What, Me Worry?


“Forget the past. The future will give you plenty to worry about.”

– George Allen, Sr.
 

“I try not to worry about the future, so I take each day just one anxiety attack at a time.”

– Tom Wilson


Welcome to the new, improved, faster-to-read, better yet still-free Thoughts from the Frontline. My team and I have been doing a lot of research on what my readers want.
 
The reality is that my newsletter writing has experienced a sort of “mission creep” over the years. Bluntly, the letter is just a lot longer today than it was five or ten years ago. And when I’m out talking to readers and friends, especially those who give me their honest opinions, many tell me it’s just too much. There are some of you who love the length and wish it were even longer, but you are not the majority. Not even close. We all have time constraints, and I wish to honor those. So I am going to cut my letter back to its former size, which was about 50% of the length of more recent letters. (Note: this paragraph is going to open the letter for the next month or so, since not everybody clicks on every letter. Sigh. Surveys showed us it’s not beca use you don’t love me but because of demands on your time. I want you to understand that I get it.) Now to your letter…
 

The middle ground can be uncomfortable. As someone now widely known as the “muddle-through guy,” I have learned this the hard way. My bullish friends call me a worrywart, and the bearish ones think I am Pollyanna incarnate.

The irony here is that I’ve never claimed to be a great trader or a short-term forecaster. I think I have a pretty good record of calling major turning points. Next week or next month is another matter. Anything can happen, and it probably will.

That said, the fact that my forecast may be wrong doesn’t prevent me from making one. So, with all the usual disclaimers, today I will review some recent analysis from my reliable sources and let you take a peek into my worry closet.

One point we all agree on: We live in unusual times.

Sell to Whom?

Last week Doug Kass sent around an e-mail comparing today’s markets to Queen’s classic “Bohemian Rhapsody.” I know that seems odd, but it was actually a good fit. I shared Doug’s full message with my Over My Shoulder subscribers. For everyone else, the point is that, like the song says, “Nothing really matters” to whoever is buying stocks these days. They just keep buying and pushing prices higher. As Jared Dillian says, “It’s a bull market, dude!” Stock prices do go higher in a bull market; and sometimes, as the end approaches, they make value investors very uncomfortable.

Neither Doug nor I quite understand the “Nothing really matters” attitude, though we have some theories. Doug is probably more bearish than I am. He has a long list of open questions. I zeroed in on the last one, which is critical: “When ETFs sell, who will buy?”

The stratospheric ascent of passive indexing is having side effects that I suspect will make markets sick at some point. Passive investing is perverting the financial markets’ core economic function, i.e., efficient capital allocation. In terms of stimulating buying interest, a company’s fundamental business prospects are now much less important than its presence in (or absence from) popular indexes.

We’ve created this environment in which badly managed companies can still see their stock prices rise along with those of well-managed companies. The actual facts about a company don’t mean all that much in a passive-investing world. Capitalization-weighted indexes aggravate this already problematic phenomenon. Money is pouring into stocks like Apple (AAPL) and Amazon (AMZN) simply because they are big. The resulting higher prices make them bigger still, and they pull in yet more capital. Here’s a look at the five largest stocks in the S&P 500.


What about the QQQ or the NDX? The five stocks above represent 42% of the NDX and 13% of the S&P 500. That means every time you buy an index based on the NASDAQ, 42% of your money goes into just five stocks, leaving 58% for the remaining 95. By the time you get past the largest 25, you are under 1% per stock. Apple alone is 12% of the NASDAQ 100 Index and 4% of the S&P 500. That explains, in part, why the NASDAQ has outperformed the S&P 500.

For the record, Goldman Sachs researchers recently released a paper with a strong fundamental forecast for those stocks. That is, they expect them to continue to go up, absent a recession or something else that triggers a bear market. I keep scanning the horizons in every direction, and I just can’t see anything that would trigger more than a minor correction today. Of course, a minor correction could deliver outsized impacts, given the heavy weighting of a few stocks and passive index investing. Be careful out there.

Doug asks, When ETFs sell, who will buy?” The ETFs of the world may quickly begin trading below their actual net asset values (NAV). This is called price discovery, and the arbitrageurs will not be slow to take advantage of that difference. This means the indexes will drop much faster than they have gone up. I am neither a fortuneteller nor the son of a fortuneteller, but there are a few things I’ve picked up along the way. One of them is that, next time, stocks are going to go down breathtakingly fast once they begin to roll over.

This bull can’t end well, but it will end. At that point, Doug’s question becomes critical: Who will buy? I don’t know, but someone will. Prices for good and bad stocks will drop to whatever levels attract buyers. The indexes will eventually fall lower than any of us think likely right now. Whether that will happen next month, next year, or next decade is anyone’s guess.

Sidebar: You should think of cash as an option on your ability to buy the stocks that will lose 50% of their value and suddenly become the value stocks of the future. The option value on your cash today is not that much. You don’t make much on it, but you don’t lose much holding it. The time is going to come when you will be glad you have a little cash to put to work. Think March 2009.

(Almost) Everything Is Awesome

While Doug was musing about Queen, Louis Gave was thinking about rugby. Should one go where the ball is now, or try to figure out where the ball will be?

Louis asks that question while noting that it has been extremely difficult to lose money this year. Almost every tradable asset class has been climbing. You are probably making good returns this year unless you have been:

Overweight energy and materials, and/or

Overweight financials.

Those have been the primary weak spots. Investors in everything from technology to emerging markets, to Europe and even utilities have done well. All you had to do was avoid energy, materials, and financials.

The reasons for this are pretty simple. Inflation remains low to nonexistent in most places, which hurts commodity prices along with companies in the energy and materials sectors. The widespread belief that inflation will stay low is keeping long-term bond yields low, which reduces the net interest margin for lenders, particularly banks. Hence, we see underperformance in financial services stocks, too. Further complicating the energy story is the continued expansion of unconventional shale oil production in the United States. Eventually the technology will spread to the rest of the world. Countries that depend on high oil prices are hurting. (And not just Saudi Arabia and Russia but a whole host of Middle Eastern countries).

The conditions that will change this pattern aren’t complicated: higher inflation expectations and rising long-term bond yields. That combination would push energy and metals prices up and steepen the yield curve. But the problem there is that the Federal Reserve remains intent on raising short-term rates. If they tighten another notch next week, as everyone expects, the current trends seem likely to continue.
 
Here’s Louis’s conclusion:

In sum, it is hard to foresee what will disturb the current Goldilocks scenario. So, investors who liken themselves to Rugby forwards (aka “piggies”) [an actual rugby term that is a double-play pun on investors getting greedy and hungry – JM] will want to continue dining at the trough of the current bull market. Meanwhile, investors who like to get their hair blow-dried before games (backs, or princesses), and prefer to run where the ball is going to be rather than where it is, may want to look at reducing their underweights in financials.
 
After all, at current global fixed income valuations, it wouldn’t take much – central bank hawkishness, upside surprises to core CPI – to trigger a mild fixed income sell-off. And any steepening of the yield curve would lead to a very different investment environment.

The shape of the yield curve is clearly critical in assessing markets right now. I agree with Louis that any steepening would lead to big changes. I wonder if we might get a steepening the other way: An inverted yield curve – when short-term rates are higher than long-term rates – is a classic recession indicator. It’s something the US hasn’t seen lately but can’t avoid forever.

How can we get an inverted yield curve with short-term rates so low? The Federal Reserve just slowly and surely raises rates; the weight of debt begins to slow economic growth even more; and long-term rates drop. Voilà, inverted yield curve. That is at least classically what is supposed to happen. So let’s think about that for a few paragraphs.

Bending the Yield Curve

The other much-anticipated news from next week’s FOMC meeting is how/when the Fed intends to start reducing the massive bond portfolio it accumulated during the QE years. The initial move may be simply to stop reinvesting the proceeds when bonds mature. That is still billions of dollars each month – enough for even the very deep Treasury bond market to notice. (Then again, maybe they just let their mortgage bonds roll off and keep buying the Treasuries. They have so many options, and they haven’t bothered to tell us which ones they are seriously considering.)

A little-discussed aspect of this situation is, who will buy the Treasury bonds once the Fed backs out? That part is beyond the Fed’s control. The federal government won’t stop borrowing just because the Fed stops “lending.” The Treasury will have to find other buyers for its paper and will likely pay higher rates to attract them. Maybe. That is what is supposed to happen. In a world where the unthinkable keeps happening, we’ll just have to wait and see.

Brevan Howard’s chief US economist, my friend Jason Cummins (a past SIC speaker, I should note) wrote a fascinating guest column in the Financial Times on this topic. He points out something quite obvious that hasn’t occurred to many. The Treasury Department must borrow enough cash to pay the government’s bills, but it has huge discretion as to how it structures federal debt.

That means Treasury Secretary Steve Mnuchin can choose to replace the Fed’s purchases by issuing new debt at any point on the yield curve. It doesn’t have to be of the same term as the maturing paper it replaces. He can issue thirty-year bonds, three-month bills, or anything in between, in whatever combinations he thinks best.

The implication, as Jason gently explains, is that Steve Mnuchin can essentially rebuild the yield curve into whatever shape he wishes – presuming he can find buyers. He always will, of course, at some price.

The Treasury is such a massive borrower that its entry at any given maturity level can crowd out other borrowers and force rates higher. I am sure the Treasury people who manage this process try to reduce interest expense as much as possible, but they can only do so much. The government has bills to pay.

If Mnuchin decides to concentrate new borrowing at the long end, it will drive up those yields and steepen the yield curve. That’s exactly what banks would like to see. That would enhance their profit margins – but with the possible outcome of raising mortgage and other long-term rates. Not good for the housing sector.

Or, Mnuchin could do more borrowing at the short-term end. That would be a bit of a gamble because there’s no way to know what rates will be when the debt matures in the relatively near future. The strategy would also flatten and possibly even invert the yield curve.

Just to make all this more suspenseful, the government is also bumping up against its statutory debt ceiling. Congress might have to approve an increase as soon as August, and some in the House want to use the opportunity to exact spending cuts. The odds are low, but we can’t rule out the possibility of another government shutdown scenario, as we saw in 2011 and 2013.

As Cummins noted, “As the clock ticks down and investors get increasingly skittish, the last thing the Treasury needs is to have to find more private sector buyers of its debt.” Agreed. That is why I expect the Fed to delay implementing its balance sheet reductions until after the debt ceiling is raised – or maybe longer, if employment growth and/or inflation weaken over the summer and fall.

The Dangers of Passive Investing

Before we end, I want to come back to a few charts that illustrate some of the problems that are building up in the passive index world. It is not just ETFs, but also index mutual funds and the enormous amount of pension and insurance funds, along with many trust funds, that are passively invested directly in stocks. They simply duplicate indexes.

First, let’s note that Vanguard now owns more than 5% of 468 stocks in the S&P 500.
 
That’s one fund Company.


Here’s the picture for fund flows last year:


 
The number of hedge funds is at its lowest level since 2000. Passive funds are eating away at the assets under management by active funds:
 


This trend goes back to a point I made a few weeks ago but that needs to be repeated again and again. When the market obscures distinctions between good stocks and bad stocks because it buys all of them at the same time, there is no way for an active manager to take advantage of his skill in determining value. That ability to look at a company’s balance sheet and determine something close to true value is what gives active managers their edge. If you don’t have the chance to do this, you cannot add any alpha, and you are going to underperform the simple passive indexes – even though you charge higher fees. Money will leave you for the seemingly more plentiful pastures of passive indexing. One day you will be vindicated, and the money will come back (think Jeremy Grantham); but because investors will lose a great deal of their money in a bear market, you won’t get as much back in the short term as left you over the past few years. If you are an active manager, this just sucks.

The next two charts show the difference between active and passive investing in the retail fund space. It’s a huge contrast:


 
The chart below traces the widening imbalance since 2008.
 


As I stated above, this imbalance will eventually be corrected. But the correction will not be pretty, though it may be swift.

If I’m going to keep my pledge to be shorter, more thoughtful, and faster, then I’d better close on that note.

Getting Married on St. Thomas, Omaha, San Francisco, and Freedom Fest in Las Vegas

Shane and I will be leaving for St. Thomas on 24 June, and we will be married on some beautiful beach on June 26, her birthday. Then I actually intend to relax for a week, enjoying time with my new bride and reading books with no redeeming social value (also known as science fiction/fantasy). I will begin final writing on my new book when I come back. I am finally really ready to attack the topic of what the world will look like in 20 years.

I have a quick trip to Omaha in the middle of June, then I’ll head directly on to San Francisco and Palo Alto for speaking engagements, come home to Dallas, recover for a few days, and then leave with Shane to go to Las Vegas for the Freedom Fest. It has become one of the largest libertarian gatherings, and I have so many good friends who go that it’s really a lot of fun for me. And while I am not much of a gambler (as in I suck at it and hate losing money to people who are much richer that I am), I really do like the shows. And dinners with friends.

That covers July, and August is, of course, the annual Maine fishing trip, but right now the rest of August looks to be pretty wide open. If I can figure it out, I may go somewhere that has a much cooler climate than Texas does in August and relax and write.

I will be cooking a chili dinner along with some prime this week for a dozen or so investment advisors who will be coming to Dallas to learn about my new Mauldin Solutions Smart Core investment program. For those of you have not yet gone to www.mauldinsolutions.com and given me a little bit of information about you, we have a white paper we would like to send to you, and there is other information on the website that will give you an idea as to how I think core portfolios should be structured in today’s world. Whether you are an individual or a professional or an institution, the principles are the same.

And with that I will hit the send button. You have a great week.

Your not going passively into the next bear market analyst,


China, India and the clash of two great civilisations

The two emerging superpowers are engaged in a geopolitical and ideological battle

by: Gideon Rachman


© Getty


China has spent the past decade notching up firsts — world’s largest manufacturer, world’s largest exporter, world’s largest foreign reserves, world’s largest market for vehicles. In 2014, the International Monetary Fund even reported that, ranked by purchasing power, China is the world’s largest economy.

But there is one “world’s largest” title that China may have lost. New demographic research suggests that India, not China, could be the most populous country in the world — with unofficial estimates of China’s population revised down to just under 1.3bn, compared with India’s population of 1.33bn. That news could feed the growing sense in India, that while the rise of China has been the global story of the past 30 years, the next 30 will be India’s time to shine.

Population trends in India certainly look more favourable for long-term economic growth than those in China. It is not just that India’s population may have surpassed that of China and will grow faster in future. More important, the Indian population is significantly younger than that of China, which means that it will have a larger working-age population than China, and fewer retired people to support. The recent history of Japan demonstrates that an ageing and shrinking population has a powerful negative effect on economic growth.

These demographic forces may already be feeding through into growth rates. After decades in which India had to put up with jibes about the “Hindu rate of growth”, India is growing faster than China, with growth projected to exceed 7 per cent this year, compared with China’s official figure of 6.5 per cent.

But there are also some powerful qualifications to the idea that India is poised to catch up and then outstrip China. First, the Chinese economy is already five times larger, in real terms, than that of India. That means that even though India is currently growing slightly faster than China in percentage terms, the gap in the sizes of the two economies is growing, not shrinking.

Second, while demography favours India, in other important respects, China is better placed. Thirty per cent of the Indian population is illiterate, compared with under 5 per cent of the Chinese population. China’s infrastructure is also far superior to that of India, reflected in roads, railways and basic sanitation. Half of Indians still lack access to basic toilet facilities.

These kinds of comparisons are more than a mere parlour game. They matter because China and India are the two emerging superpowers of the 21st century. The nations are already engaged in a low-key geopolitical and ideological struggle.

India has reacted with alarm to China’s ambitious plans to build infrastructure links across Asia, fearing that they will create a Chinese sphere of influence that will encircle India. When China hosted its “Belt and Road” forum in Beijing last month to promote plans to spend billions on infrastructure links across Eurasia, more than 100 countries sent official delegations — but India stayed away. The Indians fear that China is re-creating a tributary system in which Asian economies are bound into an economic system in which “all roads lead to Beijing”.

The implications of these infrastructure developments are strategic and economic. At a time when China’s navy is growing fast, Chinese-funded ports in Sri Lanka and Pakistan are regarded with particular suspicion in Delhi. Growing ties between Pakistan and China create anxiety in India, which has fought four wars with Pakistan. Beijing and Delhi have their own unresolved territorial dispute, dating back to the war they fought in 1962, and the Indians worry that China is increasing pressure over its claims on the Indian province of Arunachal Pradesh.

Military budgets in China and India have been rising sharply. China has launched its second aircraft carrier and is working on a third. And India has become the world’s largest importer of weaponry, after Saudi Arabia. The Indians have also stepped up military exercises with the US and Japan — two countries regarded as strategic adversaries by China. Shashank Joshi of the Royal United Services Institute in London argues that, as strategic tension rises, Indian-Chinese relations are “in their worst state for over a decade”.

One particular Chinese gripe is the fact that the Tibetan spiritual leader, the Dalai Lama, detested by Beijing, continues to be based in India. His presence points to the ideological element in the rivalry between India and China. Chinese analysts have often contrasted the success of their development model with the slower growth produced by India’s “chaotic” democracy. Indians like to respond that their democratic system will ultimately prove more stable than China’s one-party state. There is also a moral aspect to this argument. Indians boast of freedom of speech and independent courts. The Chinese respond that the ordinary citizen in China lives a more comfortable and dignified life than the average Indian.

These arguments reflect the fact that China and India represent not just rival powers but also rival political systems, ideologies, even civilisations. Western political analysts are preoccupied by the emerging power struggle between the US and China. But as economic and political power shifts to Asia, it is the contest between China and India that may ultimately shape the 21st century.


Here Is What A Massive Jump In Speculative Gold Positions Means For Investors Heading Into The FOMC Meeting

by: Hebba Investments



- Bullish speculators increased their gold bets by the largest amount on record.

- Speculators betting on a gold drop also made large increased to their own positions.

- Next week's major event is the FOMC meeting and conference and we expect that Janet Yellen will offer investors nothing unexpected.

- Asian gold demand has been subdued with a large rise in May Indian imports that we expect will fall in June as jewelers de-stock.

- With expectations of a lackluster Fed meeting, we see no reason to change our short-term position and we expect gold and silver to follow current momentum downwards next week.

 
The latest Commitment of Traders (COT) report showed a week of speculators jumping into gold on both the long and the short side. On the long side, we saw a massive gross increase in speculative longs as traders added more than 50,000 contracts on the COT week - the largest increase in our records going back to 2006!
 
Shorts were not sleeping either, as they increased their own positions for the week by more than 10,000 contracts. After a strong start to the week and a rise close to $1300, gold ended the week on a three-day losing streak and down around 1% on the week - which matched our call for last week. Silver followed gold down for the week with a drop a little under 2%.
 
Looking forward to next week, the biggest economic event will be the FOMC meeting and rate decision. With the vast majority of market participants expecting a quarter-point rate increase, the key for PM investors will be what Yellen says during the press conference after the meeting and how it reflects in the Fed's path forward.
 
We will get more into some of these details but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
 
About the COT Report

The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.

Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.
 
The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three-day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.
 
There are many ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the exports on it.
 
What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
 
This Week's Gold COT Report
 
*Gold price data reflects the COT week (Tues-Tues) not a standard week (Mon-Fri)
 
 
For a third week in a row, speculative longs increased their gold positions - and this week it was by a huge amount. For the week, gold speculators increased their positions by 54,898 contracts, which was the biggest gross increase in speculative longs in the COT dataset dating back to 2006. Shorts were not sleeping this week either as they also increased their positions on the week by a chunk 1,812 contracts. While this is a smaller number, it was large based on historic short weekly norms.

Moving on, the net position of all gold traders can be seen below:
 
Source: GoldChartsRUS
 
 
The red line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, we saw the net position of speculative traders increase by around 43,000 contracts to 175,000 net speculative long contracts. The net speculative long position is now at levels that are on the high side of historical averages, but we do note that this COT report was based on Tuesday gold price of $1293 - it fell later in the week significantly so some of the positional data should be adjusted lower.
 
As for silver, the action week's action looked like the following:



Source: GoldChartsRUS
 
 
The red line which represents the net speculative positions of money managers, showed an increase in the net-long silver speculator position as their total net position rose by around 7,000 contracts to a net speculative long position of 50,000 contracts. After reaching a low a few weeks back (the perfect time to buy silver) we are now at average or a little higher than average levels in silver too.
 
The Upcoming Fed Meeting
 
Obviously, the big upcoming event will be Wednesday's upcoming FOMC meeting rate decision and post-meeting conference. Markets are already pricing in a .25% rate increase at the meeting, which we think the Fed will certainly do as they HATE to surprise markets, but the key thing for investors to look for will be their stance on rates moving forward - will it be hawkish or dovish?

Based on the economic data over the second quarter, the economy still seems relatively sluggish, with official inflation data very subdued. In fact, the only real bullish thing that we see concerning the economy is the stock market - and of course that is driven by expectations and not hard data. If it weren't for the rising market we feel the Fed would be much more cautious with rates.
 
Ideally, the Fed would want to see stronger economic data and a flat market as it allows stock valuations to catch up to economic conditions. The Fed has quite a dilemma here as if they are too dovish the stock market rises, while if they are too hawkish they see a drop in stocks while economic conditions are weak - which will only exacerbate the situation.
 
Thus, what we see happening is going to be a statement without conviction and a Yellen press conference that is vague and emphasizes the Fed is "data dependent" - which to us means they really have no plan. As it concerns precious metals, we expect some caution entering the Fed meeting as long positions are a bit higher than average which would be expressed in a potential early week drop in metals.
 
But since we are expecting a vague, lukewarm statement then a post-meeting reversal/recovery might be in the cards as traders realize there is nothing new with the Fed.
 
Our Take and What This Means for Investors
 
Last week we changed our short-term views on gold and silver to Neutral-Bearish as we expected a bit of a pull-back as weak Asian demand would outweigh positive investor sentiment. While preparation leading up to the Fed meeting may lead to volatility, we think after another "no-direction" Fed meeting that volatility will calm down as markets start looking to the next catalyst.
 
Having said that, we are not seeing strong Asian demand (signified through higher premiums) and we feel that Indian demand may be lackluster for the next month as jewelers had already imported significant amounts of gold in preparation for a higher tax rate. For now we expect gold and silver prices to meander with more downside risk than upside potential at this price level - thus we are maintaining our Neutral-Bearish stance.
 
 
As we said last week, we think it's wise to some profits off the table as we are concerned about the weakness in physical demand from Asia, while ETF holdings remain at or near all-time highs in gold and silver. It seems prudent to start taking profits on gold and silver positions (SPDR Gold Trust ETF (NYSEARCA:GLD), iShares Silver Trust (NYSEARCA:SLV), Sprott Physical Silver Trust (NYSEARCA:PSLV), and ETFS Physical Swiss Gold Trust ETF, etc).
 
While profit-taking applies to short-term traders, we think longer term traders have no reason to be alarmed and we expect to see much higher gold and silver prices in the future.


Summer Storm Keeps Building as Second Dip of Great Recession Approaches

By: David Haggith

These updates to my list of “Seven Troubles Assailing the US Economy” are far too important to remain buried at the end of that article since many readers may not return to the article to check for updates. The summer economic crisis I’ve been predicting is building even more rapidly than when I reported a week ago. It’s almost here:

Total household debt now exceeds the peek it hit just before the economic collapse into the Great Recession. While the number of households is also up, wages are correspondingly down, so households have maxed out … again:

"Total U.S. household debt was $12.73 trillion at the end of the first quarter of 2017, up $473 billion from a year ago, according to a Federal Reserve Bank of New York survey. Total indebtedness is now 14 percent above the 2013 trough of household deleveraging brought on by the 2007-2009 financial crisis and Great Recession. The previous peak, in the third quarter of 2008, was $12.68 trillion….

Auto loan and credit card delinquency flows are now trending upwards, and those for student loans remain stubbornly high.” The survey showed lenders tightened borrowing standards for home and auto loans, a sign of their increased caution. (Newsmax)


(Click to enlarge)

While population rose about 7% between 2007 and 2014, wages for most people have dropped about 5% during that time. (The time frame of the graph above.) Those two changes roughly cancel each other out. With lenders now tightening borrowing standards for mortgages and auto loans out of caution, they are draining liquidity out of those markets. That may be contributing to the decline in those markets as listed above. Lowered liquidity at at time when we are hitting peak debt again are combined factors that will likely keep those markets down.

Housing and all other construction take another big drop as we move into June, following March’s rise:

"U.S. construction spending recorded its biggest drop in a year in April as investment in both private and public projects fell…. The Commerce Department said on Thursday that construction spending tumbled 1.4 percent…. Economists polled by Reuters had forecast construction spending increasing 0.5 percent in April…. In April, private construction spending fell 0.7 percent, also the biggest decline in a year…. Investment in private residential construction fell 0.7 percent after six straight monthly increases…. Investment in residential and nonresidential structures such as oil and gas wells was one of the economy’s few bright spots in the first quarter." (Newsmax)

So, now, even one of the few bright spots is gone.

Financial stocks have collapsed. Financials, which shot up more than other classes of stocks during the Trump Rally, have already completely collapsed in terms of their rally gains:

Share prices of the biggest U.S. banks reportedly are flirting with bear-market territory amid fears of weak trading revenues and fading hopes for President Donald Trump’s ambitious economic agenda. “Goldman Sachs and Bank of America were among the biggest beneficiaries of the stock rally in the weeks after Donald Trump’s election victory in November, as investors looked forward to a profit-boosting mix of higher interest rates, lower taxes and lighter regulation,” the Financial Timesreported. “But some of those underpinnings have fallen away since then, as Trump’s early setback over healthcare policy cast doubt over his ability to implement other promised reforms,” the FT explained…. Bank analysts have been switching “blue-sky earnings scenarios” of late last year with “more cloudy” outlooks…. Hopes of corporate tax reform happening any time this year have almost evaporated. “Tax reform was difficult enough in 1986, when you had bipartisan support and an extremely popular president…. Without either, it always looked like a bit of a long shot.” To be sure, in an even more disturbing sign, CNBC reported that the financial sector “just gave up all of this year’s gains, and some strategists say that’s sending the broader market a message about the health of the economy.” (Newsmax)

Pending home sales also just tanked, taking their biggest drop since August, 2014. Signed contracts fell 5.4% from a year ago.

Auto inventory is back up to its highest point since just before the auto crash in 2007:
With 935,758 unsold GM units collecting dust in dealer lots, this was the highest inventory number in 9.5 years, the highest since Nov. 2007, and, as Bunkley reminds us, “one month before the recession officially began.” (Zero Hedge)

That was April inventory. May’s inventory, just in, rose by another 30,000 vehicles. When sales stall and inventory backs up, prices collapse under force. Values of used cars collapse, and that means the value of collateral also collapses, making people less likely to maintain their auto loans as the balance on a new loan exceeds the value of the car. The pressure is on for an auto collapse that has been predicted here for some time.


The state of Illinois was just downgraded to the lowest credit rating ever given to a U.S. state (one mark above junk) by Moody’s and S&P. The downgrade is due to “unrelenting political brinkmanship [that] now poses a threat to the timely payment of the state’s core priority payments.”

That brinkmanship is a just a microcosm of what is going on in the US congress. It is also due to “intensifying pressure from pension liabilities,” something congress hasn’t even begun to address with both government pension funds and Social Security and Medicare. Wait until that battle hits! If Illinois’ credit gets downgraded to junk, its financial problems instantly rise exponentially.

The retail apocalypse grows: Not even halfway through 2017, closures of retail stores have doubled last year’s closures as of this time and already exceed the last peak in closures during the crash of 2008.

The bottom line is simple here. Commercial real-estate investment trusts (REITs), malls, mortgage-backed securities (remember those?), and their bankers are in a lot of trouble. The anchor stores are closing up the worst. Because they are vital to a mall’s success, they will pull others down in the wake by reducing traffic to malls.

“Thousands of new doors opened and rents soared. This created a bubble, and like housing, that bubble has now burst.” According to Credit Suisse, 20-25% of US shopping malls will shut down within the next five years. While this is due to a paradigm shift in how people do their shopping, not an overall reduction in retail sales, it will send shudders and close shutters throughout real-estate-based retail economy, having a huge impact on construction, land sales, banking, jobs, etc.

Things look even more perilous in the stock market in terms of the CAPE ratio, which measures how pricy stocks are in comparison to their ten-year average. The CAPE just hit thirty, matching the rarified atmosphere of stock prices when the 1929 crash happened! The only time stocks have ever been more overpriced was just before the dot-com crash.

Albert Edwards, global strategist at French bank Societe Generale, said earnings reports for U.S. companies show that their overseas profits have grown but are still falling domestically.

The decline may even point toward recession. “Domestic non-financial economic profits are really struggling badly and are still down 6 percent year-over-year,” Edwards said…. (Newsmax)

The US jobs market finally tanked, coming in at 138,000 new jobs in May, which is near the generally considered recessionary level of 100,000 new jobs. That’s a 32% drop from last month and is much lower than any economists expected (the average expectation being 185,000 new jobs).


Previous months were also revised downward. Typical of these massaged job reports, May saw the biggest drop in full-time jobs since June of 2014, and the jobs that came in to replace them were largely part-time, but are counted with the same weight as if a job is a job is a job, regardless of how much less it pays, how much less permanent it is likely to be, how many fewer hours it provides and how reduced or eliminated its benefits.

Even the insanely optimistic Ron Insana said the jobs report could be a worrisome sign of a “pronounced economic slowdown,” according to Newsmax. Wage data, an area where even the Fed has acknowledged growth is mandatory in order for the economic benefits of “recovery” to be sustainable, was also softer than expected.

Insana offered a litany of economic omens: looming interest rate hikes, banks pulling back on extending auto credit, soaring housing affordability and softening inflation rates after briefly, and only briefly, touching the Fed’s 2 percent target…. “And, most important, consumer confidence has begun to dip….” “With the Federal Reserve poised to raise interest rates again in June, today’s data notwithstanding, and scant fiscal stimulus loaded in the Washington pipeline, this could be the beginning of a worrying trend,” he wrote. (Newsmax)

I rarely look to Ron Insana for anything because his permasmile on the economy is always several shades too rosy for my reality glasses. However, when even Insana is starting to read bad news in the tee leaves, you know it’s getting hard to keep putting lipstick on this pig of an economy.


Speaking of the pig, the official U.S. unemployment rate is now exactly at the nadir it has reached right before almost every recession the U.S. has ever experienced:


(Click to enlarge)

And those are just the problems inside the U.S.! They don’t even begin to include pressures that may arrive from outside, such as Europe’s rapidly failing banks in Spain, Italy, Greece, and even Germany! Nor the potential capsizing of China over the months ahead as its shadow banking system roles over just as even shadier collateral is called upon in a system that has been rank with corrupt bookkeeping and fake government statistics since Genghis Khan founded the Mongol empire. It doesn’t include an implosion of the Canadian housing explosion.

It doesn’t take into account the possibilities of the land down under turning upside down (as even one of its own famous hedge fund managers has said the Australian stock market and housing market are so insane he’s returning all of his investors’ money as there are no safe bets.)

Conclusion: Fundamentals are falling out RAPIDLY from under the stock market, but the robotraders keep trying to do their relentless programmed job of ratcheting the market up with a million incremental squeezes. Eventually, the falling fundamentals will overwhelm the machines. They will click their last ratchet upward. When they do, I highly suspect these bots that have been designed by programmers who never knew anything but a bull market during their short careers will outbid each other all the way to the bottom unless some human wisely yanks the IT cord on New York Stock Exchange to stop the slaughter.

Even in that case, restarting the stock market the next day will be problematic with all the bots on line and ready to charge downhill in mutual electronic bewilderment. If the bots have failsafes or circuit breakers built into their algos, I’m willing to bet those stops perform poorly. So, expect more jolts and plug pullings.

My observation of human-designed “failsafes” is that the word, itself, should trigger alarms.

Failsafes can can be summed up in single words or short names like like “Three-Mile Island, China Syndrome, Chernobyl, Fukushima.” All things that were human engineered to be beyond failure with all their safety mechanisms. Nature (reality) always finds a way. The slow, crushing collapse of the now-churning economy will overwhelm the algorithms, and I doubt those human replacements will have a clue as to what to do in a bear market. We’ll be at the mercy of the machines.

Stay in for the ride only if you’re good at making money on the ugly because summer is stacking up perfectly for my predictions. (But also note that I have no credentials or license as a financial advisor, so you are responsible to make your own calls. This is just one average Joe’s opinion who has a habit of seeing which way the wind is blowing when others don’t want to see it.)

Once the Fed’s fake recovery fails, even as it is now crumbling all around us, the true depth of the Great Recession will become known and felt by all … except the 1%. The Fed is knocking the props out from under their own “recovery,” which was intended to bridge the Great Recession, just as their bridge to nowhere is starting to fall of its own dead weight. They are fitting their old pattern of raising interest rates into a failing economy, something I’ve also predicted they would do because they are so good at that. Thus, their next interest raise will also assist the collapse.


As Politics Boil, Financial Markets Are In Dream Land

Elections bring anxiety yet markets are calm, but the reasons behind the anxiety threaten markets

By Richard Barley

Political shocks over the past two years suggest that life outside of the financial markets isn’t as rose. Above, protesters demonstrate in London. Photo: andy rain/European Pressphoto Agency


Financial markets are in fairy-tale land. Surprises like the U.K. election, the victory of President Donald Trump and Brexit show a deep unease with economic conditions. Yet easy money, relatively steady global growth and low inflation have encouraged talk of “Goldilocks.”

“Goldilocks has not left us yet,” was how J.P. Morgan strategists summed it up recently. They aren’t alone: analysts and economists at Société Générale , ING and Citigroup also have rolled out the markets’ favorite fairy-tale character. Growth isn’t too hot, not too cold, and performance has been buoyant. Global stocks are up, with the MSCI World index gaining nearly 10%. Low inflation means bonds are supported too. Credit markets are strong, and U.S. high-yield bonds have returned 5%. Emerging-market stocks, bonds and currencies have gained.

The metaphor bears examining closely. As a reading of a globally coordinated upturn in growth, coupled with the large amount of liquidity from central banks, and minimal wage and inflation pressures, it might not be a stretch.

But the political shocks of the past two years, particularly in the U.S. and U.K., suggest that outside financial markets, it is a different story. People are fed up with the status quo. One key component of the Goldilocks situation is the absence of a pickup in wage inflation, which means central banks can keep policy loose. But continued poor real-wage growth may also stoke more political turmoil at the ballot box. That increases the risk of electoral shocks that investors may not welcome.

The U.K. is a case in point. The Bank of England’s chief economist, Andy Haldane, last year gave a speech asking who had benefited from the recovery, noting that despite data pointing to growth, half of all U.K. households had seen no expansion in real disposable incomes since 2005. The latest rise in U.K. inflation pushed real-wage growth back below zero just in time for voting. Central bankers around the world are puzzling over the apparent failure of wage formation to respond to falling unemployment, whether in the U.S., Germany, the U.K. or Japan. Yet their easy-money policies also have helped deliver extraordinary returns in financial markets.

And those past returns may yet cause an issue with the part of the Goldilocks metaphor that doesn’t get mentioned: the porridge. While nutritious, it is hardly particularly appetizing. And the starting point for financial markets is similar, because bond yields are ultralow, credit spreads are very tight and developed-market equities are far from cheap. Future return prospects are thus skinny, although emerging markets offer a brighter outlook. That helps explain why an apparently benign situation feels uncomfortable. Even as markets rise, there are few easy trades.

Goldilocks might stick around for a while, but fairy tales don’t have to have happy endings.


SIC 2017 Highlights: 4 Reasons to Invest in Emerging Markets


Dear Reader,
 
Part one of the SIC 2017 highlights series detailed some concerns about the future of the US economy.
 
But the SIC wasn’t a bearish gathering... many speakers were very optimistic on the future of emerging markets.
 
This chart, detailing the rise of China and India over the last four decades, popped up more than once:
 
Chart
 
 
With major economic developments now happening in both nations, they will likely play an increasingly larger role in the world going forward.
 
And given that when America’s share of global GDP increased by 50%, its share of world stock market cap rose 240%, this move has massive investment implications.
 
Here are four bullish trends for emerging markets that were covered in-depth at the SIC 2017.
 
One Belt, One Road
 
Dubbed “the new Silk Road,” One Belt, One Road aims to create the world’s largest platform for economic cooperation between China and the rest of the world.
 
It's an infrastructure project unlike anything we have ever seen.
 
 
Chart
 
 
As founder and CIO of Morgan Creek Capital Management Mark Yusko quipped, “One Belt, One Road, Multiple Bull Markets.”
 
China’s Middle Class
 
The American consumer is still the driver of the global economy, but that baton will likely be passed to China’s middle class sometime this century.
 
According to McKinsey, in 2000, just 4% of China’s urban population was considered middle class. By 2020, 76% will be... a 19-fold increase. And with more spending power comes greater consumption.
 
Boston Consulting Group projects China’s total consumption will increase by 55% to $6.5 trillion by 2020. That’s more than the UK, Germany, and France combined.
 
Chart
 
 
India’s Banks
 
A massive barrier to growth in India has been the number of non-performing loans in its banking system, which have risen fourfold since 2009.
 
Chart
 
Much was made of President Modi’s move to demonetize the country in December.
 
However, outlawing 85% of the currency in circulation did achieve something very important—it recapitalized India’s banks. Since demonetization, over $80 billion has flowed into the banking system.
 
Aadhaar/India Stack
 
Raoul Pal—author and publisher of The Global Macro Investor, an elite macroeconomic and investment research service—promised his presentation would blow our minds... and he delivered.
 
In 2009, half of India’s population didn’t have any form of identification... which made it extremely hard to get a bank account, insurance, or even a driver’s license. To fix this problem, the government created a system called Aadhaar.
 
Aadhaar is a biometric database that gives users a digital proof of identity... and the best part is: This identity can be authenticated by finger prints and retina scans.
 
Then last year, India created India Stack.
 
In Raoul’s words:
 
India Stack is a series of secured and connected systems that allows people to store and share personal data such as addresses, bank statements, medical records, employment records, and tax filings and it enables the digital signing of documents.
 
Using India Stack, you can open a bank account, mobile phone account, brokerage account, or share medical records at any hospital or clinic in India with your fingerprints or by retina scan...
 
The rise of China and India present major opportunities for astute investors...
And despite growing at twice the speed of the US, the stock markets of China and India trade at a big discount to developed markets today.