THE STOCK MARKET HAS REACTED POSITIVELY TO TRUMP
But Normalized Interest Rates Will End The Party
1/03/17 11:00 AM
eight years provided a phenomenal environment for stocks, bonds, and real
estate due to the tremendous expansion of the Fed’s balance sheet and the
resulting eight year zero interest rate policy.
During that eight year period the world became familiar with terms like
Quantitative Easing (QE) and Operation Twist as the Fed moved into uncharted
waters in both the magnitude and length of its easing programs. What began as an emergency program to rescue
the U.S. and the world from the Global Financial Crisis turned into a longer term
attempt to stimulate growth through the inflation of financial assets; the
theory being that wealthy people would spend more and that wealth would
“trickle down”, and result in economic
growth. As it turned out, it should also
be mentioned, that the Fed alone pretty much carried the economic football as
the budget sequester limited the impact of fiscal policy as the U.S. government
continues to struggle with debt and deficits.
times during the past eight years, sell offs in the stock market were
alleviated or reversed as the Fed “rode to the rescue” with more QE and the
aforementioned Operation Twist. So
powerful were the effects of the Fed’s activity that other major central banks
in Europe and Asia started QE programs of their own. The ECB and BOJ have “upped the ante” by
taking interest rates to negative levels several years out on the yield curve,
and in the case of the BOJ, have even resorted to buying equities through the
ETF market. As a result approximately
$12tn of sovereign debt in Europe and Japan have negative yields and in
addition, the Government Investment Fund of Japan is a top ten shareholder in
the majority of the market capitalization of the Japanese stock market. We don’t know where the Japanese buying of
equities stops or possibly reverses, but it is not healthy to have the national
government interfere in free markets and substitute public for private capital
in the ownership of what should be the nation’s growth engine.
discussed many times how ill advised, to put it mildly, the major central bank
policies are. In essence these policies
distort the relationship between risk and return that is essential for the
efficient pricing of capital. This
causes bad investments to be made and good investments not to be made. Zero and negative interest rates also push
investors into riskier investments than would otherwise be made as they chase
yield. The companies themselves, in the
U.S. and increasingly elsewhere, have been on a “feeding frenzy”, buying stock
back at extremely inflated levels to the detriment of investing in their
businesses. In many cases, compensation
of senior managements is determined by EPS metrics not adjusted for stock
buybacks. Since it is the managements
and boards of companies that authorize and execute these programs, an inherent
conflict of interest exists as managements ”knock” options “into the money”,
thus influencing their own compensation.
With the stock market at or near all-time highs the public is not
focused on this, as the “music is still playing”. But we maintain that the day may come when
the focus of politicians and regulators will be how much money was stripped
from shareholder’s equity of U.S. companies as stock was bought back at
valuations that in more normal times would cause them to want to SELL equity,
that has taken place since the election of Donald Trump comes at a time that
the Fed is (slowly, so far) reversing the zero interest rate policy of the past
eight years. In addition, they are not selling the bonds they bought and are holding
on their balance sheet, but rather are letting the balance sheet “run
off”. Said another way, this is money
printing, i.e., currency debasement, plain and simple. In our view, the market is betting the Trump
promises of tax cuts, deregulation, repatriation, and fiscal stimulus across
defense and infrastructure related industries will outweigh the potential
negatives of possible trade wars and tariffs, a stronger dollar, inflation, and
further rising debt and deficits. To our
way of thinking, and to no surprise to our readers, we believe the market’s positive
reaction thus far will be dead wrong.
has been done over the last eight years by the Fed’s ill-conceived and
irresponsible zero interest rate policy and unprecedented money printing. Financial assets have been inflated to at or
near the most expensive levels in history.
As the Fed raises rates and tries to normalize, debt will continue to
climb, and in our view, Trump or no Trump, we will not grow our way out of the
problems that exist. Whether we have low
growth and low inflation, or whether we have stagflation remains to be
seen. But either way, when rates
normalize, as they must, the markets will become rational again. In our view, when that happens, both stock
and bond prices will be substantially lower.
PRESIDENT-ELECT TRUMP WANTS ECONOMIC GROWTH
But The National Debt Could Grow Even More
12/02/16 4:30 AM
We have to
admit to being as surprised as everyone else at the stock market’s reaction to
the Donald Trump victory. And it is not
because we think the policies of the incoming administration will be less
growth oriented than the Obama or the not to be Clinton administration. Quite the contrary. President-Elect Trump’s policies will be
friendlier to business and to the taxpaying public than the alternative. The problem is that those policies could also
explode the debt, which we believe is the most significant financial threat to
the country’s growth and economic well being.
positive side, there are a number of pro growth initiatives in the Trump
plan. A partial list would include, infrastructure
related spending and jobs resulting from the fiscal response, rebuilding a
depleted military including new investment in weapons systems, scaling back or
eliminating Obamacare, tax cuts for individuals and corporations, reducing the
maze of Federal regulations that are choking certain business activity including
energy production, building the Keystone and other pipelines, possible corporate investment in
neglected real plant and equipment due to a shift to optimism from pessimism,
and importantly, repatriation of corporate profits that are being held
offshore, mainly in Europe.
opposing side, there are at least several negatives. Among those are building a wall financed by
Mexico that causes friction and reverse immigration of low skilled workers
(ultimately very inflationary), minimum wage laws, which are not only inflationary
but actually can destroy jobs, renegotiation of trade agreements that slows
business activity, trade tariffs that are ultimately borne by the U.S.
consumer, and possible political interference in the activity of the Fed (our
readers know that we have vehemently criticized this Fed in particular, but we
have never espoused political interference).
Below are a
few statistics, sourced from www. usdebtclock.org. We compare to the same series eight years
ago, at the end of 2008, and encourage our readers to view for themselves.
The National Debt went from $10.9tn
to $19.9tn, an increase of 82.5%.
GDP went from $14.1tn to $18.7tn, an
increase of 32.6%. (This increase in debt relative to increase in GDP is
Though the National Debt stands at
$19.9tn, which given GDP is an increasing and ominous number, the Unfunded Liabilities,
which include Social Security and Medicare, stand at an almost unfathomable
Total Public and Private Debt is now $66.8tn,
up from $50.8tn. Given the above, Total
Credit Market Debt now stands at 357% of GDP.
We could go
on and on with many more statistics but we think that you, the reader, get the
point. Our thesis is, and has been, that
the excessive debt that exists has slowed growth. This is evident in the anemic GDP growth
statistics since the end of “The Great Recession”. We believe the better than expected 3.2%
increase in GDP increase reported by the government last week will prove to be
another false start, especially in light of the rapidly increasing dollar
relative to the currencies of our trading partners.
At the same
time that debt was going through the roof, the Fed was increasing its balance
sheet from $800bn to $4.5tn. Said
another way, the increase in debt, at least on the public side, was financed in
large part through the printing of money.
That has, in our view, led to the inflating of financial assets to levels
not seen before on the fixed income side, and to near the most expensive
valuations in history on the equity side.
In its most recent reporting summary S&P 500 Trailing Twelve Month GAAP earnings are $89.29 (24.2X P/E on 9/30/16 Close). We have written about what we view as
dangerously high equity valuations many times, most recently in the piece
entitled “Malaise” on this website.
us back to President-Elect Trump and what he will face as he attempts to
implement the policies he espoused during the campaign. In March 2017, the federal debt limit, which
has been suspended since the fall of 2015, will be reinstated. It is at the time, or more likely, in the
weeks immediately preceding, that the markets will focus on the issue. We could again get a glimpse of just how
topsy-turvy the world has become, for it may be the republicans that become the
debt lovers and the democrats that, in the spirit of obstruction by both
parties that has existed for some time, try to put the brakes on. While it may not be possible to predict the
outcome, we feel it is safe to say that this is one of several catalysts that
have the potential to ignite the bear market we have been anticipating for some
President-Elect Trump would be wise to heed the advice espoused by Randall
Forsythe in the last two issues of Barron’s magazine. Essentially, it boiled down to taking
advantage of artificially low interest rates and issuing 50 or 100 year bonds while cutting corporate
tax rates to a theoretically revenue neutral 22%. At $20tn in debt, each 25 bps is $200bn of
interest. In the longer term, this will
have the effect of crowding out other spending.
In our view massive
infrastructure spending may boost the economy temporarily. But more spending means more debt and potentially
more inflation and interest rate exposure.
Whether President-Elect Trump and his advisors heed the advice remains
to be seen. But from our perspective, we
see more money printing, more currency debasement, and more risk to the
financial assets that have been so grossly inflated by the Fed’s irresponsible
The CB's have to Learn You Can't Go To "Cold Turkey" from "Wild Turkey"
The Central Bankers Continue to Guess on What to do
11/02/16 11:30 AM
We have been
discussing (in the most critical way possible) the Central Banks all over the world for the past 16 years. In fact, a journalist called us this past
January and asked what we thought of the stock market? We responded that we expected the stock
market to decline sharply during the year 2016 as the Fed raised rates.
The journalist countered that every time the Fed raised rates in the
past the stock market still did quite well.
So far the journalist has been correct and we have been wrong. We believe this will change again within the
next few months since the Fed will be forced to finally reverse the damage done over the past 8 years.
We tried to
explain to the journalist that we are presently in a completely different
situation than we were in the past, when the stock market rose as the Fed
raised rates because the economy was doing well and/or there were inflationary
risks. Now we have gone through QE1,
QE2, QE3, and “Operation-Twist” where we drove rates down to zero (ZIRP), or
close to it for the past 8 years. This
time the Fed has grown its balance sheet from about $800 bn. to over $4.5
tn. This enormous amount of money has to
be eventually wound down. This injection
of money printed by the Fed has not driven us into an inflationary bubble
because there is very little “velocity” (the pick-up of transactions). The injection of money does not lead to
inflation since the money printed by the government or Fed does not get the
public to spend the money and they save it instead. This is called a “liquidity trap”, which is what
Japan went through for the past 27 years.
The high debt that we have generated, as well as Japan, has caused a
deflationary environment, which neither one of us seems able to achieve any
type of “escape velocity”.
This time is
also different from the past rate hikes since now our Fed is about to raise Fed
Funds right into the face of a manufacturing recession (down for over 6
quarters in a row). We also are
threatening to raise rates right into the face of virtually every other central
bank that is still in the loosening phase of printing more money and lowering interest
rates. All this while we are about to
tighten by increasing rates and raising the value of the US dollar. And because of the US dollars rise and
continued rise as we raise rates, it will be more difficult to compete with our
trading partners and lower our exports.
Most of our trading partners are participating in a race to the bottom,
as they do whatever they can to lower their currency in order to sell more
goods and services to the US.
given this journalist at least 4 more reasons why we believe the increase in
rates will lead to a bear market for US stocks.
Right now, we would have to admit it looks like the journalist was right
this past January. At first, we looked
like geniuses as the US stock market dropped sharply in January. However, we
still think we will win the prediction contest with the journalist (but maybe a
little later this year or early next year).
The reason we haven’t been accurate is because there were no interest
rate increases since we essentially made the challenge to whether the US market
would rise or fall with the interest rate hike that was expected. Remember, in December of 2015 Stanley Fischer
predicted that there would be at least four interest rate hikes in 2016. So far, there were frequent predictions by
voting members of the Fed that they would be voting for increases. In fact, at the latest meeting there were 3 dissenters
who voted against passing up the increase in rates. We do believe there will be enough votes to
raise rates this December, and that is when we will reverse our losing ways
with the journalist. This past month 3
Fed officials stated that we should hike the rates because they are worried
about already keeping the rates far too low for too long. They were all worried about the risk of
financial instability. We will have to
see how it works out, and will let you know as we continue to believe we will
win the so called “bet” with the journalist as soon as we start tightening,
while every other central bank is driving rates lower or even into negative
territory. As we stated before, we
believe all the central banks are guessing at the new made up remedies, that
have never been tried before, and will result in “unintended consequences” that
could be disastrous.
Our debt (helped by the central banks), as
well as Japan and the rest of the world, will eventually drive us into a global
deflationary debacle. We would put the
probability of inflating our way out of this mess at about 30 % and continuing
to fall into a deflationary global bear market at about 70%. Please keep in mind the debt is not just our
national debt of $20 tn. but the total debt of over $100 tn. if you include the
promises made by the government of Social Security, Medicare, Medicaid, and the
promises of pensions to Federal employees.
Our Fed and
other Central Bankers have been propping up financial markets all over the
world. But now that there are record
outflows of equity mutual funds, all bond funds, and other actively managed
funds, there will be nobody (including the Central Banks) remaining to buy the
financial assets as the money is going into ETF’s, savings accounts, and under
their mattresses. There is no one left to buy as the selling increases and
there are record low amounts of insider buying and corporate borrowing to buy
shares to increase earnings per share by lowering the number of shares
outstanding. This could turn out to be a
bear market worse than 2000-2001 and 2007-2008.
37 Years Later Debt Has Made Jimmy Carter Right And Stocks Are Expensive
10/06/16 9:00 AM
Back in 1979 President Jimmy Carter addressed the nation and
told his fellow citizens the country suffered from a “crisis of confidence” in
what became famously known as the “malaise speech”. Back then the country was suffering from
“Stagflation” or inflation with sluggish growth. The former president was on to more than he
knew because now, thirty seven years later, the nation suffers from a great
“malaise” by virtue of the fact that we are in the weakest recovery ever
following the Global Financial Crisis of 2008-2009. While the nation is not suffering from high
inflation (tell that to someone cashing a weekly paycheck trying to make ends
meet) as measured by the government, the fact is that GDP continues to suffer
from a “malaise” as it grows in the sub 2% area.
We have addressed this many times and just to update new
readers, we believe that the slow growth has everything to do with the
excessive levels of government, corporate, household, and student loan
debt. The Federal Reserve, for its part,
has mainly addressed this problem by increasing its balance sheet (buying U.S.
government and agency debt) and lowering interest rates (such that the price of
money is determined by fiat, rather than true price discovery in the
marketplace). While these activities
were intended to stimulate growth, what they really have done is inflate
financial assets to levels, that both on an historical basis and relative to
future growth prospects, are among the most inflated in history. For their part, the central banks of Europe
and Japan have “upped the ante” and gone to negative interest rates, and are buying
government debt, corporate debt (Europe) and also equities (Japan). They too suffer from the “malaise” of slow growth and are having little to no success in
stimulating their respective economies.
The one area where these policies have been successful is in stimulating
the savings rate, which has the exact opposite effect that they intend! This slows economic activity even more.
So given the slow growth and low growth prospects, how has
profit growth faired and where are U.S. equities priced? As always, we will be referring to GAAP Earnings,
as they are by far the better metric for corporate profitability versus
Operating Earnings, which exclude extraordinary items (share repurchases, for
example). According to the latest data
from Standard and Poors, with 97% of companies having reported for the 2nd
quarter, the S&P 500 will just eek
out a 2% gain in GAAP Earnings on a quarter versus quarter basis versus a year
ago. This is following six straight
quarters of sequential declines, with two being defined as an earnings
recession. If we give securities
analysts the benefit of the doubt on third quarter projections, 12 month
trailing GAAP Earnings will be $90.65 and given a 2,168.27 close at quarter end,
the trailing P/E will be 23.9. If you,
the reader, do not see this as expensive, ask yourself the following question:
If you owned a mom and pop business that made $100,000 per year after taxes,
that was growing at 2% or less, that could even have negative growth, and if someone
offered you $2,390,000 for it, would you sell it? (That is a 23.9 multiple.) We think you should (and go do something
else…like start another business)! To
not do so means that either you are much more optimistic about the growth
prospects or that you believe a “greater fool” will offer you even more
later. But, understand that the passive
act of not selling puts you in the position of possible greatest fool when the
bottom falls out. (If you are a regular reader of ours you likely believe that
For historical perspective let’s compare to the two previous
bubbles of the modern era, the Dot Com and Housing bubbles. The Dot Com Bubble topped on 3/24/2000 with
the S&P 500 closing at 1,527. A few
days later the quarter ended with the trailing P/E at 27.8. Keep in mind that tech stocks were on fire
(thus the name Dot Com) and the insanity had grown so great that clicks were
actually considered a valuation metric.
Needless to say, the bubble burst and when the market bottomed at 777 in
October of 2002, it had fallen 49%.
While true that 27.8 is higher than the current 23.9 trailing P/E, they
are both in the stratosphere and to justify valuation on the basis of an even
higher degree of insanity is just flat out wrong.
In the Housing Bubble, the top of the market was actually
about a year before the bottom fell out.
The closing high of 1,565.15 took place on 10/9/07. When quarter end came the trailing P/E was
17.8 and earnings were $69.93. As the
third quarter of 2008 ended, and just before the bottom fell out, earnings had fallen to $45.95 and the trailing
P/E stood at 25.4 (not far from where we are now). When the decline ended at 666 on 3/9/2009,
the market had fallen 57% from its high in October of 2007.
The point we are making, and as our readers know, we are of
the strong belief that for the many reasons we’ve espoused over the years, a
bear market of giant magnitude is close at hand. The possible (if earnings come in as
projected) 23.9 trailing P/E is very, very, rich historically. At the top of other bubbles and with similar rich
valuations, the subsequent downside was extremely large. When the bear market begins in earnest and
what the catalyst will be is basically a black swan that at this time, no
matter what anyone tells you, is a guess.
However, given the “Central Bank Bubble” that we are in, as we’ve
discussed in these last many months and given the fact that investors all over
the world have been forced to chase yield and prices all the way to the
insanity of negative territory, it cannot end well. The
last many years of zero interest and negative rates have pushed savers into
being investors, and investors into being speculators. They are all on the same side of the life
boat. And when the seas get rough, as we
believe they will, it will be their position in the boat that further exacerbates
and accelerates the tipping!
Central Bankers Have Failed to Stimulate Thus Far
But Have Produced Unintended Consequences
9/01/16 3:00 AM
As most of
our viewers know, we have not been happy with the world’s central bankers over
the past twenty years and have expressed those feelings. The U.S. Fed is the most important central
bank among the major central banks of the world, as the U.S. economy is the
most important of all major economies. But,
unlike corporations that are usually managed by people that have spent their
lives working in business and industry, the Fed is managed by people that are
in many cases from the academic world. The
U.S. economy is now in the hands of those running models based on theories and
formulas that they can only “hope” are correct.
stated in the past that the Fed, through the largest expansion of its balance
sheet ever, several QEs and an operation twist, is conducting a grand monetary
experiment. Now it is possible that they
will accomplish their objectives and the economy will de-lever and grow, and
all will be fine…but we don’t think so.
In fact, we give a good outcome a close to zero chance. We are also of the opinion that we are in
“uncharted waters” and are certain nothing like this has ever happened
previously. We speak, of course, of the
unprecedented intrusion into price discovery (interest rates) on the part of
the Fed and other major central banks. Through this intrusion, stocks, bonds, major
currencies, real estate, collectibles, and just about anything you can think of,
that has to do with the cost of money, is terribly overpriced. There are, however, two things we think are
underpriced, risk and precious metals.
The aforementioned intrusion into the pricing mechanism of financial
markets have pushed investors of all kinds much farther out on the risk curve
than is generally perceived. In
addition, the across the board printing of money to expand their balance sheets
will, in our opinion, debase the major
currencies versus precious metals over time.
discussing our criticisms of the Fed in the late 1990s. Since then, we have criticized these
officials many times with our latest documented criticism being:
We wrote in
May of 2013, “The Fed is in a Lose-Lose Situation”.
of 2016, “Difference between Past Fed Tightening and Now”.
of 2016, “More Fed Criticism—We Are in Good Company”.
In July of
2016, "The Central Bank Bubble Is Worse Than the Dot Com & Housing Bubbles.”
many more-- and you can find them by clicking on the latest comments and scroll
down the older comments. When you get to
the bottom, just click “next” to find the others.
banks of Europe and Japan have gone even farther than our Fed. On their balance sheets they carry corporate
bonds (ECB) and equities (BOJ). Through
ETFs the BOJ is now a top 10% shareholder in 90% of the market capitalization
of the Nikkei 225. To add to the
insanity, in Europe, Japan and other non EU countries, interest rates on
government bonds are negative, out in some cases past 10 years, and are nominal
out to 30 years. There are $12 tn of bonds now trading at negative rates and
central banks own $25 tn in stocks and bonds.
Clearly, investments cannot be efficiently made by corporations when the
cost of capital is being determined by fiat, rather than the marketplace. It will take time, but lots of bad
investments are being made, and lots of productivity and capital will be lost.
Just when we
thought this was about as insane as it could get, we find that Ben Bernanke
visited Japan recently and it was reported that the topic of “Helicopter Money”
was discussed. “Helicopter Money” is
turbo charged QE. In QE, central banks
create money from thin air to buy financial assets in the marketplace from
investors. Now imagine central banks creating
money to fund infrastructure projects, tax cuts, bombs that blow up or
“helicopter drops”. That’s “Helicopter
insane is the fact that the central bankers don’t realize that the most likely
outcomes will be those that are “unintended consequences”. So let’s summarize by stating what we
believe the Fed and other central banks have intended. Simply stated, the central banks have tried
to stimulate their respective economies by inflating financial asset prices and
lowering interest rates to near zero (ZIRP), and in some cases below zero
(NIRP). That was supposed to cause
people that owned financial assets to feel wealthier and spend money, and also
to cause businesses to borrow to invest in plant and equipment to help grow the
That was the
intention. Here is list of just a few
unintended consequences we can think of:
ZIRP and NIRP have punished savers and caused
those who choose not to earn zero or less, or to spend, to invest in
inflated/riskier financial assets.
Stocks are trading near the most expensive levels in history while bonds
in the U.S., Europe, and Japan have traded at the most expensive levels ever.
Those who choose not to invest are
not spending enough to stimulate the economy.
Instead, they are saving.
Corporations should be investing in
plant and equipment for future growth.
They are doing less of that, and instead, are repurchasing stock (at
shareholders expense) hand over fist, along with other mispriced money based
financial engineering. The investments
they are making are being made using the same mispriced rates.
The economy continues to grow at the
slowest post recession rate ever since coming out of the “Great Recession”.
Inflation (why a central banker would
want inflation is in itself insane!) remains below target.
By creating money in record amounts
from thin air, the U.S., E.U, Japan, and China are risking a loss in confidence
in paper/fiat money. That could manifest
itself in hyper-inflation.
The debt accumulated during the
housing bubble and great recession could unwind and we could be at risk of a
we would like our viewers to understand that what central banks are doing has
not been done before. To that extent investors,
markets, corporations and populations are all in “uncharted water”. No one knows for sure how this will all play
out. But, we believe that what has been
done by central bankers for 7.5 years has not worked. With or without “Helicopter Money”, we
believe a major bear market is coming. If and when that happens this era will
be forever known as “The Central Bank Bubble”.
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