Bonds & Interest Rates
Argentina has bluntly stated it cannot make the next bond payment. The exist fees being attacked to long-bond funds is also the realization that our models are spot on. I am off to urgent meetings in Europe. All I can say is our phone has been red-hot. Equities are rapidly becoming the new international gold and safe-haven. This adds to the trend of Austria declaring it never guaranteed the debt and France announcing 60% of their debt is illegal.
To all those sending emails on this subject and can it be stopped, the answer is of course, if there were no politicians. But this is Adam Smith in real life. They will only turn to our solutions WHEN there is no other choice. It would be against human nature for these people to say yes, you are right, let’s do something now. They will cling to power to their last dying breath. Fine, I would do whatever I can, but it is just not time. They have to bleed out of every possible orifice before they will ever yield. I truly wish I was wrong. But this is NOT my opinion – it is simple the fact of history. They will NEVER do the right thing for the country when they hold the power. They will blame the people and seize more power because that is always the answer to them.
DEBT has always been the Great Destroyer of Civilization. It is the opium of governments since the dawn of time. Government is just incapable of managing the economy and socialists like Pickitty just covet the wealth of everyone else. They alway assume they have a right to the labor of everyone else and there is never any discussion to the contrary.
….more from Martin:
Canada – the Sneak Preview
Since the crash of 2008, huge attention has been paid by regulators to systemic risk, the risk that some event will cause the crash of the entire banking system, not just of an individual bank. Tens of thousands of pages of financial regulations have been written, and almost as many thousands of speeches have been bloviated, about how we now understand the dangers of “too big to fail” and therefore a crash such as occurred in 2008 can never happen again.Needless to say this is nonsense; systemic risk is worse now than it was in 2008. What’s more, the next crash will almost certainly be considerably nastier than the last one. – continue reading HERE
Quotable
“Give me a one-handed economist.”
― Harry Truman
Commentary & Analysis
The Fed Hydra Kabuki Dance from Hell
What a performance from Fed Chairman Janet Yellen at her press conference yesterday to explain the Federal Open Market Committee rate decision.
Why does every answer from a Fed Chairman begin with “so?” Bernanke had that weird habit too. I guess it is a Fed thing. “Johnny, did you steal money from mommy’s purse?” And little Johnny says, “So…I needed to buy some candy…” and before Johnny can finish the excuse a regular father would already have stopped him in mid-sentence and said in no uncertain terms: “Answer the damn question: yes or no?” But of course the Fed can never answer the damn question. And so it goes…
- So… those inflation numbers. The latest headline CPI looked high to me, but don’t make too much out of the fact all the things real people are forced to buy, like food, medicine, education, and energy are rising while real wages are taking a dirt nap. Inflation is well under control. Prices are actually tucked tightly within our mandate and in fact we are hoping we see more inflation.
- So…the Fed funds rate is just about perfect where it is now, unless of course we need to change it for some reason.
- So…those long-term forecasts of growth are precise, but there is quite a margin of error and we have two new committee members who haven’t been properly indoctrinated; all will be good next time around. So I wouldn’t put too much emphasis on that forecast even though we use them to determine the Fed Funds rate. And so when we do raise the Fed Funds rate, whenever that may be, for some unknown reason, don’t worry because the long end of the curve won’t rise anyway.
- So… there is a growing number of structurally unemployed out there, but I am sure zero-bound interest rates will do the trick and the economic recovery will pull them back into the job market. But of course we have to remember the economy’s inability to grow at normal capacity will mean many of those structurally unemployed may not find jobs which will likely hurt the productivity of the US economy.
- So…I am concerned about the spread between junk and high quality paper, but I see no cause for concern about too much leverage being taken, or investors stretching for yield, or bubbles anywhere.
- So…employment has improved dramatically and we are succeeding on our mandate there, but of course you realize the labor market is still quite weak and zero interest rates will be needed for longer than many expect.
I could go on, but thinking about Fed Chairman Yellen’s blather gives me a headache, so I will stop there and let you add some of your favorites. But I do have a few questions and comments:
- Has the women ever traded anything in her life?
- Has she ever held a real job outside of academia?
- Is she the epitome of “no skin in the game” or what?
- Does she actually think she instills the least bit of confidence in anyone listening to her blather?
- Did she ever read Luwign von Mises’ accumulation of articles titled the Manipulation of Money and Credit?
- Does she understand the Fed is why investors are stretching for yield and taking on too much risk?
- Does she realize a country with the advantage and burden of reserve currency status is supposed to be responsible with money and credit?
- And is she really our “best and brightest,” or yet another concoction from the well-connected tribal northeastern liberal institutions and the proper gender to boot?
- Could that performance provide any better example of why we need to shut-down the Fed Open Market Committee?
- Is it any wonder why China is about to zoom past the US as the world’s eminent economic power?
So…the Fed funds rate is just about perfect where it is now, unless of course we need to change it for some reason.
- So…those long-term forecasts of growth are precise, but there is quite a margin of error and we have two new committee members who haven’t been properly indoctrinated; all will be good next time around. So I wouldn’t put too much emphasis on that forecast even though we use them to determine the Fed Funds rate. And so when we do raise the Fed Funds rate, whenever that may be, for some unknown reason, don’t worry because the long end of the curve won’t rise anyway.
- So… there is a growing number of structurally unemployed out there, but I am sure zero-bound interest rates will do the trick and the economic recovery will pull them back into the job market. But of course we have to remember the economy’s inability to grow at normal capacity will mean many of those structurally unemployed may not find jobs which will likely hurt the productivity of the US economy.
- So…I am concerned about the spread between junk and high quality paper, but I see no cause for concern about too much leverage being taken, or investors stretching for yield, or bubbles anywhere.
- So…employment has improved dramatically and we are succeeding on our mandate there, but of course you realize the labor market is still quite weak and zero interest rates will be needed for longer than many expect.
I could go on, but thinking about Fed Chairman Yellen’s blather gives me a headache, so I will stop there and let you add some of your favorites. But I do have a few questions and comments:
- Has the women ever traded anything in her life?
- Has she ever held a real job outside of academia?
- Is she the epitome of “no skin in the game” or what?
- Does she actually think she instills the least bit of confidence in anyone listening to her blather?
- Did she ever read Luwign von Mises’ accumulation of articles titled the Manipulation of Money and Credit?
- Does she understand the Fed is why investors are stretching for yield and taking on too much risk?
- Does she realize a country with the advantage and burden of reserve currency status is supposed to be responsible with money and credit?
- And is she really our “best and brightest,” or yet another concoction from the well-connected tribal northeastern liberal institutions and the proper gender to boot?
- Could that performance provide any better example of why we need to shut-down the Fed Open Market Committee?
- Is it any wonder why China is about to zoom past the US as the world’s eminent economic power?
Do you remember some of your Greek mythology? Do you remember Hydra, the multi-headed serpent? Every time one of its heads was cut off Hydra quickly grew two more, making it that much more dangerous. I couldn’t stop thinking about that as I watched Mrs. Yellen at her press conference yesterday.
So…A crash is on the way. The only question is when.
So…Hercules was able to finally kill Hydra by cauterizing the wound each time he cut off a head, keeping two more from growing back. He knew if he could do that, and finally cut off the last remaining head, it would be the end of the evil serpent Hydra. So…is there anyone out there who wants to revive Ron Paul’s call to dismantle the Fed?
It will take a Herculean effort to kill off the Fed. Our top schools seem to breed the “best and brightest” Keynesian Ph.D. clowns faster than Hydra’s heads appeared. But ending the Fed is a worthy goal. And I am sure those of us who are not members of the oligarchical intelligentsia, especially those in the structurally under- and un-employed class, would be mighty grateful.
Jack Crooks
President, Black Swan Capital
Twitter: @bswancap
P.S. If you would like to sample our forex service, I will set you up for a two week trial and you can see more of what we do and determine if Black Swan Forex could be a resource to help you make real money in the currency market.
Please click here to request a free trial. We simply need your name and email address.
P.S.S. The US dollar reserve status and case for a US dollar bull market power point presentation andIntroduction to Currency Trading webinar has been posted to our home page at the top:www.blackswantrading.com
A critical lesson about a certain kind of risk that investors often ignore is found in this heartbreaking story about about a cat. A lesson that really applies to the market evironment we have today.
Eric J. Fry specialized in long/short equity strategies during a 20 year Wall street career. This really enjoyable 
and valuable read was developed from unique insights on the societal and economic influences that create opportunity… or risk. – Editor Money Talks
In life, there are things, and there are treasures… Things are common. Treasures are rare.
Not long ago, I lost one of my treasures – a cat named Uzi. Her death reminded me just how devastating a certain kind of risk can be. The risk I’m talking about is called “asymmetric risk”… and it is one that investors often ignore or underestimate.
Asymmetric risks often seem highly unlikely, which makes them easy to ignore. But as Uzi’s heartbreaking story shows, an “unlikely” risk is not the same thing as a “manageable” risk.
Uzi was “just a cat.” I know that. But that fact did not make her any less of a treasure. She was precious to me… which is why I spent hundreds of hours during her brief lifetime trying to keep her alive.
I live next to an open hillside that is home to a variety of wildlife, notably coyotes. But this same hillside is also home to rabbits, mice, lizards, birds and numerous other varmints that excite the predatory instincts of a small feline. So it was next-to-impossible to keep Uzi off that hillside. She would hunt up there almost every day… And almost every day, she would return to the house with some sort of mauled “trophy.”
As long as Uzi conducted her hunting forays during daylight hours, the risks were very small that the hunter would become the hunted. But as soon as the sun dipped below the horizon, the balance of risk would shift dramatically against Uzi.
At nightfall, nocturnal predators like coyotes and owls make the rules for small felines. The problem was, at nightfall, felines still make the rules for mice. And so Uzi was never keen to abandon the thrill of the hunt to return to the relative ennui of watching prime-time television from my couch.
Given the chance, she would roam the hillside at night. But she was rarely given the chance. I was obsessive about keeping her indoors at night. In fact, I was obsessive about locking her indoors well before sunset.
On those rare occasions when she remained outside after sunset, I would scour the hillside until I found her. Sometimes the search lasted a few minutes; sometimes a few hours. But I would continue the search until I found her. Only twice during her two-year life did I fail to find her. Once, she spent the entire night outside. Once she returned about 1:00 in the morning with a mouse in her mouth.
On both occasions, I feared the worst. I assumed a coyote had found her before she found her way back to the house. Then one night, the worst came to pass. I searched for Uzi off and on from 5:00 p.m. until 2:00 a.m. Fifteen minutes after I walked back into the house the last time, I heard the chilling yelps of coyotes that had just captured prey.
Their prey was my cat.
I was heartbroken… and still am. But as I mentioned at the outset, this little story is not merely about Uzi and me; it is a universal story about asymmetric risk.
Investors take note…
An asymmetric risk has nothing to do with the odds of a given risk, but everything to do with the consequences of a given risk. In Uzi’s case, the odds that a coyote would kill her were relatively low, even on a hillside frequented by coyotes. In fact, the numerical odds were hugely in her favor. She spent more than 50 evenings on that hillside before finally encountering a fatal evening.
So let’s say the odds were 50-to-1 in her favor. But the consequences of that risk were massively asymmetric. In our hypothetical 50-to-1 risk, Uzi returns to the house alive 49 times out of 50. But one time in 50, coyotes kill her. By the numbers, that’s a good risk. In reality, that’s a horrible risk.
No investor would take a bet like that… at least not knowingly.
But investors take asymmetric bets every day. For example, they’ll buy the low-yielding long-term bonds of a heavily indebted nation… or they’ll hold 100% of their net worth in a single currency issued by a heavily indebted nation… or do both of these things at once!
Asymmetric risks can succeed for long periods of time… and that’s exactly why they can seem harmless or irrelevant. But when asymmetric risks fail, they usually fail catastrophically. That’s not a smart risk.
Understanding your potential reward is worthwhile. Understanding your potential risk is everything.
Good investing,
Eric Fry
for The Daily Grind
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Perhaps one of the most influential books I’ve read over the last several years is “The Era of Uncertainty”, which was co-authored by Francois Trahan and voted as the #1 Portfolio Strategist in 2013 by Institutional Investor. In the book, Francois shows how the Fed Funds Rate no longer serves as the key variable driving swings in the market and economy. Instead, he argues, in a world of nearly zero interest rates, “Inflation is the new fed funds rate.”
Why does this matter? Well, in the past, the Fed raised short-term interest rates to cool the economy and often a recession would ensue, while it lowered them to stimulate the economy back towards growth. However, with the Fed currently committed to keeping rates near zero, changes in the rate of inflation have now become the key variable acting on the business cycle. Like rising interest rates, rising inflation is a bearish force that eats into discretionary spending and corporate profit margins while falling inflation puts money back into consumers’ pocket books, boosts corporate profit margins, and helps to stimulate economic growth.
With that in mind, monitoring real-time and lagging inflation indicators is helpful for investors trying to identify or avoid heightened risks of a correction. This was a point I stressed when calling for an intermediate market top and correction in February 2012 (see Countdown to Market Peak Has Begun) based on rising inflationary trends at that time. (Note: the S&P 500 peaked in early April at 1422.38 and then underwent an 11% correction before bottoming at 1266.74 in early June.)
As I warned then and show in this report as well, various indicators suggest that inflationary pressures are again starting to build and will likely exhibit their influence on the economy later in the year (in this case around the fall). The countdown to another market peak has likely begun.
Inflationary Trends on the Rise
We received May’s Consumer Price Index (CPI) data which showed the largest monthly increase in headline inflation since 2011 with the index up 0.35% over last month. May’s increase marks the third consecutive acceleration in the headline and core inflation data.
Source: Bloomberg
This trend carries a bearish message as changes in inflation typically lead turns in the economy by roughly six months. Given inflation bottomed in February, this suggests economic weakness could begin to surface as early as August. The link between inflation trends and economic activity is shown below in which the NFIB Small Business Higher Prices index is shown advanced by six months and inverted for directional similarity with the ISM Manufacturing PMI below. With the rise in the NFIB price index to the highest level in three years, we are likely to see the ISM PMI peak in the next couple of months and then decline in the fall.
Source: Bloomberg
Indirectly, we also see an additional confirmation for the above coming from the relative performance of the consumer discretionary and energy sectors. The consumer is weakened by stronger inflationary trends while energy companies benefit, and so the relative performance between the two is closely tied to inflationary trends. Given the inflation link in the two sectors’ relative performance and Trahan’s thesis that inflation trends lead the economy, relative sector performance of the two sectors has shown a decent track record of predicting growth swings in the economy as measured by the ISM PMI index. The recent outperformance by the energy sector relative to the consumer discretionary sector suggests, like the NFIB Higher Prices Index, that the manufacturing sector of the economy should stall in the next few months and then decline heading into the fall.
Source: Bloomberg
As outlined above, inflationary trends tend to lead economic growth and since the stock market is closely linked to changes in the economy it then follows that inflationary trends influence stock market returns. The link between inflationary trends and the S&P 500’s year-over-year (YOY) rate of change is shown below with the annual growth in the CPI shown advanced and inverted for directional similarity. The recent upswing in inflation we’ve been having suggests the growth in the stock market peaks in the months ahead and then declines heading into the fall.
Source: Bloomberg
Do Not Mistake a Growth Recession for a Full Blown Recession
While I am calling for economic and stock market weakness in the fall, the bigger picture view of the economy still remains solid. Essentially, I am calling for a growth recession (a decline in the economic growth rate) but not an outright recession, which sees negative growth. While inflationary pressures have been building this year, so too has the momentum in employment. The three month moving average of monthly payroll changes is currently 234K, the strongest growth rate since early 2012. The economy’s 12-month average of 217K jobs added a month is only 22K a month shy of hitting a 14-year high.
Source: Bloomberg
Not only has the growth in monthly payrolls increased, but so too has the breadth of that growth as roughly 70% of industries are adding to their payrolls, higher than the best levels seen during the 2001-2007 economic expansion.
Source: Bloomberg
Outside of payrolls, various leading economic indicators (LEIs) are also not flashing any warning signs to suggest a recession is on our horizon. The Philly Fed’s State LEI for the US is still well above negative territory and comfortably above the warning level of 0.50% (orange line).
Summary
With the advent of the Fed’s zero interest rate policy (ZIRP) that began in 2008, short-term interest rates can’t account for the economic swings we’ve had since 2009. As Francois Trahan eloquently argued in his book, “The Era of Uncertainty,” following inflation trends can help investors get an early read on future economic growth and, thus, the stock market. We’ve clearly seen a pickup in direct and indirect measures of inflation recently, which suggests economic growth and the stock market may stall in the months ahead before declining in the fall. While we could be setting up for our first 10%+ correction in some time, by no means am I calling for a bear market or recession, but rather a growth recession similar to what we saw midyear for 2010, 2011, and 2012. Current employment momentum and breadth in addition to various LEIs argues against making a recession call. Rather, the warning provided in this article suggests to shift one from focusing on return to focusing on risk management as we head into the fall and to look for a good buying opportunity should a correction occur.
Portfolio Manager at PFS Group
Primary Tel: 858.487.3939
Other Tel: 888.486.3939
Fax: 858.487.3969
PO Box 503147 San Diego CA 92150-3147 USA
cpuplava@puplava.com
http://www.puplava.com
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