon sovereign debt, as investment grade and even some junk-rated debt in Europe now carry negative yields. Even stranger, Market Watch just wrote about a Danish bank offering consumers’ negative interest rate mortgages (LINK).

You might be thinking, “Wow, I can take out a negative interest rate loan, receive payments every month or quarter and then pay back what was lent to me?” That is not how it works, at least not yet. Below are two examples that walk through the lender and borrower cash flows for negative-yielding debt.

Some of the bonds trading at negative yields were issued when yields were positive and therefore have coupon payments. For example, in August of 2018, Germany issued a 30 year bond with a coupon of 1.25%. The price of the bond is currently $143, making the yield to maturity -0.19%. Today, it will cost you $14,300 to buy $10,000 face value of the bond. Going forward, you will receive coupon payments of $125 a year and ultimately receive $10,000 in 2048. Over the next 29 years you will receive $3,625 in coupon payments but lose $4,300 in principal, hence the current negative yield to maturity.

Bonds issued with a zero coupon with negative yields are similar in concept but the mechanics are slightly different than our positive coupon example from above. Germany issued a ten-year bond which pays no coupon. Currently, the price is 106.76, meaning it will cost an investor $10,676 to buy $10,000 face value of the bond. Over the next ten years the investor will receive no coupon payments, and at the end of the term they will receive $10,000, resulting in a $676 loss. The lower the negative yield to maturity, the higher premium to par and the greater loss of principal at maturity.

We suspect that example two, the zero-coupon bond issued at a price above par, will be the issuance model going forward for negative yielding bonds.


At this point, after reviewing the cash flows on the German bonds, you are probably asking why an investor would make an investment in which they are almost guaranteed to lose money. There are two predominant reasons worth exploring.

Safety: Investors that store physical gold in a gold vault pay a fee for safe storage. Individuals with expensive jewelry or other keepsakes pay banks a fee to use their vaults. Custodians, such as Fidelity or Schwab, are paid fees for the safekeeping of our stocks and bonds.

Storing money, as a deposit in a bank, is a little different from the prior examples. While banks are a safer place to store money than a personal vault, mattress, or wallet, the fact is that deposits are loans to the bank. Banks traditionally pay depositors an interest rate so that they have funds they can lend to borrowers at higher rates than the rate incurred on the deposit.

With rates negative in Europe and Japan, their respective central banks have essentially made the storing of deposits with banks akin to the storage of gold, jewelry, and stocks – they are subject to a safe storage fee.  Unfortunately, many people and corporations have no choice but to store their money in negative-yielding instruments and must lend money to a bank and pay a “storage fee.”  

On a real return basis, in other words adjusted for inflation, whether an investor comes out ahead by lending in a negative interest rate environment, depends on changes to the cost of living during that time frame. Negative yielding bonds emphatically signal that Germany will be in a deflationary state over the next ten years. With global central bankers taking every possible step, legal and otherwise, to avoid deflation and generate inflation, betting on deflation via negative yielding instruments seems like a poor choice for investors.

Greater Fool Theory: Buying a zero-coupon bond for 101 today with the promise of receiving 100 is a bad investment. Period. Buying the same bond for 101 today and selling it for 102 tomorrow is a great investment. As yields continue to fall further into negative territory, the prices of bonds rise. While the buyer of a negative-yielding bond may not receive a coupon, they can still profit, and sometimes appreciably as yields decline.

This type of trade mindset falls under the greater fool theory. Per Wikipedia:

“In finance and economics, the greater fool theory states that the price of an object is determined not by its intrinsic value, but rather by irrational beliefs and expectations of market participants. A price can be justified by a rational buyer under the belief that another party is willing to pay an even higher price. In other words, one may pay a price that seems “foolishly” high because one may rationally have the expectation that the item can be resold to a “greater fool” later.”

More succinctly, someone buying a bond that guarantees a loss can profit if they can find someone even more willing to lose money.

Scenario Analysis

Let’s now do a little scenario analysis to understand the value proposition of holding a negative-yielding bond.

For all three examples we use a one year bond to keep the math simple. The hypothetical bond details are as follows:

  • Issue Date: 9/1/2019
  • Maturity Date: 9/1/2020
  • Coupon = 0%
  • Yield at Issuance: -1.0%
  • Price at Issuance: 101.00

Greater fool scenario: In this scenario, the bondholder buys the new issue bond at 101 and sells it a week later at 101.50. In this case, the investor makes a .495% return or almost 29% annualized.

Normalization: This next scenario assumes that yields return to somewhat normal levels and the holder sells the bond in six months.If the yield returns to zero in six months, the price of the bond would fall to 100. In this case, our investor, having paid 101.00, will lose 1% over the six month period or 2% annualized.

Hold to maturity: If the bond is held to maturity, the bondholder will be redeemed at par losing 1% as they are paid $100 at maturity on a bond they purchased for $101.


Writing and thinking about the absurdity of negative yields is taxing and unnatural. It forces us to contemplate basic financial concepts in ways that defy common sense and rational thought. This is not a pedantic white paper discussing hypothetical central bank magic tricks and sleight of hand; this is about something occurring in real-time.

Excessive monetary policy has been the crutch of growth for decades spurred by an intense desire to avoid and minimize otherwise healthy and routine economic corrections. It was fueled by the cult of personality which took over in the 1990s when Alan Greenspan was labeled “The Maestro”. He, Robert Rubin, and Lawrence Summers were christened “The Committee to Save the World” by Time magazine in February 1999.  Greenspan was then the subject of a biography by famed Watergate journalist Bob Woodward infamously titled Maestro in 2000.

Under Greenspan and then Bernanke, Yellen and now Powell, rational monetary policy and acknowledgement of naturally occurring business cycles has taken a back seat to avoidance of these economic cycles at all cost. As a result, central bankers around the world are trying justify the inane logic of negative rates.

Weekend Reading: Complacency Rules The Day

Chart of the Day

Today’s chart of the day is the high-yield or “junk” bond spread, which shows the percentage difference between high-yield bond (corporate bonds that are beneath investment grade) yields and investment grade corporate bonds or U.S. Treasury bonds. In central bank-manipulated environments like we’ve had for several decades, very low high-yield bond spreads indicate the formation of a dangerous economic bubble. The high-yield spread was unusually low during the late-1990s Dot-com bubble and mid-2000s housing bubble, as well as during the current “Everything Bubble” that I have been warning about. Click here to read the full article about how high-yield bond spreads reveal dangerous investor complacency.

High Yield Spread

You can also watch my video on this topic:



The End of (Artificial) Stability (Daily Reckoning)

Bill Gates says it’s ‘a certainty’ that we will have another financial crisis similar to 2008 (Business Insider)

Larry Summers Warns Next U.S. Recession Could Outlast Previous One (Bloomberg)

Global Growth Narrative Stumbles As Nomura Warns “Best May Now Be Behind Us” (ZeroHedge)

Foolishness of Trump’s Steel Tariffs in One Image (Mike “Mish” Shedlock)

Trump’s Tariffs Deal a Blow to Already-Shrinking U.S. Auto Sales (Bloomberg)

A Great Big Warning Sign (Peter Schiff)

Tudor Jones says US will ‘regret’ the tax cut (CNBC.com)

Is The U.S. Losing Its Tech Edge? Trade Data Hints Yes (Forbes)

Debt Matters (Sven Henrich)

Inflation is in the Rear-View Mirror (Mike “Mish” Shedlock)

U.S. Pending Home Sales Unexpectedly Dive to Lowest Level in 3.5 Years (Mike “Mish” Shedlock)

Senate Republicans Cast Doubt on Trump’s Infrastructure Plan (Bloomberg)

US Gross National Debt Spikes $1 Trillion in Less Than 6 Months (Wolf Richter)

The Real Reason Behind The U.S. Student Debt Problem (Forbes)

Weekend Reading: Tax Reform Doing Exactly What We Expected

Shortly after the Tax Cut/Reform bill was passed by Congress, I did some analysis discussing the various myths of how those “tax cuts,” since they were primarily focused on corporations, would actually turn out.

Well, just two months into 2018, we already have some answers.

Myth 1:  Tax cuts will lead to a huge ramp up in earnings.

The problem with the idea that tax cuts will result in a huge increase in bottom-line earnings, is that estimates got way ahead of reality.

For example, in October of 2017, the estimates for REPORTED earnings for Q4, 2017 and Q1, 2018 were $116.50 and $119.76 respectively. As of February 15th, the numbers are $106.84 and $112.61 or a difference of -$9.66 and -7.15 respectively. 

First, while asset prices have surged to record highs, reported earnings estimates through Q3-2018 have already been ratcheted back to a level only slightly above where 2017 was expected to end in 2016. As shown by the red horizontal bars – estimates through Q3 are at the same level they were in January, 2017.  (Of course, “hope springs eternal that Q4 of this year will see one of the sharpest ramps in earnings in S&P history.) 

Wall Street ALWAYS over-estimates earnings and by about 33% on average. That overestimation provides a significant amount of headroom for Wall Street to be disappointed by year end, particularly once you factor in the “effective” tax rate that most companies actually pay.

But even if we give Wall Street the benefit of the doubt and assume their predictions will be correct for the first time in human history, stock prices have already priced in twice the rate of EPS growth.

It is quite likely that once again Wall Street is extrapolating the last few quarters of earnings growth ad infinitum and providing even more fodder for the market rally. It is also quite likely Wall Street will be proven wrong on earnings as so often has occurred in the past.

Myth 2: Corporations will use those tax cuts to hire employees and boost wages

As I discussed previously:

“The same is true for the myth that tax cuts lead to higher wages. Again, as with economic growth, there is no evidence that cutting taxes increases wage growth for average Americans. This is particularly the case currently as companies are sourcing every accounting gimmick, share repurchase or productivity increasing enhancement possible to increase profit growth.

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” and something RIA analyst, Jesse Colombo, noted yesterday:

“How have U.S. corporations been deploying their new influx of capital? Unlike in prior cycles – when corporations favored long-term business investments and expansions – corporations have largely focused on juicing their stock prices via share buybacks, dividends, and mergers & acquisitions. While this pleases shareholders and boosts executive compensation, this short-term approach is detrimental to the long-term success of American corporations. The chart below shows the surge in share buybacks and dividends paid, which is a direct byproduct of the current artificially low interest rate environment. Even more alarming is the fact that share buybacks are expected to exceed $1 trillion this year, which would blow all prior records out of the water. The passing of President Donald Trump’s tax reform plan was the primary catalyst that encouraged corporations to dramatically ramp up their share buyback plans.”

SP500 Buybacks & Dividends By Year

“What is even more unwise about the current share buyback mania is the fact that it is occurring at extremely high valuations, which is tantamount to ‘throwing good money after bad.'”

Furthermore, there is scant evidence that wages are improving for the masses versus those in the executive “C-suite.” 

While well-designed tax reforms can certainly provide for better economic growth, those tax cuts must also be combined with responsible spending in Washington. That has yet to be the case as policy-makers continue to opt for “continuing resolutions” that grow expenditures by 8% per year and tack on another $2 Trillion in spending rather than doing the hard work of passing a budget.

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. 

In the end, it is all working out exactly like we expected.

Here is your weekend reading list.

Economy & Fed


Deficits Do Matter

Research / Interesting Reads

“Based on my own personal experience – both as an investor in recent years and an expert witness in years past – rarely do more than three or four variables really count. Everything else is noise.” ― Martin Whitman

Questions, comments, suggestions – please email me.

Weekend Reading: Hurricane Boost Dissipates

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.

“The fallacy of the ‘broken window’ narrative is that economic activity is only changed and not increased. The dollars used to pay for the window can no longer be used for their original intended purpose.”

If economic destruction led to long-term economic prosperity, then the U.S. should just regularly drop a nuke on a major city and then rebuild it. When you think about it in those terms, you realize just how silly the whole notion is.

However, in the short-term, natural disasters do “pull forward” consumption as individuals need to rebuild and replace what was previously lost. This activity does lead to a short-term boost in the economic data, but fades just as quickly.

A quick look at core retail sales over the last few months, following the hurricanes, shows the temporary bump now fading.

The other interesting aspect of this is the rise in consumer credit as a percent of disposable personal income. The chart below indexes both consumer credit to DPI and retail sales to 100 starting in 1993. What is interesting to note is the rising level of credit card debt required to sustain retail sales.

Given that retail sales make up roughly 40% of personal consumption expenditures which in turn comprises roughly 70% of GDP, the impact to sustained economic growth is important to consider.

Importantly, the latest CPI, inflation, report showed a strong rise that was directly attributable to rising rent, health care, and oil prices. Even the previous increases in retail sales were primarily comprised of gasoline, which directly impacts consumers ability to spend money on other stuff, and building products from rebuilding efforts.

Importantly, what the headlines miss is the growth in the population. The chart below shows retails sales divided by those actually counted as part of the labor force. (You’ve got to have a job to buy stuff, right?) 

As you can see, retail sales per labor force participant was on a 5% annualized growth trend beginning in 1992. However, after the financial crisis, the gap below that long-term trend has yet to be filled as there is a 23.2% deficit from the long-term trend. (If we included the entirety of the population, given the number of people outside of the labor force that are still consuming, the trajectory would be worse.)

The next chart below shows the annual % change of retail sales per labor force participant. The trend has been weakening since the beginning of 2017 and shows little sign of increasing currently.

While tax cuts may provide a temporary boost to after-tax incomes, that income will simply be 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. It is also why, as wages have continued to stagnate, that the cost of living now exceeds what incomes and debt increases can sustain.

Yes, corporations will do well under the “tax reform” plan. Already compensation for the top 20% of income earners are seeing wages rise, while corporations have doubled their planned stock “buybacks” to boost earnings per share. But such does not increase the take-home pay for the bottom 80% of the population that drives the majority of economic growth long-term.

Very likely, the next two quarters will be weaker than expected as the boost from hurricanes fade and higher interest rates take their toll on consumers. So, when mainstream media acts astonished that economic growth has once again slowed, you will already know why.

Here is your weekend reading list.

Economy & Fed


A Warning Shot For Passive Investing

Research / Interesting Reads

“When an investor focuses on short-term investments, he or she is observing the variability of the portfolio, not the returns – in short, being fooled by randomness.” ― Nassim Taleb

Questions, comments, suggestions – please email me.

Weekend Reading: Did The Market Just Get “Woke?”

Since the beginning of this year, we have been warning of the potential for a correction. Of course, such warnings seemed pointless as the nearly “parabolic” rise in the markets seemed unstoppable. The chart below shows the current acceleration through the end of January.

But all of a sudden, something seems to have changed as the market stumbled this past week and has been unable to regain its footing.

So, what “woke” the markets?

Was it the sudden realization that Central Banks globally are reducing Q.E. programs? Or, that economic growth may be weaker than expected given recent numbers? Or, something else?

Whatever, the excuse turns out to be, the real culprit is seen in the chart below.

As I have been discussing “ad nauseam” over the last couple of years, interest rates are now stuck in a trading range that will likely remain between 0-1% during the next recessionary drag with a 3% ceiling as seen in 2014. Importantly, rates are at levels of overbought conditions only seen 3-times previously going back to 1980.

I am going to discuss this in more detail in this weekend’s forthcoming “Real Investment Report.” However, the point here is that since interest rates drive everything from borrowing, to spending, to capital investment – higher rates negatively impact economic growth. Since stocks are ultimately a reflection of the economy, it is hard to suggest that stocks will continue to rise in the face of higher rates.

Furthermore, higher rates are rapidly crushing the one argument used by bullish investors over the last eight years which has been “low rates justify higher valuations.” As I have repeatedly stated in the past, it is one argument that can literally change overnight.

Is this the beginning of the next major market correction?

Probably not.

There is simply too much exuberance currently in the market. It will take several failed rally attempts to begin to erode that base of bullishness.

But therein lies exactly what you want to look for. Rallies that fail at previous resistance levels, rising volatility and declining rates of participation.

As with every previous major market correction in history, investors were always given multiple warnings BEFORE the crash actually occurred.

(We have a special report coming out next week to our newsletter subscribers only discussing these warning signs.)

Of course, few investors heeded those warnings because they had been lulled into the belief “this time is different.”

It wasn’t then. It won’t be next time either.

Here is your weekend reading list.

Economy & Fed


You Should Never Time The Market?

Cryptocurrency Mania

Research / Interesting Reads

“Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.” ― Fred Schwed Jr.

Questions, comments, suggestions – please email me.

Weekend Reading: What Could Possibly Go Wrong?

What goes up, eventually comes down.

That is just reality.

The bull market that began in 2009, has now entered the final stage of “capitulation” as investors throw caution to the wind and charge headlong into the markets with reckless regard for the consequences.

Of course, it isn’t surprising given the massive amounts of liquidity continually injected into the financial markets and global Central Banks have now figured out that continually rising financial markets solve much of the world’s ills. Simply, with enough liquidity, you can cover up bad (credit risks) by guaranteeing holders they will never default.

It’s genius.  It’s a “no lose” investment scheme.

Unfortunately, we have seen this repeatedly in the past.

In the 1980’s it was “Portfolio Insurance” – a “no lose” investment program that eventually erupted into the crash of 1987. But not before the market went into a parabolic advance first.

In the 1990’s – it was the dot.com phenomenon which was “obviously” a “no lose” proposition. Even after Alan Greenspan spoke of “irrational exuberance,” two years later the market went parabolic once again.

Then in 2006-2007, banks invented the CDO-squared, a collateralized derivative obligation based on other collateralized derivative obligations. It was a genius way to invest with “no risk” because the real estate market had never crashed in history.

Today, it is once again an absolute “certainty” that markets will rise from here as global Central Banks have it all under control.

What possibly could go wrong?

Here is your weekend reading list.

Economy & Fed


The “Honey Badger” Market

Cryptocurrency Mania

Research / Interesting Reads

“Strategy without tactics is the longest path to victory; tactics without strategy is the noise before defeat.” – Sun Tzu, The Art of War

Questions, comments, suggestions – please email me.

Weekend Reading: What You Do Matters Most

Confidence is soaring…everywhere.

In last weekend’s newsletter, we showed multiple charts of surging investor confidence all at, or near, record levels. But while investors are indeed confident about the markets over the coming year, business and manufacturing surveys (sentiment) have also surged to near record levels. The National Federation Of Independent Businesses (NFIB) just released their December survey which showed a near record level of confidence for business owners.

One thing to notice is that spikes in optimism have generally occurred near peaks in the market.

Why should that be the case?

The reason is simple, exuberance tends to be disappointed by reality. When you dig down into the NFIB survey what small business owners are “saying,” and “doing,” are two different things.

For example, while business owners “SAY” they are optimistic about the economy currently, when it comes to committing their capital they are not nearly as brash. In fact, their level of planned capital expenditures continues to run at levels more normally associated with weak, or recessionary, environments.

What about consumers? They are optimistic as well.

Well, maybe not as much as you think. The survey shows that while business owners “SAY” sales should be improving, their biggest concern, which is spiking higher, is “poor sales.” 

Furthermore, notice that while there has been an immense amount of “chatter” about how the recent tax reform has lowered the burden on business which will lead to a surge in economic growth, etc., the level of concern over the amount of taxes being paid has budged from post-recessionary levels. While taxes were recently lowered, the “cost” of labor is rising which will absorb, for small business owners, much of the impact of any tax cut received. 

There is also a big difference between what the “hope” sales will be and what “actually” occurs. With such high levels of expectations currently, the risk of disappointment in future sales volumes is elevated.

While there is much “hope” that economic growth will boom this coming year due to regulatory and tax changes, history suggests the current levels of “economic optimism” are also likely to be disappointed.

Ultimately, for the markets and for investors, it is what you DO that matters the most.

Investors are currently set up for disappointment on many fronts over the next 12-24 months. While “exuberance” currently reigns, and investors are piling into risk equity with reckless abandon, the markets will continue to push higher.

Just be aware that “reality” will eventually set in.

Here is your weekend reading list.

Economy & Fed


RIA Chart Book: Q4-2017 Most Important Charts

Cryptocurrency Mania

Research / Interesting Reads

“Risk comes from not knowing what you are doing.” – Warren Buffett

Questions, comments, suggestions – please email me.

Weekend Reading: The “Brawny” Market

Yesterday, as I was researching the data on the Fed’s balance sheet as it relates to the future direction of interest rates, I stumbled across an interesting piece of analysis.

The chart below shows the deviation of the market from the underlying liquidity provided by the Fed’s balance sheet.

Not surprisingly, in 2006-2007 as the deviation reached extremes, market liquidity became problematic. While we only recognized this in hindsight, the correlation is important to consider.

Currently, this “Brawny Market” has become the “quicker picker-upper” of market liquidity. The issue becomes, as discussed yesterday, with the Federal Reserve beginning to extract liquidity from the markets, along with the ECB tapering their QE program simultaneously, at what point does liquidity once again become a problem? 

For now, however, market exuberance has completely overtaken investor mentalities. Such is not surprising as we head into the 9th-year of the current bull market advance. As shown in the chart below, the current market conditions, while bullish and positive which keeps portfolios allocated toward risk, are at levels seen only three-times previously.

Such does not mean a “crash” is coming tomorrow, but it does suggest that this “Brawny Market” has much more limited upside than what most investors currently believe.

Remain long equities for now. But don’t forget that what goes up, will eventually come down. So it is worth paying attention to the risk and having a plan of action in place to do with the eventual reversion when it comes.

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

Economy & Fed



Technically Speaking: Revisiting Bob Farrell’s 10-Rules

Cryptocurrency Mania

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.

Weekend Reading: Ignorance Is No Excuse

The “tax bill cometh.” According to the press, this is going to be the single biggest factor to jump-starting economic growth since the invention of the wheel.

Interestingly, even the Fed’s economic projections are suggesting that economic growth will pick up over the next two years from the impact of tax cuts. (Chart is the average of the range of the Fed’s estimates.)

Of course, you should note the Federal Reserve has NEVER accurately forecasted future economic growth. In fact, it has become an annual tradition of over-estimating growth and then slowly ratcheting down estimates as reality failed to achieve overly optimistic assumptions.

However, despite the Administrations hopes of long-term economic growth rates of 3% or more, in order to pay for the deficits created by cutting revenue, even the Fed has maintained their long-run outlook of less that 2% annualized growth. (Down from 2.7% in 2011) Hardly the supportive stamp of endorsement for the “greatest tax cut” of all-time.

But for economic growth to blossom, the consumer will have to pull their weight given consumption makes up roughly 70% of GDP. The problem, as witnessed by the latest retail sales report, is that consumptive spending is far weaker than headlines suggest.

On Thursday, the retail sales report for November clicked up 0.8%. Good news, right?

Not so fast.

First, sales of gasoline, which directly impacts consumers ability to spend money on other stuff, rose sharply due to higher oil prices and comprised 1/3rd of the increase. Secondly, building products also rose sharply from the ongoing impact of rebuilding from recent hurricanes and fires. Again, this isn’t healthy longer-term either as replacing lost possessions drags forward future consumptive capacity.

But what the headlines miss is the growth in the population. The chart below shows retails sales divided by those actually counted as part of the labor force. (You’ve got to have a job to buy stuff, right?) 

As you can see, retail sales per labor force participant was on a 5% annualized growth trend beginning in 1992. However, after the financial crisis, the gap below that long-term trend has yet to be filled as there is a 22.7% deficit from the long-term trend. (If we included the entirety of the population, given the number of people outside of the labor force that are still consuming, the trajectory would be worse.)

But wait, retail sales were really strong in November?

Again, not so fast.

The chart below shows the annual % change of retail sales per labor force participant. The trend has been weakening since the beginning of 2017 and shows little sign of increasing currently.

While tax cuts may provide a temporary boost to after-tax incomes, that income will simply be 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. It is also why, as wages have continued to stagnate, that the cost of living now exceeds what incomes and debt increases can sustain.

Yes, corporations will do well under the “tax reform” plan, and while the average American may well see an increase in take-home pay, it will unlikely change their financial situation much. As a result, economic growth will likely remain weak as the deficit expands to $1 Trillion over the next couple of years and Federal debt marches toward $32 trillion. As noted by the CFRB

“Fiscal conservatives on the right have lost a massive amount of credibility based on the GOP budget they passed this year. After many years of calling for a budget that cut spending, reformed entitlements, controlled the debt and balanced the budget, they failed to enact even one of those goals when they finally had a chance.

Out of a possible $47 trillion in spending over 10 years, the budget called for cutting an utterly pathetic $1 billion. Their fiscal credibility died with a whimper. I doubt that credibility can be regained, but it seems quite likely that some of the more conservative GOP members will call for letting the sequester hit.”

So, when someone acts astonished that things didn’t work out as planned…just remind them that “ignorance is no excuse.” 

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

Trump, Economy & Fed


Research / Interesting Reads

“When the music stops in terms of liquidity, things will get complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” – Chuck Prince, Citigroup

Questions, comments, suggestions – please email me.

Weekend Reading: Recession Risk Hidden In Tax Bill

Since the election, equity bulls have been pinning their hopes on “tax cuts” as the needed injection to support currently elevated stock prices. Stocks have advanced sharply since the election on these expectations, and while earnings have recovered, primarily due to the rise in oil prices, whatever economic growth was to come from tax reform has likely already been priced in. 

For some background on our views, both Michael Lebowitz and I have been discussing the tax bills as they are currently proposed since May of this year.

Buy The Rumor – Sell The News

We are currently in the second longest economic expansion since WWII. While Republican lawmakers are betting on jump-starting economic growth, the problem becomes the length of the current liquidity-driven expansion. All economic cycles end, and we are already closer to the end of the current expansion than not.

However, Patrick Watson over at Mauldin Economics recently made a brilliant observation. To wit:

“The gap between the gray line (potential GDP) and the red line (actual GDP) represents unused capacity. You can see we had a lot of it at the recession’s 2009 depth. The gap slowly shrank since then. Now it’s closed.

Great news, right? Yes, it is—but don’t celebrate just yet.

Actual GDP can’t stay above potential GDP for long before bad things start happening. This chart proves it:”

“We see here how GDP moved above and below its potential since the 1970s. Notice that each time the green line went above zero, a recession (the gray bars) began soon after.

‘Soon’ can vary, of course. GDP ran above potential for extended periods in the late 1990s and 2006–2007, but in both cases, intense downturns followed. Plus, the Fed wasn’t tightening as it is now—which suggests the current expansion is at least approaching its endpoint.”

While the Trump administration, and congressional Republicans, suggest their tax changes will stimulate years of economic growth and more than pay for themselves, the reality is likely quite the opposite.

What investors are missing is that while tax reform could well provide for a modest bump to GDP growth, that growth bump is being offset by the Federal Reserve tightening monetary policy by lifting interest rates. Don’t forget, the reason the Fed lifts interest rates is to SLOW economic growth to quell inflationary pressures.

Furthermore, as the brilliant minds at the Committee for a Responsible Federal Budget penned recently, the tax reform legislation will likely bring back trillion-dollar deficits by 2019. To wit:

“If they aren’t careful, we estimate legislation under consideration could bring back trillion-dollar deficits by next year. Even under current law, deficits are likely to reach almost $600 billion this year and $700 billion next year. By our estimate, a combination of tax cuts, sequester relief, and other changes would increase deficits to $1.05 trillion by 2019 and $1.1 trillion by 2020.”

Of course, a trillion-dollar deficit would require further debt growth in order to fund the revenue gap. As the debt levels continue to expand, estimated to hit $30 trillion over the next 8-years, the impact to economic growth will continue to be negative. 

With the Federal Reserve already in the process of reducing their balance sheet, with the rest of the world set to follow, the primary support of the markets is quickly fading. This elevates the risk of a policy mistake by the Fed, and as Doug Kass noted Wednesday, the risk of a Congressional mistake has also risen: 

History shows that if the Senate version is adopted and the corporate tax rate reduction is delayed for another year, the odds of a recession are greatly increased. (A position that Art Laffer has publicly taken.)

The biggest mistake made by the Reagan Administration was to delay the corporate cuts by a year as the Senate version does. Companies waited a year to expand capital investments back then — causing a recession in 1981-82.”

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

Trump, Economy & Fed


Research / Interesting Reads

“As contrarians, the only thing to fear is the lack of fear itself.” – Bernie Schaeffer

Questions, comments, suggestions – please email me.

Weekend Reading: Keeping You Awake At Night

In her last testimony before Congress as head of the Federal Reserve, Janet Yellen made a curious statement:

I would simply say that I am very worried about the sustainability of the U.S. debt trajectory. Our current debt-to-GDP ratio of about 75 percent is not frightening but it’s also not low. It’s the type of thing that should keep people awake at night.”

 I find this statement interesting given that both Michael Lebowitz and I have been arguing the point that tax cuts and reforms “pay for themselves” through stronger rates of economic growth, employment or wages.

As Mike stated this past week:

“The historical evidence above tells a different story than the bill of goods being sold to citizens and investors.  Corporate tax rates are positively correlated with economic growth which means that lower corporate tax rates equate to slower economic growth. Further, there is strong evidence that corporate profits are largely unaffected by tax rates.

Investors buying based on the benefits of the tax proposal appear shortsighted. They value the benefits of corporate tax cuts, but they are grossly negligent in recognizing how the tax cuts will be funded.”

But while Janet Yellen was focused on Federal Debt, the real issue is total debt as a percentage of the economy. Every piece of leverage whether it is government debt, personal debt and even leverage requires servicing which detracts “savings” from being applied to more productive uses. Yes, in the short-term debt can be used to supplant consumption required to artificially stimulate growth, but the long-term effect is entirely negative. As shown in the chart below, total system debt how exceeds 370% of GDP and is rising.

It now requires ever increasing levels of debt to create each $1 of economic growth. From 1959 to 1983, it required roughly $1.25 of debt to create $1 of economic activity. However, as I have discussed previously, the deregulation of the financial sector, combined with falling interest rates, led to a debt explosion. That debt explosion, which allowed for an excessive standard of living, has led to the long-term deterioration in economic growth rates. It now requires nearly $4.00 of debt for each $1.00 of economic growth.

Yellen is right. The level of debt, not just at the government level, but on the whole, should keep investors “up at night.” The Fed’s monetary interventions over the last 9-years to aggressively push interest rates lower led to a high-degree of “complacency” as the assumed “riskiness” of piling on leverage was removed. However, while the cost of sustaining higher debt levels is lower, the consequences of excess leverage in the system remains the same.

The illusion of liquidity has a dangerous side effect. The process of the previous two debt-deleveraging cycles led to rather sharp market reversions as margin calls, and the subsequent unwinding of margin debt fueled a liquidation cycle in financial assets. The resultant loss of the “wealth effect” weighed on consumption pushing the economy into recession which then impacted corporate and household debt leading to defaults, write-offs, and bankruptcies.

You will notice in the chart above, that even relatively small deleveraging processes had significant negative impacts on the economy and the financial markets. With total system leverage spiking to levels never before witnessed in history, it is quite likely the next event that leads to a reversion in debt will be just as damaging to the financial and economic systems.

Of course, when you combine leverage into investor crowding into “passive indexing,” the risk of a “disorderly unwinding of portfolios” due to the lack of market liquidity becomes an issue.

While Ms. Yellen dismisses her own warnings…maybe you shouldn’t. 

In the meantime, here is your weekend reading list.

Trump, Economy & Fed

Video – Myths About Tax Cuts


Research / Interesting Reads

“You never go broke taking a profit.” – Old Wall Street Axiom

Questions, comments, suggestions – please email me.

Weekend Reading: You Have Been Warned

Investors aren’t paying attention.

There is an important picture that is currently developing which, if it continues, will impact earnings and ultimately the stock market. Let’s take a look at some interesting economic numbers out this past week.

On Tuesday, we saw the release of the Producer Price Index (PPI) which ROSE 0.4% for the month following a similar rise of 0.4% last month. This surge in prices was NOT surprising given the recent devastation from 3-hurricanes and massive wildfires in California which led to a temporary surge in demand for products and services.

Then on Wednesday, the Consumer Price Index (CPI) was released which showed only a small 0.1% increase falling sharply from the 0.5% increase last month.

This deflationary pressure further showed up on Thursday with a -0.3 decline in Export prices. (Exports make up about 40% of corporate profits)

For all of you that continue to insist this is an “earnings-driven market,” you should pay very close attention to those three data points above.

When companies have higher input costs in their production they have two choices: 1) “pass along” those price increase to their customers; or 2) absorb those costs internally. If a company opts to “pass along” those costs then we should have seen CPI rise more strongly. Since that didn’t happen, it suggests companies are unable to “pass along” those costs which means a reduction in earnings.

The other BIG report released on Wednesday tells you WHY companies have been unable to “pass along” those increased costs. The “retail sales” report came in at just a 0.1% increase for the month. After a large jump in retail sales last month, as was expected following the hurricanes, there should have been some subsequent follow through last month. There simply wasn’t.

More importantly, despite annual hopes by the National Retail Federation of surging holiday spending which is consistently over-estimated, the recent surge in consumer debt without a subsequent increase in consumer spending shows the financial distress faced by a vast majority of consumers. The first chart below shows a record gap between the standard cost of living and the debt required to finance that cost of living. Prior to 2000, debt was able to support a rising standard of living, which is no longer the case currently.

With a current shortfall of $18,176 between the standard of living and real disposable incomes, debt is only able to cover about 2/3rds of the difference with a net shortfall of $6,605. This explains the reason why “control purchases” by individuals (those items individuals buy most often) is running at levels more normally consistent with recessions rather than economic expansions.

If companies are unable to pass along rising production costs to consumers, export prices are falling and consumer demand remains weak, be warned of continued weakness in earnings reports in the months ahead. As I stated earlier this year, the recovery in earnings this year was solely a function of the recovering energy sector due to higher oil prices. With that tailwind now firmly behind us, the risk to earnings in the year ahead is dangerous to a market basing its current “overvaluation” on the “strong earnings” story.

Don’t say you weren’t warned.

In the meantime, here is your weekend reading list.

Trump, Economy & Fed

VIDEO – It’s A Turkey Market


Research / Interesting Reads

“The only function of economic forecasting is to make astrology look respectable.” – Sir John Templeton

Questions, comments, suggestions – please email me.

Weekend Reading: It’s The Debt, Stupid

As I noted last Friday, the recently approved budget was an anathema to any fiscally conservative policy. As the Committee for a Responsible Federal Budget stated:

“Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance.

Passing fiscally irresponsible budgets just for the sake of passing “tax cuts,” is, well, irresponsible. Once again, elected leaders have not listened to, or learned, what their constituents are asking for which is simply adherence to the Constitution and fiscal restraint.”

I then followed this up this past Monday with “3 Myths Of Tax Cuts” stating:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.

As the chart below shows there is ZERO evidence that tax cuts lead to stronger sustained rates of economic growth. The chart compares the highest tax rate levels to 5-year average GDP growth. Since Reagan passed tax reform, average economic growth rates have only gone in one direction.”

On Thursday, Fitch confirmed the same in their dismal report on the reality of what the effect of the “tax cut”

“Such reform would deliver a modest and temporary spur to growth, already reflected in growth forecasts of 2.5% for 2018. However, it will lead to wider fiscal deficits and add significantly to US government debt. As such, Fitch has revised up its medium-term debt forecast. US federal debt was 77% of GDP for this fiscal year. Fitch believes the tax package will be revenue negative, even under generous assumptions about its growth impact. Under a realistic scenario of tax cuts and macro conditions, the federal deficit will reach 4% of GDP by next year, and the US debt/GDP ratio would rise to 120% of GDP by 2027.

Tax cuts may lead to a short-lived boost to output, but Fitch believes that they will not pay for themselves or lead to a permanently higher growth rate. The cost of capital is already low and corporate profits are elevated. In addition, the effective tax rate paid by large corporations is well below the existing statutory rate.

Fitch expects US economic growth to peak at 2.5% in 2018 before falling back to 2.2% in 2019. The US will enter the next downturn with a general government “structural deficit” (subtracting the impact of the economic cycle) larger than any other ‘AAA’ sovereign, leaving the US more exposed to a downturn than other similarly rated sovereigns. The US is the most indebted ‘AAA’ country and it is running the loosest fiscal stance. Long-term debt dynamics are also more negative than those of peers, with health and social security spending commitments set to rise over the next decade. “

There is nothing “good” in any of the statements above,  and drive to the same conclusions I discussed last Monday.

You can’t solve a debt problem, by issuing more debt. 

While Congressional members continue campaigning that the “tax plan” would give an $1182 tax cut to most Americans, and boost wages by $4000, such has never been the case. A recent study by the Economic Policy Institute suggested the same in a recent study:

“Cutting corporate tax rate cuts would do very little to boost employment generation. In fact, cutting corporate tax rates ranks as the least effective form of fiscal support for employment generation, since corporate tax cuts primarily benefit rich households—who are less likely to increase their consumption than low- or middle-income households when they receive tax cuts.”

This is a point I have made previously. Corporate tax rate cuts will unambiguously redistribute post-tax income regressively. The corporate income tax is a progressive tax, with the top 1% of households accounting for 47% of the corporate income tax.

Don’t be bamboozled by the idea that tax cuts and reforms will lead to sustained economic growth. There is simply NO evidence that such is the case over the long-term.

However, there is plenty of evidence to suggest that further costly reforms and run-away budgets will lead to an increase of the current national debt and the ongoing low-growth economy that has plagued the U.S. since the turn of the century.

In other words….“it’s the debt, stupid.”

In the meantime, here is your weekend reading list.

Trump, Economy & Fed

VIDEO – Tax Cut/Reform Discussion (Real Investment News)


Research / Interesting Reads

“In investing, what is comfortable is rarely profitable.” – Rob Arnott

Questions, comments, suggestions – please email me.

Weekend Reading: Will Tax Reform Deliver As Expected?

As I noted last Friday, the recently approved budget was an anathema to any fiscally conservative policy. As the Committee for a Responsible Federal Budget stated:

“Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance.

While the original House budget balanced on paper and offered some real savings, the Senate’s version accepted today by the House fails to reach balance, enacts a pathetic $1 billion in spending cuts out of a possible $47 trillion, and allows for $1.5 trillion to be added to the national debt.

Make no mistake – this is a defining moment for the Republican party. After years of passing balanced budgets and calling for fiscal responsibility, the GOP is now on-the-record as supporting trillions in new debt for the sake of tax cuts over tax reform and failing to act on the pressing need to reform our largest entitlement programs.”

Passing fiscally irresponsible budgets just for the sake of passing “tax cuts,” is, well, irresponsible. Once again, elected leaders have not listened to, or learned, what their constituents are asking for which is simply adherence to the Constitution and fiscal restraint.

As the CFRB concludes:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.”

That is absolutely correct.

As the chart below shows there is ZERO evidence that tax cuts lead to stronger sustained rates of economic growth. The chart compares the highest tax rate levels to 5-year average GDP growth. Since Reagan passed tax reform, average economic growth rates have only gone in one direction.

However, the most likely unintended consequence of the proposed tax “cut” bill is that it will likely translate into a “hike” on middle class Americans. Take a look at the proposed tax bracket chart below.

Now, compare that with the actual breakdown of “who pays taxes.”

“The bottom 80% currently pay only about 18% of individual taxes with top 20% paying the rest. Furthermore, the bottom 40% currently have a NEGATIVE tax liability, and with the new tax plan cutting many of the deductions currently available for those in the bottom 40%, it could be the difference between a tax refund and actually paying taxes. “

“Of course, those in the top 20% of income earners are likely already consuming at a level with which they are satisfied. Therefore, a tax cut which delivers a few extra dollars to their bottom line, will likely have a negligible impact on their current levels of consumption.”

Given the newly designed tax brackets compresses individuals into fewer groups, it is quite likely a large chunk of the bottom 80% will likely experience either a hike or an inconsequential change. With the bottom 80% already consuming at max capacity, as discussed yesterday, a tax increase will hit the economy right where it hurts the most – in consumption expenditures. 

 “As the chart below shows, while savings spiked during the financial crisis, the rising cost of living for the bottom 80% has outpaced the median level of ‘disposable income’ for that same group. As a consequence, the inability to ‘save’ has continued.”

But while Congressional members were campaigning yesterday the “tax plan” would give an $1182 tax cut to most Americans, it should not be forgotten that since they failed to “repeal and replace” the Affordable Care Act, any tax cut will only be diverted to offset a substantial rise in health care premiums in 2018.

Regardless, the proposed tax bill is just the first step.

Let the “horse trading” begin.

In the meantime, while we await the actual tax reform bill, here is your weekend reading list.

Trump, Economy & Fed


Research / Interesting Reads

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations which do not meet these requirements are speculative.” – Benjamin Graham

Questions, comments, suggestions – please email me.

Weekend Reading: Markets Love Central Banks – No Matter What They Do

I discussed yesterday, the apparent “myth” of the Fed’s proposed “balance sheet reduction” program as the most recent analysis shows a $13.5 billion “reinvestment” into their balance sheet which has helped fuel the recent market advance.

But therein lies the potential “fatal flaw” of the “bullish logic.” 

At the September FOMC meeting, the Federal Reserve announced their latest decision which contained two primary components:

  1. No rate hike currently, although, further rate hikes are likely in the future, and;
  2. The beginning of the process to cease reinvestment of the Fed’s balance sheet. 

That announcement was notable for two reasons:

  1. The Fed did NOT hike rates because the underlying economic data, and, in particular, the inflation data, suggests the economy is too weak to absorb a further increase currently, and;
  2. The unwinding of the balance sheet is generally believed to be bullish for stocks. 

So, despite the clear evidence of the support for the markets provided by near zero-interest rate policy and trillions in monetary injection, it is believed that “unwinding” those supports will have “no effect” on the market. In other words, it doesn’t matter what the Fed does, it’s “bullish.”

The same is also believed to be the case for the European Central Bank and Mario Draghi who just announced yesterday that the ECB’s QE program will begin to be reduced by €30 Billion per month (down from €60 Billion). While this will continue the expansion of their balance sheet currently, “QE,” as the markets have come to know it, is coming to an end.

Don’t misunderstand me, Central Banks are still very actively engaged in the support of the financial markets for the time being which keeps asset prices positively buoyed. However, with Central Banks now “tightening” monetary policy, the risk of a policy error has risen markedly. This is particularly the case when the financial markets insist on ignoring the knock-off effects of less liquidity.

Tax Reform With Complete Disregard

Yesterday, the House of Representatives passed the Senate-approved budget. This budget is an anathema to any fiscally conservative policy. As the Committee for a Responsible Federal Budget stated:

“Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance.

While the original House budget balanced on paper and offered some real savings, the Senate’s version accepted today by the House fails to reach balance, enacts a pathetic $1 billion in spending cuts out of a possible $47 trillion, and allows for $1.5 trillion to be added to the national debt.

Make no mistake – this is a defining moment for the Republican party. After years of passing balanced budgets and calling for fiscal responsibility, the GOP is now on-the-record as supporting trillions in new debt for the sake of tax cuts over tax reform and failing to act on the pressing need to reform our largest entitlement programs.”

Passing fiscally irresponsible budgets just for the sake of passing “tax cuts,” is, well, irresponsible. Once again, elected leaders have not listened to, or learned, what their constituents are asking for which is simply adherence to the Constitution and fiscal restraint.

As the CFRB concludes:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.”

That is absolutely correct.

Here is your weekend reading list.

Trump, Economy & Fed


Research / Interesting Reads

“There have been three great inventions since the beginning of time: fire, the wheel, and Central Banking.Will Rogers

Questions, comments, suggestions – please email me.

Weekend Reading: 24000 By Christmas?

This past week, the Dow crested 23000 sending the networks into a “tizzy.” It took about 5-minutes of crossing that magical “round number,” before questions raised of how long before the markets cross 24,000, and 25,000.

The chart below shows the 1000-point milestones of the Dow going back to 2009. After a long break between 18,000 and 19,000 in 2015 through the election in 2016, the Dow has surged higher ticking off 4-more milestones in less than a year.

As I have shown previously, these late stage “melt-ups” are not uncommon. In fact, as shown below, it is something witnessed prior to every market peak previously. 

As I stated just recently:

“This past weekend, I discussed what appears to be the markets ongoing melt-up toward its inevitable conclusion. Of course, that move is supported by the last of the ‘holdouts’ that finally capitulate and take the plunge back into a market that ‘can seemingly never go down.’ But therein lies the danger. 

‘However, it should be noted that despite the ‘hope’ of fiscal support for the markets, longer-term conditions are currently present that have led to rather sharp market reversions in the past. Regardless, the market is currently ignoring such realities as the belief ‘this time is different’ has become overwhelming pervasive.’”

With volatility crushed, and record short positions on the VIX, there will likely be an event at some point that leads to a massive reversal in the assessment of “risk” and an unwinding of the market.

However, such is not the case currently as even “small dips” are met with eager buyers which continues to reinforce the very dangerous lack of fear.

With more ETF’s currently available to investors than there are stocks to fill them, it is quite likely the demand ramp for ETF’s will continue to push the Dow higher into the end of the year.

Dow 24,000 by Christmas?

Don’t be surprised if it happens.

Just remember, all market melt-ups end just when things look their brightest.

Here’s your reading list to for the weekend.

Trump, Economy & Fed


Research / Interesting Reads

“A bear market returns capital to those who it rightly belongs to.Ian McAvity

Questions, comments, suggestions – please email me.

Weekend Reading: $7 Trillion To Manipulate Prices

As the stock market continues to press new highs, the level of optimism climbs with it. I discussed yesterday Richard Thaler’s, a recent recipient of the Nobel Price in Economics, comments about not understanding the current “irrationality of investors relating to their investing behavior.”

What is interesting is that Thaler’s received his Nobel Prize for his pioneering work in establishing that people are predictably irrational — that they consistently behave in ways that defy economic theory. For example, people will refuse to pay more for an umbrella during a rainstorm; they will use the savings from lower gas prices to buy premium gasoline; they will offer to buy a coffee mug for $3 and refuse to sell it for $6.

The fact that a man who studies the “irrationality of individuals” is stumped by current investor behavior should be alarming at the least.

But as earnings season gets underway we once again return to quarterly Wall Street “beat the estimate game,” in which companies are rewarded by beating continually lowered estimates. Of course, the primary catalyst used to beat those estimates was not a rise in actual revenue, or even reported earnings, but rather ongoing accounting gimmickry and stock buybacks. As shown below, through the second quarter of this year, reported EPS, which includes “all the bad stuff,” actually declined in the latest quarter and has remained virtually unchanged since 2014. (But, even that is an illusion as shares have been aggressively bought back in order to sustain that same level of EPS.)

The difference between reported earnings with and without the benefit of share repurchases is substantial. The chart below shows the net difference between gross reported earnings with and without the buyback impact. Importantly, the net effect of buybacks is having less impact which, as was the case in 2007, was a precursor to the crash. 

Ralph Nader just recently did an in-depth expose on the problems with share repurchases. To wit:

The monster of economic waste—over $7 trillion of dictated stock buybacks since 2003 by the self-enriching CEOs of large corporations—started with a little-noticed change in 1982 by the Securities and Exchange Commission (SEC) under President Ronald Reagan. That was when SEC Chairman John Shad, a former Wall Street CEO, redefined unlawful ‘stock manipulation’ to exclude stock buybacks.”

Yep, stock buybacks used to be considered stock manipulation, yet today, it is widely accepted by investors as “just the right measure to boost earnings in the ongoing “beat the estimate” game.

As Ralph Nader points out – there is a problem.

“The stock buyback mania was unleashed. Its core was not to benefit shareholders (other than perhaps hedge fund speculators) by improving the earnings per share ratio. Its real motivation was to increase CEO pay no matter how badly such burning out of shareholder dollars hurt the company, its workers and the overall pace of economic growth.

The bottom line is that while companies take trillions of dollars and buyback shares, it only benefits the executives of the company at the expense of both workers and, ultimately, shareholders as companies with excessive stock buybacks experience a declining market value.

The interview is worth watching, and read the article, and think about it.

Here’s your reading list to for the weekend.

Trump, Economy & Fed


Research / Interesting Reads

“Making it, and keeping it, are two different things.Anonymous

Questions, comments, suggestions – please email me.

Weekend Reading: Bull Market In Complacency

With the market recently breaking above 2500, there seems to be nothing to dampen the bullish exuberance. The recent run, which has largely been focused on areas in the market with the most sensitivity to tax cuts, has exploded over the last two weeks to record highs. That explosion has also lead to a surge in the Market Greed/Fear Gauge which comprises different measures of market complacency and bullishness.

But the rush to chase performance can be clearly seen in the chart below of the S&P 600 index (small cap) which is now 4-standard deviations above the 6-month moving average.

Then there is the widely viewed CNN Fear/Greed Index.

Of course, not surprisingly, with investors as optimistic and bullish as they can be equity to money market ratios are at extremes.

And “Dumb Money” is continuing to pile into markets as “Smart Money” is willing to sell positions to them.

After 9-years of a bull market, and pushing a 270% gain from the lows, investors have now decided it is now time to get back into the market. But that is the nature of a bull market, and particularly one that has entered into the final stages of long-term cyclical advance, where the last of the “holdouts” are sucked back into the game.

As we enter into earnings season, we once again enter into the “beat the estimates game,” where analysts act surprised that companies “beat” lowered estimates. In the short-term, these “beat rates” will provide support for the bullish case, but in the long-term, it is valuations and actual revenue growth that matters.

I agree with Doug’s sentiment yesterday:

  •  Massive injections of liquidity from the world’s central bankers
  • Passive investing (quants and ETFs) are now dominating markets (at nearly 40%) at the margin
  • Machines and algorithms, as well as many individual investors, are behaving differently as they are now programmed and conditioned to buy the dips.
  • 17% of the listed shares outstanding have been retired in corporate stock repurchases since the Generational Low in March, 2009.
  • More than half of the listed companies on the exchanges have disappeared over the last eight years

“We have a Bull Market in Complacency.” – Doug Kass


Here’s your reading list to for the weekend.

Trump Tax Cuts…


Research / Interesting Reads

“In a bear market all stocks go down and in a bull market they go up.Jesse Livermore

Questions, comments, suggestions – please email me.

Weekend Reading: Tax Cut Wish List

On Wednesday, the President announced his plan to cut taxes for Americans, return jobs to America and return the country to economic prosperity.

It’s a tall order to fill, and the proposed tax reform is a “Christmas Wish List” that will have to checked twice to determine which parts are “naughty” and “nice.”

As I pointed out yesterday,

“The belief that tax cuts will eventually become revenue neutral due to expanded economic growth is a fallacy. As the CRFB noted:

‘Given today’s record-high levels of national debt, the country cannot afford a deficit-financed tax cut. Tax reform that adds to the debt is likely to slow, rather than improve, long-term economic growth.’

The problem with the claims that tax cuts reduce the deficit is that there is NO evidence to support the claim. The increases in deficit spending to supplant weaker economic growth has been apparent with larger deficits leading to further weakness in economic growth. In fact, ever since Reagan first lowered taxes in the ’80’s both GDP growth and the deficit have only headed in one direction – lower.’

That little green bump in the deficit was when President Clinton “borrowed” $2 trillion from Social Security to balance the budget, and since there were no cuts to spending, led a surplus that lasted about 20-minutes.

The problem is that the tax plan may not provide the benefits as hoped. While President Trump suggests the plan will return “trillions” of dollars locked up overseas to create jobs, the reality, according to Goldman Sachs, is likely closer to $250 billion that will primarily go to share buybacks, dividends, and executive compensation.  

Of course, such actions do not boost economic growth but are a boon to Wall Street and the 10% of the economy that invest in the market. 

But here is the key point with respect to tax cuts. History is replete with evidence that shows tax cuts DO NOT lead to a rapid growth in the economy. As shown below, the slope of economic growth has been trending lower since the “Reagan tax cuts” were implemented.

Lastly, tax cuts have relatively low economic multipliers particularly when they primarily only benefit those at the top of the income spectrum. With the average household heavily indebted, credit is being used to sustain the standard of living, there is likely to be little transfer of “tax savings” back into the economy.

It is a simple function of math. But the following chart shows why this has likely come to the inevitable conclusion, and why tax cuts and reforms are unlikely to spur higher rates of economic growth.”

As is always the case…“it’s the debt, stupid.” 

However, here are plenty of discussions both for and against the tax plan so you can decide for yourself.

Trump Tax Cut Plan


Research / Interesting Reads

A bull market is like sex. It feels best just before it ends.” – Warren Buffett

Questions, comments, suggestions – please email me.

Weekend Reading: Yellen Takes Away The Punchbowl

September 20th, 2017 will likely be a day that goes down in market history.

It will either be remembered as one of the greatest achievements in the history of monetary policy experiments, or the beginning of the next bear market or worse.

Given the Fed’s inability to spark either inflation or economic growth, as witnessed by their dismal forecasting record shown below, I would lean towards the latter.

The media is very interesting. Despite the fact there is clear evidence that unbridled Central Bank interventions supported the market on the way up, there is now a consensus that believes the “unwinding” will have “no effect” on the market.

This would seem to be naive given that, as shown below, the biggest injections of liquidity from the Fed have come near market bottoms. Without the proverbial “punch bowl,” where does the “support” come from to stem declines?

I tend to agree with BofA who recently warned” the paint may be drying but the wall is about to crumble.”

This point can be summarized simply as follows: there is $1 trillion in excess TSY supply coming down the line, and either yields will have to jump for the net issuance to be absorbed, or equities will have to plunge 30% for the incremental demand to appear.”

“An unwind of the Fed’s balance sheet also increases UST supply to the public. Ultimately, the Treasury needs to borrow from the public to pay back principal to the Fed resulting in an increase in marketable issuance. We estimate the Treasury’s borrowing needs will increase roughly by $1tn over the next five years due to the Fed roll offs. However, not all increases in UST supply are made equal. This will be the first time UST supply is projected to increase when EM reserve growth likely remains benign.

Our analysis suggests this would necessitate a significant rise in yields or a notable correction in equity markets to trigger the two largest remaining sources (pensions or mutual funds) to step up to meet the demand shortfall. Again, this is a slower moving trigger that tightens financial conditions either by necessitating higher yields or lower equities.”

Of course, as I have discussed previously, a surge in interest rates would lead to a massive recession in the economy. Therefore, while it is possible you could experience a short-term pop in rates, the end result will be a substantial decline in equities as money flees to the safety of bonds driving rates toward zero.

“From many perspectives, the real risk of the heavy equity exposure in portfolios is outweighed by the potential for further reward. The realization of ‘risk,’ when it occurs, will lead to a rapid unwinding of the markets pushing volatility higher and bond yields lower. This is why I continue to acquire bonds on rallies in the markets, which suppresses bond prices, to increase portfolio income and hedge against a future market dislocation.”

My best guess is the Fed has made a critical error. But just as a “turnover” early in the first-quarter of the game may not seem to be an issue, it can very well wind up being the single defining moment when the game was already lost. 

In the meantime, here is what I am reading this weekend.



Research / Interesting Reads

“If you are playing the rigged game of investing, the house always wins.” ― Robert Rolih

Questions, comments, suggestions – please email me.

Weekend Reading: They’re Baaaccckkk!

I remember the first time I saw the movie “Poltergeist.” It scared the $*#@ out of me, and I slept with the lights on for a month.

Recently, I got a chance to catch a rerun. It certainly wasn’t the same experience. It was kind of like eating a “twinkie” as an adult, the sponge cake and creamy filling aren’t nearly as delicious as I remembered them. “Poltergeist” is now more of a “campy” flick with bad special effects.

But the run up in the markets over the last few days, on really no news at all, reminded me of the scene where “Carol Anne” is pointing to the static filled television screen proclaiming “they’re back.”

After a brief decline, market sentiment got bearish enough to provide the catalyst for a short-term rally. With Trump now caving in to “Chuck and Nancy,” the North Korean threat deflated, and hopes for tax cuts on the horizon, “the bulls are back.”

Since the election, there has been a concerted effort to push stocks higher on the hopes of tax reform, ACA repeal, and infrastructure building which would lead to strongly improving earnings for U.S. companies. Now, eleven months later, stocks have been breaching the psychologically important levels of 2200 in December, 2300 in February and finally 2400 in May. 2500 is the next target.

The problem is that NONE of the legislative agenda has been passed. Zero, Nada, Zip.

But such small details have not, as noted yesterday, deterred investors who have once again fully abandoned reason and have gone “all in.”

With cash levels at the lowest level since 1997, and equity allocations near the highest levels since 1999 and 2007, it also suggests investors are now functionally ‘all in.'”

“Here is the point, despite ongoing commentary about mountains of “cash on the sidelines,” this is far from the case. This leaves the current advance in the markets almost solely in the realm of Central Bank activity.”

Yes, the bulls are indeed back for now.

The ending of this version of “Poltergeist Market” will surely be just as scary as the last.

In the meantime, here is what I am reading this weekend.



Research / Interesting Reads

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” – Alan Greenspan

Questions, comments, suggestions – please email me.

Weekend Reading: The “Real” Vampire Squid

First, it was Hurricane “Harvey” and an expected $180 billion in damages to the Texas coastline. Now, “Irma” is speeding her way to the Florida coastline dragging “Jose” in her wake. Those two hurricanes, depending on where they land will send damages higher by another $100 billion or more in the weeks ahead.

The immediate funding needed for relief to Americans is what you would truly deem to be “emergency measures.”

But that is not what I am talking about today.

Nope, I am talking about Central Banks. On Thursday, Mario Draghi, of the ECB, announced their latest monetary policy stance:

“At today’s meeting, the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.

Regarding non-standard monetary policy measures, the Governing Council confirms that the net asset purchases, at the current monthly pace of €60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. The net purchases are made alongside reinvestments of the principal payments from maturing securities purchased under the asset purchase programme. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the programme in terms of size and/or duration.”

Ladies and Gentlemen, these are “emergency measures.” According to the Bank for International Settlements:

“Policy tools that involve the active use of central bank balance sheets – both the assets and the liabilities – can help monetary authorities to navigate the policy challenges during times of financial stress and when interest rates are close to zero.

But wait, this is what Draghi said next:

“The economic expansion, which accelerated more than expected in the first half of 2017, continues to be solid and broad-based across countries and sectors.”

So, what is it?

If you actually have “solid and broad-based” economic growth across countries and sectors, why are you still flooding the system with “emergency measures,” and keeping interest rates near zero?

That’s a rhetorical question.

The reality is that Central Banks are keenly aware of the underlying economic weakness that currently exists as evidenced by the inability to generate inflationary pressures. They also understand that if the financial markets falter, the immediate feedback loop into the global economic environment will be swift and immediate.

This is why there continue to be direct purchases of equities by the ECB and the BOJ. Which is also the reason why, despite nuclear threats, hurricanes, geopolitical tensions and economic disconnects, the markets remain within a one-day striking distance of all-time highs. (Charts courtesy of Yardeni Research)

Of course, the question becomes just exactly what will Central Banks do when economies on a global scale slip back into the next cyclical recession? There is a “limit” to the amount of “assets” that can be held by the Central banks unless the markets are to become entirely centralized by the tentacles of the real “vampire squid.”

As the BIS concludes:

“Let me remind you too about the considerable fiscal risks that many countries face – risks that could at some point confront central banks with extremely difficult choices.”

In the meantime, here is what I am reading this weekend.



Ray Dalio’s recent TED Talk – “How To Build A Company Where The Best Ideas Win”


Research / Interesting Reads

“Sometimes the market does something so stupid it takes your breath away.” – Jim Cramer

Questions, comments, suggestions – please email me.

Weekend Reading: Harvey & The Broken Window Fallacy

As the waters recede from “Hurricane Harvey,” the rebuilding efforts begin. It will take quite some time before Houston fully recovers from the tragedy, but recover we will. Hopefully, lessons were learned by a city government that has avoided dealing with the drainage and flooding problems for far too long. Despite hundreds of millions of dollars extracted from the citizenry of Houston via a “rain tax,” the money was absorbed by the profligate spending of repeated feckless Mayors who chose to spend on “bike trails,” “green energy.” and other liberal agendas rather than resolving a critical issue that has plagued Houston for years.

We’ll see. But I won’t hold my breath as Houston continues to follow the shining examples of other fiscally responsible governments like Chicago, Detroit, and others. [sarcasm alert]

But that is a story for another day.

Currently, the mainstream story is the “economic boost” which will come from the recovery process. This is the essence of the Broken Window Fallacy.” 

“A window is destroyed, therefore the window has to be replaced which leads to economic activity throughout the economy.

However, the fallacy of the ‘broken window’ narrative is that economic activity is only changed and not increased. The dollars used to pay for the window can no longer be used for their original intended purpose.

There is no free lunch.”

To put a finer point on it:

She is right. Obviously, nuking cities to create economic growth is just plain silly.

However, in the short-term, there will be thousands of temporary jobs created, supplies used, services needed and wages paid which will provide a temporary economic boost. Unfortunately, what is not being accounted for is the offsetting of lost wages, business incomes, and other costs for the individuals and businesses that have been devastated and displaced by this tragedy.

From a market perspective, hurricanes have little impact in reality. In 2005, the U.S. was rocked by three hurricanes over a three month period. The market dipped but recovered shortly thereafter as the event was quickly absorbed by market participants. There was also a quick spat of economic growth which quickly faded over the next several quarters.

In 2008, “Hurricane Ike” made landfall at the same moment that Lehman was forced into bankruptcy. However, what was not known by market participates at that time, because the NBER had not declared it, was the U.S. was already in a deep recession. It only got worse following the event.

“Hurricane Sandy”, much like “Katrina,” “Wilma,” and “Ike,” also provided a 2-quarter boost to economic output which quickly faded as the temporary inputs came to an end. The market blinked, but then continued its advance.

The difference between the outcomes of “Ike” and the other storms was really dependent on the overall cycle of the market. “Ike” occurred with market and economic sentiment already turning negative. That is not the case with “Hurricane Harvey” as overall market and economic sentiment remains very robust, even exuberant.

Over the next couple of quarters, market participants will have their attitudes bolstered by better than expected economic numbers. Such will also give President Trump some cover despite the lack of legislative agenda moving forward. However, it is the trend of the economic growth rates that must be paid attention to. Despite hopes of a never ending “bull market” supported by ongoing “emergency measures” from Central Banks globally, the reality is we are very late in the current economic cycle.

Just like in 2008, it was well after the fact, when the economic data was negatively revised, the recession became clearly evident. Given the deterioration is credit, the rise in delinquencies and plunge in savings rates, the economic back drop is likely far weaker than headlines currently suggest.

While Harvey may extend the current cycle for a little while longer, I would not get overly complacent with highly aggressive allocation models. Like I said, there is no free lunch.

Here is what I am reading this weekend.



Research / Interesting Reads

“Never forget, things change.” – Lowell Miller

Questions, comments, suggestions – please email me.

Weekend Reading: Storm Warning

No, I am not talking about “Hurricane Harvey” which will likely be the first hurricane to strike the Texas coast since 2008, but rather the potential for another “debt ceiling” debacle brewing in Washington.

Just recently, Goldman Sachs raised its odds for a government shutdown from 33% to 50% which was further supported by recent statements from President Trump that he would be willing to risk a Government “shutdown” to get his border wall funded. However, as Axios.com noted yesterday:

A top Republican source put the chance as high as 75%: ‘The peculiar part is that almost everyone I talk to on the Hill agrees that it is more likely than not.’

This may all come down to Trump’s mood. As Swan puts it: ‘Trump is spoiling for a fight and the [conservative House] Freedom Caucus haven’t had a fight for a while. That’s a dangerous dynamic.'”

While a Government shutdown is often used as a mechanism to force legislative action by threatening default on the national debt. Let me just reassure, the Government WILL NOT default on its mandatory spending requirements which include the social welfare system and interest payments on the debt. Given those items comprise 75% of the budget, the remaining 25% of discretionary categories could see cuts such as the temporary furloughs of some 900,000 government workers considered to be “non-essential.”

Of course, if you have a job that is considered to be “NON-essential,” maybe that is a good place to start cutting Government spending to begin with. 

Sorry, I digress.

The REAL problem with a government shutdown is it will serve as another distraction to keep the current Administration off of their primary task of passing their legislative agenda of tax reform, cuts, infrastructure spending and immigration reform. As I have stated many times previously, this is one of the biggest risk to the markets currently.

While much of the mainstream analysis ballyhoos over the recent increase in operating earnings, it is often overlooked that operating earnings still haven’t surpassed their previous peak. Reported earnings and actual sales even less so. Importantly, a large chunk of forward estimates and guidance have been based on the assumption of the “dollar for dollar” impact of tax-related legislation.

Quick Note: It is worth noting that while mainstream analysts continue to point to the “number of companies beating estimates,” can I just remind you that it took estimates being DRAMATICALLY lowered in order to achieve that goal. In fact, for the end of 2017 estimates are more than $10 LOWER than where they began.

After all, we live in a society where “everyone gets a trophy”, right?

That will only go so far, and if Congress fails to push through the tax forms to support the currently elevated estimates and valuations, at some point, the markets are going to demand – “Show Me The Money!”

But that is for another day.

For now, since I live in Houston, I am going to hunker down, spin up my special blend of “Frozen Hurricanes,” and delve into my reading list.

A Frozen Hurricane “Harvey”:
  1. 2 oz light rum.
  2. 2 oz dark rum.
  3. 2 oz passion fruit juice.
  4. 1 oz orange juice.
  5. ½ oz fresh lime juice.
  6. 1 Tablespoon simple syrup.
  7. 1 Tablespoon grenadine.
  8. Garnish: orange slice and cherry.
  9. Blend with sufficient ice to make a “slushy concoction”

Feel free to join me.


Why You Suck At Investing



Research / Interesting Reads

“The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.” – John Templeton

Questions, comments, suggestions – please email me.

Weekend Reading: Losing The Faith?

Last week, I penned the following:

“Now, you would suspect the possibility of nuclear war might just be the catalyst to send markets reeling, but looking at the market’s reaction on Thursday, I suspect there will be t-shirts soon reading:

‘I survived the threat of nuclear war and the ‘great crash of 2017’ of 1.5%'”

Of course, as markets touched on their 50-dma, the algos kicked in hard on Monday morning sending the markets surging higher. The reason, according to the media, was the reduction in global risk as Donald Trump briefed Kim Jung-Un about the U.S.’s retaliatory response should North Korea decide to attack Guam.

I was able to acquire a copy:

And with that…. “NOMO NOKO” as Kim Jung-Un backed off his more aggressive posture, letting traders rush back into the markets to once again “BTFD.”

That excitement was short-lived.

On Wednesday, following a conflicted response by the White House to the Charlottesville, VA. protest, numerous CEO’s resigned from Trump’s economic council. The resignations eventually led to its full dismemberment.

Surprisingly, and as we have addressed in recent weeks, this was the catalyst that sparked a sharp decline on Thursday? Have investors “Lost The Faith?”

With President Trump embroiled in one entanglement after another and constrained by a deeply partisan legislature, the ability of the Administration to pass legislative agenda seems to be fading. 

The reality is this was the headline. Over the last couple of months, the markets have remained on a weekly “sell signal,” at a very high level, even as stock prices continued to struggle higher amid eroding internal measures. However, the break below the “accelerated advance trend line,” as noted, suggests the current correction could accelerate IF the markets don’t regain their footing by Monday.

One note of importance is that outside of the speculative enthusiasm of investors, there has been a continuing pressure in earnings as the lack of legislative agenda advancement is beginning to weigh on Q3 estimates.

Given the bulk of the upward push in earnings estimates since the election was based on hopes of tax reform/cuts and infrastructure spending, the realization such will not occur soon is elevating the “risk of disappointment.”  Without a driver to push economic growth higher, the market has likely priced in the majority of expectations.

The repricing of expectations could be fairly brutal. 

Just remember, the “running of the bulls” was the method to transport the bulls from the fields to the bull ring where they were killed later that evening.

As with the market, it’s great to be the “bull” until you get to the end of your run. 

Here’s what I am reading this weekend.


Thoughts On Long-Term Investing


Research / Interesting Reads

“While some might mistakenly consider value investing a mechanical tool for identifying bargains, it is actually a comprehensive investment philosophy that emphasizes the need to perform in-depth fundamental analysis, pursue long-term investment results, limit risk, and resist crowd psychology.” – Seth Klarman

Questions, comments, suggestions – please email me.

Weekend Reading: On A Cliff’s Edge

After a week on vacation, I got the joy of coming back to an Administration threatening North Korea over nuclear weapons.

Now, you would suspect the possibility of nuclear war might just be the catalyst to send markets reeling, but looking at the market’s reaction on Thursday, I suspect there will be t-shirts soon reading:

“I survived the threat of nuclear war and the ‘great crash of 2017’ of 1.5%”

As shown, the market did register a short-term “sell signal” last Friday and downward pressure has continued to build all week. The sell off on Thursday led to a break of the 50-dma and is threatening the bullish trend support line which has existed since the beginning of the year. IF the market does not regain the 50-dma by close of the markets today, I would suspect we will likely be looking for a decline to 2400. Such a correction, a whopping 3.03%, would likely shock many investors who have become overly complacent in recent months due to the abnormally low levels of volatility.

The sell-off on Thursday also resulted in a sharp snapback in volatility which had recently touched historically low levels. While this is likely not the beginning of the next cyclical upswing in volatility just yet, it should serve as a good reminder of what will happen when volatility does return.

One interesting note was the consternation by the mainstream media and analysts over why stocks did not perform better in the recent earnings reporting season when it was so good. Well, despite the much trumpeted operating earnings growth of 7.67%, reported earnings (the actual earnings that matter) only rose by 0.51%. Furthermore, revenue, which is what happens at the top-line of the income statement, has remained mired at the same level as it was in Q4. With markets having already priced in much of the forward estimates, there seems to be little catalyst to push stocks higher at this point leaving investor risk elevated.

While the markets can certainly remain “irrational” longer than logic would dictate, it only seems prudent to step back and the question of “what will likely happen next?”

For me that question has three outcomes:

  1. The bull market continues for another 12-18 months as “greed” and “exuberance” push asset prices to further extremes. The subsequent “reversion to the mean” wipes out the majority of gains from the 2009 lows resetting valuations and investor psychology for the next bull market.
  2. There is a mid-term correction within the next few months, like the beginning of 2016, which fails to shake out investors and sets the market up for the final leg of the bull market melt-up as the final capitulation of buyers makes its appearance. The subsequent “reversion to the mean” resets the market by 50-60%.
  3. The market drifts sideways for the next couple of months, and then, as the realization that legislative agenda is not forthcoming, the debt ceiling fight or some other political debacle sends investors rushing for the sidelines. The sell-off sends “algo’s” into a “sell the rally” mode and margin calls exacerbate the selling. The stampede to “sell everything” will result in the same “reversion to the mean” which will, as noted, wipe out 50-60% of investors portfolios as the next recession resets expectations to economic realities.

There is no case that be made that supports “the bull market will continue forever.”

When you are standing on the edge of cliff, looking at the ground far below, there is always that momentary desire to take a leap. Fortunately, for most, rationality takes hold.

Unfortunately, in the financial markets, irrationality historically prevails and very few investors survive the fall.  

So, with that said, here’s what I am reading this weekend.



Research / Interesting Reads

 “Wide diversification is only required when investors do not understand what they are doing.” – Warren Buffett

Questions, comments, suggestions – please email me.

Weekend Reading: Vacation Head

Ah…yes. It is FINALLY that time of the year when I take a week off with the family for our summer vacation.

Don’t worry, I have been fiendishly writing for the past two weeks and have blog posts all ready to go for next week. You won’t left hanging.

However, let me just leave you today with one parting thought.

The chart below is the S&P 500 on a WEEKLY basis going back to 1992. While it is clear the bullish trend is currently intact, which suggests the markets could indeed rise further, the deviation from the 1-year moving average is pushing more historical extremes.

Furthermore, the two circles on the lower part of the chart show the longer-term “buy/sell” signals which have been historically accurate in adjusting risk in portfolios. As you will notice, just like in late 1998 and early 1999, there was a sell signal which was reversed WITHOUT the market dropping into a bear market. The subsequent rally pushed asset prices and valuations to extremes in early 2000.

I don’t need to remind you what happened next. 

Currently, we see the same build up in exuberance, leverage, and speculation. The sell signal in 2015/2016 has been reversed following the Trump election. More importantly, just like in 1999, the indicators are running at historically very high levels.

I probably don’t need to remind you what will happen next. 

It is just a function of time.

In the meantime, the bullish trend remains intact. So, we participate for now but we do so with a high level of caution and very tight stop losses.

So, with that said, this is what I will be reading on vacation.



Research / Interesting Reads

 “Sometimes buying early on the way down looks like being wrong, but it isn’t.” – Seth Klarman

Questions, comments, suggestions – please email me.

Weekend Reading: Charge Of The Light Brigade

As you I discussed last week, we added risk exposure to portfolios with the breakout to new highs that came in conjunction with a short-term “buy signal” as shown below.

However, when we zoom out a bit, a different picture emerges. Note that in all 3-cases, there was a “Stage-1 Advance” followed by a correction which led to a “Stage-2 Advance.” The correction that followed then provided for the final bullish advance which I call the “Charge Of The Light Brigade.”

The “Charge of the Light Brigade” was a charge of British light cavalry led by Lord Cardigan against Russian forces during the Battle of Balaclava in 1854, during the Crimean War. Lord Raglan, the overall commander of the British forces, had intended to send the Light Brigade to prevent the Russians removing captured guns from overrun Turkish positions, a task well-suited to light cavalry. However, due to miscommunication in the chain of command, the Light Brigade was instead sent on a frontal assault against a different artillery battery, one well-prepared with excellent fields of defensive fire.

Although the Light Brigade reached the battery under withering direct fire and scattered some of the gunners, the badly mauled brigade was forced to retreat immediately. Thus, the assault ended with very high British casualties and no decisive gains. War correspondent William Russell, who witnessed the battle, declared:

“Our Light Brigade was annihilated by their own rashness, and by the brutality of a ferocious enemy.”

This current set up is very much like what faced the British Calvary. A market is that overly bullish, overly complacent and overly valued has already had horrible outcomes for those that charged headlong into it.

Simon Maierhofer recently noted much the same in a recent article:

“The blue arrows in the updated chart below show where the S&P 500 is currently within the larger bull market cycle.”

“Regardless of where exactly the market’s at, a correction is getting closer. The initial correction will likely be a wave 4 correction (see labels). Waves 4 are notoriously choppy and frustrating. This choppy correction should be followed by another rally (wave 5) and a more pronounced drop (likely late 2017 or early 2018).

In a nutshell, although the S&P 500 is unlikely to make net progress in the coming year, there will be an opportunity for investors to lock in profits (at higher prices) and avoid a significant draw down.”

I agree with Simon. Whether it is sooner, or later, the current run-up in stocks will end very much the same as they always have with investors “annihilated by their own rashness and the brutality of a ferocious enemy.”

For now, investors race forward with swords drawn, shouting the “bull market passive indexing” battle cry in the face of insurmountable odds solely with a conviction of invincibility.

But such is the nature of every bull market cycle in throughout history.

In the meantime, this is what I am reading.




Research / Interesting Reads

 ““Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” – Sir John Templeton

Questions, comments, suggestions – please email me.