A new report was released today showing significant improvement in the labor market today. As you know, there were 6 people unemployed for every 1 job opening not too long ago, but that has changed. Now there are only 5.5 people for every 1 job opening, let the good times roll! While this is good news it is not at all very promising considering the government is hiring thousands upon thousands for the census.
Does anyone even ask themselves if the recent positive data is only indicative of a low quality unsustainable recovery? From my point of view that is all it is, a low quality unsustainable growth spurt. How a negative 36K job report last week was considered good is beyond me as most bulls predicted positive job growth now. What I found very interesting is the fact that all the pundits were blaming bad weather for a bad jobs report when there were no or limited snow storms when the survey was conducted. Furthermore, snow really does not cause a huge decline in payrolls, a statistically significant impact anyhow, but let’s not let the facts get in the way of a recovery story.
There have also been many large firms still forewarning of layoffs coming in the near future. While this may make for higher profit margins it is not good news for a country that is over 2 year into a recession, or whatever we want to call it now, and we are still losing jobs, albeit at a lower rate. Less bad is not good, but that is how the data is being spun which is ridiculous. It is not that I want the market to crash or that I want things to get worse, quite the opposite in fact, I just want an honest take on what is happening out there. Telling people that they have lying eyes is just crazy, but that is what everyone is doing.
This is true of the government data which has conveniently reduced the workforce in order to reduce the unemployment number. I just saw a report which shows that if you add in all the people the government takes out, because they are discouraged, the unemployment rate jumps to 11-11.5%, but even that is low. If we go by the U-6, which we should, as that is the equivalent of what we used during the 1930’s, the rate is sky high. We just came off of a low quality recovery from the 2000-2003 recession which spurred the current recession and clearly the further we kick the can the worse the problem becomes. Stop kicking the can and let people know how bad it is, stop the government intervention (we are now paying people to short sell their homes!) and let the bad debt get cleaned away by the system.
If we do this the problem may not just get kicked down the road, but it might get fixed. Of course, health care is now taking the spot light so who cares about jobs or what is happening in the real world. While I do not favor political intervention in the economy I want Congress to really pass a jobs bill, i.e. a comprehensive bill that provides employers tax cuts, what can I say, I am optimistic.
Regular readers know that I am or have become a bigger proponent of income investing lately and if you don’t know what I am talking about you should be reading my material more. However, there seems to be preconceived disconnect with my philosophy and what you believe to be true about interest rates moving forward. Some people see my bullishness on bonds in the face of rising interest rates as purely insane, especially given what treasuries are doing, but I can assure you it is not.
Keep in mind I am talking about investment grade corporate bonds and high yield bonds, my favorites are ‘BB’ and ‘BBB’ rate paper in an ETF format, I do not like mutual funds because of the once a day pricing. As an aside I do like selective sovereign debt as well, but don’t go out and buy Eastern European government debt or anything, be selective as the risk return is there, but supply is going to be an issue moving forward so it will pay to be extremely selective in 2010. Anyhow, back to corporate debt and why I like it.
Treasuries are entering a bear market for the first time in my memory and I expect there to be a bear market until the next crisis hits, so for only a few months. The reason there is a bear market is simple, supply, end of story. You cannot issue an endless amount of paper and expect the market to eagerly accept it without paying more for it because people, foreign central banks in this case, know they will never fully be repaid for the US debt they buy now, it is mathematically impossible for the US to repay its debt so don’t shoot the messenger hate the calculator. Because of that mathematical probability interest rates on treasuries are going higher and, according to those wonderfully bullish, and misguided, government data figures investors are pricing in interest rate hikes which kill treasuries and other high grade corporate debt, high grade being the operative word, so remember that please.
High grade corporate debt is technically, and in my opinion, anything rated higher than ‘A’ and issues interest rates slightly above treasury yields. We are talking about your really safe corporate paper issued by IBM and similar firms. Essentially, those are a riskless investment which is why your yield is so close to treasuries and why those bonds will get crushed when/if interest rates go higher. For those who do not understand how bonds work think of bonds and interest rates like a teeter-totter with interest rates on one side and bond prices on the other side, when one goes up the other side goes down. Therefore rising interest rates are bad for bonds because new bond issues will have higher yields so your existing bond will have less appeal in the marketplace and if rates go down new issue bonds will have lower rates which means your existing bond will be more attractive because it has a higher interest rate. Make sense, good.
All of that is important because we are at zero interest, technically we are in the negative interest rate area because of quantitative easing and deflation which is bond friendly. However, this red hot economy we are in, sarcasm is my trademark, many people are expecting an interest rate hike to happen at some time this year and they are right. The Fed will raise interest rates in 2010 from 0-.25% to .25-.50%, wow. There is an outside chance that rates may go to 1% by the end of the year, but that is pure speculation right now because the economic data or ‘recovery’ is spotty at best. Even if rates go up it is relatively meaningless to lower grade corporate bonds because it does not hurt the spread as badly as it does for higher grade corporate bonds.
What I mean is newer higher grade corporate debt and treasury debt will have higher yields than current issues so existing paper will get slammed. However, existing lower quality corporate paper will do OK as we would need rates to go up substantially in order to really hurt the spread. I am not saying that there is no risk in lower quality corporate debt, defaults will be a huge issue moving forward, but I am also betting that the Fed’s liquidity programs end up not going away either. In fact, I would speculate that the Fed’s balance sheet will continue to expand over the next 12 months, perhaps double again if the FASB gets its way and the SIV’s have to be added to banks balance sheets right away, but again that is speculation right now.
If the Fed does actually raise interest rates this would be a bullish signal to the markets because it means we have real growth in the economy as well. This means lower grade paper would perform better, even if that growth is only at lower levels. However, higher interest rates will not be good for stocks, in my opinion, which is why I shifted focus to lower quality corporate bonds and to companies like Alteria. I would not expect, even if the economy is cruising, to see rates go much higher than 1-1.5% though because the Fed is stuck and it cannot move rates higher or to a meaningful level ever again. Regardless, corporate bonds of ‘BBB’ or ‘BB’ and selective ‘junk’ should do OK moving forward in the face of higher interest rates because of what I said previously. We will not see huge returns like that of 2009, but I think they will do better than stocks moving forward, plus you are first in line when the company folds, something to think about.
Why the Fed is stuck
What do I mean by that, a meaningful level? You see, the US is in a debt trap that we cannot escape from, it is simple mathematics. The Fed will not be raising rates to protect the dollar, they want a weak dollar that is for another post, they do not really care about inflation as they really want massive inflation but we cannot create it. The Fed will raise interest rates to keep politicians off of its back and that is about it, but raising rates higher than 1.5% presents problems that the US cannot handle.
Congress just had to raise the debt ceiling by a few hundred billion to fund the government for the next 6-8 weeks, unbelievable, and a more ‘permanent’ fix of raising the debt ceiling to about $14T will be coming soon.
I know this is no big deal to liberal democrats because, after all, under Bush we had to raise the debt ceiling 7 times and to them 8 or 9 wrongs make a right, but this is a major, major problem. Considering that raising the debt ceiling to $14T moves the total US debt to just about 100% of GDP marks a new low for the US and is the greatest amount of debt any country has ever attempted. What I am saying is that our current debt servicing costs with the Fed holding rates at 0% and using QE is about $500B+ a year and our average maturity of our debt is less than 10 years, again this is a first in all of the world’s history.
If the Fed moves rates up past 1.5% then that debt servicing cost will go up, dramatically, and there will be major consequences that the American people are not ready to face. Forget the debt ceiling, we will repeal that silly little rule, especially since we have to raise it almost every year anyhow. Within 7 years out debt servicing costs will begin to take its toll on the national budget squeezing out typically paid for items, like earmarks. Defense spending will have to decline immensely which is why the US remains a superpower even though we have a relatively small manned military compared to say a China, India or North Korea. The dollar will decline much further, it will anyhow as the latest rally, which I anticipated, is a head fake and was driven by Dubai, Greece, Fear, short covering and the selling will comeback harder and faster than you could ever imagine.
All of the senseless spending is coming home to roost, now. China is telling us where to stick it as there is not enough dollars to buy our debt, which is kind of funny in a sick way, and they said no to strengthening their Yuan which makes sense for them and smells of protectionism to me. When we demand a foreign country make their products more expensive in the US just so we can shrink out trade deficit thereby boosting our GDP and sell more products to them that is protectionism, straight up. I do not like to be so grime, but many of the things I foresaw and have been keeping to myself are coming out in the open. Things are not good, but hey as long as the market keeps going up, who cares right? Well, you will when it comes crashing down around you. Fixed income never looked so attractive right now.
Watch out Gold was down $56 today! Of course there was talk of bubbles bursting, the trade is crowded, etc., which is all true, kind of. Gold definitely got ahead of itself, I do not deny that in the least, but it is not a bubble. I have been saying it will correct for some time now and have been wrong. Frankly, I hope it goes lower, a lot lower.
Why, would I want one of my larger holdings to go lower? Simple, I hate the negative talk on CNBC all the time and the constant pump and dump they do. Every time it breaks out I have to hear about how it is a bubble or it is a nominal high, not an inflation adjusted high, and that gold bugs are “creepy.” It is rather annoying because to me gold is at an all-time high since I did not buy it in 1980 and I own it a heck of a lot lower than where it trades now. Whether or not I am creepy is a question I will not answer since I am biased on the answer, but my wife says I am not.
Gold is not a bubble, in my opinion, based on supply and demand, but even more importantly if we look at the monetary base it looks way undervalued. However, it got way ahead of itself over the past couple of weeks, there is no question about that given its parabolic rise. Like all assets that go straight up it must consolidate or correct to shake out the speculators. Given the leverage it takes to play with the yellow metal in the futures market I am hoping a few days of heavy losses will kill many of the speculators, but only time will tell.
When the speculators are gone there will only be the serious buyers left, which is good news. Since the serious buyers right now are China, Russia, India, Iraq, other central banks and, I guess, me there are only long-term holders in the market moving forward. Given that Helicopter Ben will only increase the monetary base and the US will have some $4-5T in debt to issue next year I do not see the Fed’s balance sheet shrinking anytime soon. I also do not see the Fed raising interest rates as debt service currently consumes 3% of GDP right now and a 1% increase would be, well, not good. Within 10 years if interest rates get back to normal than our debt service costs will be so large that it will consumer our entire national budget.
Therefore, the Fed has one choice, other than, stop laughing now, forcing Congress to cut spending, fire government workers and balance the budget, devalue the currency. That is very bullish for gold and the primary reason I am buying the metal. Other precious metals will also do very well for the above stated reasons, but they also have other supply, demand and scarcity reasons for owning them. That is why I am diversified between all metals, not just gold, as each metal has a specific role depending on what the economy is doing or how the geopolitical arena plays out.
In the meantime, this bug is rooting for gold to come down so he does not have to hear about it on CNBC. Hopefully, without all the YV attention, interest in the yellow metal will fade and the real investors can regain control. Unfortunately, that will probably not happen. As we saw with oil, once speculators run with a commodity it is tough to get them out until it totally crashes and burns which is what I do not want to see happen.
The internet is riddled with rumors of the imminent collapse of the US dollar with time frames ranging from hours to months away. Now, there are legitimate concerns over the value of our currency and clearly the only thing that has buoyed its value is the entire globe has printed money on a colossal scale. However, we have certainly done more than most when it comes to printing currency with our super bailouts and mammoth stimulus projects.
The question is when will the dollar collapse? There is no real answer to this question and that is the beauty of free market capitalism. The one thing I can say is this, on the short-term I am probably more bullish than I am bearish on the US dollar simply because everyone and their grandmother is short the USD and if/when US equities head south people will run to the dollar for safety. Proof of this was last year when the markets crashed and we saw the DXY climb to the high 80’s. However, I don’t think we will see that type of rally again if we see the markets tank this time around because the fundamentals are far worse than they were last year and the dollar is far more diluted.
On a longer term basis I am very bearish on the dollar and I believe when we see the Chinese Yuan or RMB float or if we see the IMF SDR issued in greater quantities we could see the US dollar lose its reserve currency status. Those who think that this cannot happen need to learn their history as it happened to the British and many other nations in the past and the US is no different. Given our debt load and the current administration’s willingness to spend money like it’s going out of style, on top of our staggering existing liabilities, we are in serious trouble. Not only has that, but the rebalancing of central banks as of right now proved that they are not comfortable holding vast quantities of US dollars.
The question that remains is whether there will be an orderly or disorderly exit out of the dollar. This is a tough question for anyone to answer and there are a ton of variables to calculate in. For example, we have 2 wars that could escalate and possibly a third with, pick your axis of evil country, we could have another trillion dollar stimulus package, heath care reform could get passed and it could end up adding a trillion a year to the deficit, programmed trading could cause a precipitous drop in the currency and the list goes on. At this point in time I would say it is 51 to 49% in favor of a disorderly drop in the currency versus an orderly drop in the currency. Mainly because Ben thinks he can actually control the devaluation process, which no government in history has ever been able to do.
There is no doubt that this is a scary topic and that we should al be concerned about this issue on a longer term basis. Do I think we need to worry about this happening this month or year? No. However, this could happen within a 12 month period of time very easily, but again, I think it is unlikely. We know that the name of the game is supposed to be a slow devaluation of the currency, but, as I just said, no country has ever been able to actually control the devaluation process and with computerized trading this is more dangerous than ever. A few things need to happen before we see a total failure of the currency and as of right now these events are not happening.
For example, I often talk about the treasury bubble of the late 1970’s when the US suffered from inflation and dollar devaluation. There was a buying spree and a bubble in long-term treasuries and when Volker became the Fed Chairman he was charged with stomping out inflation. He did not know there was a bubble and let the market raise rates for him, which was odd, but it worked. Unfortunately, it basically almost put out of business most of the primary government bond dealers and led to credit controls. What it did was save the currency and stopped inflation cold, along with economic growth.
Many people familiar with that story seem to think we are close to that scenario today, effectively failed treasury auctions, which is not true. We have a long way to go and many more steps to go before that happens, but those steps could come fast and furious. Unlike the late 1970’s the dollar is falling a lot faster now than it did then, but the buying in the treasury market is a lot more fierce now and on the shorter end of the yield curve, unlike then when we saw it on the longer end of the curve. So, we will see what happens, but things move so fast in today’s market anything is possible and this boom bust economy cyclical period is getting shorter and much more severe. The signs are coming for a currency crisis, but not in the immediate future.
According to the group’s voodoo economics, or survey data, 80% of their group declares that the economy is growing again. However, I beg to differ since whenever the majority of economists agree on anything they are typically wrong. Case and point, 2002 and several other times all throughout history, not to mention that the vast majority of economists CNBC and the major media outlets parade have this recession confused with the typical inventory recession, which this is not. This is a credit collapse recession, not the typical recession that we have experienced most times all throughout our history.
In fact, the closest example I can draw upon for a correlation to what we are going through is the Great Depression. During other recessionary periods we have not suffered the same symptoms that we have today and anyone who claims we have is simply not looking at the facts. During the 2000-2003 recession did credit collapse along with major banks and investment banks? No. How about in the early 1990’s? Kind of, but that was limited to smaller, much smaller savings and loans and we still did not see the sheer size of institutions fail like we have over the past 2 years. In fact, the credit contraction is astounding if we examine this period to the early 1990’s and nullifies any real comparison.
Other than that period we literally have to go back to the 19030’s for anything close to what have seen in the markets or the banking industry. It was/is that severe and the global impact that profound. It is also vastly different from the consumer prospective because the consumer is so leveraged compared to the 1930’s, now we have credit cards, mortgages of all flavors and consumer debt like we have never seen. Back in the 1930’s consumer debt was limited to the wealthy or upper middle class, mortgages were much different than they are today and HELOC or home equity loans were basically non-existent back then. All of these newer things makes today’s problems actually much worse than the problems of 80 years ago. Not to mention the derivative dangers, according to some experts these products basically guarantees the worlds GDP almost twice over.
How these experts, and I use that term loosely, determine that the recession is over with consumer credit contracting at a record pace, home prices contracting, government stimulus supporting GDP, banks still on the government life support system, the suspension of mark-to-market still hiding major losses and a host of other painfully obvious items indicating there is much more pain to come is beyond me. We know that the market has gone nowhere in real returns when we look at it priced in gold or subtract the dollars losses from the S&P’s return’s, but then again the market is not the economy and should never be confused with the economy.
I think that is the disconnect that economists have as they view the market as the indicator of recovery. If the market is the great forecaster that everyone thinks it is and truly looks 6 to 9 months out then why in 2007 did it hit all-time highs? In fact, stocks are horrible indicators of the economy and history is on my side on this one. See 2002 when the ISM gave a false impression of a recovery and stocks rallied only to hit new lows a few months later, the same thing happened several times throughout history. Before the 87 crash, during the 73-74 decline, in the 1930’s there were spectacular rallies. The Nikkei has had 420,000 total point rallies during the 1990’s, the so-called “lost decade”, some of which we 60% plus rallies. Many of these events were correlated with economic recoveries when, in fact, they were technical events and had nothing to do with economics.
Rising stock markets are not always a measure of economic stability or recovery. In many cases it is simply technical’s or, in our case, HAL9000 buying, since volume is at an all-time low and fund flows suggest it is not the retail investor. This is a traders market and only a fool would buy to own this market. I am not even sure I would rent this market since we had weak volume today and the market could not even hold a 60 point rally with the second string traders in today. The economic data is weak, bank earnings are probably going to be mixed and we know commercial real estate is collapsing, $22B in defaults in August of 09 versus $3B in August of 08 come on that’s a problem.
I may have missed a few points, 60 on the S&P to be exact, but I have done OK this year. Not to mention I bought silver at $9, gold at $880, platinum at $900, and palladium at $225. I don’t do everything right, but I realized I could not fight the liquidity bubble and I do know that this same liquidity bubble will implode eventually taking the US dollar along with it.
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