What a Week

Noug Dolan

The S&P500 jumped 2.3% Monday in what appeared growing confidence that Hillary Clinton was on the verge of becoming the next POTUS (buoyed by Director of the FBI Comey’s statement). It’s worth noting that Monday trading saw both the Financials (XLF) and the Industrials (XLI) jump 2.5%, only to be outdone by the Biotechs’ (BTK) 4.1% surge. EM equities (EEM) rose 3.6% Monday. Election day trading was then relatively quiet, with the S&P500 adding 0.3% Tuesday.

After closing Tuesday’s session at 2,135.50, S&P 500 futures jumped to 2,151 in evening trading on exit polling and early reports from Florida that appeared favorable for Clinton. Futures, however, reversed course as it became increasingly apparent that Donald Trump was performing better than expected, especially in Florida, Pennsylvania, Michigan and Wisconsin. By midnight on the East Coast, S&P futures were “limit down” 5%. DJIA futures reversed a full thousand points, and Nasdaq futures fell almost 6%.

The huge move in U.S. equity futures was outdone by a stunning 14% collapse in the Mexican peso. In a span of a couple hours, the U.S. dollar/Mexican peso moved from 18.205 to a record high 20.78. After trading near 17,400 (futures) in overnight trading, the DJIA closed Wednesday’s session up 257 points (1.4%) to 18,590. Financial, industrial and biotech stocks, in particular, were in melt-up mode. The Banks (BKX) closed Wednesday up 4.9% - then added another 3.8% Thursday, before ending the week up 12.7%. The Broker/Dealers (XBD) surged 5.9% and 3.7%, with a gain for the week of 14.8%. Not to be outdone, the Biotechs (BTK) spiked 9.2% higher Wednesday and 17% for the week. The Industrials (XLI) gained 2.3% both on Wednesday and Thursday, closing out the week 8.1% higher.
As exuberance took over, the broader market dramatically outperformed. The small caps (RTY) traded higher all five sessions this week, with Wednesday’s 3.1% rise the strongest in a noteworthy 10.3% weekly advance. The Midcaps (MID) gained 1.9% Wednesday and 5.7% for the week. The DJIA traded to a record high this week, with the S&P500, small caps and midcaps just shy of all-time highs.

There are different perspectives through which to interpret this week’s extraordinary market action. The bullish viewpoint will take a casual look at U.S. stock performance and see overwhelming confirmation that the bull trend remains intact. And with news and analysis, as always, following market direction, rather quickly we’re deluged with material professing a bullish outlook courtesy of a Trump Presidency and Republican House and Senate. Apparently the country is now on the verge of a major infrastructure investment program, positive healthcare reform, corporate tax reform, and a dismantling of Dodd-Frank financial regulation (for starters). In particular, a focus on infrastructure and de-regulation implies a Trump Administration lot likely to place confrontation with the Yellen Federal Reserve (or the securities markets) high on their priority list.

From my perspective, it was anything but a so-called “bullish” week. I saw alarming evidence of dysfunctional markets. There was also further confirmation of a bursting bond Bubble. Indeed, there was strong support for the view of a faltering global securities Bubble – even in the face of surging U.S. stock prices.

Let’s return to election late-night. I doubt traders and the more sophisticated market operators will easily forget what almost transpired. It’s worth noting that while S&P500 futures and the Mexican peso were collapsing, the yen was in melt-up. In just over two hours, the dollar/yen moved from 105.47 to 101.22 – an almost 4% move. Meanwhile, EM and higher-yielding currencies were under intense selling pressure – the Brazilian real, South African rand, Turkish lira, Colombian peso, Australian dollar and New Zealand dollar (to name a few). At the same time, gold surged from $1,270 to $1,338. Crude sank 4%. Global markets were on the brink of a serious episode of speculative de-leveraging.

There had been significant hedging across global markets going into the U.S. election. Especially after Monday, the markets viewed a Trump win a low probability. With markets shaky of late, along with an approaching historic political event, enormous derivative positions had accumulated in various markets. In the event of a surprising outcome, those that had written (sold) market “insurance” would be forced to aggressively (“dynamically”) hedge their losses by selling/shorting into already weak markets – perhaps even with major markets highly illiquid (or already halted limit down).

When a marketplace significantly hedges against a perceived low-probability event – and the unexpected actually occurs – contemporary markets face dislocation. Markets simply can’t hedge themselves. To offload risk, someone has to be on the other side of hedging trades – and these days that someone generally has a sophisticated trading model requiring selling/shorting to ensure positions capable of generating the necessary cash-flow to offset derivative losses. Significant derivative-related selling risks a (“Black Monday” 1987) portfolio insurance debacle of selling betting selling, begetting illiquidity and panic.

Tuesday’s election outcome was at the cusp of creating a very serious test for global derivatives markets. It was not, however, meant to be, as another one of those well-timed miraculous reversals transformed potential panic selling into manic buyers’ panic. Instead of those on the wrong side of derivative trades forced to sell into illiquid markets, it became a frenzy of bearish hedges and speculations unwinds. Another memorable short squeeze.
It’s no coincidence that this week’s melt-up was most acute in sectors that were 2016 underperformers and generally under-owned (financials, biotechs and industrials). Moreover, many of this week’s top performing stocks were heavily shorted. To be sure, there is no quicker way to trading profits than to jump on a bearish theme that suddenly has a plausible bullish story. It’s spectacular Buyers’ Panic as the desperate shorts, the opportunistic “wise guys” and the trend-following/performance-chasing Crowd brawl over a limited supply of available securities. A destabilizing (downside) systemic liquidity event was avoided Wednesday, which ensured sporadic upside dislocations in various stocks, sector ETFs and “king dollar” more generally.

November 9 – Bloomberg (Lu Wang): “You need to go all the way back to the dark days of 2008 to find a stock market reversal to rival that of the last 12 hours, in which S&P 500 Index futures erased a 5% loss triggered by Donald Trump’s surprise presidential election win. Bigger turnarounds only happened three times before, twice in the final months of 2008 and the other in October 1987…”
It’s no coincidence that Wednesday’s wild reversal ranks right up there with three previous major volatility events – two in late-2008 and the other in October 1987. Fragile fundamental underpinnings foster unstable market dynamics – i.e. significant shorting, hedging and speculation. And there’s no more breathtaking market advance than a major bear market rally.

It’s also worth noting that the favored technology stocks underperformed this week. The Morgan Stanley High Tech Index actually declined 1.5% post-election (up 1.6% for the week). The Nasdaq 100 (NDX) fell 1.1% post-election (up 2.0% for the week). The favorite – and previously outperforming – Utilities dropped 4.2% this week.

It’s such an extraordinary backdrop. I believe the pierced global Bubble continues to flounder, but the policy responses of $2.0 TN annual global QE, near zero rates and record Chinese Credit growth have created major Bubble Anomalies. Surely, all the QE-related global liquidity excess has created aberrant market behavior (on full display this week).

On the one hand, central bank liquidity backstops have thus far allayed fears of “Risk Off” de-leveraging quickly evolving into a systemic liquidity event. On the other, the massive pool of global speculative finance (including hedge funds, ETFs, SWF and trend-followers more generally) foments a liquidity backdrop with extraordinary flow volatility between various sectors and markets. Underlying market instability has made it difficult for fund managers perform (absolute and relative to indices). In particular, the backdrop has ensured that hedges don’t perform well at all. Intense performance pressure then makes it imperative both to rotate quickly into the outperformers and to not miss general market rallies.

While resilient U.S. stock prices captured bullish imaginations, this week saw global bond markets get rocked. If not for QE, I believe surging yields and attendant de-leveraging would have spelled major problems for securities markets more generally. Instead, too much speculative “money” chases the outperforming stocks, sectors, asset classes and countries. Importantly, this week’s exuberance at the U.S. “Core” came at the expense of a vulnerable “Periphery.”

Mexico was close to meltdown. The Mexican peso sank 8.7% this week to a record low. Mexican 10-year dollar bond yields surged 74 bps to 3.98%, with peso bond yields surging 95 bps to a multi-year high 7.25%. Mexican stocks dropped 3.7%. The Mexico EFT (EWW) sank 17.9% post-election, with a 12.2% loss for the week. Gold dropped 5.9%, while Copper surged 10.8%. Despite all the focus on inflation, crude declined 1.5% to a multi-week low.

EM came under heavy selling pressure starting Wednesday. The EEM ETF sank 7.8% post-election (down 3.8% for the week). In the currencies this week, the South African rand fell 5.3%, the Brazilian real 4.9%, the Polish zloty 4.6%, the Hungarian forint 3.6%, the Russian ruble 3.3%, the Romanian leu 3.0% and the Turkish lira 2.8%. China's currency declined 0.8% vs. the dollar, the biggest weekly decline since January.

In EM equities, Brazil’s Bovespa index dropped 3.9%, the Argentine Merval 3.5%, India’s Sensex 2.5%, Indonesia’s Jakarta Composite 5.2%, South Korea’s Kospi 0.9%, Taiwan’s TAIEX Index 2.1% and Thailand’s Thai 50 1.4%.

Yet the bursting Bubble thesis saw the clearest confirmation in surging global bond yields. EM bonds were just clobbered. Brazil real bond yields jumped 67 bps to 12.02%, with yields up 30 bps in Colombia (7.55%) and 47 bps in Argentina (16.07%). Eastern Europe bonds were also under pressure. This week saw yields surge 27 bps in Poland (3.32%), 32 bps in Hungary (3.38%) and 28 bps in Romania (3.33%). Russian ruble yields surged 43 bps to a five-month high 8.88%. Turkey’s 10-year bond yields jumped 31 bps to a 10-month high 10.10%. South African yields surged a notable 50 bps to a five-month high 9.15%. Indonesia yields surged 58 bps to a four-month high 4.12%. Malaysian yields jumped 25 bps to 3.88%. EM ETFs saw outflows of $1.8 billion over the past week, reducing y-t-d flows to $26.3bn (from Bloomberg). It was a rout.

“Developed” bonds didn’t fare much better. Australian ten-year yields surged 22 bps to 2.56%, the high since April. New Zealand yields jumped 26 bps (3.03%) and South Korea’s rose 22 bps (1.94%). Canadian 10-year yields rose 20 bps to a six-month high 1.43%.

European bonds were under heavy selling pressure. German 10-year yields rose “only” 18 bps, as spreads widened significantly throughout the Eurozone. French yields surged 28 bps, Netherlands 21 bps, Spain 21 bps and Portugal 19 bps. Ominously, Italian yields jumped 27 bps, back above 2% for the first time since July 2015. The Italian to German 10-year bond spread widened to a two-year high 171 bps.

Perhaps ominous as well, 10-year Treasury yields surged 37 bps this week to 2.15%, the high since January. Long-bond yields rose 38 bps to an almost 2016 high 2.94%. It was a case of so-called “risk-free” securities showing their true colors. The TLT (Treasury ETF) dropped 7.4% this week, wiping out most of its 2016 return. The popular AGG (IShares Core U.S. Aggregate Bond ETF) and BND (Vanguard Total Bond Market ETF) dropped 1.8% and 1.9%. Corporate high-yield (HYG) and investment-grade (LQD) EFTs this week declined 1.8% and 2.3%, respectively.

Headlines from the FT: “What is the Trump Reflation Trade?” and “’Trumpflation’ Risk Rattles Bond Markets.” From Bloomberg: “Goldman Warns Bond-Market Carnage Threatens Global Reflation.” “Bonds Plunge by $1 Trillion This Week as Trump Seen Game Changer.” And from the Wall Street Journal: “The All-Powerful Bond Market Is Getting Rocked by Trump.”

I guess we’re now in the political “honeymoon” period, one I fear will be short-lived. It would be more gratifying to be optimistic. But watching the global bond Bubble begin to unravel leaves me apprehensive. I fear this week’s wild market instability could portend some type of financial accident. There were some large losses suffered throughout the markets this week.

Inflationary biases were already percolating before the election. It’s worth noting that M2 “money” supply expanded $941bn, or 7.7%, over the past year. The Fed – and global central bankers – have brought new meaning to “behind the curve.” And as speculative markets trade inflation’s revival, the job of the Fed (and global central bankers) becomes a whole lot more challenging. Do they raise rates to help dampen fledgling inflation psychology and support faltering bond markets? Or, instead, will the prospect of a real central bank tightening cycle further weigh on bond market confidence? Hard to imagine halcyon markets in a world devoid of QE and near-zero rates. 

Actually, bond trading is bringing back unpleasant memories of early 1994. Yet 2009-2016 Bubble excess makes 1991-1993 looks pretty inconsequential. And this time it’s global. Systemic. Look closely this week and one can see some weak links: Mexico, Brazil, South Africa, Indonesia, Poland, Hungary, Argentina, EM generally, Ireland and Italy. Italian bond yields are all the way back to 2%. It’s worth recalling that they were at 7% in early-2012.

New president has an economic in-tray full of problems

The US system has its strengths but still shows scars from the Great Recession

by: Martin Wolf

In the country of the blind, the one-eyed man rules. The US economy shows significant flaws.

But it is a king when compared with its peers. It has recovered from the Great Recession, with unemployment low and real incomes rising. It also possesses abiding supremacy in new technologies.

Nevertheless, the next administration will take over a country with mediocre growth of productivity, high inequality, a growing retreat from work and a declining rate of creation of new businesses and jobs. At least the US fiscal position is not a really urgent threat. That is to the good, since nothing much is likely to be done about it.

The financial crisis of 2007-09 was a devastating event, economically and politically. But real gross domestic product per head had reached its trough by the second quarter of 2009 and recovered to pre-crisis levels by the final quarter of 2013. Similarly, the unemployment rate peaked at 10 per cent in October 2009 but is now back to 4.9 per cent. The financial sector is also in far better health than during the crisis.

Too many casual observers take this rapid turnround for granted. But the Great Recession could have been another Great Depression. It took bold action by the Federal Reserve, the administration of George W Bush and that of Barack Obama to turn the economy around so quickly. Everyone has benefited greatly from this success.

Nevertheless, the crisis has left deep scars. In the second quarter of 2016, real GDP per head was still only 4 per cent above its pre-crisis peak, almost nine years before. Labour productivity has grown slowly since the crisis, by historical standards, largely as a result of weakened investment. One study estimates US potential output is 7 per cent below levels suggested by pre-crisis trends. Yet average growth of US labour productivity, albeit slowly subsiding, has exceeded that of other leading high-income economies over the past 15 years. This is probably due to its dominance of high-tech innovation: the aggregate capitalisation of the five largest US technology companies is now over $2.2tn.
Yet, the scars left by the crisis, which include diminished confidence in the probity and competence of the financial, intellectual and policymaking elites, also came on top of older ones.

Real median household income increased by 5.2 per cent between 2014 and 2015. But it remains below pre-crisis levels. Indeed, it is below levels reached in 2000 and has even fallen relative to real GDP per head consistently since the mid 1970s. This performance helps explain the tide of disillusionment, even despair, revealed so starkly by this grim election (see charts).

Not surprisingly, inequality has worsened markedly. Between 1980 and the most recent period, the share of the top 1 per cent in pre-tax income jumped from 10 per cent to 18 per cent. Even after tax, it rose by a third, from 8 to 12 per cent. The rise in compensation of chief executives, relative to that of workers, has been huge. The US has the highest inequality of any high-income country and has seen the fastest rise in inequality among the seven leading high-income economies. The divergence among these countries suggests that rising inequality is far more a social choice than an economic imperative.

Closely related to the rising inequality has been a decline in the share of labour in GDP from 64.6 per cent in 2001 to 60.4 per cent in 2014. Workers have not only suffered from declining shares of the pie. Just as significant is the steady rise in the proportion of men aged 25 to 54 neither in work nor seeking it from about 3 per cent in the 1950s to 12 per cent now. Even France had a higher fraction of prime-age men in jobs than the US every year since 2001. Since 1990, the US has had the second-largest increase in male non-participation in the labour force of all members of the Organisation for Economic Co-operation and Development. After 2000, the declining trend in non-participation of prime-age women also halted. The proportion of US women in this age category in employment is now among the lowest of all the members of the OECD.

No less disturbing is a decline in economic dynamism. The rate of creation of new jobs has slowed markedly, as have rates of internal migration. The rate of entry of new businesses into the marketplace has also been falling over an extended period, as has the share of ones less than five years old in both the total number of businesses and employment. Meanwhile, business fixed investment has been persistently weak. Evidence also suggests a rising variation in returns on capital.

These are long-term trends, not just post-crisis events.
For all its strengths, the US economy could do better. In addition to the trends identified above, deteriorating infrastructure, worsening relative educational performance and a terrible tax code are challenges. Halting immigrants and imports would be an act of self-harm. The US must build on its historic strengths of an open and dynamic economy, together with government provision of infrastructure, research, education, and balanced tax and regulatory policies. A new administration needs the right diagnosis and co-operation from Congress. Pigs may also fly.

China’s Debt Addiction Could Lead to a Financial Crisis

China’s borrowing spree could end badly, with dangerous repercussions for the rest of the world.

By Jonathan R. Laing

With China’s debt climbing to 300% of GDP, critics warn of a potential financial crisis. Illo: C. J. Burton for Barron’s

The China state-capitalism model was the talk of the annual Davos Economic Conference in 2011. Not only had the Middle Kingdom managed to deftly sidestep the 2008-09 global credit crisis, but its gross domestic product was also growing smartly—up 10.6% in 2010 alone—when much of the emerging and developed world was still wallowing in a slough of economic despond.

These days, however, China has lost much of its economic luster. GDP, or gross domestic product growth has slowed dramatically; the economy expanded by only 6.7% in the first three quarters of this year, according to government reports that most deem wildly inflated. Even so, that’s the slowest growth rate in 25 years. The nation is likewise afflicted with unhealthy asset bubbles that come and go with worrisome rapidity, most recently, last year’s stock market boom and bust.

Spates of asset atrial fibrillation are often precursors of economic trouble, especially in developing economies like China’s. The root problem is that China has relied on mindless monetary stimulus since 2008 to muscle its way to continued output growth. As a consequence, debt levels, mainly corporate borrowings, have surged. According to China finance expert Victor Shih, an associate professor of political economy at the University of California, San Diego, and founder of China Query, the country’s debt load has expanded from 150% of GDP before the onset of the 2008 global credit crisis to about 300%.

That is $30 trillion of debt sitting precariously atop a $10 trillion economy. And, he says, that ratio could rise to more than 330% by next year.
Even some Chinese officials concede that much of this tidal wave of new credit has been essentially wasted on white-elephant infrastructure projects and corporate loans to build redundant production capacity and keep zombie state-owned companies on life support.

How much of the current $30 trillion in Chinese debt and other impaired financial assets in the financial system is nonproductive, or yielding no net return? For an informed answer, we turned to Charlene Chu in Hong Kong, a widely respected Chinese credit analyst who cut her teeth at Fitch before joining the research shop Autonomous Research Asia. Chu estimates that about 22% of this pile will be nonperforming by year end. And of this troubled paper, totaling $6.6 trillion, actual losses after recoveries are likely to weigh in at more than $4 trillion.

“I don’t know whether China faces a slow burn in economic growth ahead or some kind of financial crisis,” she says. “But you can’t continue on a path of allowing new credit infusions to grow at more than twice the pace of GDP growth.”

THE DEBT TREADMILL China finds itself on these days is best illustrated by looking at its capital-efficiency ratio, or the number of yuan of new credit it takes to produce one yuan of GDP growth. In June, Torsten Slok, chief international economist at Deutsche Bank Securities, published a chart showing that China’s credit bubble exceeded even that of the U.S. in 2007, on the cusp of the subprime mortgage meltdown that set off the global credit crisis.

According to Slok, in 2015 it took more than $450 billion in bank credit to produce one percentage point of GDP growth in China. In the U.S., it took $350 billion to produce one percentage point of GDP growth at peak inefficiency in 2007. As recently as 2008, the amount of credit needed in China was less than half the 2015 number, before China amped up credit growth to levels never scaled by any major economy.
The efficiency ratio has since improved in the U.S., as lenders tightened their credit standards, took huge debt and asset write-downs, and repaired balance sheets with large equity infusions.

China shows no stomach for following a similar path. Deleveraging, or allowing credit growth to go negative, would unleash the baleful forces of widespread business bankruptcies, soaring unemployment, negative economic growth, and, ultimately, massive social unrest.

Among others, hedge fund titan George Soros has predicted a hard landing for the Chinese economy. In a speech delivered last spring in New York at the Asia Society, he asserted that what’s unfolding in China bears an “eerie resemblance” to what happened during the financial crisis in the U.S. in 2007-08, which was “similarly fueled by credit growth.…Most of the money that banks are supplying is needed to keep bad debt and loss-making enterprises alive.”

In a September interview with the BBC, Kenneth Rogoff, a professor of economics at Harvard University, opined that China’s “credit fueled” economy, as the postcrisis “engine of global growth,” is rapidly losing velocity and constitutes a major threat to the world economy. Forget Brexit and other issues. “There is no question. China is the biggest risk,” he said.

Likewise, the Bank for International Settlements issued a review in September showing that China’s banking-system credit had blasted off in the first quarter to a level 30 percentage points above long-run trend levels. The report further warned that even a 10 percentage-point deviation from the trend is “a reliable early-warning indicator of banking crises or severe distress.” Trouble typically arrives “in any of the next three years,” according to the report.

THE CHINESE ECONOMIC apocalypse thesis has been around for several years, pushed by such hedge fund managers as Jim Chanos of Kynikos Associates and Kyle Bass of Hayman Capital Management. While they wait expectantly for Godot, the Chinese economy continues to muddle along, albeit at a slower pace. Beijing has built up plenty of street cred in many international circles after presiding over decades of extraordinary growth.

But that’s not to say there haven’t been some economic tremors in China of late that shook international markets. In the summer of 2015, Chinese stock markets plunged 50% in a matter of months, after government cheerleading and heavy buying on margin drove prices in June of that year to untenable heights.

Then two months later, and again in January 2016, disappointing economic numbers, declines in the value of the yuan, and rampant capital flight from China sent world stock market and commodity prices careening lower.

These China shocks proved temporary, as the authorities resorted to their normal expedient of stepping hard on the monetary accelerator to calm anxieties and revive growth. In this year’s first quarter, Beijing pumped almost one trillion dollars into the economy, a quarterly record for monetary stimulus.

With that, China’s economy appeared to steady, slowing capital flight, and the nation quickly fell off global investors’ list of worries. Complacency vis-à-vis China reigns. Most of its debt is domestically owned and therefore not vulnerable to foreign capital flight. The Chinese are prodigious savers, with a gross savings rate of nearly 50% of GDP, compared with 18% in the U.S., according to the latest World Bank data. Bank deposits tend to be sticky. Like Las Vegas, what happens in China is expected to stay there, or so many global investors apparently believe.

YET RUCHIR SHARMA, chief global strategist at Morgan Stanley Investment Management and author of the recent best seller The Rise and Fall of Nations, is deeply pessimistic about China’s economic prospects.

“It’s scary that China seems to be continuing its debt binge to achieve its unrealistic output growth targets,” he says. “To me, the China economy is like a ping-pong ball falling down a steep staircase, bouncing upward temporarily when credit stimulus is added before continuing its relentless downward path.”

Sharma’s concerns arise from a study, done by his team, of nations that saw their private (corporate and household) debt-to-GDP ratio increase by 40 or more percentage points over a period of five years since 1960. They suffered mightily in the succeeding five years. China’s debt-to-GDP ratio more than doubled that ominous pace between 2009 and 2014.

In all 30 cases studied, output growth slowed by 50% or more over the following half-decade.

Likewise, 18 of the same 30 countries suffered serious financial crises. By Sharma’s reckoning, China is already two years into the throes of a GDP slowdown that figures to get far worse.

DEBT SURGES ARE DESTRUCTIVE for a number of reasons, Sharma says, as their rapid pace leads to sloppy credit practices. Borrowers tend to get increasingly flaky. Asset bubbles develop as easy money triggers unhealthy speculation. Rising collateral values give lenders a false sense of security. All of this also leads to epic misallocations of credit, with money going into increasingly dubious projects and investments. This phenomenon is writ large these days in China.

More than half of the credit that has been extended there since 2008 has gone to nonfinancial state-owned enterprises, or SOEs, even though China’s private sector is far more dynamic and accounts for roughly three-fifths of the Chinese economy. A number of the SOEs are industrial behemoths laid low by declining export growth.

Patrick Chovanec, who taught in the business school at Beijing’s Tsinghua University for five years before moving to New York in 2013 to become chief strategist at Silvercrest Asset Management Group, ticks off a number of examples of gross capital waste during the post-2008 Chinese spending boom.

He points to the mountain ranges of empty apartment buildings that rim Chinese cities large and small, a giant gold-colored statue of Mao, replicas of Beijing Olympic stadiums in third- and fourth-tier cities, bullet trains and toll roads far too expensive for the average citizen to afford, redundant international airports and deepwater ports with little or no business, opulent high-tech centers with no tenants, and exposition centers in improbable locations that sit largely empty throughout the year.

INFRASTRUCTURE INVESTMENT has been a favorite policy lever in China to turbocharge gross domestic product. Even the many white-elephant projects of recent years gave a temporary boost to output during construction, employing hordes of workers and consuming vast amounts of steel, cement, glass, and aluminum. But these projects, showing little or no return on investment over the longer term, became a dead weight on the Chinese economy, requiring ever-growing amounts of new credit to refinance loans and cover debt service.

One can argue that China is structurally susceptible to the kind of debt problems with which it is now struggling. “Capital flows in China these days are largely determined by political connections, state and local government ownership of corporate assets, and the financial interest of the party elite, and not by return on capital and economic viability,” notes Anne Stevenson-Yang, co-founder of China-focused J Capital Research.

In the dog-eat-dog economy, rent-seeking by insiders trumps the public interest. Moral hazard lies at the heart of the system, allowing those with political clout to take risks with the conviction that the state—and ultimately the general public—will always bail them out.

Most of the dodgy paper sits in China’s fast-growing shadow banking system, whose assets now amount to nearly $8 trillion, according to a Moody’s estimate this summer. The shadow institutions—trust companies, brokers, wealth managers, and insurance companies—derive most of their funds from investors looking for higher yields and not directly from bank depositors.

The shadow players, in turn, invest in all manner of assets, from corporate bonds and stocks and loans to local governments for infrastructure projects, to loans to less-creditworthy corporate credits, which are packaged as high-yielding wealth-management products, or WMPs.

Chinese banks also use the shadow market to get nonperforming loans off their balance sheets by injecting the bad loans into WMPs and then buying the WMPs, transmogrifying the bad debt into what they depict as “investment receivables.”

These WMPs are starkly reminiscent of the bad mortgage-backed paper in the U.S. that metastasized in 2008 into a full-blown global credit crisis. The primary problem in the shadow sector, as cited in an International Monetary Fund report this summer, is interconnectedness.

In the mosh pit of China’s current financial system, banks invest in a wide variety of WMPs, and WMPs invest in one another. Layers of liabilities accrete on the very same loans and other damaged paper. Therefore, any debt defaults have the potential to create a full-fledged contagion.

Chu, the credit analyst, estimates that by next year these opaque, off-balance sheet wealth-management products will be double the size of the mortgage-structured investment vehicles and conduits that brought the U.S. banking system to its knees.

THE OVERARCHING QUESTION about China is what catalyst could cause the debt bomb to detonate. One flashpoint could be a collapse in overheated asset markets pumped up by the explosion in monetary growth.

Fortunately for Beijing, the 2015 collapse in the Chinese stock market didn’t hurt that many households. The victims weren’t that numerous—just a bunch of heavily margined punters in cities and the countryside who banked on the misbegotten notion that government stimulus ensured ever-rising stock prices.         

Another bubble developed earlier this year in commodity futures markets in iron ore, coking coal, and farm commodities, as prices and trading volume soared, only to subsequently crash. Again, government authorities stepped in to pop the bubble with minimal damage.

But the bubble of all bubbles is unfolding in the housing market, as gobs of new credit are being lavished on developers and home buyers alike.

The market has been on fire, with prices in September soaring year over year by 34.1% in Shenzhen, 32.7% in Shanghai, and 27.8% in Beijing, according to the National Bureau of Statistics of China. Even some secondary cities have seen solid price gains, despite sky-high unsold inventories. Chinese real estate billionaire Wang Jianlin said in a September interview with CNNMoney that the Chinese residential real estate market is now “the biggest bubble in history.”

Indeed, prices have become untethered from local incomes or even any basic need for shelter. Typical investors regard town houses and apartments as pure financial investments and often buy multiple units they don’t bother to live in or even rent out. The latter is deemed to only diminish eventual resale value. The homes are merely stockpiled by investors, whether citizens, SOEs, or banks, in the conviction that growing urbanization will bail them out.

Any major collapse in this most speculative market would have a major impact on the Chinese financial system. Credit directly tied to housing sits at about a third of GDP. Much household wealth would be vaporized. These days, mortgage borrowing accounts for much of the acceleration in household debt levels, which have soared from just over 10% of GDP in 2006 to 40% now.

A substantial dent in household wealth would also play havoc with the nation’s ambition to transform its economy from an industrial export powerhouse to one emphasizing consumption and services.

BY POURING NEW MONEY into its economy, China is also having more difficulty in “managing” the value of its currency, the yuan, which has already declined by 9% versus the dollar in the past 18 months. An oversupply of credit—or, in effect, money—inevitably lowers its value and promotes capital flight from China to more financially hospitable climes.

Despite strong capital controls to inhibit it, there are a number of indications that the capital-flight trend is well entrenched and will only grow in intensity as the yuan continues to weaken.

Chinese buyers are key to real estate bubbles in Sydney, Vancouver, San Francisco, and New York. Last year, for the first time in history, foreign direct investment by Chinese companies exceeded that coming into China. This capital flight springs from many motives, but the overriding consideration is that the economic prospects are better in many climes outside China. And Chinese investors better move quickly before the yuan depreciates more.

So far, the government has been reasonably adept in snuffing out forest fires in various markets, such as the $3 trillion corporate-bond market, heading off defaults by effecting restructurings with still more debt. But what happens if Beijing is overwhelmed by a string of loan defaults or capital leakage outside China?

Then the Chinese debt bomb could well detonate, taking with it broad swaths of the global economy. 

Midnight In America

by: Peter Schiff

- Talking heads are blown away by Trump's election.
- But they are missing the real issue.
- The USA's economic problems will not be an easy fix.

Stunned political analysts are missing the most plausible argument explaining Donald Trump's unexpected victory. The misreading of the American electorate stems from the political class' acceptance of mistaken (and increasingly insane) economic dogma that has arisen over the past generation. Based on their flawed understanding of economics, the pundits could simply not understand why the electorate had become totally disillusioned.
According to the ideas favored by economists on Wall Street, in government, and in the Federal Reserve, Americans should be enjoying a marginally good economy. Unemployment is low, home values and the stock markets are high, credit is cheap and plentiful, prices are stable, auto sales are robust, healthcare is available to all, and GDP is growing, albeit at levels that are below optimal.
These are conditions that would normally favor the incumbent party, and would discourage voters from taking a chance on an unknown who has promised to tear down the entire system.
But that is precisely what happened. There can only be two explanations: Either Trump supporters were motivated by hatred strong enough to cause them to vote against their own economic interests, or they understood the economic reality better than the Ph.D.'s. I believe the people got it right.
In countless commentaries over the last few years, I have argued that the economy has been getting worse, not better, since the Great Recession of 2008. My points were simple. I suggested that the economic signals created by the Government's deficit spending and the Federal Reserve's eight year stimulus program were not creating growth but were actually hollowing out the real economy. I argued that prices were rising faster than Washington cared to admit and that inflation was an economic problem for ordinary Americans, not a magic elixir for growth. I argued that unemployment came down only because people either gave up looking for work (and then dropped out of the labor force), or took multiple low paying part-time jobs to compensate for the loss of good-paying full time jobs. I argued that increased workplace regulations, minimum wage increases, and Obamacare would create hostile conditions for small businesses and would stifle job creation. I argued that zero percent interest rates and quantitative easing were simply a benefit for the investor class and did nothing to generate real or sustainable growth (in fact those monetary policies guaranteed stagnation). I argued that these low rates would inflate debt bubbles in the auto and student loan sectors and would set up our economy for years of pain when those bubbles burst.

That is why my gut told me that Trump would win, despite the polls and the widely held belief that a Clinton victory was assured. I believed that voters (who live in reality, not the fantasy world concocted by the elites) would express their dissatisfaction the only way they could, by voting for Trump. Obama came into office eight years ago promising change but delivered more of the same.
Clinton's promise to continue that failed legacy was a loser from the start. The rank and file saw things the way I had, and reacted the way I believed they would.
But just because the electorate has finally noticed the emperor has no clothes does not mean that we are now on the path to recovery. Donald Trump has proven to be a master of identifying the hopes and fears of voters, but whether or not he has the wisdom and courage to do what is necessary to restore the country's economic health is an open question. While it is true that Trump is less likely to continue with the status quo, no one really knows what path he will follow broadly. His election likely sounds the death knell for Obamacare and for a slew of environmental and workplace regulations imposed by Obama executive orders, but beyond that, it's anybody's guess.
He has said that he wants to lower taxes and reduce regulations, which are needed goals, but he has said nothing about the hard work of reducing spending or reining in our country's runaway national debt. Trump has openly admitted that his business successes have been based on his ability to go deep into debt, and then to emerge, Phoenix-like, on the back of good deal-making, marketing, and braggadocio. He probably thinks he can do the same on the national level. But there the rules are much different.
It is unlikely that he understands the chemicals he will be playing with, nor is it likely that he will rely on the opinions of those who do. It's clear that his only solution is that we "grow our way out of debt." This is a gambler's mentality that is likely integral to his DNA. It didn't work for him in Atlantic City, and it won't work for him now.
Our best hope is that the real Trump is actually a lot cagier than his campaign persona. The wisest leader can do nothing if he can't get elected (a phenomenon with which I have some experience).
Trump managed to get himself elected to the most powerful position in the world. Perhaps he has a better understanding of the problems that face us than he let on during the campaign.
Perhaps he knows how excessive debt will choke the economy, that entitlement spending will overwhelm us if we don't enact Social Security and Medicare reform, that unending monetary stimulus will create a zombie bubble economy, and that trade wars will do more harm than good. Only time will tell.
Of particular concern is that Trump fails to understand how American living standards have been subsidized by our trade deficits. Yes, the hollowing out of our manufacturing sector has meant the loss of millions of good American jobs. But it is not the trade deals that are responsible for their loss, but rather the inability of American manufactures to compete in a high cost, high regulation world.
And while we have lost jobs, we have nevertheless gained access to very low cost foreign goods and services, without having to expend the resources necessary to produce them. We have been able to consume these things despite the fact that we can't pay for them in full. For now, the trade deficits are a problem for our creditors, not for us. Of course, they will become a big problem for us if our creditors decide to cut us off. Trade wars may not bring back good American jobs, but they will surely raise prices and reduce choices for American consumers.
For now we should celebrate that the election of 2016 shows that the American public knows that they have been misled, that they are mad as hell, and that they refuse to take it any longer. But as bleak as the picture Trump painted of the current state of the U.S. economy, it was not bleak enough.
Before things can actually get better, they must first be allowed to get much worse. Decades of government promises to supply voters with benefits taxpayers can't afford must be broken, starting with many of the promises Trump made himself to get elected. Rising consumer prices and long-term interest rates can bring this decades-old party to a catastrophic end.

Ronald Reagan was the last Republican president who was swept into office promising great change.
He made good on his "Morning in America" promises to cut taxes and regulations. But he failed in his promises to reduce spending. Trump has never even paid any lip service to spending cuts. And while Reagan's failure to deliver on spending cuts was cushioned by the steady declines of interest rates during his presidency, Trump will not have that wind at his back. Plus the economy of 2016 has far deeper problems than the economy of 1980. Reagan's morning now looks more like Trump's midnight.
Trump did not make this mess, but he will likely be in office to clean it up.

 Krugman Gets His Alien Invasion – And Gold Bugs Get Paradise 

Nobel Prize winning economist and uber-liberal New York Times columnist Paul Krugman likes to illustrate his philosophy by noting that the threat of an alien invasion would help the economy by stimulating government spending.

Well, last week’s election gave Krugman and the rest of the Keynesian establishment their alien invasion (Trump and company being only partially human when viewed through Beltway-culture eyes). And sure enough, it’s resulting in massively-higher government spending.

Infrastructure is phase one:

Donald Trump Proposes to Double Hillary Clinton’s Spending on Infrastructure

(New York Times) – Donald J. Trump took a step to Hillary Clinton’s left on Tuesday, saying that he would like to spend at least twice as much as his Democratic opponent has proposed to invest in new infrastructure as part of his plan to stimulate the United States’ economy.
The idea takes a page out of the progressive playbook and is another indication that the Republican presidential nominee is prepared to break with the fiscal conservatism that his party has evangelized over the past eight years. 
“We have bridges that are falling down,” Mr. Trump said on the Fox Business Network.  
“We have many, many bridges that are in danger of falling.” 
Mrs. Clinton has called for $275 billion in infrastructure spending over five years. That would include the creation of a national infrastructure bank, which would be given $25 billion to support loans and loan guarantees. In sum, the plan would support about $500 billion in spending on infrastructure. 
Senator Bernie Sanders of Vermont, who competed against Mrs. Clinton for the Democratic nomination, also wanted to outspend her on infrastructure, calling for a $1 trillion investment over five years. 
Asked how he would pay for $800 billion to $1 trillion in infrastructure spending, Mr. Trump described a strategy that has been favored by liberal economists over the years.  
He said he would create an infrastructure fund that would be supported by government bonds that investors and citizens could purchase. 
“We’re going to go out with a fund,” he said. “We’ll get a fund, make a phenomenal deal with low interest rates and rebuild our infrastructure.” 
He added, “We’d do infrastructure bonds from the country, from the United States.” 
If Mr. Trump’s call for more spending sounds familiar, that could be because Lawrence H. Summers, who was President Bill Clinton’s Treasury secretary and the director of President Obama’s National Economic Council, has been saying the same thing. At a Democratic National Convention round table last week in Philadelphia, he said the United States should invest between $1 trillion and $2 trillion in infrastructure over the next 10 years.
And of course now that Washington is a Republican town, defense spending will soar:

Trump Win Lifts Defense Stocks On Expected Trump Push For Military Buildup

(TheStreet) – Shares of industrial stocks tracked the broad market higher with defense stocks leading the way while materials and manufacturers trailed close behind as investors reckoned President-elect Donald Trump will focus on strengthening the U.S. military.
Lockheed Martin ( (LMT) ) rose almost 6%, Raytheon added 7.5%, and other defense contractors including Northrop Grumman ( (NOC) ) and General Dynamics (GD) rose more than 5% each on the prospect of a Trump presidency and, as importantly, Republican control of both houses of Congress.

Meanwhile tax cuts – which are, in Keynesian terms, a form of spending – are of course high on the wish list:

Trump and Congress Both Want Tax Cuts. The Question Is Which Ones.

(New York Times) – Several economic issues divide many Republicans in Congress from Donald J. Trump, the Republican president-elect. Free trade versus tariffs to limit imports. Immigration reform versus a border wall. Cutting Social Security and other benefit programs versus protecting them. 
But one economic matter unites just about every member of the Republican party: support for tax cuts, particularly for those at the top of the income ladder. 
Whatever fault lines have emerged during this campaign, the belief that lower taxes targeted at “job creators” will unleash a roar of economic growth crosses them.  
Both Donald J. Trump and Paul D. Ryan, the House speaker, have released tax proposals that hark back to the supply-side programs of the Reagan and George W. Bush eras, promising that the multitrillion-dollar cost will be more than offset by the extra revenue flowing into the Treasury from the growth that will follow. 
“Tax reform is the thing that always unites Republicans,” said William Gale, a co-director of the nonpartisan Tax Policy Center and a former economic adviser to President George H.W. Bush. “I would guess that that’s Item 1 on the congressional agenda.” 
While sweeping tax cuts were never a crusading theme of Mr. Trump’s, they have long been near the top of Mr. Ryan’s agenda. And Mr. Trump has suggested he would be happy to let Congress take the lead.

 Some thoughts

The above proposals have antecedents in Eisenhower’s construction of the interstate highway system in the 1950s and Regan’s tax cuts and defense build-up in the 1980s, both of which were seen as successes at the time.

There’s just one problem. Those programs were enacted when debt levels as a percentage of GDP were miniscule compared to today. Since borrowing, like any other activity, tends to become less effective with overuse, ladling another few trillion on top of the hundred or so trillion already owed won’t accomplish much. In economists’ terms, the “marginal productivity of debt” has plunged as total debt has soared, which implies that we can now borrow infinite dollars and get virtually zero new wealth.


But it’s possible that massive increases in government borrowing and Fed currency creation will generate the inflation that Keynesians love and conservatives don’t seem to understand. If so, a falling dollar would – in the best-case scenario — bring back the stagflation of the 1970s.

Which, readers of a certain age will remember, was a great time to own gold and silver.


Why Aren’t Americans Getting Raises? Blame the Monopsony

Instead of bidding up wages, firms collude to keep pay low and enforce noncompete clauses.

By Jason Furman and Alan B. Krueger

Pat Cason-Merenda had worked as a registered nurse at the Detroit Medical Center for four years, unaware that she was being underpaid. That changed when a class-action lawsuit alleged that her employer, along with seven other hospitals, had colluded to suppress the wages of more than 20,000 nurses. The suit claimed the hospitals conspired to keep pay low by inappropriately sharing information about nurses’ salaries and pay increases. By this year, the hospitals agreed to pay $90 million dollars to settle the wage-fixing case.

Stories like this are too common, thanks to many employers’ exercising monopsony power over workers. A monopsony is the flip side of a monopoly: It occurs when a buyer, rather than a seller, has sufficient market power to set its own price. While economics textbooks often describe the labor market as perfectly competitive, in reality employers often use their power to underpay workers.

In addition to holding down workers’ paychecks, monopsony power can depress overall hiring and output, as employers are unable to find enough workers at the wage they offer. If monopsony power creates barriers to workers switching jobs, it can slow labor turnover, reducing dynamism and innovation. Counteracting monopsony power would lead to higher wages, lower unemployment and stronger economic output.
Some employers act as monopsonists by illegally colluding, as alleged in the case of Detroit hospitals. Others require employees to sign noncompete agreements that prevent them from working for a competitor in the future. And nearly all employment arrangements involve a degree of implicit monopsony power: Frictions, such as finding new child-care arrangements or spending time searching for work, can make it costly for workers to change jobs. Many companies exercise monopsony power even though they are not the only employer in town.

Evidence suggests monopsony power is restricting pay increases. Job openings have steadily risen in recent years, but hiring has not kept pace. Some employers cite this as evidence of a shortage of skilled workers. In a competitive labor market, however, employers would bid up workers’ compensation until vacancies were filled. Yet wages have not grown faster in sectors with rising job openings, according to the Washington Center for Equitable Growth, suggesting that companies are resisting raising wages.

New research also highlights excessive use of noncompete clauses. Nearly 20% of American workers have signed a noncompete agreement, according to economic researchers. This is far higher than any plausible estimate of the share of workers with access to trade secrets that could harm their employers if taken to a competitor. Even in states where noncompete agreements are effectively banned, they remain prevalent, suggesting a blanket approach to their use by employers. There is no reason why employers would require fast-food workers and retail salespeople to sign a noncompete clause—other than to restrict competition and weaken worker bargaining power.

The trend toward greater concentration among businesses in recent decades could be exacerbating these problems. Large corporate mergers make it easier for the remaining firms to explicitly or implicitly collude and enforce noncompete agreements.

Last week, the Obama administration called on states to adopt a set of best practices ensuring that noncompete agreements are narrowly targeted and appropriately used. The White House also announced commitments to initiate the largest-ever data collection of its kind on noncompete usage.

The Justice Department and Federal Trade Commission last month released new guidance for human resources professionals to help identify and report wage collusion among employers, including information about a reporting hotline. And allegations of companies engaging in illegal wage-collusion will now be criminally investigated by the Justice Department.

A strong voice for workers and robust labor standards can also help counteract monopsony power and lift wages. Congress should raise the federal minimum wage, which has been stuck at $7.25 an hour since 2009. Supporting collective-bargaining rights also helps workers negotiate with employers on a more level playing field. To assure adequate benefits, the Labor Department recently acted to modernize overtime regulations, and Congress should follow suit by expanding paid leave.

The idea that employers take steps to suppress pay is not new. Adam Smith wrote in “The Wealth of Nations” that employers were “always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate.”

Hundreds of years later, the U.S. needs policies that prevent and counteract monopsony power. Greater labor-market competition can help the entire U.S. economy—and ensure that workers like Ms. Cason-Merenda in Detroit share in the economic growth they help create.

Mr. Furman is the chairman of President Obama’s Council of Economic Advisers. Mr. Krueger, a former chairman of the council (2011-13), is a professor of economics at Princeton University.

Trump Won Yet Gold Is Falling...Why?

by: Hebba Investments

- Donald Trump surprisingly won the US election, yet gold has fallen in a move opposite to what analysts expect.

- Stanley Druckenmiller sold all his gold during election night as he believe massive infrastructure spending and tax cuts will benefit stocks.

- If it were not for current global debt levels we would agree with Druckenmiller, but nobody has an answer for how debt markets will deal with these initiatives.

- Bond yields are rising chaotically and we believe its the beginning of the end for the 30+ year rally in bonds.

- Chaos in bond markets are not good for stocks but good for gold, thus we believe that the recent plunge in gold is a buying opportunity for investors.

As everyone knows by now, Donald Trump will be the 45th president of the United States, and what supposedly would rocket gold beyond $1400 has actually resulted in gold DROPPING after the election. With gold experts and analysts scratching their heads, we will offer our opinion on what is going on with gold and how gold investors should position themselves moving forward.
What is Going on With Gold?
On election night, investors could have ignored CNN and simply watched the gold price to see who was winning the election. In fact, we saw one of the craziest 12 hours in gold in history as it jumped to rise more than $60 in a few hours to rise above $1340, and then it started to fall below its election day start.
That's a pretty volatile move and depressing for gold investors that expected Trump would lead to $1400 gold.
What happened here is that investors (or more appropriately "traders") were originally shocked at the impending Trump victory and bought gold, sold stocks, and sold the US Dollar in their emotional reaction to the election results.

In fact, if we compare the gold price with the US Dollar we find an almost tick-to-tick move.
As the night went on many investors include Jim Rickards and Stanley Druckenmiller, who publicly announced he sold all of his gold the night of the elections, took the opportunity to book profits. Other investors like Carl Icahn bought large amounts of stocks during the overnight bloodbath, figuring the initial overreaction was a good opportunity to buy - and they were right as stocks rose the very next morning.
The reason for the opposite moves to what was originally predicted in stocks, gold, and the US Dollar, was that much of the initial reaction was completely emotional due to the surprise uncertainty.
But then when investors took a step back they realized that Trump's plan to spend massive amounts on infrastructure was good for stocks and commodities. Additionally, the Republican sweep of both sides of Congress meant that there was a good chance all of these policies would be implemented - after all this is the first time in quite a while that the White House and Congress were held by one party.
That Explains Why Stocks and the US Dollar Rose, But Why Did Gold Drop?
The answer is best summed up by Stanley Druckenmiller on an interview aired via CNBC, where he stated that "I sold all my gold on the night of the election… because I'm very optimistic" and he's betting on growth inspired by Trump's massive infrastructure plan and deregulation push. In a growth environment, it is better to own risk-on assets and stocks rather than gold - and we agree after all rising revenues mean increasing asset values while with gold you'll only end up owning exactly the chunk of gold that you bought.

This is actually evidenced in history. In Roy Jastram's excellent book The Golden Constant, he analyzes hundreds of years of the gold price versus commodity pricing (remember for most of economic history gold was money and thus had no "price" other than commodity ratios) and found that gold did well during economic recessions and depressions, while it underperformed commodities during economic booms. Essentially, you wanted to own gold (i.e. cash) during rough times and commodities during booms - pretty logical.
If That is the Case Then Is it Time to Sell Gold for Commodities and Stocks?
Based on just those facts it would make sense to sell gold - but there is one issue that makes Jastram's analysis not quite accurate for today's world and it's a big hole in Mr. Druckenmiller's argument in selling his own gold and buying stocks… The Bond Market.
Unlike the centuries of data that Mr. Jastram studied, our bond market is an artifice in central bank suppression of the natural interest rate. It is the only world where European 10-year bonds can offer negative yields and Japan can raise money over 30 years at 0.5%. We pointed out a few weeks ago that this is starting to change, and after Trump's election, bonds have been going vertical - look at the chart for US 30-year treasuries.
That is a scary thing for investors holding multi-billion-dollar treasury portfolios (think central banks and large mutual funds), and those are big paper losses that will be realized when bonds are sold - and will only increase as yields rise. In one week, bond investors have already seen $1 trillion in losses - we highly doubt those investors will be buying more treasuries in a rising-yield, inflationary environment.

Which brings us back to Mr. Druckenmiller's economically optimistic view of markets based on the massive infrastructure plan Mr. Trump proposes to implement - how are bond markets going to react and fund that plan?
While details are still very few and far between on Mr. Trump's spending plans, what we do know is that he plans on significantly increasing the budget deficit through spending and tax cuts. Even when CNBC's Joe Kernen questioned Mr. Druckenmiller in the interview cited earlier about how the plan will be beneficial for stocks when it is projected to blow out deficits by so much that many Republicans are hesitant to back them. After a long-winded discussion of Reagen, the only response was that "I don't worry about the other stuff…" Not very comforting.
That is exactly what we think is happening in stock markets which are trading to the upside on expecting big infrastructure spending and lower taxes and following Mr. Druckenmiller's "I don't worry about the other stuff" attitude.
This line of thinking has worked for the first few days after the election based on the initial emotional charge of the election results, but we don't see how a collapsing bond market with rising yields will be good for stocks and the US Dollar…
We Do See Why It Would Be Good for Gold
Summing it all up we see a number of reasons why this environment is very negative for markets:

  • Trump's plans call for massive fiscal spending, deregulation, and cuts to taxes that all will increase the US budget deficit and long-term debt and put more upward pressure on bond yields.

  • Rising yields also mean the required rate of return for stocks (used in DCF analysis) will rise, which are negative for stocks.

  • Rising rates also put a damper on real estate markets around the world as the cost of mortgage payments rise and lower prices buyers are willing to pay for real estate.

  • Individuals, companies, and governments used to extremely low interest rates will now have a hard time raising money or will be forced to pay higher rates thus lowering investment.
All of these things start with central banks losing control of bond yields and those yields starting to rise to more natural levels - and that's what we think is happening.
To strengthen our argument further we remind investors about this chart from the McKinsey Global institute showing where bond markets stand in terms of debt outstanding.
While the chart is dated and we know of no more current chart from the institute, its plain to see that global debt levels have been growing very fast - probably due to the extremely low interest rate environment we have been in since 2007. What happens when yields rise on more than $200 trillion worth of global debt?
So in summary:
  • Inflation: Check
  • Rising Government Deficits: Check
  • Rising Bond Yields: Check
  • Rising Debt Loads Around the World: Check
  • Panic in Bond Markets: Check
  • Calls for Protectionism: Check
We wouldn't be particularly comfortable with owning stocks in this environment, but we certainly like gold in this environment.
Conclusion for Investors
It all comes down to an investors' view on whether or not increasing US budgets will be feasible in the currently over-leveraged and overly-indebted that we live in today. If you believe that bond markets will accept trillions of dollars of additional debt and higher inflation without spiking, then you want to be a buyer of stocks and commodities.
But if you are of the view that the next crisis in going to be in the bond markets, then there will be probably be significant road-blocks to any major government spending program and that will provide headwinds for US stocks and the US Dollar. As an alternative reserve currency without the ability of governments to dilute it via massive spending, gold provides investors with an excellent hedge in this environment - and that is the environment we believe we are heading for.

Thus, we think this is an excellent opportunity for investors that heeded our advice and lightened up positions prior to the elections to beat the mainstream investment herd by accumulating physical gold and the gold ETFs (SPDR Gold Shares (NYSEARCA:GLD), PHYS, and CEF). In fact, we have begun accumulating precious metals miners again after being uninterested for many months, as the valuations have come down significantly from a few months ago and there is now value in owning them again.
It is time for investors to a step ahead of the crowd and understand that if massive government spending is undertaken we will see even more chaos in bond markets - and that is very gold positive.