Fed Gives Up On Inflation, Welcome To The U.S. Of Japan

by: Lance Roberts


- Retest confirms bullish breakout. 
- Fed gives up on inflation.
- Welcome to the U.S. of Japan.

Retest Confirms Bullish Breakout
"If you are a bull, what is there not to love?"

That was the message from two weeks ago, and the reasoning behind increasing our equity exposure in portfolios as we head into the end of the year.

With the Fed cutting rates on Wednesday, and companies winning the "beat the estimate game" as earnings season progresses, the markets finally broke out to new "all-time" highs this past week.


This breakout is consistent with the "revival of the bulls" which is needed as there is too much attention focused on a "recession" and "bear market." (If a recession/bear market would have occurred, it would have been the first time in history "everyone" saw it coming.)

"Over the last 30 years, when the Fed has implemented an 'insurance' rate cut policy of 75 basis points, the equity market has been 'lights out' as the S&P 500 has posted a 12-month forward return of ~23%, on average."  
- Raymond James
(H/T G. O'Brien)

That's the good news.
However, before you go jumping in with both feet, there are a couple of points to be made.

Concerning the chart above, you have to decide whether the recent rate cuts by the Fed are "mid-cycle adjustments" or "cuts entering a recession." While most people only notice the tall black bars, given we are in the longest economic expansion in history, the short-blue bars may be important.

Again, since bear markets/recessions NEVER occur when everyone is expecting them, the breakout to new highs is exactly what is needed to "suck investors" back into the market at the potential peak. This is how bear markets have always begun in history.
On a shorter-term basis, whether you are bullish or bearish, the market is now more than 6% above its 200-dma. These more extreme price extensions tend to denote short-term tops to the market, and waiting for a pullback to add exposures has been prudent.
The other concern is the weakness in overall participation in the market. Despite the markets pushing to all-time highs, the number of stocks trading above their respective 50-, 150-, and 200-dma's remain in downtrends. These negative divergences have preceded short to intermediate-term corrections in the past.

How To Play It

As we have been noting over the last month, with the Fed's more accommodative positioning, we continue to maintain a long-equity bias in our portfolios currently. We have reduced our hedges, along with some of our more defensive positioning. We are also adding opportunistically to our equity allocations, even as we carry a slightly higher than normal level of cash along with our fixed income positioning.
We also realize that "all good things do come to an end." While we are currently "riding the bull," we are simply waiting for the "8-second buzzer" to prepare for our dismount. (That's a Texas rodeo thing if you don't know the reference.)
Therefore, make sure you have stop-losses in place on all positions and be prepared to execute accordingly. The worst thing investors consistently do over time is to turn a "winner" into a "loser" before they eventually sell. (And they always sell.)

While you will certainly reduce your tax liability with this method, it is not a strategy by which you will increase your wealth. Being "rich on paper" and having "cash in the bank" are two ENTIRELY different things.

The Fed Gives Up On Inflation

On Wednesday, the Fed cut rates for the third time this year, which was widely expected by the market.
What was not expected was the following statement.
"I think we would need to see a really significant move up in inflation that's persistent before we even consider raising rates to address inflation concerns."  
- Jerome Powell 10/30/2019
The statement did not receive a lot of notoriety from the press, but this was the single most important statement from Federal Reserve Chairman Jerome Powell so far. In fact, we cannot remember a time in the last 30 years when a Fed Chairman has so clearly articulated such a strong desire for more inflation.
Why do we say that? Let's dissect the bolded words in the quote for further clarification.
  • "really significant" - Powell is not only saying that they will allow a significant move up in inflation but going one better by adding the word significant.
  • "persistent" - Unlike the prior few Fed Chairman who claimed to be vigilant towards inflation, Powell is clearly telling us that he will not react to inflation that is not only well beyond a "really significant" leap from current levels, but a rate that lasts for a period of time.
  • "even consider" - If inflation is not only a really significant increase from current levels and stays at such levels for a while, they will only consider raising rates to fight inflation.
We are stunned by the choice of words Powell used to describe the Fed's view on inflation. We are even more shocked that the markets or media are not making more of it.
Maybe, they are failing to focus on the three bolded sections. In fact, what they probably think they heard was: I think we would need to see a move up in inflation before we consider raising rates to address inflation concerns. Such a statement would have been more in line with traditional "Fed-speak."

We have published an article for our RIAPro subscribers, which discusses our views on using Treasury Inflation-Protected Securities (TIPS), a hedge against Jerome Powell and the Fed getting inflation, or worse, failing and fostering deflation.

There is another far more insidious message in Chairman Powell's statement which should not be dismissed.
The Fed just acknowledged they are caught in a "liquidity trap."

What Is A Liquidity Trap
Here is the definition:
"A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels."

Let's take a moment to analyze that definition by breaking it down into its overriding assumptions.
  • Are the central banks globally injecting liquidity into the financial system? Yes.
  • Has the increase in liquidity into the private banking system lowered interest rates? Yes.
The chart below shows the increase in the Federal Reserve's balance sheet, since they are the "buyer" of bonds, which in turn increases the excess reserve accounts of the major banks, as compared to the 10-year Treasury rate.

Of course, that money didn't flow into the U.S. economy, it went into financial assets.

With the markets having absorbed the current levels of accommodation, it is not surprising to see the markets demanding more. (The chart below compares the deviation between the S&P 500 and the Fed's balance sheet. That deviation is the highest on record.)

While, in the Fed's defense, it may be clear the Fed's monetary interventions have suppressed interest rates, I would argue their liquidity-driven inducements have not done much to support durable economic growth.

Interest rates have not been falling just since the monetary interventions began - it began four decades ago as the economy began a shift to consumer credit leveraged service society.

The chart below shows the correlation between the decline of GDP, Interest Rates, Savings, and Inflation.
In reality, the ongoing decline in economic activity has been the result of declining productivity, stagnant wage growth, demographic trends, and massive surges in consumer, corporate and, government debt.

For these reasons, it is difficult to attribute much of the decline in interest rates and inflation to monetary policies when the long-term trend was clearly intact long before these programs began.

While an argument can be made that the early initial rounds of QE contributed to the bounce in economic activity, there were several other more important supports during the latest economic cycle.
  1. Economic growth ALWAYS surges after recessionary weakness. This is due to the pent up demand that was built up during the recession and is unleashed back into the economy when confidence improves.
  2. There were multiple bailouts in 2009 from "cash for houses", "cash for clunkers", to direct bailouts of the banking system and the economy, etc., which greatly supported the post-recessionary boost.
  3. Several natural disasters from the "Japanese Trifecta" which shut down manufacturing temporarily, to massive hurricanes and wildfires, provided a series of one-time boosts to economic growth just as weakness was appearing.
  4. A massive surge in government spending which directly feeds the economy.
The Fed's interventions from 2010 forward, as the Fed became "the only game in town," seems to have had little effect other than a massive inflation in asset prices.

The evidence suggests the Federal Reserve has been experiencing a diminishing rate of return from their monetary policies.

Welcome To The U.S. Of Japan

The Federal Reserve is caught in the same "liquidity trap" that has been the history of Japan for the last three decades. With an aging demographic, which will continue to strain the financial system, increasing levels of indebtedness, and unproductive fiscal policy to combat the issues restraining economic growth, it is unlikely monetary interventions will do anything other than simply continuing the boom/bust cycles in financial assets.
The chart below shows the 10-year Japanese Government Bond yield as compared to their quarterly economic growth rates and the BOJ's balance sheet. Low interest rates, and massive QE programs, have failed to spur sustainable economic activity over the last 20 years.
Currently, 2-, 5-, and 10-year Japanese Government Bonds all have negative real yields.
The reason you know the Fed is caught in a "liquidity trap" is because they are being forced to lower rates due to economic weakness.
It is the only "trick" they know.
Unfortunately, such action will likely have little, or no effect, this time due to the current stage of the economic cycle.
If interest rates rise sharply, it is effectively "game over" as borrowing costs surge, deficits balloon, housing falls, revenues weaken and consumer demand wanes. It is the worst thing that can happen to an economy that is currently remaining on life support.
The U.S., like Japan, is clearly caught in an on-going "liquidity trap" where maintaining ultra-low interest rates are the key to sustaining an economic pulse. The unintended consequence of such actions, as we are witnessing in the U.S. currently, is the ongoing battle with deflationary pressures.
The lower interest rates go - the less economic return that can be generated. An ultra-low interest rate environment, contrary to mainstream thought, has a negative impact on making productive investments and risk begins to outweigh the potential return.
Most importantly, while there are many calling for an end of the "Great Bond Bull Market," this is unlikely the case. As shown in the chart below, interest rates are relative globally. Rates can't rise in one country while a majority of economies are pushing negative rates. As has been the case over the last 30 years, so goes Japan, so goes the U.S.
Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled. Eventually, the void will be too great to fill.
But hey, let's just keep doing the same thing over and over again, which hasn't worked for anyone as of yet, and continue to hope for a different result.
What's the worst that could happen?
See you next week.
A Conservative Strategy For Long-Term Investors

There are 4 steps to allocation changes based on 25% reduction increments. As noted in the chart above, a 100% allocation level is equal to 60% stocks.
I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend.
Emotions keep us from taking the correct action.

The Fed Unleashes The Bull
Given the "bulls" have the upper-hand heading into the end of the year, we are increasing our equity exposure slowly. Given the markets tend to pull back just before Thanksgiving, and during the second week of December, we will have a better opportunity increase allocations if we are patient.
We need to see a bit of pullback to reduce the rather excessive extension of the market above the 200-dma, but a pullback that doesn't break back below the previous highs. Such action will confirm the breakout and suggest our target of 3,300 is attainable.
However, please direct your attention to the chart above.

The market is once again pushing above its cyclical bullish trendline and testing the cycle trend highs from 2007. This has been a point of failure for the markets each time previously, so some caution is advised until a breakout is confirmed.
This week, continue making adjustments to prepare to opportunistically increase equity exposure on a pullback which doesn't fail at support levels.
  • If you are overweight equities - Hold current positions.
  • If you are underweight equities - rebalance portfolios to target weights
  • If at target weight equities, hold positioning and look for a pullback to increase exposure.
Understand this increase could well be short-lived. The markets have been in a very long consolidation process and the breakout to the upside is indeed bullish. However, we must counter-balance that view with the simple reality we are VERY long in the current economic and market cycle which is where "unexpected" events have destroyed capital in the past.

Current 401-k Allocation Model

The 401k plan allocation plan below follows the K.I.S.S. principle. By keeping the allocation extremely simplified it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree.)
Model performance is based on a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter.
This is strictly for informational and educational purposes only and should not be relied upon for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.


Sanctions are Donald Trump’s new way of war

The president has merged America’s economic policy with its security strategy

Philip Stephens

 Comment illo WEB 17-10-2019
© Daniel Pudles

Call it America’s new way of war. Forget aircraft carriers, stealth fighters and cruise missiles.

Think instead about dollars, silicon chips, digital data — and sanctions, embargoes and blacklists. Nations have often employed economic coercion. Donald Trump has gone three steps further. He has merged America’s economic policy with its national security strategy.

When Steven Mnuchin, the Treasury secretary, was asked if the US could halt Turkey’s onslaught against the Kurds in Northern Syria, he had an easy answer.

“We can shut down the Turkish economy”. Mr Mnuchin, a former banker and hedge fund investor, was once what the president calls a “globalist”.

Now, it seems, part of his job is to roll back the frontiers of globalisation.

Perhaps nothing about Mr Trump’s presidency should surprise us.

After all, a couple of days before he slapped sanctions on Ankara, he had all but blessed President Recep Tayyip Erdogan’s invasion by announcing the withdrawal of the US troops who fought alongside the Kurds against Isis.

Mr Trump says that by pulling out he is redeeming an election pledge to bring home US troops from the Middle East. And, after Iraq and Afghanistan, there is something to be said for his reluctance to put US troops in harm’s way.

Mr Trump’s peremptory dismissal of John Bolton as national security adviser may well have averted a war with Iran.

Throwing the Kurds overboard is a different story.

The president has handed strategic victories to Russia, Syria and Iran simultaneously, while damaging America’s own regional credibility.

The Kurds were vital partners in the defeat of the jihadis.

By betraying them, Mr Trump shows the US to be a wholly unreliable ally — as capricious in dealing with friends as with enemies.

Mr Trump is not the first president to weaponise America’s economic might.

In 1956, Dwight Eisenhower’s administration forced Britain to withdraw from Suez by blocking international support for sterling.

Ronald Reagan and Margaret Thatcher were famously firm allies, but had a protracted fight about the extraterritorial reach of US sanctions on the Soviet Union after the invasion of Afghanistan.

Throughout the cold war, most western nations restricted the export of sensitive technology to the Soviet Union. More recently, the EU imposed its own sanctions on Moscow, alongside those of the US, after the annexation of Crimea and occupation of eastern Ukraine.

Now, tariffs, embargoes and the like have become America’s remedy for all seasons. The dollar’s role as the sole reserve currency gives the US a unique capacity to control the international financial system.

The tariffs imposed on Chinese, Canadian and Mexican goods at the start of Mr Trump’s presidency had the limited aim of tilting bilateral trade accounts back towards balance. Since then the myriad restrictions applied to China signal a more fundamental goal of decoupling the two economies.

The communications giant Huawei, along with scores of other Chinese companies, has found itself on the so-called entity list, which bars it from buying US technology. The list was conceived to hit terrorists and proliferators of weapons of mass destruction. The 2018 Foreign Investment Risk Review Modernization Act caps investment in Silicon Valley by Chinese businesses. The Denied Persons List imposes even more draconian curbs on technology transfer.

Mr Trump reaches for the sanctions manual whenever the mood takes him.

The latest set directed against Beijing supposedly provides a response to the repression of the Uighur population in China’s Xinjiang province.

The president has invoked cold war legislation passed by the Kennedy administration to declare imports to the US of European and Canadian automobiles and flows of immigrants across the Mexican border as national security threats demanding retaliation.

During Barack Obama’s presidency, sanctions on Iran helped persuade it to reach an agreement with the international community on its nuclear programme. Mr Trump disowned that accord, only to apply even tougher measures. The purpose now reaches well beyond nuclear ambitions to include Iran’s behaviour across the region.

Where the US goes, Mr Trump expects its allies to follow. By denying Iran access to dollars, Washington has all but broken the back of European efforts to salvage the nuclear accord. Not content with pushing Huawei out of the US market, the administration is demanding that European allies exclude it from their 5G digital communications networks. The allies have been warned they will lose access to US intelligence if they step out of line.

And much of the time the administration does not need to apply direct pressure to achieve such extraterritorial effect. Western companies operate within complex, cross-border supply chains. Many have operations or sales in the US. They cannot risk finding themselves added to a US blacklist or at risk of losing access to dollars.

The White House is unapologetic. Peter Navarro, the president’s trade adviser, says economic security is indivisible from national security. Another way of putting it is that for as long as the US holds the only reserve currency and a preponderance of economic power, America has decided it can do as it pleases. In Mr Trump’s world, rules are for the weak.

Locking China Out of the Dollar System

By broadening the nexus between economic interest and national security, Trump is encouraging the decoupling of the world’s two largest economies and the emergence of a bipolar world order led by rival hegemons. Beyond fragmenting the trade and financial system that has underpinned the global economy for decades, the stage would be set for a devastating conflict.

Paola Subacchi


LONDON – The recently announced “phase one” agreement between the United States and China has been touted as an important step toward a comprehensive deal that ends the trade war that has raged for over a year. But if you think that US President Donald Trump is ready to abandon his antagonistic China policy, think again. In fact, the Trump administration is already moving to launch another, closely related war with China, this time over financial flows.

In a highly integrated world economy, trade and finance are two sides of the same coin. Cross-border trade transactions depend on a well-functioning international payments system and a robust network of financial institutions that are willing and able to issue credit. This financial infrastructure has been built around the US dollar – the most liquid and exchangeable international currency.

The dollar’s position as the leading global reserve currency has long afforded the US what Valéry Giscard d’Estaing, then France’s finance minister, dubbed an “exorbitant privilege”: America can print money at negligible cost and use it to purchase goods and services globally. But, with the opening up of global capital markets, the US has also gained exorbitant leverage over the rest of the world.

Today, some 80% of global trade is invoiced and settled in dollars, and most international transactions are ultimately cleared through the US financial system. About 16 million payment orders transit daily through the Euro-American Society for Worldwide Interbank Financial Telecommunication (SWIFT) network.

Thus, US restrictions on capital flows have more far-reaching effects than any trade tariff. And yet imposing them requires only invoking the 1977 International Emergency Economic Powers Act (IEEPA), which allows the US president to declare a national emergency and deploy a range of economic tools to respond to unusual or extraordinary threats.

The IEEPA has formed the legal basis for many US sanctions programs, with presidents using it largely to block transactions and freeze assets. For example, in the 1980s, President Ronald Reagan issued an executive order under the IEEPA blocking all payments to Panama after a coup brought Manuel Noriega to power. (Funds intended for Panama were diverted to an escrow account established at the Federal Reserve Bank of New York.)

Trump – who has proved more than willing to cry “emergency” when it suits him – has cited the IEEPA many times, including to justify tariffs on imports from Mexico and to assert his authority to demand that US companies “immediately start looking for an alternative to China.” Hoping to drive Venezuelan President Nicolás Maduro from office, he used the IEEPA to freeze the assets of state-owned oil company PDVSA. 
Trump has also forbidden US investors from purchasing any debt owned by Venezuela’s government or trading in shares of any entity in which it holds a controlling stake. Meanwhile, Trump has given Juan Guaidó, the US-backed interim president, access to Venezuelan government assets held at the Fed since his predecessor, Barack Obama, froze them in 2015.

Contrary to popular belief, Trump has not imposed more sanctions than his forebears. But he has devised particularly creative ways – often taking advantage of America’s disproportionate financial leverage – to ensure that his administration’s measures impose maximum damage, regardless of the effects on third parties. Likewise, Russia faces not only standard asset freezes and transaction blocks, but also limits on access to the US banking system and exclusion from procurement contracts.

China, which is already struggling with declining exports, sluggish investment, weak consumption, and a growth slowdown, apparently is next. The Trump administration is reportedly considering restrictions on US portfolio flows into China, including a ban on US pension funds from investing in Chinese capital markets, delisting Chinese firms from US stock exchanges, and limiting their access to stock indexes managed by US firms.

How such policies would be implemented remains unclear; it would be no easy feat. But lacking a well-defined strategy has never stopped Trump before, especially when it comes to using economic levers to advance geopolitical objectives.

This approach may work in the short term, but it is sure to catch up to the US. Trump’s repeated weaponization of the dollar undermines trust among holders of dollar-backed and US-verified assets. How many foreign companies will be willing to list on a US stock exchange knowing that they may be delisted at will? And how many non-US residents will keep their assets in US banks if any geopolitical skirmish can result in a freeze?

As mistrust of the US mounts, the drive for international monetary reform, which China has been advocating for the last decade, will gain momentum. This could mean expanding the international role of other currencies, such as the euro or, if China has its way, the renminbi. It could also lead to the creation of an alternate monetary system, centered on the needs of developing countries, especially oil and commodities exporters.

By broadening the nexus between economic interest and national security, Trump is encouraging the decoupling of the world’s two largest economies and the emergence of a bipolar world order led by rival hegemons. Beyond fragmenting the trade and financial system that has underpinned the global economy for decades, the stage would be set for a devastating conflict.
Paola Subacchi, Professor of International Economics at the University of London’s Queen Mary Global Policy Institute, is the author of The People’s Money: How China is Building a Global Currency.

Financial Markets To Federal Reserve: Is That All You’ve Got??

So the Fed, as expected, cuts interest rates again. And – also again – Fed Chair Powell implies that he’s done cutting for a while.

The financial markets – also once again – react like junkies contemplating their final hit.

Stocks are falling…

S&P 500 monetary delusion

…and Treasury yields are plunging, which is to say Treasury bond prices are rising as everyone goes “risk off”:

10 year Treasury monetary delusion

Which brings us back to the perennial question of how bad the withdrawal has to get before the Fed caves. This is monotonous, but also a nice, tradable pattern, one that seems obvious to everyone but the main players.

Consider the delusions now driving monetary policy:

• Fed governors appear to think they can stop cutting interest rates if they want, when in fact they can’t, ever. Rates must continue falling to make the debts taken on at past higher rates manageable. Put another way, in a financial system this overleveraged, there can be no “neutral” interest rate. Every rate is catastrophically high in the face of a mountain of bad debt and has therefore to be replaced by ever-lower rates to delay the eventual/inevitable deflationary Depression.

• Wall Street traders seem to think that easy money is a good thing for asset prices no matter how bubbly the assets’ valuation. This explains the near-universal bullishness among money managers, as evidenced by their willingness to be long at current prices. Their delusion is not so much wrong as one-sided. At cyclical extremes (like now), what easy money produces is volatility. So yes, asset prices can rise during the manic phase of the process, but they plunge commensurately when the market’s mood shifts and hot money stampedes for the exits. That day is coming.

• Trump appears to believe that bullying the Fed into negative interest rates “like the rest of the world” will produce an outcome different from the stagnation/chaos of those other countries. But it won’t because interest rates are price signaling mechanisms that, via the “cost of capital,” tell entrepreneurs and businesses how and where to invest. Move rates below zero and borrowing itself becomes a cash flow positive endeavor, making productive investment beside the point. This explains the ongoing leveraged buyout of US public companies via share repurchases, as executives choose to make their money the easy way.

Viewed from a slightly different angle, by the time rates turn negative, all the available projects with positive returns on capital will have been financed (since money was available all the way down; if a project wasn’t financed when credit cost 2% or 1%, then by definition that project wasn’t worth much). So by the advent of negative rates, all that’s left to finance are bad projects that are only viable if the financing itself is profitable. That’s why Japan and Europe are stagnant despite all the free money.

• The Democrats, last but definitely not least since they might be in charge shortly, think massive new entitlement programs are feasible in an already hyper-leveraged economy. This is a big subject with a lot of moral angles, but here it’s enough to say that we’re broke, so big new entitlements will be swept away in the coming national bankruptcy in any event, making their implementation wasted effort.

Target-rich environment

The nice thing about mass financial delusion is that it offers a target rich environment for the non-delusional. So let’s make some lemonade by sketching out a trading strategy for the next round of official mistakes.

Month 1: While the Fed tries to ignore the junky markets writhing on the floor, short US stocks, with an emphasis on wildly-overvalued Big Tech. Put whatever funds are left into “risk-off” staples like bonds, cash and gold.

Month 2: As the realization begins to dawn that an equities bear market might break the global financial system, consensus shifts to not whether the Fed will cut again, but when. Ease out of your stock shorts and long bonds. Keep your gold. Because you should always keep your gold.
Month 3: When everyone has concluded that the next Fed meeting will see another, possibly big, cut along with at resumption of QE, shift back to “risk-on”. Dump your remaining bonds and stock shorts, and go long the stocks that made you all those short profits.

Month 4: Leave the party. Convert the past few months’ trading profits into real assets like farmland, energy stocks, a rental house, and gold – always more gold.

Then sit back and watch the delusions crumble.

US stock market highs baffle investors

Fed rate cuts and buybacks have provided support to equities

Richard Henderson and Jennifer Ablan in New York

A trader at the New York Stock Exchange in August
Persistent stock buybacks have supported prices © AFP

As Jared Woodard, a Bank of America investment strategist, steps into the elevator at work each morning in Midtown Manhattan, he already knows what investors will call to ask.

Why has the US stock market hit record highs while investor confidence, reacting to a worsening economic outlook, has deteriorated?

“It’s the most frequently asked question we’ve had this year,” Mr Woodard said. “Investors we speak to are incredibly cautious. They see the market rally but they don’t trust it.”

US economic growth slowed in the third quarter as business investment continued to weaken, adding to concerns the global economy rests on a knife-edge. But the S&P 500 hit a record high this week, capping a 20 per cent rise this year. If this performance holds until the end of December, it would mark one of the best annual returns since the financial crisis.

Other market indicators seem more responsive to the economic picture. The closely monitored yield curve of US government debt inverted earlier this year, a haunting sign that has foreshadowed recessions over the past five decades, and a capital squeeze in the market for overnight bank lending has caught the Federal Reserve off-guard, forcing it to inject billions of dollars of liquidity.

Nervous investors have continued to rush to their favourite retreats, including cash and low-risk bonds, sending yields plummeting. This has swelled the universe of negatively yielding debt to $13.5tn. “It’s hard to think of a better measure of pessimism about global growth,” Mr Woodard said.

Set against the gloomy economic picture, the US stock market’s meteoric rise is “a fantastic dichotomy”, said Mr Woodard.

Chart showing S&P 500 hitting a record high this month

A series of rate cuts by the Fed — including a quarter percentage point cut on Wednesday, the third this year — and cautious optimism that the US and China will resolve the trade stand-off have pushed stocks higher.

The Fed’s decision to increase temporary liquidity injections to $120bn a day from the current $75bn have also added further support for stocks, said Nick Maroutsos, co-head of global bonds at asset manager Janus Henderson.

The stock market has a record of pricing in today what will happen to the economy in the near future. But given the weak growth outlook, this pattern is being called into question, said Alessio de Longis, a senior portfolio manager on the multi-asset investing team at fund manager Invesco. “There is a disconnect between where the market is going and where the economy is heading,” Mr de Longis said.

On this reading, investors should look instead to the bond market to understand why stocks continue to climb. The debt market, highly sensitive to bad news, has been raising red flags about slowing domestic and international growth as reflected in sliding yields.

Major central banks responded quickly to the deteriorating economic outlook with aggressive monetary policy action in the form of interest-rate cuts and bond-buying. This seems to have reassured investors. “We hit a bottom in global yields over the summer and since then they’ve moved up, suggesting the fears of a global recession have eased,” said Alicia Levine, chief market strategist for BNY Mellon Investment Management.

Yields on Japanese, German and Chinese government debt have inched higher since the summer, as investors have sold safe bonds in favour of riskier assets like equities. “Everyone was really negative and the most crowded trade was the safety trade,” she said. Analysts now think this trend is reversing.

Chart showing global bond returns are outpacing stocks

Corporate activity is another part of the puzzle. US corporate profits contracted in the first and second quarters of the year, sending them into an “earnings recession”, according to FactSet data. It expects this trend to continue into the third quarter.

Balancing that, stock buybacks — where a company repurchases its own shares — continue to provide support to the stock market. When companies buy their own stock, they reduce the total amount of shares on the market, inflating common metrics like earnings per share, which typically boosts the stock price.

Last year, companies in the S&P 500 spent a record $806bn buying back shares. Activity this year has slowed slightly, but remains on track to be one of the most active on record. In the third quarter alone, companies are expected to spend around $170bn on their own stock, according to data compiled by Howard Silverblatt, senior index analyst for S&P Dow Jones Indices. “Whether it’s good or bad, the market has gotten used to buybacks,” Mr Silverblatt said.

Apple, which consistently ranks among the most active companies to buy its own stock, spent almost $18bn on buybacks in the third quarter, in line with prior quarters.

Persistent stock buybacks combined with the upbeat tone on trade negotiations between the US and China and historically low rates in the US are likely to keep stocks elevated, said BofA’s Mr Woodard.

Investors who have sat on the sidelines will begin to grow anxious that stocks will just keep rising, he added. “When the market reaches new highs there is a ‘fear of missing out’ trade,” he said. Fresh all-time highs would suggest that this “FOMO trade” is in effect.

China’s Crackdown on Risky Deposits Ignores Structural Problem

Authorities are cracking down on structured deposits, but they are ignoring the reasons they are so appealing to banks and customers

By Jacky Wong

A twist on traditional bank deposits has become wildly popular in China. Authorities are reining it in, once again treating the financial system’s symptoms without addressing the disease.

The country’s banking regulator laid out tighter rules last Friday on regulating so-called structured deposits, which amounted to 10.8 trillion yuan ($1.5 trillion) as of September. Yields on such deposits are linked to the prices of other assets from foreign currencies to commodities so they could potentially offer higher returns than conventional deposits. The amount outstanding had doubled since the end of 2016, outpacing 27% growth in traditional deposits overall.

The new rules will make it harder for customers to put money into such deposits while creating more stringent criteria on who can offer them. Instead of considering them a type of bank deposit, the new regulations effectively treat them more like wealth-management products. The latter are wildly popular high-yield investment vehicles marketed by banks that often financed the riskiest projects but were seen by the public as carrying an implicit guarantee.

The use of such risky funds by banks to raise money has dropped as the government has tried to contain their risks in the past couple of years.

Smaller banks will be particularly hard hit by the latest crackdown. Two-thirds of structured deposits in China are with them—some 8.2% of deposits at China’s small and medium banks compared with 4.3% at large ones, according to data from China’s central bank. One reason for the disparity is that deposit rates in China are still under soft regulation so smaller banks struggle to attract customers for traditional deposits. Larger banks are perceived as being safer.

A bank employee counting 100-yuan notes in Nantong, China. New rules in China will make it harder for bank customers to put money into so-called structured deposits. Photo: -/Agence France-Presse/Getty Images

Regulators are right to have been concerned. Depositors theoretically take on the risk of fluctuating yields by making structured deposits, but some banks have essentially guaranteed a certain return to attract customers. This effectively makes them more like conventional deposits in disguise, circumventing limits on interest rates. Some of China’s central bank’s liquidity support also may have been diverted into structured deposits because borrowers can take out loans backed by them at lower rates.

While clearly open to abuse, China’s authorities are ignoring a straightforward reform that would make such products less appealing in the first place—liberalizing deposit rates. Banks could then compete for customers’ cash without such gimmicks and their attendant risks. That seems unlikely at the moment, though, because the indirect effect would be to choke off bank funding for state-owned zombie companies. They depend on cheap loans from large, state-owned banks made possible by regulated deposits.

Until then, regulators’ Whac-A-Mole game will continue.

The Jackson Hole Jolly For Central Bankers, And The Ramifications For Gold

by: Bob Kirtley

- The Jackson hole Meeting of Central Bankers has concluded and the volatility follows.

- The S&P 500 fell on the lack of financial stimuli.

- The US Dollar fell on the possibility of more interest rate cuts.

- Gold and the precious metals stocks jumped to higher ground as the Gold Bull gains traction.

Investors and speculators alike awaited with bated breath for the latest meeting of the central bankers to be concluded. Given a less than positive economic future the bankers are looking to more financial stimuli in an attempt to cushion the upcoming recession.
Some news outlets have reported that there is now $16 trillion worth of global negative interest rate debt. Who in their right minds invests their hard-earned cash in a dead certainty of a loser? A pension fund that is paying out at a rate of 5%-6% is reliant on an investment that has a negative return, how long can that go on, frankly its beyond me.
For the Danes there is a benefit in that there are now negative interest rate mortgages in Denmark. A Danish bank has launched the world’s first negative interest rate mortgage giving out loans to homeowners where the charge is minus 0.5% a year. Jyske Bank has begun offering borrowers a 10-year deal at -0.5%. Jyske said; “We don’t give you money directly in your hand, but every month your debt is reduced by more than the amount you pay,” said Jyske’s housing economist, Mikkel Høegh.
This is a ‘first’ in my lifetime and it is a far cry from the 1979 period when the base rate in the UK was around 18% with mortgages a few percentage points higher and we all struggled like crazy to maintain a roof over our heads.
These are truly unchartered waters and treacherous to navigate as we are all on this journey into the unknown.
A Brief Look At Some Of The Current Issues
In the US The Chairman of Federal Reserve has outlined his view of the economy and it wasn’t well received by the markets. The Fed tends to be ‘data driven’ and the likelihood is that they will consider rate cuts on a month by month basis, whereas the markets are looking for an aggressive implementation of rate cuts in order to keep the markets at record levels. The Federal Reserve also has pressure from the US President who is demanding a 100-basis point rate cut and “perhaps some quantitative easing as well” in a recent tweet.

The German government is also preparing fiscal stimulus measures to prop-up Europe’s largest economy. Germany’s economy is heading into recession and the country’s central bank has warned that a slump in exports during the summer had every chance of continuing. The bank noted a fall in exports and blamed Brexit and the trade war between China and the US as among the factors responsible for a 0.1% drop in GDP.
In Italy the Prime Minister Giuseppe Conte has resigned as tensions between the far-right League party and the leftist Five Star Movement have gotten out of hand. It is now up to Italy's president, Sergio Mattarella, to decide if there can be a newly formed government or, if not, its fresh elections. Another election means more uncertainty for the European Union as they will probably be held at the same time that Brexit is coming to a head.
Talking of Brexit, the UK is now under a deluge of ‘fear’ politics as the remainers try to halt the exit process. This is a real headache for Mark Carney, the Head of the Bank of England, as UK interest rates are already at record lows so there isn’t much wiggle room left in terms of fiscal stimulus.
In India, their automobile manufacturer Mahindra and Mahindra, recorded a 15% decline in its domestic sales for the month of July 2019 as new car sales dwindle worldwide. No doubt they would appreciate some relief regarding borrowing costs.
The central bank of China announced last Saturday that interest rate reforms were in the pipeline which should make borrowing costs more affordable.
The overall theme that we are seeing is that we are in for a period of even cheaper money and possibly more Quantitative Easing.
Jackson Hole has concluded with a vague statement of intent leaving the door open for the bankers to move at their own pace. However, the markets expected more and didn’t get it, so they fell around 2.5% as the chart of the S&P 500 shows.
It is clear that the central banks will ease monetary policy via interest rates and some form of financial stimuli, although the timing of such moves remains vague.

Quantitative Easing is another name for printing money which dilutes the buying power of the any currency making it less desirable to hold.
Interest rate cuts means that savers are taking it on the chin and making next to nothing by having money in the bank.
Banks carry risk and in most countries your savings are their assets in time of distress so your funds may not always be readily available to you.
It is rollover time for the S&P 500 as this long recovery period draws to a close.
Gold and silver were once derided as the precious metals because they do not pay interest, but they are now neck and neck with most currencies as they don’t pay interest either.
And when it starts costing us to deposit funds with a bank, we will get creative and do something else with our cash, hence this Bull Market begins.
I am not a perma-bull on anything, but as a speculator I am firmly of the belief that the gold is now in a bull market to be followed by silver. This bull will be spectacular with the metals outperforming all other sectors and the stocks delivering handsome profits.
We acquired physical gold and silver some time ago and have now placed 80% of our allocated funds for stocks and we continue to search for new opportunities in this field.
The options on some of these stocks will go ballistic when the time comes. This is a highly speculative process however we will be involved from time to time as and when our selection criteria is reached.

Go gently but rotate out of some of your assets and into this sector right now and hold on tight as it will be a roller coaster of a ride.