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Why the Trump Rally?
At around 1AM EST on election night the Dow Jones futures were down 900 points, due entirely from the Trump election victory that so few really thought was possible.
But then something really strange happened…… the market closed up sharply the following day on November 9th and since then has continued to rally an astonishing 1600 points since that Wednesday following the election. So in effect the Dow Jones average has rallied some 2500 points since that 1AM plunge in the futures. But why?
It’s the same reason the market has rallied so much since 2009 — a telegraphed debt explosion. Instead of tanking as expected on the uncertainty all agree comes with a Trump presidency, the market chose to repeat the same pattern since the March 2009 spike, when debt explosion is clearly telegraphed. For most of the rally since 2009, it was QE and interest rates at zero by the Federal Reserve that sparked the Dow Jones, S&P and Nasdaq to new all-time highs. But this recent and remarkable rally it was the perception of government fiscal stimulus that carried the day. Sprinkle in the favorable seasonality, and nearly all fund managers offsides chasing performance into year end — and you get a massive 2500 point rally in just a few weeks.
Dare to argue with this notion that debt explosion, not profits, goose the market? Then just look at a chart of the S&P since 2009 overlaid with a chart of the expansion of the Federal Reserve’s balance sheet. Charts don’t lie, and these two correlate almost perfectly until 2015 when QE combined with negative interest rates from Europe, Japan and China hit full throttle to more than overcome stall speed from our monetary policy.
This also explains how the S&P managed to make new highs this year, despite having five consecutive quarters of declining profits and an economy that can’t exceed 2% growth for the past eight years. The end result is a market trading at a very high historic PE multiple that far exceeds growth in profits and revenues. And let’s remember that profit growth is even more pathetic when you account for the trillions in stock buybacks from companies in the S&P 500 over the past several years. As I mentioned in my last post, those stock buybacks have exceeded all profits in the S&P 500 since 2009.
When looking at the largess of the currently stretched PE multiples, just look at the Russell 2000 index. I tried to find on the Internet a table that measured this PE multiple, but each search resulted in Not Available. Why? Because the true number would leave you speechless. Fortunately, our good friends at ZeroHedge.com recently posted a well-organized piece measuring this index and it was calculated at an eye-popping 273 times earnings, a level so high it’s actually hard to comprehend.
The reason it is so sky-high is that many of the companies in this index are losing money, not making profits. Another reason for this PE escalation is that so many fund managers have become too lazy to engage in single stock analysis and instead just buy the entire basket of 2000 stocks through index funds. Since 2009 the Russell 2000 has far outperformed the S&P 500 despite being comprised of the smallest and riskiest stocks. So the Russell 200 now trades at 273 times earnings while the much safer large profit blue chips trade around a 20 PE multiple. Of course it should be the other way around, but irrational exuberance can last for extended periods, much like the internetstocks at the turn of the century. But we all know how it ends.
I am very disappointed that the debt explosion in recent years nor the Federal Reserve were ever mentioned in the long and grueling Presidential campaign over the past two years. Voters vented their frustration over immigration, Obamacare, and other issues but not a peep about our country’s ballooning debt levels. It reminds me very much of the conditions brewing in 2007 just before the housing crisis took hold. Back then the laughable and ridiculous NINJA loans were known to most and thus hid in plain sight and amazingly investors and even the largest and most savvy Wall Street firms seemed dumbfounded when it crashed so suddenly. Weren’t home prices to rise forever?
Expect the same to occur in the coming years when the Kondratieff Winter really takes hold. Just like the housing crisis, it seems absurd just before it seems self evident and it also now hides in plain sight. History does repeat and people do forget its lessons. Since 2009 this evolving Kondratieff Winter has lived up to it’s billing on economic growth with sub 2% growth since 2008 despite tens of trillions in fiscal deficits and monetary stimulus.
No one would have believed this in 2008. But unlike all the past K-Winters, the stock and bond markets have rallied as a direct result of the outsized interference of global monetary policy since the financial crisis. I expect this condition to reverse soon as interest rates and inflation continue to rise as they have in 2016 and finally damage stock and bond prices. No telling when — it will happen when it happens.
When looking at the big picture of global stocks and bonds consider this: Bloomberg reported today that the value of all US stocks rose 9% in 2017 to $25.3 trillion. This amount, the highest ever, is still less than the total debt of the US with the current deficit over $20 trillion and the Fed’s balance sheet well over $5 trillion. This would mark the first time ever that total federal debt exceeded stocks. This is because their debt levels are far exceeding stocks gains and this deficit will continue for many, many years and it is likely stocks will not exceed debt in our lifetimes.
The election of 2016 echoed the wave of populism now sweeping the globe as voters everywhere are expressing their outrage over globalism that has lead to many job cuts as corporations export labor where it is cheapest. Very sadly there has not been a single politician anywhere on Earth who dares to defend globalism when they see jobs lost in their district or state.
But they should. There are so many benefits of globalism that are not being touted. By lowering the cost of capital globalism leads to lower prices for everyone on many goods (see Walmart) and creates scale to our benefit. It also decreases poverty in many nations by creating new middle classes in countries like China and India totaling in the billions of people that can now buy our products (see Apple Computer) and contribute to global GDP growth. Such growth has also contributed to the vast increase in corporation profits since the early 1990’s, which has contributed to increased wealth fro stocks for so many Americans not withstanding the monetary largess we mentioned.
Americans in all states should encourage globalism because it allocates labor in a far more efficient way and allows capital to chase its highest utility. Kondratieff Wave theory has much to say on this matter. As the winter season changes into Spring, a vast array of new technologies takes hold to create a whole new paradigm through the “creative destruction” process championed by Joseph Schumpeter. (See more in our tab on the homepage.) And who cares if all the horse and buggy jobs are gone?
It is inherent in long wave economic cycles that new and more efficient paradigms are created, especially at the beginning of the Spring cycle phase. Debt is purged and new technologies lift all boats higher. As I have said in previous posts we are now having the first ever overlap where the Spring and Winter cycle phases are underway at the same time. The historic debt levels associated with Winter phase and the transforming technologies of Spring that include the internet cloud, oil and natural gas fracking, smartphones, nanotechnology, etc. now coexist as strange bedfellows. The challenge for our leaders now is to articulate this to the voters and propose legislation to fund job training in these new industries that have displaced workers fired from old paradigm industries.
But our politicians seem ignorant of these benefits and instead choose to take the path of least resistance- blaming corporations for lost jobs. I sure hope we don’t see any more interference with free markets from President elect Trump as he did with Carrier as there is already too much interference in the capital markets.The voting public at large cannot be expected to understand all of these complex dynamics of long wave cycles so I hope our politicians will brush up a bit on this. Oh, one more plus-the jobs coming from these new industries will also pay much more in wages than the old jobs too.
The Federal Reserve policies of ZIRP and trillions of QE stimulus are the root cause of inefficiency on a mass scale because under their policies capital cannot chase its highest utility. The ECB and the Bank of Japan’s monetary policies are far worse however. With such low macro economic growth companies have been reticent to reinvest their profits to expand their business so instead they buy back their stock. Thus the Federal Reserve actually destroys job creation in the private sector while robbing tens of millions of savers with tens of billions in interest just to blow the largest asset bubble in world history just a bit higher.
We are, sadly, left with trillions more in debt, and voters should voice their anger over that.
Consensus growing on global asset bubble
In Q3 we saw more of the same- ever slowing global growth combined with central bank measures that seem more desperate than ever before. In fact the WSJ just reported that global growth has slowed from 5.4% in 2011 to around 3% this year. Of course more than half of that growth coming from bloated GDP figures from China that can’t be seen as credible. This means that global growth is more like sub 3% and even our own US growth has been sub 2% for many years.
These figures are amazing when you consider that global interest rates are zero to negative around the world combined with tens of trillions in central bank stimulus since 2008. This stimulus provided by central banks combined with multi-trillion dollar global fiscal deficits is so large the average person cannot completely appreciate it’s true scale and yet despite this enormous tailwind global growth is not only awful but has been declining each of the past five years. Good thing for central bankers that they are not elected by the public for if they were they would have been fired long ago.
Instead these modern day money changers insist on doubling down on failed policies because that is the only path they know. They remain thoroughly ignorant and clueless about the Kondratieff Wave theory of long wave economic cycles and as a result there is no monetary or fiscal restraint to be seen anywhere. Such preposterous ignorance remains the primary purpose for this website as we want as many people as possible to know about the naturally recurring cycles of boom and bust that results in a prosperous creative destruction process that we should embrace. Sadly the top global government officials and central banks remain ignorant of this to the detriment of all of us. However the day soon that will change when the final stage of this Kondratieff Winter occurs. Only then will these notions pivot from far flung ideas now in denial to be self evident and obvious all along.
Why is global growth so pathetic despite the gigantic stimulus unleashed since 2008? Simple- we are in the very late, late stages of a credit cycle that began over 60 years ago that now sports almost $200 trillion in global debt, a level so staggering that no human alive can comprehend it’s scale, much like it is impossible to comprehend the distance from our Earth to Pluto. Last week the IMF sent its strongest warning ever that the bloated levels of debt threaten global growth and prosperity for years to come. That is the essence of KW theory- that growth is hampered in the very late stages of a long wave credit cycle because the severe debt overhang serves as an albatross that cannot permit substantial growth and prosperity. And of course that is precisely what we see all over the world. And yet the Kondratieff Wave theory continues to flourish and hide in plain sight, only to be exposed to most after a severe crash in global paper assets such as stocks and bonds. Never mind the all-time highs in both stocks and bonds- K-Wave theory is flexing its muscles now like never before.
One day soon I promise K-Wave theory will be embraced as the public backlash of the ruling elites intensifies. We are already seeing a global revolution of sorts with populism raging all over the world in a revolt against the trend of globalism over the past three decades. Events such as the so called Brexit vote in late June are becoming the norm and we can expect more of that for sure in the coming years. As I have described at length in previous posts we are now experiencing so many of the same conditions of the last K Winter in the 1930’s such as rising nationalism, global trade wars and the like.
The only difference I see between this decade beginning in 2008 and the 1930’s is that modern day central banks are determined to elevate paper assets to unsustainable levels and try to be super heroes with all their extravegent and over the top policy measures determines to print our way to prosperity. But no can do as the natural forces of a late stage economic winter with hundreds of trillions in debt are just too much to overcome. Here’s a secret few realize- global central banks pray at night for the only thing that can save them- hyper-inflation. Yet despite all their printing for the past eight years they cannot even attain their paltry 2% target levels. This just underscores how futile this approach has been and how one day the shame of this approach will be laid bare for all to see.
Given that such low growth rates have endured for over eight years corporations, along with global central banks, have been forced to turn to draconian measures to keep their stock prices elevated. Chief among these are stock buybacks and to a lesser degree increases in dividend payouts. Just last month the WSJ reported that the total sum of corporate buybacks since 2008 had exceeded profits for the same period, a fact that is truly astonishing. These buybacks are very telling because they reflect management’s conclusion that their excess capital is better deployed buying their stock because the opportunities for reinvestment in their businesses are so poor. Such a mega-trend does not bode well for corporate profits in the coming years but who cares? Management prefers boosting their share price in the short term through financial engineering over the more classic reinvestment that was a hallmark of US corporations for so long.
Central banks have also followed suit in their ongoing desperation to keep stock and bond prices elevated. Through their bold yet questionable actions we have seen bond prices go up since 1982 (save a brief period in 1994) and stocks as well despite a few short periods in 1987 and 2008-2009. They have deployed every conceivable measure, even negative interest rates, with enormous scale to overcome the naturally recurring economic winter but have failed miserably to generate any meaningful growth. But the forces associated with a late stage Kondratieff Winter have thwarted their plans to generate economic growth or the inflation they so desperately want so they can repay the tens os billions in debt notes they hold with a more depreciated currency in the future. But their own financial engineering will prove to be futile when the sovereign debt bubble, the biggest one in world history, bursts one day in spectacular fashion.
Let’s now pivot to the biggest threat near term to the house of cards built by central banks- the looming fate of Deutsche Bank. DB is the absolute poster child for too big to fail banks given their actions since the financial crisis of 2008. DB today can be seen as a bankrupt entity enduring a perfect storm of challenges. They have far more non performing loans than their books would suggest and their profitability is hampered by Europe’s sub par growth that is among the worst in the world, even more so than US banks they are handicapped by the ECB’s horrific policy of negative rates. Thus, their Tier 1 capital levels are dwindling and last week it was reported that several prime brokerage firms pulled their money out of DB in a classic run on the bank.
They were also hit with a proposed $14 billion fine by our DOJ and even though the final settlement is likely to be lower no one can doubt they are in peril from a capital crunch. Add in their exposure to some $3-400 trillion dollars in notional derivates and you have on hell of a powder keg brewing here. A bailout by the German Bundesbank or the ECB is I believe a certainty, the only question is when. I suspect there is a decent chance that all their shareholders could be wiped out but I am more sure they just wont allow Europe’s largest bank to fail. But look to news on the perils of DB to be a barometer of global stock levels in the coming months as even a bailout will shake global investors to their core. Let’s all hope a DB debacle won’t spread into another global financial crisis. Since 2009 global central bank policies combined with several brilliant innovations have forestalled any stock market crash and have enabled the major averages to hit new all-time highs. But I suspect these gains cannot be maintained even in the intermediate term given the outsized levels of debt among sovereign nations and corporations who have borrowed trillions in recent years to finance their outrageous stock buybacks.
Even more daunting is the fact that nearly all the gains in the major averages over the past few years have come from Amazon, Google, Apple, and Facebook because this tiny pack of brilliant innovators are the only firms showing real sustainable growth. Such a lack of breadth in gains is a hallmark of market tops and we could be near one now but it is senseless for anyone to call a market top here as long as the absurd measures that have been noted above persist. The collapse of these paper stock and bond prices will crash under the pressures of the KW when they the weight of the levitation is just too much to bear. We don’t know when but we do know it will.
Brexit vote signals new era
Mark Thursday June 23rd as a key date in the Kondratieff Winter cycle phase that began in March of 2000. This underscores yet another wave of protectionism that is a hallmark feature of late stage economic winters. We have advanced this theme more and more in recent months by pointing out that the currency wars seen over the past few years have closely resembled the trade wars of the 1930’s. Now the theme of every man, or country, for himself just intensified even more as the UK voters chose to reject the onerous terms being imposed upon them by an EU that had strayed from its original purpose.
Such draconian actions are the result of countless policy missteps by central banks and governments all over the world who have been more concerned with keeping paper asset prices elevated than achieving any meaningful reform. There are headlines each day pointing to new proposed trade barriers in Europe, Asia and in the US underscored by the bombastic rhetoric in recent weeks by Donald Trump. Even the Wall St.Journal took note of the parallels with a recent article titled How the 1930’s are Echoing in Today’s Politics. It underscores a core theme of the K-Wave theory that history repeats itself within each of the long wave cycle phases as the same cycle phase components are repeated over and over again.
The end result for all these protectionist measures is deflationary. Advocates of this brewing protectionist wave don’t realize that the impact of their collective actions hurt their own cause because the deflationary impact on the macro level severely outweighs any benefit gained on the micro level. History has proven that to be true time and again but protectionist advocates refuse to let the facts get in the way of a good rabble rousing claim.
Negative Rates all the buzz
For most of 2016 the debate and growing outrage over negative interest rates set by Japan and Europe and others have been all the rage. Former PIMCO chief Bill Gross recently proclaimed that capitalism can’t survive negative rates and he is right. Today there is over $10.4 trillion in global sovereign debt now in negative territory and this has caused serious dislocations in the allocation of capital that is sure to have a horrible ending. Last week Swiss 50-year bonds went negative, which just goes to show we are living in a capital markets fantasy land. Aside from denying savers and right to earn any interest the negative rates are causing mayhem for the world’s largest commercial banks, especially in Europe. Shares of Deutsche Bank are now trading lower than the nadir of the 2008 crisis and together with Credit Suisse and so many others it suggests a banking crisis in Europe is looming.
I look at Deutsche Bank as perhaps the single best “tell” on a global banking crisis because it’s balance sheet is loaded with billions in non-performing loans and it has exposure to trillions in derivatives meaning that any small spike higher in interest rates or other unexpected event could cause it to be insolvent quicker than anyone could believe. So many of the world’s large commercial banks, especially in China, have ever growing non-performing loans that aren’t properly accounted for. So in essence the entire global banking system is underpinned by fictitious figures, i.e. their books are cooked.
Yet global investors in paper assets such as stocks and bonds have been whistling past the graveyard, blissfully ignorant of these non-performing loans sure to default together with hundreds of trillions in aggregate global sovereign, corporate, municipal and individual debt that has more than doubled since the 2008 crisis. Yet the TINA theme- There Is No Alternative- keeps blowing the asset bubble bigger than ever. Just look at the insane PE multiples of the small cap index (mid 70’s) and the utilities (mid 30’s) as they are several standard deviations removed from their norms. Any reversion to their historical measures is sure to result in a market crash pure and simple.
Central banks finally see their limitations in this late stage winter Something notable occurred in this second quarter of 2016- our Federal Reserve and their global peers changed course in dramatic fashion. They did not signal plans to engage in hawkish policy measures but instead declined to make open ended promises of unlimited monetary QE and further push negative rates down to even more surreal levels. This development is monumental given these twin towers of monetary largess have become a hallmark in their policy actions since the 2007-8 financial crisis. For the first time since the crisis they all blinked.
And why not? We have advanced time after time for seven years here that their approach of trying to stimulate the economy with such outrageous, radical and monetary measures is utterly futile. The jury has been out for many years now on this catastrophic failure that has produced seven years of sub 2% growth and hundreds of trillions in new debt obligations that aren’t going away.
So let’s review the recent sudden policy shifts and try to glean their impact.
The first domino toppled in the May policy statement from Japan’s central bank chief Karouda who stunned everyone by announcing no additional QE or rate changes in his recent statement. Japan has been plunging into an economic abyss for over 20 years and had recently entered their fourth recession since the 1990’s. Every financial analyst still breathing had forecasted a further push deeper into negative rates and a new round of QE given the accelerated decline in their GDP since the downturn for most global markets that began last fall.
But finally they admitted the futility of their largess and stood pat, a courageous but tough move to make. Given Japan’s stature as the godfather of modern day QE this was a real shocker. But given that since they initiated their negative rate policy last year their stock market has declined almost 20% and their currency has appreciated to much higher levels it was the right move. Their policies were meant to cheapen their currency to promote growth and also to boost their market and the exact opposite occurred. That one-two punch was enough to finally shake some sense into them and they responded accordingly.
This unexpected outcome occurred because they are so deep and late in their own Kondratieff Winter as Japan is the most indebted country on Earth and thus they would naturally be the first country to see their policies backfire. This outcome is going to be seen over and over in the coming years in so many countries and all for the same reason- central bankers and most people still remain clueless about the existence of long wave economic cycles, i.e. the Kondratieff Wave Theory.
The second major reversal occurred in mid-June soon after the worst employment report in several years as Janet Yellen declared at the Federal Reserve meeting that the outlook for growth in the US and abroad would be so challenged that she telegraphed perhaps only one or a few rate hikes were on the table for the next several years and the Fed would not push for negative interest rates like her desperate European peers.While this outlook was seen as ultra dovish at the outset, some investors chose to focus on how pathetic and gloomy her forecast was and how much it reflected a real shift in policy. And while Mario Draghi did continue his claim to do “whatever it takes, and it will be enough” a new reality had set in- the sheer inventory of corporate bonds available was so low it was clear they would not be able to buy as much bonds as they had originally promised. No matter what the bulls may proclaim there are limitations to what global central banks can accomplish. We are without a doubt now in the late innings of their grand experiment that has failed so miserably.
In each case central banks failed to deliver what was expected because a new reality was setting in that promises of unlimited QE to eternity was indeed not plausible after all. Yet markets have for so long believed in central banks would act to backstop the markets in case a crisis was looming it is going to be very interesting to see their reaction when this new normal finally does set in to them. This new normal is a natural feature of any late stage economic winter where the real limitations of unlimited monetary fantasies are put in check by the sheer weight of the hundreds of trillions of debt that has amassed globally over this economic long wave cycle that has endured longer than any other due entirely by the collective efforts of global central banks so committed to overcome this naturally recurring boom-bust cycle with ever more debt issuance.
So where do markets go from here? They plunged worldwide after the initial shock last Friday but rebounded the following week I suppose because most of the damage will be done down the road. But we are still left with pathetically slow global growth, debt levels in the stratosphere, and slowing productivity that has resulted in five consecutive quarters of reduced corporate earnings and revenues yet the US market is within 1% of its all-time high. But most other stock markets are down on average between 12-15% from their recent highs which indicates we are in a topping pattern in the overall long wave pattern. US corps have for years been more determined to use stock buybacks and dividend increases to keep their stocks propped up but how long can that continue, even with low rates?
I believe we are closer than ever to peak highs in the US market as the confluence of all of these factors looms larger than ever before. All the central bankers, governments and investors have fought this long wave economic winter for a long time now but the forces we have advanced here are stronger than ever.
K-Winter End Game Marked by Surreal Conditions
No end in sight for negative interest rates, ever-expanding QE and more
Since our last posting in January, global stock markets have rallied sharply for all the wrong reasons. However of all the warped rallies the past few years, this one takes the cake. It began on February 11th when the US retail sales figures that exceeded expectations were released and investors reasoned that maybe things werenʼt so bad after all. As it turns out no they weren’t so bad- they were in fact more awful than knew. in fact the revisions for these came a month later and showed retails sales had actually plunged over 2% instead of rising over 1% as reported. Such a huge miss was ignored by the markets since then as most of the worst fears in mid February have abated- for now. How appropriate it is that the launch was born on news that tuned out to be as bogus as a four dollar bill.
Such are the times we are now living in where nothing seems to matter except central bank printing and promises of zero or negative interest rates for the rest of our lives. Yes, nothing is real in the world of economics because it is in fact surreal. Soon after the bogus retail sales numbers were released then the Bank of Japan committed monetary arson with through negative interest rates and the ECB announced a major ramp in their QE program by targeting corporate bonds, a first. Such draconian measures reflect their desperation to stem a deflationary wave now almost a decade old that shows no signs of abating anytime soon.
In mid-March the Federal Reserve moved the goal posts again for the umpteenth time by in a complete reversal from their previous meeting and walked back their stance of four rate hikes they proffered in December, proving again that the Fed and most other central banks are truly awful at economic forecasting.
Such lunacy already compounds their ever growing problems formulating a coherent policy to address the worst ten years of global growth since the 1930ʼs. Their incoherent policies has failed so miserably since 2009 by misallocating our financial resources, concentrating our wealth to all-time extremes, and fostering more bubbles than you can imagine. And sadly our world is even more polluted now than at the peak of the crisis seven years ago as central banks, corporations and sovereign and municipal governments have altogether added more than $80 trillion in aggregate debt. The total now is a mind blowing level that exceeds $300 trillion in total debt, not even counting any derivatives.
The backdrop for central banks is that they are nearing the end of an awfully conceived policy that assumes that record low rates combined with QE in tens of trillions will somehow promote growth. The reasons for their abysmal failure are too long to recount here but the primary causes of such an epic failure center on the idea that if the bulk of the recipients of QE donʼt need it then they will just wonʼt use it. And the law of diminishing returns assures that each additional measure will provide less af a boost than the last one much like your fourth cheeseburger in one sitting does not match the first in taste or satisfaction.
So why do these central banks insist on sticking to a policy so many regard as doomed to fail? Simple- the Federal Reserve and itʼs global peers have only one playbook for battling deflation and have made it clear they arenʼt open minded to consider anything else. Itʼs just not in their DNA. But thereʼs a far more ominous reason supplants that one to be the key driving force- these central banks are now “all in” on QE stimulus and ever lower rates as they keep doubling down and praying for a miraculous economic recovery that cannot and will not ever occur until most of the trillions of toxic global debt is allowed to default as it should have in the 2008-9 financial crisis. They seem to be willing to risk a ruinous economic depression and stock market crash to preserve a small glimmer of hope it may work. But they still remain as delusional as Hitler was in his final days in the bunker in Berlin as the city was destroyed.
The 2008-9 period was the proper time for all the necessary defaults and the needed restructuring that should have occurred but sadly did not. And soon it will all too clear that all those in the US Treasury and the FED should have read a primer on Kondratieff Wave theory as they could have meaningfully lessened the pain to come. Perhaps Brazil and Russia would not be on the verge of a Depression or even worse to be considered a failed state. These two countries, together with a few others, were riding so high until the critical turning point five years ago when silver topped at $50/oz and the Fukishima disaster ruined hopes for a resurgence in uranium.
Since those events five years ago combined with oilʼs dramatic plunge since late 2014 from $120 to the mid 30ʼs level the commodities sector has crashed almost 70% and the multi-billion defaults are making headlines each day. But sadly the Putinʼs misplaced confidence that oil would remain over $100/barrel lead him to believe they could maintain an economy solely dependent on the energy sector without any industry diversification. Russiaʼs dollar reserves now continue to plunge with oil mired in a protracted tailspin and US the lead sanctions damaging their fragile economy.
Brazil likewise squandered their fortunes by massively increasing the debt loads of so many mining projects completely oblivious to the notion of K-Wave theory and it shows now in their current disastrous state. Their arrogance and naivety in long wave cycles however was eclipsed by the upheaval in their handling of their largest national project of all- the state owned oil giant Petrobras which has become nothing short of a national nightmare that should result in the largest bankruptcy ever recorded.
If only someone in Brazil could have stood up and shown them the K-Wave charts and empirical evidence that proves that you donʼt make such large directional bets like they did on oil and mining against a backdrop of aggregate global debt that now exceeds some $300 trillion combined with this occurring at the tail end of the K-Wave credit cycle that is now almost seventy years old and long overdue for the past 8 years. Anyone who knows K-Wave theory could see the demise of Brazil would be prolific and sure to happen sooner than later.
A Petrobras BK could perhaps be the gravest economic ever to befall Brazil and itʼs scars will last more than a generation. I am very concerned now that both Russia and Brazil are soon to enter new and uncharted waters of pain and a Depression that will be awful for their people and will roil the global capital markets in a profound way. And letʼs remember too that Saudi Arabia is not far behind. Through these three large scale disasters we can see the seeds being sown for the end game of this very extended K-Wave cycle that is so long overdue. In the next few years the global Kondratieff Winter will give the capital markets and global economies a spanking they will never forget and that can be taken as a mathematical certainty. Servicing the interest and principal of most of the trillions in toxic debt outstanding will prove to be oh so futile.
In fact, the great unwind of the final stages of this economic winter has already begun with so many tens of billions lost in all the bankruptcies already seen in the energy sector and yet we are only in the second inning in that process with several hundreds of billions more to come in the near term. The WSJ has recently reported also that more than 43% of all student loans are either in default or behind on their payments. Given that student loans exceed $1 trillion we can be sure that many waves of defaults are likely soon to come- itʼs just an arithmetic certainty much like the energy and sovereign bond defaults soon to come. I expect the prevailing PE multiple of global stocks to plunge well into the single digits from the lofty levels now near twenty that assumes no fallout whatsoever to come from a world drowning in hundreds of trillions in toxic debt.
In my post last summer I began to emphasize the enduring and nasty currency wars occurring everywhere as a key component in comparing the current winter phase and the last one in the 1930s. Turns out there is more substance here than I could have ever imagined so letʼs examine this some more.
In my last few postings I have advanced the notion that the currency wars that have been advanced by the global central banks are a proxy of sorts of the trade wars of the 1930s. The tariffs of the last winter are being mimicked by the beggar thy neighbor currency wars since 2010 in that each reflect by outright and wholesale desperation by individual market participants to save their ass and to hell with the rest. However both scenarios inevitable leads to a much worse outcome for all because it destroys confidence and credibility which are much harder to regain.
To compound matters to be even worse is the ever stronger rhetoric by some of our Presidential candidates who are uninformed on long wave economics or even the most basic themes of modern economics. I believe they all need some remedial courses in modern economics so they donʼt keep putting their foot in their mouth. We all know that Donald Trump is a primary culprit here by picking a fight with the Chinese by accusing them of de-vauling their currency for so long.
Yet in fact only since last year have they even begin this in a very modest way and that pales in comparison with the policy of our Federal Reserve who has championed currency debasement from its inception in 1913 and has since 2009 has been the poster child for monetary arson by piling one QE after another and also lowering interest rates to near zero during the same period. So calling them out on currency debasement is the epitome of the pot calling the kettle black.
On the other side, Democrat challenger Senator Bernie Sanders has made income inequality the hallmark of his entire campaign. While I am despondent over the vast gap of wealth of our society, I also realize whoʼs to blame- not the President, not Congress but the Federal Reserve. Their policies for so long have been the equivalent of a reserve RobinHood- stealing from the poor and giving it to the rich on a very big scale. How can seniors with limited income survive if they canʼt make a dime of interest on their accumulated savings and yet face inflationary pressure that are oh so real and so absurdly understated by our government.
The conclusion to much of the material I have laid out so far leads to one major conclusion that is sad and foreboding- leaders of the major industrialized nations in the government, banking, corporate and other key sectors are clueless and incapable to understanding the root causes of our ultra dysfunctional economic system. Naturally they are all also unable to remedy such an enormous problem because they donʼt even understand it themselves. The natural result of such a condition is the occurrance of the inevitable- a global crash of stocks and bonds and a severe recession that soon morphs into a real economic Depression.
It may have possibly been avoided by some clever maneuvering in 2008 if QE had only been used temporarily to unlock the frozen credit markets, but no the Federal Reserve bit off way too much in their subsequent QE programs which lead to the current bubble in stocks and bonds which is now the biggest in world history. Global debt levels are at present several standard deviations above the threshold for stable markets and simply put the gig is up soon. Global stocks peaked over two years ago and law of diminishing returns is proving less bang for the for each new program. Global stocks and bonds, together with global economic output, now resemble the gambler who is blissfully unaware his markers are about to be called because he doubled down too many times. Letʼs see how long it takes before Mr. Market gets his markers called.
A mortgaged future to protect status quo
Since our last post, the fourth KW of the modern era has spread to nearly every country and is gaining momentum. Investors have few places to hide.
In September global stock markets plunged over 15% and were teetering on the brink of key support levels on their long term charts. But once again they were rescued by massive central bank stimulus, coupled with jawboning for more if needed. The rebound was swift and powerful, led by short covering, just like mid-October 2014. However this time, the snap back rally wasnʼt as big and much shorter than that one and was noted for its lack of breadth as the so-called FANG quartet of Facebook, Amazon, Netflix, and Google accounted for most of the gains. The rest came from short covering from the worst-performing stock in the so-called “dash for trash” stocks.
In fact today much of the S&P is already in correction mode yet you wouldnʼt know it by looking at the broad indexes. But on December 30th all that changed. The price action in the final 30 minutes of the 30th and 31st was really awful which allowed the S&P to mark its first annual decline since the financial crisis. The S&P then plunged another 5% in the first week of January, provoking new fears about contagion. This may prove to be a very foreboding sign that 2016 will be troubling and volatile for stocks. So let me try to explain this backdrop in terms of our Kondratieff Wave theory.
Today the global capital markets (except bonds, for the time being) are in free-fall as a direct result of so many of the things we have advanced here for many years, including mal investment from too much cheap easy money, rampant overproduction of goods that has created the most over capacity condition ever. Furthermore, tens of trillions more in debt obligations by sovereign governments, corporations, and others suggest they will be forced to spend too much on debt service in the coming years instead of investing in their businesses. And look no further than our new budget agreement recently signed into law that increases the debt ceiling by several more trillion in the next two years. Folks, we have just hit peak debt for several generations and the fallout has already begun. Long wave economic theory helps reconcile the existing paradoxes and conundrums.
We must view the dramatic recent developments of the past few days through the lens of the long wave cycle to have any hope of understanding how perilous our current state of nature really is at present. Long wave theory is the only thing that can explain why deflationary forces refuse to abate despite tens of trillions in fiscal and monetary stimulus. We have repeated here so often over the years that deflationary forces will remain and accelerate until most of the excesses of debt have been removed through defaults and this process is still in its early stage. Accordingly, this explains why the US, Japan and nearly all developed countries just cannot get inflation even near their 2% targets and why the USD is rising and not falling as so many feared.
The truth is this: as of this week, the US and nearly all other nations on Earth have mortgaged their future several times over just to keep the status quo going as long as possible. But the cracks in the veneer are showing, and the markets are taking notice. investor sentiment for some time has been less than euphoric like early 2000 and some say we must reach that state for a true secular market top to be in. However a closer look at many charts says the top is in so look out below.
This Kondratieff Winter has played out much differently than ones in the past for one simple reason-central banks and sovereign governments all over the world have tried since 2009 to battle the deflationary forces with over $100 trillion in stimulus and zero to negative interest rates to overcome this deflation. Global growth since 2009 has been so weak and continues to decline each month, each quarter, and each year we can now say this grand stimulus was a horrific mistake because the trillions of debt still remain and no country ever reached the escape velocity in growth that was promised.
Yet the true scale of the present condition has largely gone unnoticed because global stock markets have been goosed to high levels and it seems like business as usual in our daily lives the past few years with no soup lines or mass bankruptcies or brewing revolutions on the horizon. And here in 2016, over 99% of the people have no idea what a Kondratieff Winter is but that is sure to change in the coming years.
The truth is that a Kondratieff Winter has already taken hold in many markets. Oil has plunged over 70% from its 2014 highs and natural gas has plunged over 80% since its 2007 highs. In fact the entire commodity universe has plunged to multi-decade lows and this has lead to massive reductions in capital spending and so many lost jobs. These industries are all suffering from an overwhelming over capacity that will take many years to abate. Such over capacity is a hallmark feature of any K-Winter and many are just now coming to understand this condition will endure much longer than they imagined.
There are many other important sectors also enduring the hardships of a K-Winter. Industries related to commodities such as mining and materials have been devastated for over two years and most are unable to raise enough capital to finish their projects. More than 80% of all listed mining stocks now trade under ten cents per share and are just zombies until market sentiment improves. The shipping industry is also in ruins with too many ships and not enough goods to transport. In fact the Baltic Dry Index that measures transported goods fell to an all-time low last week, underscoring the severe downturn in produced goods worldwide.
This downturn has accelerated in recent weeks as evidenced through the release of economic data measures worldwide. Hereʼs the bottom line- globally we are now in a full-blown manufacturing recession. No one can challenge that, especially after the recent release of Chinaʼs PMI numbers last week showing a contraction in produced goods. That was unimaginable this time last year. If China cannot avert a hard landing this year then the scale of this global slowdown could be much larger than we dare to believe.
I just shake my head each time I see articles or TV news telecasts reporting that the Fed or the IMF downgrade their forecasts for economic growth. Why? Because I have never seen the numbers reflect better than expected growth as they always miss by being too optimistic about economic output growth. Why might that be so, and why has no one ever heard of a Kondratieff Winter? I will now try to take a stab at both as I believe they are related.
The importance of long wave economic cycles
The answer as to why the Federal Reserve,the IMF, and most economists and financial journalists repeatedly have their forecasts downgraded is because they all fail to appreciate long wave economic theory. We are now almost sixty years into this cycle that has seen hundreds of trillions of debt issued with much of that sure to default. Today all the Fed, IMF, Wall Street and the public at large are by and large unaware of the looming storm brewing of hundreds of billions in debt sure to default in the next few years. They and sell side Wall Steet firms make projections on stocks using simplified models featuring PE multiples, projected growth rates on revenues and earnings, etc. and completely ignore the threat coming from the existing backdrop of the existing $3 trillion of debt outstanding. It seems no one wants to recognize the true threat from the spike in non-performing loans that will eventually lead to hundreds of billions in defaults.
This week Arch Coal, a Wall Street darling until just a few years ago, filed for bankruptcy and evidence continues to mount that these defaults are looming large now and will dominate the headlines for years to come. This is what occurs at the end of a very long economic long wave credit cycle. Just last week Puerto Rico announced a partial default on some of their bonds and this is just the tip of the proverbial iceberg, Now that the Federal Reserve has reversed course and have begun a tightening cycle this will put even more pressure on the holders of hundreds of billions of dollar denominated debt that must be repaid at a premium.
Thus, a new vicious cycle has now emerged with the large spike higher in the US dollar since late summer. That is when China began to devalue their currency in earnest. They now remain on that path of devaluation, marking a new era in the ongoing currency wars that are sure to disrupt the allocation of capital and accelerate the flight of capital from China.
These developments are sure to hamper global growth and reinforce the deflationary condition most thought was defeated all the massive stimulus over the past few years. We have advanced here many times that our K-Wave theory would prove otherwise and it has. I suspect that 2016 will prove to be very volatile and difficult for those who remain long this market and perhaps finally many investors will awaken to the virtues offered by Kondratieff Wave analysis.
China’s plunge leads global rout
Deflationary winter cycle thrives despite doubters
For many years here we have advanced that the stimulus coming from all the senseless printing schemes by central banks and the runaway deficits of sovereign governments would prove nomatch for the awesome scale of the deflationary forces that accrue in a long wave naturally recurring economic winter cycle advanced in our Kondratieff Wave theory. In recent years nearly everyone doubted this deflation would ever resurface again given the tens of trillions in global fiscal and monetary stimulus puked out by all the developed sovereign nations. We insisted all along that ultimately the higher truths underlying our Kondratieff Wave theory would prevail and the developments in the global capital markets and economies over the past six weeks have more than validated that claim. Oh yes, global debt deflation is alive like never before, proving the K-Winter cycle phase is still evolving and has much further to go before the real bust.
Even those most zealous about the prospects for sustained strong economic growth and an equally rosy outlook for a new bull market are now anguished that the reality of a sustained period of deflation is upon us. At present nearly all of the world’s largest economies such as Japan, Russia, Brazil, and Canada, etc. are in a recession while most of the rest are eking out GDP growth well below 1% a year. Such performance is dreadful especially occurring so long after the financial crisis and given such massive stimulus thereafter. In fact Brazil and Russia are in free-fall and on the verge of a full blown depression. This has occurred mainly from the near 70% plunge in oil over the past two years that in now being felt everywhere. In these two flagship BRICS countries the nasty combination of soaring interest rates and negative economic growth is so awful that their currencies are now in free fall yet sadly each one feeds on each other to create a death spiral condition that’s very difficult to fix in the near term.
Yellen’s press conference performance was incoherent at best On September 17th the Federal Reserve elected to maintain interest rates at zero but threw investors two curve balls we are still talking about today, namely that the call to keep rates near zero wasn’t even close (despite rhetoric to the contrary from several voting members including Bill Dudley before the vote) and also global markets and economies would now have an impacton their decision. This meant the Fed would react later to things such as the plunge of over 40% in China stocks since late June. Such an approach is not part of their dual mandate of stable prices and sustained growth given by our Congress and Yellen’s explanation for their decision at the press conference that followed was confused and conflicted to anyone who watched.
Global economic growth today is in tatters, and not just in the resource dependent nations such as Australia, Canada, China, etc. All nations are suffering from titanic debt loads, severe policy missteps, and weak leadership. The stated policy for so long of kicking the proverbial can down the road has finally caught up us and this new investor worldview was quite evident on when the Fed held rates two weeks ago. At first the markets first cheered then jeered their decision to postpone raising interest rates again for the first time in almost ten years. For the first time I can remember, an ultra-dovish tone from the Federal reserve did not lead to a sustained appetite for risk; instead their dour forecast had the opposite effect. For the first time I suspect since the 2008 crisis investors have awoken to the idea that central bank accommodation is a bad thing as the S&P first soared to 2020 from the algo’s on the headline of no rise in rates but then plunged over 600 Dow points in just over one session as the absurdity of their actions became too clear to ignore. I’ve been waiting to witness such a reaction as this for many years and it seems finally for the first time in years there is bona fide skepticism from investors that mindless printing and ZIRP to infinity is not such a good thing. And that my friends is a big sea change in sentiment worth noting. After all, any addict knows the first step in any recovery is admitting your addiction and clearly at 3PM on September 17th the market finally awoke to that reality. Since then the S&P has plunged almost 7% so I suspect the top may be in for this cycle.
Some propose the record setting carnage in stocks seen in the past several weeks was some garden variety “correction” that was long overdue and welcome. But when the Dow plunged 1080 points at the open on Monday August 24th, it was the biggest intraday plunge in points ever in the Dow, even exceeding the 1000 point intraday plunge of the Dow in May 2010 in the so-called “flash crash”. So it’s not too hard to propose the plunge in stocks in recent weeks is not fleeting. It does have legs. Unlike the late 1990’s Asian Tiger currency crisis or the Black Monday one day crash of 25% 1987, this crisis is unlike those because it is occurring so very deep into this very extended long wave credit cycle and is enjoined with such enormous debt loads. And two other developments suggest this time is different. First, China as the world’s second largest stock market has crashed over 40% in under two months and that has shaken confidence in their leadership more than we know. Second, China’s own economic growth has plunged to 40 year lows and since China for the past five years has provided more than half of all global economic growth and that poses a clear and present danger now to global growth.
Such a toxic confluence can’t be ignored any longer by the sell side pollyanna’s preaching China as a non-stop bull market. That dog just won’t hunt anymore nor will their pack of lies claiming 7% economic growth. Second quarter EPS numbers released by Apple, 3M and so many other US companies proved that once and for all. It’s possible China is now heading for its first Kondratieff Winter ever as an industrialized society. If that’s true it could resemble the 1873-79 period in the US that was marked by a severe decline in growth and capital investment as the excesses of the first major credit cycle in US history came tumbling down as railroad over expansion caused an investor panic so severe that credit conditions were not regained for almost seven years. The common denominator with both cases was unchecked infrastructure growth that was way too much, too fast. In the US the railroads were the culprit, in China it’s the ghost cities with all those empty skyscrapers that are a metaphor for the proverbial fools errand of spending money to dig a ditch and then refill it with the same dirt. In both these cases debt fueled growth that wasn’t so efficient and capital was not chasing it’s highest utility as it must. So if we mix one part China hard landing, one part recession for the key BRICS countries (save India), and another part Federal Reserve recalcitrance in raising interest rates then it’s hardly a stretch to imagine that stocks are under severe pressure. This deflationary time bomb, so very long in the making, seems to have taken a stronghold of the global economy in much the same way cancer can take hold of the human body- slow and steady at first, then suddenly acute.
The solution to such excessive debt must be treated right away and decisively, or else. But the main problem is that there is only one solution for this prognosis- massive debt defaults, lots of them. How did this economic cancer grow so quickly upon the global economic landscape? We would advance that the global aggregate debt now eclipsing $230 trillion USD is the principal cause although others are cited above. Anyone clued in to the notion of compound interest knows this won’t end very well. K-Wave theory proposes the more any entity is indebted over time the more onerous to overcome its debt servitude, which is common sense. Tens of trillions in defaults are on on the horizon and there’s no bailout that can prevent what must ultimately come to pass — very substantial wealth destruction coming from these defaults.
It’s the destabilizing currency markets, stupid! China’s move was a game changer Global stock markets began to decline in mid June when the indexes in China peaked and then plunged due to large margin calls on the debt that retail investors had amassed (gambled). They have been pretty shaky since then as the German DAX declined over 20% in less last month and US markets also plunged the most since the 2008 financial crisis. And then something really, really big happened August 11th, 2015 that will no doubt go down in the history books on global finance when China chose to devalue its currency to reduce its peg to the US dollar. That move was a decisive event that offers a very clear narrative underpinning the troubling but true state of nature in the global currency markets- rampant debasement by nearly all countries. But these aren’t your Daddy’s currency wars of the late 1990’s that were marked by weak Asian tigers such as Thailand or Malaysia,etc. Instead these currency wars are much more disturbing given how widespread they have become and that the worst offenders are the biggest countries on Earth- Japan, the ECB, China and the US.
These three serial debasers are also top three countries in the world for GDP and stock market valuations. And let’s not forget that Bernanke began this race to the bottom in late August 2010 with his fateful decision at the Jackson Hole summit to engage in the ultra- risky and ultra-controversial QE programs designed to monetize the US Treasury debt to goose paper assets in a ill advised attempt to create a so-called “wealth effect” to spur further US economic growth, In recent years other central banks copied
BB’s playbook despite material obstacles to successful implementation that include severe conflicts of interest politically and far too shallow of a pool of available securities outstanding to achieve the desired results. This farce will be all too clear when we come to realize we now have both lousy growth prospects and tens of trillions more debt accrued that was incurred for the stated purpose of alleviating such dour growth. Oops.
1930’s Trade Wars redux- deja vu of the last K-Winter?
We advanced here six months ago the notion that the protracted currency wars seen since 2010 are likely a modern version of the 1930’s trade wars last seen at the peak of the last Kondratieff Winter. Those trade wars began though a collective sense of self interest best understood as the classic “every man for himself” mantra that then prevailed. Such a mantra provoked most nations to panic to protect their own economic markets (but not capital markets), yet ultimately these practices exacerbated a global recession into the Great Depression. The US was all too complicit in promoting this madness then when Congress passed the Smoot Hawley Tarriff Act of 1928 that set the stage for the global trade wars of the 1930’s. The rest is history, as they say.
These protectionist policies were enacted by so many nations to prevent damage to their own economies but in fact they had quite the opposite effect since they were all done in concert and thus ultimately severely limited trade. We advanced here in early 2015 that this was occurring again yet in a much different form- currency debasement- which has become the preferred tool for nations seeking to engage in the same selfish behavior they did in the 1930’s. In fact last week in the Wall Street Journal, CEO Andrew Mackenzie of the world’s largest mining company, BHP Billiton, provided ample evidence how these protectionist policies have come to dominate the landscape in recent years. He referred to, among other things, proposed policies such as the US oil export ban and certain tariffs imposed by European countries since 2009 in what he referred to as a “clamor for protectionism” . And who would be more clued in to this than the CEO of the largest provider of materials to the entire world? No doubt, he’s keen to the peculiar and vexing challenges marking late stage economic winters and his peers are also taking note.
Moreover, President Obama has recently promoted severe trade sanctions and tariffs against China if they don’t immediately cease to be a serial violator of cyber crimes against the US and other western nations. Inaction on both sides however seems likely given how difficult is for any one or two leaders to reverse overnight several generations of accepted behavior. Although I have no credentials as a diplomat on these matters, I am quite sure that protracted trade wars and divisive tariffs are not the preferred solution here as they are likely to cause great harm to both countries much like all trade wars have over time. But sadly we are in the end game on this serious matter where nations will forge their path for years to come. Will it be like the disastrous path taken from 1928 (HSAct) to the late1930’s, or will a more evolved approach take shape that seeks to prevent the 1930’s style disaster? No one knows, but I do know this- our beloved K-Wave theory has been holding up quite well. The nuances occurring within each season are playing out much as we have projected despite the sustained rise in stocks the past few years that came in large part to ZIRP and tens of trillions in fiscal and monetary stimulus.
When conditions are so extreme as they are today at the tail end of a 70 year super-cycle of debt then the case for a Kondratieff Winter is made more clear by the higher truths that make the case for an economic winter so evident. I can think of nothing that better suits our making the case comparing the 1930’s and the present economic winter than this parallel action seen today by among all the global market players in today’s currency wars versus the approach taken during the last Kondratieff Winter cycle with those trade wars. I could live three lifetimes and never get a better chance to highlight the hallmark features that supports K-Wave theory. And that case is now stronger than ever given all that has happened since early August.
Where are we now exactly in this very extended K-Winter cycle phase? Well, my friends that is the multi- trillion dollar question that trumps everything and I am unable to provide any precise forecast due to the ceaseless printing schemes executed by all the global central banks so determined to overcome this fourth Kondratieff Winter of the modern industrial age. However I can provide some very clear guidance on the forecast of one David Barker, who I consider to be the world’s foremost expert on Kondratieff Wave theory. In fact he has no peer.
Over the years I’ve read his books, spoken to him and subscribe to his newsletter. He asserts that the very worst aspects of this extended winter won’t likely take effect until 2017 or a bit later as central banks will do whatever it takes to preserve the status quo in finance as we know it. Such a forecast that does not imply a near term and terminal stock market crash may seem a bit shocking and even disappointing to those like me who have researched this theory for so long and would be bewildered at the notion that this winter season may extend even further out to be over 20 years total (2000-2020). But over the years I’ve been very impressed that Barker has been among the very few long wavers refraining from predicting even a severe correction until recently, meaning he has been the rarest of this breed in having resisted for so long calling for a total crash
This is quite unlike the Elliott Wave advocates who since 2010 have repeatedly forecasting a market crash. Baker’s model is entirely focused on the Kondratieff economic long wave whereas the Elliott Wave model is focused on the performance of stock prices over time. But as we all know stocks have received an enormous boost since 2009 through ZIRP and so many QE programs by the Fed designed to goose paper stocks far above their true level on a real price discovery basis. This has turned the EW primary count on its head time and again for the past five years as their wave count keeps getting extended due to human interference. It is a natural flaw of that discipline even though it did work so well until central bankers put their 88 trillion pound finger on the scale to basically render the EW primary count moot in the near term.
Naturally, stocks and economic growth have decoupled like never before and this explains why Kondratieff Wave theory has trumped Elliott Wave theory the past several years. However historically, both these long wave disciplines have been more in lockstep because typically stock markets decline or tread water when global economic activity is so meager. But unchecked and seemingly unlimited QE programs from nearly every central bank on Earth has thrown out the playbook and provided for this extreme gap between stocks and the underlying economic fundamentals. Stocks eventually will revert to the mean, so to speak, but when? The primary count put out by Barker suggests we will see a severe decline of up to 25-30% from the all-time highs through October and then a new round of QE by the US and global central banks that will provide enough cushion for the markets to avoid a major crash until the very last Kitchen cycle which is expected to end in a few years.
The central bank manipulation in recent years has indeed been undertaken to a primary degree, some 20-30 or more standard deviations removed from historical norms relatively speaking and this farce just cannot be overstated. It has no doubt impacted our Kondratieff Wave theory too, but not so much really. Massive and unprecedented monetary intervention hasn’t rendered us unable to make many successful and unlikely forecasts here that have came to pass since our inception in the summer of 2007. These include forecasting the financial crisis of 2008-9 and the global stock market crashes that followed, the US Dollar index soaring, not the feared hyperinflation despite all-in QE by Bernanke’s QE schemes, gross misallocation of resources leading to rampant over-production by corporations creating a massive commodity glut, and weak global GDP growth despite all the trillions of global fiscal and monetary stimulus. But above all, KWave theory principles strongly suggested that deflation could not be tamed despite all the trillions of fiscal and monetary stimulus put forth to overcome it. For that, all the advocates of long wave economic theory can take a victory lap.
Anyone who had researched our extensive material here over the years could see there would be no escape velocity in global growth because unlike other downturns this one occurred at the end of a long wave credit cycle noted for multi-trillion dollar excesses. Tales of such miraculous rebounds from the ashes just do not occur at such late stages of these cycles until the excesses of debt are removed via massive defaults. Why? Because $230 trillion in outstanding debt (not including over one quadrillion of derivate liabilities incurred) that keeps compounding is just too much to bear. For proof of this just look to the swift and shocking annihilation of the world’s top commodity trading firm Glencore PLC or Brazilian state owned oil giant Petrobras. Like so many others they were so certain only a few years ago that commodities and most assets would keep rising higher forever yet they ultimately buckled under their own weight of excessive debt loads and brio. They are now troubled by virtue of ignoring the implications of making such heavy investments at the tail end of the largest long wave credit cycle in human history. Oops.
Despite the certainty of the awful Kondratieff Winter endgame, one certain to make the 2008-9 crisis a picnic by comparison, I must alert our readers that the primary count from David Barker remains that the endgame financial crisis has most likely been delayed until 2017 or a bit later perhaps. His models are based upon some unique harmonic ratios of the universe such as the Fibonacci sequence, golden ratio, etc. and his model goes back to the early 11th century at the genesis of mercantile commerce in Europe. His long wave model divides the long wave, into 144 equal parts. It was believed that October 14th 2014 was the end of the 144th cycle dating all the way back to the 11th century but when Barker noticed the oversized response (some tens of trillions in commitment by 4 central banks in a few days) and then realized and conveyed to us that these central banks had in fact bought one more Kitchen cycle that would extend the final carnage into the 2017-2019 period.
When I read his report then in mid October 2014, I was fit to be tied because I was so sure all these printing schemes were sure to fail soon and wasn’t that so obvious to everyone? But the four key central banks tripled down to avert a looming crash and the markets rallied into mid 2015 due to the determination of central bankers who had thwarted yet another disaster. But now the sins of the past have come hone to roost and Barker’s primary count for now is this- US and global stocks will plunge far below the 1820 S&P lows seen last October, perhaps to the 1570 levels last seen in November 2012 as the full impact of QE to infinity was initially being absorbed by the markets. The recent meltdown in stocks, GDP and confidence is now already sufficient to support such a bold call. This plunge that began in August 2015 is expected to break through the October 2014 lows, and then look out below. At some point this fall, it may seem to most like the real K-Winter end game has arrived. But Barker holds that one more massive round of global QE is in store that could delay the true reckoning until the end of the this last Kitchen cycle in a few years. While that now remains the primary count, there are several potential foils that could shatter this bull market and upend this rather optimistic count.
The scenarios below could accelerate KW end game into the near term and render the 144th Kitchen moot if any of the were to manifest in the near or intermediate term:
a) Interest rates spike too much too quickly. Even 150 bps gain on the UST 10 year note in a month or so would be plenty to destabilize global credit markets given all that leverage. Interest rates are the single largest cost of capital in any society and nearly all nations are today so dependent upon enormous credit to maintain that pace.
b) The US dollar index soars above 106.77 (FIB breakthrough number) triggering massive foreign debt repayments in USD to avoid outright defaults on several trillions in dollar denominated debt where there is a race to repatriate in a currency crisis. Any close in USD Index above 106.77 would be ultra -deflationary and incur massive EM repatriation of USD denominated debt (to mitigate currency risk from negative USD exposure. All hell would break loose from a USD index close above that level as it would trigger the biggest flight to safety ever seen in the capital markets. Deflationists like Barker and K-Wave advocates know this is the absolute worst case scenario.
c) a derivative blow-up at at one of the six global money center banks- i.e. Citibank, JPMorgan, Deutsche Bank, Barclays, etc. Their books are the mother of all black holes and even the regulators are clueless to their off balance sheet liabilities.
d) a bona fide black swan such a solar storm surge cutting off electricity, the internet being shut down or a hacking incident that takes the cake. Or something like an assassination of a major leader or a geopolitical wild card such as Russia invades Ukraine ,Estonia, or Poland
e) a China hard landing that freezes credit in China and and crushes global global growth.
It is shocking that as recently as late June of this year, most investors were still in a Xanadu phase, mesmerized by all the multibillion dollar takeover offers from big game corp hunters such as biotech Pacman Allergen and Valiant, ceaseless multi- trillion dollar stock buybacks and spinoffs (Hewlett Packard), massive stock splits (Apple and Netflix), and excessive one time special events (Abbie Vie) all designed to goose stocks in the near term, never mind the consequences. But, oh how the mighty have fallen. So look where they are now- bellwether Apple Computer near a bear market, Amazon down even more, Netflix, down over 20%, from its highs and Disney down 20% and Freeport McMoran down over 50%%, etc. since last year. Altogether there are so many of these unnerving development for our markets when the most owned and most revered icons come tumbling down to Earth so fast.
Evidence mounts that a big-time reversion to the mean is looming for stocks soon as investors come to realize that central banks are no longer important — they are just impotent.
Global stocks on the brink
Markets plunge on Greek default and bursting of China stock bubble
Until just recently, stocks in nearly all the developed nations were making all-time highs, boosted by seemingly unlimited monetary and global fiscal stimulus and ignorance by investors that nothing could ever go wrong. Not anymore.
While these problems been with us seemingly forever- a Greek default, stubbornly low economic growth rates, excessive global debts exceeding $180 trillion USD, etc. it seems they suddenly matter now. In my last post I proposed an ending diagonal chart pattern in US and global stocks was unfolding that if validated could result in a much bigger plunge than most could imagine and would shock so many leveraged and complacent investors. That remains the primary count as farces and absurdity are evident everywhere you look, especially in the state controlled Chinese stock markets.
Oops! Recent dramatic moves by China are incoherent
In fact China has plunged 30% from it’s all-time high on June 12th, when it’s total market cap topped $10 trillion for the first time ever, to bear market status in less than three weeks. This is very sobering all investors. A serious and unwelcome reality check has set in for Chinese investors who now realize that growth in stock margin debt can’t exceed levels of 15,000% per annum without some real damage. Or that the disconnect from the recent $10 trillion USD all-time high has occurred just as their GDP levels hit thirty year lows. The price action across their primary exchanges this month has been nothing less than the theater of the absurd that reigns at market cycle tops marked by excessive leverage, overcapacity, and ignorance by market participants.
China matters to us all, and more than we think. China has accounted for more than the lion’s share of global economic growth for over a decade and now they are slowing down faster than anyone dared believe despite all the desperate measures by their government to prevent a naturally occurring economic winter that is long overdue after decades of hyper growth and excessive debt levels. One must now wonder how bad things could be now in China given the sheer magnitude of their desperation recently in slashing interest rates every few days and initiating other stimulative moves at such a dizzying pace. Are they in full panic mode? Yes, of course. Have they blundered even more by telegraphing their panic to us all? Yes, of course.
Their low vibration measures would even make Stalin blush in that they are bold all day long but without any sense. Here China chooses to increase stock participation by millions of novice investors through margin buying, serving the big casino that spots markers to anyone who breathes. In recent weeks the measures taken by their government have been confusing, desperate, and confounding as they have sought to goose their growth while also reigning in margin requirements. Their left hand sends signals to goose economy while the right says- hey wait minute, our markets have gone too far. So what are investors to think? It has been all to clear for the past year they are trying to overcome their housing bubble crash by creating another bubble in their stock markets to coax their gambling prone citizens into yet another unsustainable bubble.
That has been the case with China for years and no doubt the real growth numbers are much worse than reported. This has been common knowledge to most in the know for years and this discrepancy is best reflected in two aggregate measures that cannot be so easily fudged- electricity demand in China and the CRB index of global commodities that has crashed in the past two years due to its heavy dependence on China demand. Both measures suggest China is in deeper trouble than most believe.
Keynesian failures now take center stage
Recent developments in China, Greece, and other nations underscore a universal truth that remains hidden plain sight- there is just too much global debt for any enduring prosperity. We have advanced here since our 2007 debut that the abysmal failure of the Keynesian model, born out of the 1930’s Great Depression and since then the global standard, would eventually implode in grand fashion. After all, this theme is at the very heart of K-Wave theory that claims that excessive debt is perilous and is grotesquely inefficient and also does not promote capital chases its highest utility. There can be no doubt this has been the case since the global financial crisis yet it has been overlooked by most because stocks and bonds have surged to record highs. But the tide turned in May when the absurdity of negative bond yields peaked in so many sovereign markets by topping out at an astonishing $5.3 trillion USD equivalent in sovereign debt yielding negative returns. What do you think the history books will say about those negative bond yields on sovereign countries that so pathetically indebted?
Many of the major developed countries now have trillions in debt that are just unpayable. Given that the bailout price tab for Greece has risen by tens of billions in recent weeks and with their banks still closed and their economy imploding the likelihood of an enduring solution could remain elusive, further underscoring the absurdity and audacity of the Keynesian model once and for all. If the baseline premise the Keynesian model were to ever be betrayed as doomed, which is clearly inevitable, then the acute ramifications to paper asset valuations are unspeakable.
Bernanke misnomer in famous “Helicopter Ben” speech
While the ruins of global sovereign and municipal fiscal deficits are no doubt worthy of a jaundiced eye, and perhaps scorn, so too is the excessive multi trillion debt levels of global central banks. These extreme debt levels have their roots in a 2002 speech given by one Ben Bernanke and I suspect most don’t appreciate the importance of this speech. In 2002 BB was a humble Princeton professor who had shown for years a particular zeal in his expression of what he perceived was a timid a policy response from the Federal Reserve in the 1930’s in battling the Great Depression. He embraced Japan style QE wholeheartedly as the ideal remedy to post modern deflation so long as it was a much larger response that the Japanese all-in monetary response to their deflationary woes that began in the early 1990’s. As a long wave buff this troubled me to no end so I was sure to follow Ben as I noticed his views on this matter were uncommonly aggressive and oh so passionate. He was a zealot of the highest order, but most saw him as just the gentlemanly professor type, hardly one who would become iconic. Yet his Napoleon style monetary aggression had been laid bare for all see.
So did President George W. Bush, who appointed him to the Federal Reserve Board in 2002 and then to Fed Chairman in late 2005 to replace the retiring Alan Greenspan. President Bush had been advised that Bernanke would prove to be the most dovish and aggressive monetarist of all time and this is what they wanted at the time. In hindsight, he proved them right, and then some. I knew Bernanke would be a force unto himself given his outspoken nature proclaiming he has the RX for any deflation so I included most of all his magnum opus was his 2002 speech was titled “Deflation” making sure it doesn’t happen here”. My purpose in showing this to advocates and students of K-Wave theory was to advance the notion that such a capricious approach to battling economic downturns was problematic and rife with conflicts. I maintain strongly however it this a must read for anyone seeking to understand the dynamics of monetary policy in the modern age and It can be found here in our Fiat Currency section under the TABOO tab.
This is because the canons of K-Wave theory promote that classic fiscal Keynesian or monetary schemes cannot propel true economic recovery until the excesses of the previous cycle are rooted out. By nature any policy that goes out of its way to promote the opposite is heresy to me, much like K-Wave theory is heresy to monetarists and those Keynesians the world over. But I had to include that speech into the site content as I suspected that speech could form the battle lines of battling this long wave winter.
It is not too hard today to make the case that the premise of that 2002 speech was deeply flawed given that central global bankers cannot produce one ounce of inflation during a prolonged six year winter of unprecedented fiscal and monetary stimulus, much like Japan since the 1990’s. Instead, the so-called remedy that has emerged has helped the wealthy and has severely punished all savers. In hindsight, perhaps Bernanke’s 2002 speech could have been more appropriately titled “Paper asset inflation- making sure it happens here.” Global central bankers have taken Bernanke’s lead and global stocks have surged while global economic growth has stagnated under the central policies that mandate exponential debt is required to stimulate national economies. Today the futility of this approach all too clear to me.
These policies have not promoted the general welfare nor the common good nor price stability or economic growth as per the mandate. Instead they have promoted stock bubbles, an escalation in the levels of income inequality among the population and much more. The sad truth here is also ironic in that central bank policies to defeat naturally occurring slowing growth instead feeds the very deflation monster they loathe so much. This flawed approach of the Federal Reserve, still now unchecked after over 100 years of abysmal failure, should make us wonder if Bernanke’s 2002 speech could have been also renamed another way- Deflation- making sure it happens here. Mission accomplished.
The enduring deflation evident today can be regarded perhaps as merely severe price dis-inflation right now given that we are not yet in a terminal phase of asset deflation. But if you polled any stock analyst, financial journalist , or pundit today I suspect that less than 5% would advance the idea that deflation was alive and kicking. In fact, deflation is considered R.I.P. while some are taking a victory lap or declaring mission accomplished in the battle against deflation. But maybe the case for deflation today can be best seen through the chart of the global CRB index of commodities that now stands at 217, down over 30% in the past year alone. This broad index by its very nature can’t be so goosed by all the monetary stimulus and manipulation that dominate most other financial charts. It foretells a world awash in overproduction, saturated by a glut of products financed by cheap easy money. When the gig is up, several trillions of global debt will begin to default and it will begin with the weak sisters like Greece, Puerto Rico, etc. and spread form there. If it begins with China however the terminal phase of this fourth Kondratieff Winter of the modern era will begin with a much bigger bang to put it mildly. History was made this week with the first default to he IMF from a major country yet global markets continue to whistle by the graveyard. But for how long?
Global paper assets for the moment still enjoy the “Greenspan, Bernanke, Yellen put” and the 11th commandment is Thou Shall Not Fight The Fed. But really, for how long? On this matter, K-Wave theory in unwavering- the global forces of deflation at the tail end of any economic winter are so enormous that no monetary scheme can overcome. Keep this in mind as you see global central banks lose control of the monetarism that has enforced a failed Keynesian system for so many decades.
Beware the Bearish Wedge
It foretells the pain of a looming earnings recession
Today global economies just can’t muster any meaningful growth no matter how many trillions are printed by all the central banks. The perception is growing they are boxed in like never before, a baffled and bewildered bunch terrified to consider raising interest rates under any conditions. In for a penny, in for a pound so to speak. How pathetic.
For most of the first quarter, the bad news bulls had their way. As the awful economic numbers became evident, so too did the hope that central banks would keep pouring it on and this prevented a major stock slide in Q1 of 2015. Yet the brutal reality of plunging earnings expectations and ever weakening economic data is now undeniable. Yet all the while EPS estimates from Wall Street have been plunging like never before. It is likely the robust financial engineering and peak cyclical earnings that has marked the past several has finally run its course and would revert to the mean. If this were to occur to even a modest degree it is likely stocks would endure a long overdue correction or worse.
We must recognize that the driving force for the greater portion of the rally of nearly 40% in the broad markets since late 2012 has come from a combination of stock buybacks, hefty increases in global central bank accommodation and multiple expansion. None of these elements improve economic conditions in the least so not surprisingly levels of productivity has declined much in the past two years as corps incur billions in new debt to promote the value of their paper assets much like the proverbial lipstick on the pig. One could argue that the divergence between economic fundamentals and current stock market valuations has never been higher. Although such a wide divergence can exist for a brief period and be unappreciated by investors, we intend to show here later that the broader chart patterns of the US markets imply clearly this enormous divergence is in peril much like 1987 through the dreaded rising wedge formation now unfolding.
Investors have discounted that aggregate corporate profits may have already peaked in 2013 even though they have been so goosed on an EPS level due to the largest corporate buybacks in world history the past three years. Right now, consensus estimates for Q1 and Q2 corporate profits are negative 2-3% for both quarters and when you factor in the titanic stock buybacks you can come to only one conclusion- profits have peaked for this cycle. These estimates are so solid that you can declare that in April 2015 that we are now in an earnings recession. Smoke and mirrors combined with unlimited central bank sloth are not the components that create long term wealth creation. Historically corps that buy back stocks often do so at relatively high valuations.
Today, that list is growing each day in the likes of IBM, Viacom and so many so-called stalwarts that have wasted tens of billions in a fools folly all to mask their own fundamental flaws. This cycle of folly is only in the early innings right now. These blue chips corps- IBM, Viacom, and many others that are now down more than 10% in the past year in truth advance the notion of peak cyclical earnings for a generation. Going forward the next 5-15 years the beasts of inflation, higher interest rates, and $2-300 trillion in toxic debt will surely make historians marvel at the audacity of these corps in deciding to waste so much cash on buying their own stock at these levels. In fact the largest corps today are more leveraged than ever, albeit at all-time low rates. Nonetheless, they are still over levered. Any perceived protracted decline in US economic activity will put severe pressure on margins and constrain their available cash, given that most corporate cash is frozen overseas and subject to a sizable tax hit is repatriated. Investors have ignored this reality it seems. It is likely that corporate profits peaked for a generation in 2013-14.
But who can be surprised? Corporate profits have typically ranged from 4-6% of GDP over the past century but in the past few years they have catapulted to 13-14% of GDP a level that was clearly unsustainable and demanded a clear reversion to the mean. Since 2013 I have often emphasized in my updates the model championed by Robert Shiller that measures the S&P earnings multiple in a blended fashion over ten years that shows that an honest assessment of the current PE multiple is far higher today (27, in fact) than perceived by investors and is clearly unsustainable. It now appears that reversion to the mean is picking up some major steam. And so is the buzz about bubbles.
The debate about bubbles forming in various market segments hasn’t been this high since the last bubble burst in 2008. The more I hear the pundits scream from the hilltops there is no bubble forming in NASDAQ, biotech, etc. the more I ask why are they so defensive? They all point to the same old boring mantra- this time is different. They point out (and accurately) that the PE multiple today on the NASDAQ index is a fraction of what it was in March of 2000, that central bank accommodation is certain for the foreseeable future, and that the present paradigm of zero to negative interest rates in the developed economies means stocks go higher given that most bonds have zero or negative yields. That’s all fine if you can convince yourself that such a wild illusion can last forever.
Bubbles are everywhere, but why not view the prospects of bubbles in a different light? I see many bubbles now evident on a micro basis more than the macro basis through the broad indexes. I see an enormous bubble in the private market technology companies such as Uber, an icon for a classic peak in valuations for this era. I see a bubble in bonds of most countries in the world but most notably Italy, Spain, France and most other bankrupt European issuers. Other obvious bubbles include the sustainability of US corporate profits, the biotech sector that has quadrupled since 2009 even though only 25% of it’s index is now profitable. But perhaps the most egregious example of all is the
Russell 2000 index of smaller US companies that now boasts a downright filthy PE multiple of near 70 versus around 18 or so for the broader S&P index.
In my last post I emphasized the currency wars now dominating the global landscape and I related them to the last Kondratieff Winter in the 1930’s that was marked by the same malady but executed through trade tariffs. The present winter cycle uses a different delivery system- a shameless and purposeful currency devaluation as the means to overcome the perils of an economic winter. Trade tariffs failed miserably in the last winter and these ongoing currency wars will not lead to any escape velocity from this economic winter that continues to accrue and compound hundreds of trillions of dollars in debt every day, month and year until the debt deflation is purged.
I liken the present condition of each country trying to outdo their peers in cheapening their currency as a very low vibration approach to a very serious matter. These leaders — global central bank presidents, the IMF, and finance and treasury ministers of developed nations — all seem to lack the common sense and wisdom relating to the unspeakable policies of negative interest rates and mindless printing of new debt that has already proven to be futile. Although I don’t doubt their good intentions, I wonder if they really understand the basic principles that underly the free markets and our universe. The purpose of our venture is to illuminate the general public and these leaders to these core universal themes. I hope our message reaches the central bank leaders and finance ministers of the largest developed countries so they can become more aware of these themes given their decisions have such an outsized effect on the rest of the world. I believe they need a remedial primer on the relevance and impact long wave dynamics have had on overall prosperity for many centuries.
Central banks have relied on pithy rhetoric, misplaced logic, and printing bazookas in the past 6-7 years to overcome the finale of the largest credit expansion in the history of world, one that now stands at nearly one quadrillion USD. Yet today central banks have are under siege perhaps more than any other time since the formation of the Federal Reserve in 1913. The fact is the global economy, and even the hallowed US economy, remains mired in slow to negative growth even after six years of central bank policies enabling tens of trillions in new debt combined with negative interest rates. Their record is so pathetic it is only eclipsed by the silence of those in abstention. And look no further than Japan as the so-called poster child for an ostrich with its head in the sand. They have endured the deflationary winds of the Kondratieff Winter for over twenty years and still refuse to own up to their delusion that has been evident for quite some time. Yet they remain hopeful that their latest parlor trick- a bigger bazooka- will win the day. Today Japan is still mired in a recession despite the largest QE program in world history.
And yes the US and all the developed nations are too suffering these zero to negative growth rates because they all have just too much debt and the debt service alone cramps GDP growth and the new business start-ups that are so important in fostering new cycles of growth. But tragically, central bank policies have fostered all the wrong things- stock buybacks, employee layoffs, plant closings, and just about anything to boost corporate efficiency because so many of the “deciders” of these policies such as CEO’s, board members, hedge fund activists, etc. all are paid so handsomely to advance these not so productive measures. Meanwhile, corporate revenues have plunged for almost two years and earnings are sure to be negative for Q1 and Q2 for 2015. Investors clearly maintain hope that the central bank methadone of perpetual printing and zero to negative interest rates will be a cure-all to ignite global growth. But it hasn’t happened for six years now.
Under Kondratieff Wave theory doctrine, the preponderance of the excesses of the tens of trillions in toxic debts must be weaned from the global financial system in order to promote the proper foundation for growth in the spring cycle season just ahead. But this spring season has been delayed for more than eight years already due to ZIRP and unlimited QE bazookas from all the global central banks. Central banks have destroyed the function of price discovery for along time now through a deliberate and undeniable destruction on free market principles so charting the end game is not so easy.
Truth be told, the Federal Reserve, combined with all the central banks of the world and 90% of sovereign governments have for years mangled the free market in the three most crucial elements of business enterprise- interest rates, global equities, and financial derivatives summing some several trillions USD. The conclusion is all too real- the final purging of a 70 year credit cycle as advanced in the K-Wave theory will be oh so brutal when it occurs. We have been in uncharted territory for so long now so we are numb to any sense of reality with respect to the elements inherent in the free market pricing of paper assets, i.e. stocks and bonds. Although K-Wave theory principles are indeed sound and proven over centuries it remains nonetheless captive to a certain degree to the vicissitudes of the whims of a few central key bankers who are ever determined to overcome a naturally occurring economic winter through synthetic means.
It is for this reason that I have declined in the past year or so to make any projections on the stock markets as I have been humbled by the sheer audacity the collective measure of global central bank bazookas. However I do venture today that central banks are losing credibility with investors and that their days of such clear and effective policy transmission are behind them. I point to one fresh stock chart that is quite compelling. It is from my preferred source of the sacred geometry chart services and can be found at www.danericselliottwaves.blogspot.com . I have followed this source for over five years and have been impressed that they have been so reluctant to call a top in the US markets but they now suggest we are at a tipping point illustrated by a rising bearish wedge formation, a death star of sorts technically speaking. Unlike other Elliott Wave counting sources, they have given credence to the power wielded by central banks and saw it was trumping the classic wave count.
This rising bearish wedge, or ending diagonal, implies a severe and swift decline in US stocks perhaps in the form of a rerun of 1987 price action that saw a 25% decline in one day that was the climax to a 42% decline in that one month. Some sort of reset, perhaps not so dire, may be on the horizon soon given the outsized complacency and record margin debt now evident. I will be looking closely at the trajectory of US profits in the earnings season that begins next week to see if the outlook is as awful as the recent data has suggested and to see how investors react to the suddenly of tens of billions in profits of so many US multinationals that earn more than half their profits overseas in currencies that have been plunging for several months. So it’s very possible we will finally see the 10% plus market correction not seen for so long.
Let’s call it de-stagflation
70’s-style stagflation meets winter deflation
Since our last posting a Nor’easter of global deflationary gale winds hit the good shipping crew of investors twice, and hard. In mid-October its fury sent most stock markets around the world listing and plunging into a near panic until… the real panic began. Global central banks recoiled and responded in kind with some of the most desperate and audacious measures we’ve seen.
It began with Fed governor Bullard, who after the close of trading on October 15 leaked to his preferred media outlets that new rounds of QE were indeed not off the table, never mind that such a move would have destroyed their credibility for a generation given they had jawboned so much in recent months to remove this opium from their toolkit. The algo’s went with the headline as always and said never mind, let’s ramp it higher. Soon after, ECB chairman Draghi inserted new and more exacting language in his rhetoric to imply US style QE was soon to be a done deal for Europe as Draghi claimed the Euro was far too high for his liking. It’s amazing what a decline of 7% or so will do to such a panicked bunch.
But no doubt the most audacious and bewildering move of all was made in a Pearl Harbor surprise attack launched fittingly on Halloween by Japan monetary chief Korouda and his central planning peers. To everyone’s shock they ignited another multi-trillion plus in QE stimulus and also proclaimed that their pension fund would reallocate trillions to buying Japanese and even global stocks in addition to their manipulation of Japanese bonds.
These coordinated moves helped ignite a nine week moonshot rise higher for most global stock markets thanks to unchecked central bank stimulus now featuring negative interest rates and other gimmicks that are over the top if nothing else. In December China lowered rates and promised more stimulus to offset the fallout coming from a property bubble they now admit is bursting and recently Janet Yellen again delayed any clear sign the Fed would raise rates anytime soon. In a short span the four dominant central banks had delivered yet another round of artillery against global deflation that still has yet to stem the global economic slowdown. This fall Europe entered its third recession in five years and many other major countries such as Russia and Brazil also entered into recessions. However the worst performing country was Japan which entered it’s fourth recession since 2008 with back to back quarters of negative 1.6% and 7.3% growth despite providing the most stimulus of any other country.
What to make of all this drama? We take a stab at this here in our postings each quarter. The objective is to provide our readers with analysis of how the recent developments on the global economic and capital markets interplay with the hallmark features of the winter cycle phase advanced by Kondratieff in his long wave theory. It is a uniquely daunting task given the sheer magnitude of the interference provided over the past six years by global central banks and sovereign governments and their measures have no doubt elevated paper assets for higher and longer than most would have believed. But several core themes advanced by K-Wave theory have proven true over this period, namely that despite tens of trillions in central bank and government stimulus deflationary forces would not abate and there would be no hyper-inflation or crash in the USD.
Could it be though that global central banks have finally met their match in a hard asset (oil) they can’t manipulate so well as paper assets (debt)? Proof of their impotence to contain commodity price deflation can be seen today in the utter devastation of the broad commodity index known as the CRB index that includes all commodities from gold and coal to cotton and base minerals. It’s breadth and dept is so vast it cannot be so easily juiced by the central banks as paper stocks. Recently the CRB took out the 2008-9 crisis lows of 250 with prejudice and today stands at 233 indicating a large global retreat from the demand side coming in large part to the continuing slide in China GDP growth.
The CRB slide over time has been consistent but gradual, much unlike the 53% plunge in oil since July that has shaken some global markets to their core. The dramatic and swift plunge in oil is eerily similar to one seen in the summer of 2008 that preceded the greatest financial crisis of the past three generations. Could this dramatic plunge in oil be a red herring for a much steeper drop in stocks? Such a steep and persistent plunge in the CRB is quite ominous to me and forebodes a steep market decline in the first quarter of 2015. I advance that the plunge in this CRB index cannot be overstated and those who believed so in the summer of 2008 realized something more sinister was on the horizon later that fall and we all know what happened next. I find it amazing the mainstream financial press has yet to make this connection and propose the same.
Stock bulls better pray this CRB index finds support and rallies soon because if not then it will be all too clear this commodity price crash means there are serious problems on the demand side going forward and that will cause big problems for a global financial system now at the highest leverage levels of all time. Someone is lying- either the CRB index or stock prices. One is dead wrong- so which will it prove to be? A continuing slow motion crash on this CRB index simply cannot coexist with stocks at record highs. One of them will give soon. The economy will either maintain enough steam to put a floor in commodities or it won’t and they will plunge to new lows. But for now, understate this CRB plunge at your peril. It’s not goosed liked paper assets and may be the real tell.
Kondratieff’s claim that lasting prosperity cannot be fostered until the excesses of the previous cycle now demand further scrutiny today given that six years into this “recovery” there’s still no meaningful growth in the labor force participation rate, wages, or productivity and global economic growth has been plunging for several years. There is one excess, however, that right now rivals debt as the biggest threat to global growth and stability- overproduction.
We have discussed here for many years the fallout coming from the excesses that accompany the extreme debt levels that are the hallmark of all late stage economic winter cycle phases and we have witnessed for years the futility that has marked the efforts by central banks to overcome the naturally recurring economic winters. But we have not focused so much on the other twin tower hallmark of the winter cycle phase- global overproduction of goods.
Such extensive overproduction is a natural feature of any winter cycle phase and is a direct result of the overextension of credit. This has accelerated since 2000 or so as global debt levels and our national debt and consumer credit (primarily mortgage) have exploded to unspeakable levels today. The result is waning global economic demand from nearly all nations on Earth not named the United States.
This excessive global overproduction has been fostered and expedited through the ever-expanding growth in credit that marks the long wave economic cycle. Unlike today, If you entered the workforce at say 21 years old in the mid sixties you weren’t swamped with multiple credit card offers, you couldn’t put down only 3-5% on a house, and you could only get a car financed if you had a steady and well paying job. Not today, and that’s why there are too many cars produced, too much iron ore and other minerals mined, too much oil being produced, etc. for global economies that are too burdened with crippling debt levels.
Another hallmark of the winter cycle phase is the uncooperative and hostile actions nations take against each other as a result of the stresses built up over the economic long wave period. In the last winter occurring in the 1930’s nations engaged in nasty trade wars with the clear intent of hurting the competitiveness of other nations seeking to compete in the global marketplace. Sound familiar? These actions were self-serving, unilateral and ill conceived and they very likely accelerated and magnified what came to be known as the Great Depression. Many point to our own Smoot Harley tariff bill in1929 as a key culprit instigating the sharp decline in global trade that enabled the last winter to endure so long.
These defensive postures taken by so many countries were meant to protect their interests but instead they backfired with a decline in trade that lead to a loss in confidence and then a run on the banks. Such maladies tend to rear their ugly heads during winter cycle phases of the long wave since that’s when competing foes are more frustrated and more likely to take desperate measures. We now see that kind of desperation evident with so many central banks are all determined to see who can devalue their currency the most in order to get a temporary edge at the expense of others. And like the last winter it’s not turning out as they planned.
The pain from the global currency wars is not limited to hyper-inflation at home in the nations choosing to devalue their currency. As the USD index continues to soar, other problems emerge. Since the majority of all global debt is denominated in USD, the real, global reserve currency, any rise in the USD vis-a-vis other currencies means that dollar denominated loans must be repaid in hard USD which is now far more expensive to repay any indebted nation or corporation. Any Russian corp would have incurred ever-expanding losses that incurs huge default risks for many who failed to hedge their exposure. In fact the WSj reported on this today and said there are sure to be defaults in the multi-trillions in dollar denominated loans outstanding from emerging market corps and nations.
This is precisely what happened two weeks ago when Russia decided to bail out oil giant Rosneft with hard reserves from their sovereign fund that were meant to protect pensions of Russian government workers. The bailout occurred becasue Putin deemed Rosneft too big to fail but he failed to see he could not hide such a huge drain from their foreign reserves which are now under much more scrutiny due to the crash in oil which accounts for most of their exports. Investors realized the significance of this bailout and the other panic decision made the same day to increase their interest rates from 10% to over 17% overnight. Investors promptly sold the ruble off to all time lows vs. the USD and it is now all too clear there will be pressure on the ruble currency and the Russian stock market for some time to come. This is significant given that Russia is still considered a major power and sports outsized leverage as the ninth largest economy in the world. Get used to these bailouts, currency crises and defaults for the rest of this winter cycle. It comes with the territory. Just too much debt. Russian corps today owe more than$100 billion more in total than the entire supply of dwindling dollar reserves the Russians now have on hand. Too bad for them they forgot to hedge their rubles.
It’s likely the plunge in oil of over 50% since the summer combined with a moonshot rise in the US dollar over the same period will result in tens of billions or more in defaults over the coming year or so as those loans must be repatriated back into much higher USD. Furthermore, a large chunk of US profits are derived from overseas and are now worth much less. The fallout from these currency wars is sure to be worse than believed once the final tab is in at winter’s end.
The decisions by the Federal Reserve, the ECB, China, and above all Japan serve to showcase the very nature of late stage economic winters. It’s only natural the wars in this cycle take a different form (currency) than yesteryear (trade). This underscores a hallmark feature of Kondratieff’s theory- that each cycle season would have the same characteristics that would unfold in new ways in successive cycles. It’s happening again today with the vicious currency wars that render large population segments screwed unless they can successfully hedge or short their own currency. That’s not likely in these developing and frontier nations so sadly billions of people today in Russia, Venezuela, Brazil, and other nations are all suffering from his race to the bottom in currency wars much like so many in the 1930’s suffered in the Global Depression that was exacerbated by similarly selfish behavior by many nations.
Other selfish behavior is on display at present by the forces in the oil and iron ore markets, perhaps the two most basic and relevant of all commodities. Recently the Saudi controlled OPEC oil cartel decided to maintain strong production despite global overcapacity, weak demand and plunging prices. Why? Because they just want to preserve their billions through a very deliberate and transparent action intended to bring nations with high production costs to their knees in a classic price war. They can produce oil at $10 a barrel and can stomach global oversupply for longer than we imagine, so global oversupply we will have.
The same thing is occurring now in the iron ore market that is controlled, like potash, by a consortium of three players – BHP Biliton, Rio Tinto, and Vale that behave as a cartel yet also enjoy the luxury of no media attention since news of an iron ore cartel seems too boring for the mainstream media to report. In the past year the price decline of iron ore has far eclipsed the price declines of the overall commodities complex and this shadow cartel is still determined to maintain production full steam ahead to forgo short term profits for the lure of putting a sleeper hold on their competition that will endure. And like the Saudi’s, all the major players can afford to maintain a stance that will guarantee global overproduction for some time to come.
That global deflation still endures in so many economies despite the mighty efforts by central banks is very simple- global central banks are ignorant to the futility of their measures. They fail to see the irony that they are seeding and feeding the deflation frenzy they so despise. They accomplish their fait accompli through ZIRP and QE, etc. that promote rampant mal investment, overproduction, and over consumption through ZIRP and QE policies promoting a negative feedback loop that assures more overproduction, consumption, and deflation.
There is much to this condition of deflation that is vexing and difficult to fathom. The conditions we see today are so unique, so perplexing and such a conundrum they beg for a new term to be coined to give its proper due. I choose to call this new term global de-stagflation. It incorporates the two pillars of classic 70‘s style stagflation- rising prices and stagnant near zero growth- with bona fide deflation not evident in the 1970’s. For the first time ever we see systemic deflationary forces coupled with very stagnant global growth combined with acute inflation, especially in South America and other oil dependent countries like Russia, Iran, Nigeria, and Venezuela that depend so much on oil for their tax revenues.
If you think I am nuts to suggest inflation is rampant and can still coexist with deflation then just ask any of the billions of people living in Russia, now entering hyperinflation from the crash of their ruble, or Venezuela, Argentina, Japan, etc. that are suffering from ultra high inflation coming from policy missteps from their governments and central banks who made clear decisions to tank their own currency knowing it would lead to much higher prices and pain for their people. Rampant inflation and even hyper-inflation is now evident in many countries around the world, just read the papers.
Or you could ask any of the millions of US residents who have routinely seen double digit increases in healthcare college tuition, sports events, bar tabs, etc. that represent persistently high yet not runaway inflation. These inflationary pressures are indeed real, never mind the headline numbers from our government that are so biased to preserve an illusion of muted inflation that is a fantasy. Such an approach is rooted in our government’s desperation to minimize annual cost of living increases in its welfare programs that now total tens of trillions.
Altogether these inflationary pressures are prohibitive, and not so marginal at all. Quite unlike the 1970’s however, much of the global inflation component won’t come the demand side of the curve. Instead, 21st century style inflation madness comes almost exclusively from the beggar by neighbor policy so many nations seek to cheapen their currency in a futile attempt to overcome their own fundamental and strategic weaknesses in how they can compete. But there can be no doubt at this time that debt deflation, stagnant global growth and that very large and concentrated levels of inflation do coexist all at once today.
I guess we never knew how good we had it with the 70’s style stagflation. All we had to deal with then was the two headed monster of inflation and slow to stagnant economic growth. Fed Chairman Paul Volker knew what to do- raise interest rates and continue to jawbone to be sure to throw the US into a recession, which he did. It only took only several months of slower growth in 81-82 to whip inflation and sow the seeds for the greatest economic expansion and capital gains in world history. But overcoming this dilemma today for any Fed chief or Treasury Secretary is much tougher I believe because the aggregate levels of debt among federal, state and local governments together with global central banks have proven to be a prohibitive foe in establishing enduring global growth.
So now we have a three-headed monster with the newest foe- debt deflation- now looming large and the most formidable of all. But here’s the rub- this deflation brand is coming at the tail end of a grand super-cycle of credit now 70 years in the making that now amasses over $100 trillion in the aggregate between all the various sovereign governments, corporate bond debt and consumer debt and over $3 quadrillion in notional derivates exposure by the large global commercial banks. This means that any unexpected developments in the financial markets could and would upset the apple cart like never before.
Most economists and those in the mainstream financial press would not argue with some of our claims but they would counter it doesn’t matter so much to the US given the newly emerging investment doctrine known as “fortress America” that has become mainstream and assumes the US can overcome any global structural weakness. Here I disagree with them. I take issue with any notion that the US, while certainly exceptional in so many areas, is immune to the global forces of deflation that are building up quite ahead of steam again despite tens of trillions in global fiscal and monetary stimulus.
I advance there may be acute complacency among investor perception of US stocks like never before, even in the 2000 Internet bubble. Consider that all other global stock markets are today still down over 24% collectively from their 2007 highs and over 30% inflation adjusted yet US stocks have more than tripled from the March 2009 lows. Such a disparity is several standard deviations removed from reality and has never occurred, nor has any lasting period of corporate profits that exceed 4-6% of GDP yet today corporate profits exceed 12% of GDP.
It seems few realize this or the simple fact that we have been enduring an economic winter all along since 2008, masked by cheap easy money from central banks, financial engineering from corporations, and the headlines of nominal highs that don’t look so great upon further review.
Deflation to the fore
Oil, gold, bonds and global GDP scream deflation
Here we go again. For the umpteenth time since the 2008 financial crisis the rate of global growth has plunged yet again. But this time is different- on two counts.
One is that US stocks are at all-time highs and stocks in most other markets are either near all-time highs or at multi- year highs and this is occurring at a time when global GDP rates are plunging. This is a first since the 2008 financial crisis and such a vast discrepancy is worth noting. The other unique development is just how broad based this latest downturn has been all over the world.
Today even the mighty German and Chinese economies are suffering headwinds not seen since the last crisis. In fact Germany experienced its first decline in growth in the second quarter and most Eurozone countries are now steeped in a recession despite negative interest rates from the ECB, underscoring the folly of their gimmicks. Yet despite their LRTO to commercial banks, negative interest rates and the like the ECB decided at their last meeting this wasn’t enough to spur growth so they finally decided to deploy full scale QE (Ponzi) measures.
In recent weeks commodities, bonds and global GDP rates have plunged together to invoke fresh worries about deflation. Last week the CRB index of all the major commodities plunged below its key trend line as silver joined oil and many other commodities experiencing severe technical breakdowns in their price as global demand continues to wane. Aggregate commodity prices better reflect economic conditions than stocks and bonds because they are not as directly monetized by the global central banks. Thus this recent plunge in commodities can be seen as very indicative of another leg down in global growth.
Another tell implicating deflation is the global bond markets. Yields on US and other sovereign debt refuse to break out higher as they should with stocks at all-time highs. And despite 25% unemployment and negative growth in Spain investors have somehow decided that prices of their bonds should be higher than US bonds. Same deal for Germany, Italy and even Ireland. This suggests two things are in play- sheer insanity on behalf of those who own those bonds and also that these bond markets collectively are also expecting deflation in the near term. And despite the most havoc in the Middle East and elsewhere in decades, oil prices continue to swoon and gold cannot catch a bid. Something is different here -global demand for goods in no doubt waning in this late stage of this long wave economic cycle.
It’s all too evident that global central bankers are now staring into the deflation abyss with seemingly with little to offer other than a hollow promise to never allow rates to rise again. They are now compromised by the overhang of trillions in accrued debt that was supposed to be a remedy and restore growth. But it turns out you can’t restore growth by massive monetary stimulus at the tail end of a major credit super-cycle as advanced by the Kondratieff Wave principles. Too bad the central banks didn’t study the Japanese economy and stock market over the past 25 years for a remedial primer on the importance of long wave cycles.
The perils faced by Japan can hardly be overstated. The capital flight from Japan in recent months is staggering and without precedent and accounts for the dramatic depreciation in the yen against other currencies. In fact this plunge is alarming on many fronts because it’s pace suggests something more ominous could be at hand. For anyone who applauds Abenomics in boosting their stock portfolios there are thousands of Japanese citizens and small business owners who curse them.
Since the fall of 2012 the average Japanese citizen has seen their purchasing power greatly diminished by the rampant inflation caused by a determined effort by PM Abe to devalue their currency. There is just no free lunch with superficial schemes to reflate economies through wholesale currency debasement. Wiser investors in Japan knows this and want no part of owning Japanese assets as they fear their value will continue to erode in real terms as the yen continues it’s epic plunge unabated. I wonder if the infinite wisdom of PM Shinzou Abe ever considered the fallout from seeing trillions in institutional capital flee the country. Same could be asked of PM Putin in Russia. It does matter. Oops.
Currency moves on this order of such a major developed country are quite rare and unsettling to say the least. In 2012 I posted comments titled Japan: Land of the Rising Yields suggesting that one day Japan would become so indebted their currency would plunge and their rates would rise as investors demanded more yield for such risky debt. The sudden and awesome capital flight from Japan in recent weeks may just provide the impetus for those rising yields. Heck, at near zero yield they have nowhere to go but up. Let’s remember that Japan is by a mile the most indebted country on Earth and they also have the second largest and most liquid bond market on Earth, making any disruption in that bond market quite an international event. Investors of paper assets in any market should be very afraid of anything that would trigger a sudden rise in JPY bond yields.
This capital flight from Japan has taken much longer to play out than many expected because for so long Japanese citizens and corps have for years bought Japanese debt like fools at near zero returns. But now the trillions of institutional fund flows have finally gotten the memo and abandoned Japanese debt for much greener pastures in the US and elsewhere forcing the yen to plunge like never before. The soaring inflation coming directly from Abenomics impacts the average citizen in Japan more than other countries because they have to import so many basic raw materials, namely oil, and thus most of their citizens suffer from outsized inflation that destroys their purchasing power. More proof of the colossal failure in their incoherent monetary scheme was delivered with the release of their Q2 GDP numbers which showed an alarming contraction. Oops.
The people of Japan have now for decades suffered from the severe effects of the fool’s errand of a botched monetary policy- near zero return on their savings, a stock market that has lost more than 70% since 1989, and recently a crippling and outsized inflation since 2012 coming from a currency now seen as junk from global investors. Any gains in their stocks are mostly overwhelmed by the very real destruction of their currency. Turns out there there is a price to pay for such a massive and capricious currency printing scheme by Japan and the rest of the world should take note. Turns out you cannot overcome a Kondratieff Winter with pure debt monetization. Mother nature does not take so kindly to that.
Japan has been for decades and is now still paying a very steep price for ignoring K-Wave principles and I suspect many other nations will too in the coming years. Once again, a global Kondratieff Winter is likely to have its roots in the one country most entangled with it’s traits- Japan. Hopefully other nations will come to see the empirical record in Japan since 1989 as one that showcases the sheer absurdity of expecting QE and other central bank gimmicks to effect true and meaningful change that can provide a sound foundation for meaningful growth.
The long anticipated collapse in Chinese property prices has begun to manifest in earnest of late despite last ditch efforts this spring by the Chinese authorities to relax lending standards. It hasn’t worked according to recently released data and many still expect a wave of corporate defaults to soon mushroom there, reflecting a horrendously overbuilt landscape that is a hallmark of any late credit cycle that precedes a Kondratieff Winter. It appears now perhaps closer than ever for the inevitable bursting of the Chinese property bubble.
To thwart this and maintain their target of 7.5% GDP China recently announced another stimulus of almost $1 trillion to their banking system but that is unlikely to remedy such vast over expansion over so many years. And just last week a top official basically confirmed that attaining 7.5% growth in China is most unlikely. When this is confirmed later this year it will further validate the quandary global central banks face in stimulation growth through policy tools that are outdated and increasing ineffective.
One tell that the gig may already be up in China is that the gambling revenue in Macuau has plunged dramatically since late spring. Another tell is the desperate selling of homes by Chinese bureaucrats eager to avoid the wrath of the severe clampdown of corruption by the new ruling regime. China will be hard pressed to achieve their self imposed capricious and arbitrary mandate of 7.5% growth year despite their extensive goosing of the numbers. Yes, the deflationary choo-choo train is still chugging along despite the tens of trillions of fiscal and monetary stimulus from the global central banks. As It turns out the money changers aren’t all that and long wave credit cycles do matter after all. Oops.
This premise of deflation to the fore is further cemented by the moon shot advance seen by the US Dollar Index in the past few month, breaking through all kinds of long term resistance through a combination of global reticence and the growing divergence of economic output between the US and all other nations. We have advanced here on our site time and again since the financial crisis that the US dollar would not crash until most of the global debt deflation had been removed and as of today that is hardly the case. The critical 78.50 USD Index line in the sand held once again this summer which no doubt implies that deflation will reign until the final purge of excess debts are removed.
The dollar surge and such persistent global deflation is very much in line with Kondratieff Wave principles advancing that no sustainable growth can ever be achieved until the preponderance of excesses of existing toxic debt are removed from the global financial system, Given that these excesses are now at historic highs so we can expect this nasty little bitch we call debt deflation to continue unabated despite all those trillions in stimulus. We have advanced for years here that the folly of hyper-inflation wasn’t likely to occur until the full measure of debt deflation had been exorcised and that has proven true. A robust US dollar and a crashing commodity complex shows the battle against deflation is hardly over.
Since the 2008-9 crisis, we deflationists have been too early on forecasting the major corrections in the stock markets as we have underestimated the ability of central banks to pull off their balancing act of promoting some growth without risking the ruin of our financial system. But the hallmark principles of the Kondratieff Wave have clearly been true to form in forecasting so many of the conditions now baffling the experts- the ultra-low growth and high unemployment in global economies, low inflation everywhere and the US Dollar juggernaut that have altogether served ironically to help stocks maintain their elevated levels. These together with unprecedented corporate stock buybacks have sent stocks higher and higher despite a worsening global backdrop.
So the divergence between global economic impotence and global market omnipotence is peaking now before our eyes. The stock markets in the US and many other developed nations are now reflecting some of the traits seen at market tops- near zero bearish zeal, expanding PE multiples, frenetic IPO markets, and more. Our primary count remains that the US amid most global stock markets are now topping and have very limited upside before a sizable pullback occurs this fall into March of 2015 and what began as a needed correction could morph into a bear market If central banks lose their ability to influence the credit markets. No one can predict the true fallout coming from any bona fide change in sentiment among investors to the long overdue reversal in interest rates. If such a reversal was anything less than orderly one could expect a significant pricing of risk along the entire continuum of paper asset securities like stocks and bonds.
More than six years removed from the financial crisis most had expected much better results from global economic performance from ZIRP and the monetary firehose of tens of trillions printing by the Federal Reserve and other central banks around the world. The only inflation to be seen has come from stocks and bonds that can’t help but rise with such tailwinds. Fed policy in the Yellen era has centered on the the promulgation advancing the notion of macroprundential regulation in formulating the monetary policy responsible for allocating credit in the most dynamic and complex financial system ever. It is essentially an overkill in the micro management of an financial ecosystem that is not feasible. These directives coming from the Fed and other central banks are the antithesis of market based solutions and will ultimately prove to be futile. The command economy style championed by the Federal Reserve has no place in our modern and dynamic financial marketplace.
GDP Growth Still Elusive
After 6 years, folly of QE & ZIRP all too clear
The aftershock tremors of the recently reported final GDP revision of negative 2.9% growth for the first quarter of 2014 is still reverberating in many circles, but you wouldn’t know it by looking at the S&P index which keeps making new all-time highs. This pattern has been evident for many years as investors have equated debt with prosperity and ignore any threat, real or perceived.
The lousy revision also highlights another folly the market ignores- that GDP growth estimates made by central banks, the IMF and Wall Street firms are pure garbage. It is much like the dance CEO’s do during each quarter with Wall Street analysts in quietly lowering expectations so they can then beat the lower number. These GDP growth forecasts are typically too optimistic and are then revised down but never up. The real growth numbers reported since the financial crisis have been nothing less than awful given the tens of trillions in global fiscal and monetary stimulus intended to spur growth. Instead of this liquidity from central banks, economies need structural reform to ignite growth, namely debt and spending reductions together with productivity gains. Presently productivity gains are declining for the first time in a generation.
Despite all this stimulus we are likely to conclude the first half of 2014 with negative growth. For this not to occur, the Q2 GDP would have to grow at 3% or more. The current estimates of final 3.5-4% are likely too optimistic and are now quietly being revised down. That would be two consecutive quarters of negative growth when averaged and that’s almost a recession. But imagine how much lower it would have been without the massive extension of credit to sub-prime borrowers of autos that comprised most of total purchased. These goosed figures are indicative of what many call the “phony economy” that promotes consumption and consumerism financed with ever increased debt loads.
Another example of economic data that is mangled by the mainstream media each month is the jobs report, perhaps the single most important of all the economic data released by the government. The recent jobs report showed a marked decline in full-time workers with most of the new jobs are low paying part-time jobs that do not add productivity to our economy. Wage growth has stagnated for decades but even more so in recent year. But investors chose instead to trade the headline number of 288,000 jobs created and so the rally continues despite a near recession and fewer people working now than six years ago before the financial crisis.
There are some today who feel the economic winter of the preceding K-Wave cycle has come and gone with the rally in the stock market coupled with a lack of global recession or a financial meltdown. But the trillions in unpayable debt from weak sovereign, corporate and individual borrowers cinches that’s not the case. However there is one development worth noting to those follow K-Wave theory closely. It is that a key element of the Kondratieff Spring Cycle (new and disruptive technologies) has emerged to overlap with this winter to greatly help the US economy and helped forestall the final capitulation of the Kondratieff Winter. In recent years oil fracking and the emergence of cloud computing in particular have been critical in creating jobs and increasing productivity.
In past K-Wave cycles, we would now be in the early stages of a sustainable long wave growth cycle if most the bad debts were allowed to default in 2008-9. But for the first time global central banks and governments doubled down on debt through bailouts, etc. instead of allowing defaults in an attempt to overcome the winter cycle. It did prevent a global catastrophe at the time but also sowed the seeds for a greater one down the road. There is just no free lunch here folks- the immutable laws of finance dictate that prosperity cannot be achieved by piling on more debt as most of the developed world has done for the past six years.
The truth is that central banks and governments have pushed this winter season out farther than ever before. Just ask the 80-85% of Americans who are not so rich if the economic winter of 2008-9 ever dissipated. The winter season indeed never ended and the evidence lies in the fact that global growth just cannot get any traction despite the trillions of fiscal and monetary stimulus and the massive overhang of so much debt is the culprit. Such an overhang is prohibitive, not marginal. The day of reckoning will occur eventually when the bond vigilantes finally return to sort out the distortions now prevailing in the pricing of risky debt. These distortions are now at levels that are unspeakable.
For example, the Spanish ten year bond recently traded at yields lower than their US Treasury equivalent despite the enormous gulf between the two economies. Putting it simply and bluntly, at present there is nothing real in the world anymore as it relates to the pricing of risky debt and equity securities. Italian and Greek bonds have rallied to laughable levels as have junk bonds which now yield only 4.8% as a group. The majority of leveraged loans issued recently are covenant light in that they lack adequate collateral or risk controls. The surge in auto sales for the past two years is entirely traceable to the huge increase in financing provided to those who are sub-prime credits. In fact the WSJ recently reported that sub-prime borrowers accounted fro more than 70% of used cars and 35% of new cars sold this year. And credit card companies have also followed suit in providing more credit to borrowers with the highest risk profile. They may have ended the NINJA home loans, but banks and the credit markets are today every bit as frivolous and unsound as they were in the days preceding the last crisis.
These developments have occurred as a direct result of central bank policies designed to push investors out the farthest on the risk continuum in a sick and pathetic chase for yield in a Zero interest Rate Policy (ZIRP) world. It has goosed the economy to some degree but at what cost? Much of this junk debt will likely default eventually. In fact the default rates on student debt are skyrocketing and so are the late night infomercials of companies promising to remedy this tragedy. We can expect this student loan bubble to be in the headlines for the next several years given the incredible surge in levels of this debt over the past few years combined with the higher interest rates that went into effect on July 1st.
So while the party rages on in the stock market, the trends in so many areas that affect the broad population remain challenged beyond the student loan bubble. Today tens of millions of homeowners have negative equity in their homes and cannot sell or move despite the recent increases in home prices. Untold millions of US citizens, many of them seniors, can’t earn anything on their savings thanks to the Federal Reserve. And tens of millions of Americans have been unemployed for longer than six months rendering them as being completely removed from the US labor force. Sadly these problems affect perhaps many more Americans than those who have benefited from central bank easy money policies.
A recent op-ed in the Wall Street Journal opined that America is morphing into a bifurcated society made of of two distinctly different groups- the top 10-15% who are benefitting enormously from asset price inflation and the rest who are mired in a decades long slump in wage growth. Surely the policies of central banks and past and present administrations are directly to blame for this. At worst cynics could argue it’s all intentional and a conspiracy for those in power to consolidate their gains and power. Others argue the policies are well intended and helped the US over the years by avoiding a financial meltdown.
I have a different take as an advocate of long wave economic theory. The policies may or may not be well intended and I don’t advocate promoting any conspiracy here because it would be too hard to prove and would be futile. But I do believe emphatically that the global central banksters and heads of state of the major Western democracies get a grade of F minus in their obvious ignorance of basic economic long wave dynamics. Through their ignorance they have failed in their basic task to provide and promote the general economic well being of the US in the coming years. They seem to share two traits- the desire for self preservation and to maintain the status quo and have acted accordingly by always choosing policies causing the least pain in the short term in response to pressing issues. You don’t have to know much about economic long wave theory to know they have put us at great risk by allowing fiscal spending and monetary debasement run amok for so many years.
I believe we are close to some event that will shake thing us quite a bit that could leave many investors unprotected for a serious and swift decline much like we saw in 1987. Then the market plunged 25% in a single day and a major reason for that decline was a very high level of complacency coming from the belief that the so-called “portfolio insurance” products being touted would prevent a crash and we all know it did not.
Today investors are equally as complacent with the belief central banks can and will protect them. Even a small development that was troubling could trigger a large sell-off because in the back of most investors minds they do not trust this rally. It is overextended to the upside to a prohibitive degree. I would not be surprised if such a sell-off would be triggered overnight in the futures caused by an event in Europe or Asia such as a geopolitical or credit market event. By the time the US markets open the futures would far below the key support levels the S&P had to defend and this would create a gap down sequence that would feed on itself as everyone realizes “OOPS!”all at once. It seems to me all the elements needed for such an event are lining up quite nicely.
Awesome Divergences: Big Cracks in Winter’s Ice
But still waiting for the trigger event
Despite the recent nominal highs in the S&P, the risk that the long wave credit bubble is bursting still remains formidable. The major averages were mixed but basically flat for the first quarter of 2014, halting major advances made last year. Several flashpoints emerged to spook investors such as the turmoil in the Ukraine, the broad meltdown in the key emerging markets of Turkey, Brazil, and others and mounting evidence that China’s credit bubble is now imploding.
Deflationary forces are still lurking everywhere, especially in Europe, despite joint efforts to stimulate growth from central banks on every continent on Earth except Antarctica. Since 2008 central banks have lifted heaven and earth to overcome the deflation typical at the end of a debt super-cycle yet have only accomplished one thing- extending this long wave winter for a more dramatic collapse.
Global growth rates so far in 2014 have continued their descent since mid- 2012, especially in the high growth countries that have fueled the global market rally in recent years. Current stock market valuations have diverged from economic conditions which are still quite shaky today some five years after the March 2009 lows. And there are so many other divergences now evident that are noteworthy.
So where do we start? How about the three major US indexes that diverge from each other seemingly each and every day. For example, on Friday the Dow Jones average was down less than 1% but the NASDAQ plunged over 3.5% from it’s intraday high. The S&P made new nominal highs in March but the Dow Jones could not for one day post a closing above its all-time high set late in 2013. Friday’s performance in the Dow Jones average was particularly troublesome for the bulls given that it made a new intra-high in the mid-morning and then plunged for the rest of the session. They call that an “outside reversal” in Wall Street jargon and if history is any guide it means a major reversal has just begun.
But even the S&P’s recent nominal high can be seen as suspect as it still falls short of the all-time inflation adjusted high in early 2000 when one considers how much the true inflation rate has diverged from the laughable levels reported over the years our government. Only a close through S&P 2000 or so would make the case that stocks had made new highs in real terms. Likewise, the NASDAQ index today is still some 70% or so under of it’s March 2000 peak over 5100 and China is still over 60% below it’s 2007 peak and Japan’s Nikkei index is over 80% below it’s 1990 high so you get the point. So please forgive me if I don’t proclaim the recent low volume melt-up to new all-time nominal highs as something so totally awesome. These nominal highs were made in the most stretched bear market rally in history reeking of massive non-confirmation divergences coupled with ultra low volume. They are a farce that could only exist from global central bank intervention that proffers the illusion of real gains in nominal terms.
Contributing most to all these divergences is the scale of the response given since the crisis in 2008 by the global central bankers to distort price discovery in the most important economic input of all- the cost of money via interest rates. By holding them down so low for so long capital has naturally flowed to inefficient uses and hasn’t chased its highest utility. What has been planted by central banks since 2008-9 has sprouted and isn’t so pretty. Confusion and wild weeds abound, not flowers. Here are some prime examples.
In the developing world, such as the major emerging market nations of Brazil, India, Turkey, and others interest rates and inflation have soared over the past 18 months as the cheap easy money has been removed. This is unfortunate since most investors had expected these countries including China to carry the torch of global growth for many years to come. But instead their growth rates plummeted from double digits in 2010 to modest levels today. Since 2012 the Goldilocks outlook for these BRICS nations (ultra high growth with low capital cost) has been turned upside down by the reality that easy hot money flows from the West are now gone with the wind. Just days ago Brazil was forced to raise their interest rates to over 12% to combat ever escalating inflation. Such levels are off the charts and as another example of the awesome divergences evident today.
Another group of nations facing headwinds are the developed nations that have a much different challenge- they are crippled with tens of trillions of sovereign and regional state debt that threatens to hamper their economic growth for many years to come. Led by the US, Japan, UK, France, etc. they have all used their central banks to monetize their debt to prop up their stock and bond markets much higher than would be otherwise. In pursuing this they have forsaken strong currency policies that were for decades a pillar of strong industrial nations seeking to maximize their prosperity.
Sadly today these sovereign nations have also chosen to race to the bottom to debase their currencies faster than the others to seek short term gains. This “every man for themselves” approach can be seen as a proxy for the devastating protectionist trade wars that broke out in the late 1920’s that endured throughout the Great Depression. These short sighted policies are a hallmark feature of past economic winters as nations act in self interest out of fear of what may happen in the short term with disregard to any long term benefits. In the last Kondratieff Winter this took shape in the form of tariffs such as the Smoot Hawley Tarrif Act of 1930 and today it is given expression through the enduring currency wars of monetary debasement taken by every country on Earth not named Norway.
Even China joined the party recently with measures designed to weaken its currency. We have now come full circle since 2005 when the US Senate deliberated on labeling China as a serial currency manipulator for keeping their currency too high. Remember all the fuss back then? But all that fuss is old news now that the deflationary forces of this economic winter have finally arrived onto the shores of the mighty Chinese economy that until recently had been considered too mighty to meet such a fate.
Currency debasement has been a staple of human history for thousands of years and each scheme over the ages has failed because the temptations for abuse were too alluring to those in power. The futility and tragedy of currency debasement is a core theme of any economic winter so we were sure to include material here on our site relating to this history that can be found in the Taboo tab under Fiat Currency. History proves you cannot achieve enduring prosperity through shady schemes like QE, currency debasement, or manipulating coinage.
The unfolding crisis in the global emerging markets that came to the fore in mid January squarely has its roots in central bank actions taken in 2008-9 by the Federal Reserve that altogether rejected the core principles of K-Wave theory to promote the removal of excessive debt to enable a fresh recovery unburdened with debt from the previous cycle. Instead the money changers and global bureaucrats doubled down on printing tens of trillions of new debt in a futile attempt to overcome a economic winter that’s a natural component of free market economies. But that’s obvious and is old news to most of our readers. Even the ECB, the final holdout on implementing the absurdity of QE, recently all but said they will do this given the looming deflation knocking at their door. These policies have proven to be futile but central banks now seem boxed in to this policy.
Since 2008 the draconian policies of the Federal Reserve, the ECB, the Bank of England, and the Bank of Japan, etc. altogether induced hot money flows to chase the higher yields in riskier emerging asset markets to overcome the limitations imposed upon them in low yielding securities such as US Treasuries. Soon after trillions of hot money flooded the emerging markets umbrella- Brazil, Turkey, India, etc. But in May of 2013 this hot money bailed out of those markets under the realization that the Federal Reserve would not provide easy money forever. Since then investors of all many emerging market nations have suffered because they lack their own central banks that can prop up their local sovereign bonds through outright debt monetization like the Fed, ECB, BOJ, etc.
In this 2009-early 2012 period Brazil, Turkey and other nations received a real gift horse- far lower interest rates than they deserved – courtesy of central bank madness determined to flood the world with cheap credit. In this period some of these EM nations squandered this with pet projects and unchecked wasteful spending, confirming once again that easy money policies by design serve to prevent capital from chasing its highest utility because the misallocation of credit is the end result of short sighted agendas advancing no fallout is possible.
Parsing the trinity of EM classes
Most emerging markets are alike in that they face a very difficult path ahead but yet for entirely different reasons. China is facing a debt bubble of historic proportions that is fueled by excessive consumer debt and a shadow banking system that has ballooned to tens of trillions that is spiraling out of control. Their shadow banking system now is so levered that it’s only supported by 2.5% equity. So any hiccup in growth there could have serious consequences for the investors who hold trillions in trust notes issued through their shadow lending system. In March two China corporations defaulted on these trust notes and that is likely just the tip of the iceberg given that that over $600 billion of this sub-prime credit must be rolled over just in 2014 alone. These defaults are now accelerating given that the Bank of China has finally chosen not to bail them out, so look out below.
If confidence were to ever be lost by those Chinese investors who finance these companies, that trust system would crash quickly and severely impact China’s GDP growth. Their economy could crumble from such an overdependence on shadow banking to finance growth in their economy and this development may now already taking shape with the release on March 10th that China’s exports fell 18% from the previous year. This is a staggering figure unthinkable just weeks ago that points the finger squarely at growing global deflation that naturally occurs when overall credit levels have peaked. Yes, they have.
Naturally any default scenario would hamper the mighty Chinese export machine and thus likely impact global GDP growth substantially. The Chinese pattern of hyper-growth over-expansion is similar to to first major bust the US experienced from 1873-1879 coming after the growing pains of a very extended expansion following our coming of age as an industrial power. The parallels are striking now between these two models. In China, the state sponsored infrastructure build out in China from 2001-14 was too much too fast and capital did not chase its highest utility. This is much like the railroad expansion in the US that began in 1835 that imploded in 1873 and caused a stock market crash and a continuous recession of negative growth of over seven years, by far the longest in US history.
Such dubious overcapacity is a hallmark feature of any Kondratieff Winter that cannot be so easily overcome by any level of cheap credit from central banks. i repeat here that the parallels between the US in 1873 and China today are just amazing although few may be aware of the first major economic winter in the US with the Panic of 1873 that seemed to have escaped our national consciousness. Perhaps there will be a great awakening of this when the China credit bubble implodes from its own weight and it suddenly becomes self evident that it’s not a good idea to goose short term growth with capital spending that is inefficient and reckless. Most of the so-called white elephant projects in China that are now ghost towns, all dressed up with nowhere to to. Many major property developers there are now sure to default, marking the end of an era of easy credit in China.
The current economic backdrop of these various nations I have described here is very unfortunate given that billions of people are now suffering from the policy mistakes of those few who are so committed to ignoring natural economic law. While it is difficult to predict the exact outcome of each of these troubled nations it’s not so hard to predict the outcome of them as a group- the net effect will be very deflationary. The party is now winding down as global GDP growth rates are plummeting, led by none other than the group of nations investors were counting on to carry global GDP growth for years to come- the emerging market nations now under siege very late in this credit supercyle.
I have advanced here in the past comments on this blog of the notion of a Rising Yield Deflationary Crash, entirely unlike any other crash scenario in history that were all based on bank runs, hyperinflation, or a decline in economic growth such as a major recession or a depression that trumped everything else. This rising yield scenario may already be well underway through the recent flattening of the yield curve even though to date this has not had a direct consequence to stocks but may at some point. Today US Treasury yields while still very low, have been rising for nine months and this coupled with the explosion in emerging market yields could very very troubling if rates rise too fast.
In fact, short term US Treasury yields, most notably in two year Treasury notes, have exploded since new Fed Chief Janet Yellen’s misstep last month in parsing the timeline for rate increases. If this were to continue it could be devastating for the capital markets as stocks and bonds and most paper assets would plunge in value. Why? Because most of the tens of trillions in US government debt is in shorter term maturities that must be rolled over in the near term. If short rates rise too fast it will dramatically increase our interest expense and impair our credit outlook with billions more of interest expense to pay each year. It would also destroy billions of investor wealth quickly given that there is 4-5 times more capital invested in bonds than stocks.
institutional investors who bought bonds or any other securities that are interest rate sensitive with leverage would incur steep losses at even the slightest rise in short term rates. Furthermore any rise in short term rates will also incur the collateral damage of freezing up the short term paper markets that grease the wheels of American business each day. If they were to ever become frozen, the mighty US economy could plunge into recession quicker than most think.
Don’t underestimate the consequences if this were to transpire because it would have large ripple effects coming from the unwinding of so many levered positions that were so sure the Federal Reserve mandates of forward guidance could prevent such an event. It would trump everything in the coming months and years, rendering GDP growth forecasts, company EPS estimates, PE multiples and other relics of the past not so useful. Instead, the havoc of rising rates in a world polluted with hundreds of trillions of debt would be a tour de force of its own. In a landscape littered with manipulation from central banks it is impossible to determine when this may come to pass, but the higher truths of natural law mandate such a reckoning eventually.
When it does come to pass nothing much else will matter as the final stages of this Kondratieff Winter unfold. Everything will be her little bitch. EM’s would feel the most pain as they are so dependent on foreign capital. Since the global output component from EM is now over 33% vs. around 10% in 1998 a much bigger ripple would come from any 21st century Asian Tiger crash, unlike the one in 1998 that was plugged in a few weeks with a quick infusion of central bank liquidity. Any bust from EM today coming from this toxic combo of rising rates, plunging currency and soaring current account deficits would be much more devastating than the brief but alarming Asian Tiger crisis of 1998.
Rates must and will rise eventually and will do so much faster than what is currently accepted today. The move higher in rates will naturally be inversely symmetrical to the aggregate of the QE policy response since 2008 which was and that implies pain in the form of wealth destruction as the trajectory of interest rates ascends higher. Any pundit who says that’s a good thing because it reflects an improving economy is clueless about where we are in 2014 in the long wave credit cycle and it’s implications for credit and wealth destruction.
Ben Bernanke post mortem
We bid farewell to Ben Bernanke a few weeks ago and despite my misgivings about his policies I did admire his determination and ability to handle the pressure of such an crucial post. My grade for him is C minus but only that high given his decisive actions in late 2008 to prevent what was then a true run on the banking system. At a critical moment he did take measures to provide the needed confidence to grease the wheels of a credit system that had ground to a halt.
That aside however, I believe he failed in many areas. Fed minutes show he was the intellectual force behind their policy in 2003-4 to lower rates and then maintain them far too long that helped enable the housing bubble. And he made the infamous 2007 proclamation that sub-prime crisis was contained – yet hardly. There’s no doubt he failed to foresee the magnitude of the greatest financial crisis of the past two generations until it had already crashed. And in May of 2013 he failed to appreciate the fallout coming from the unintended consequences of 0% rates which backfired when investors abandoned EM assets ten seconds after he alluded to the tapering of QE, creating havoc in EM that has endured.
But his worst mistake was the “great experiment” of multiple QE programs deployed long after the credit markets were restored in 2009. This created moral hazard which will likely come home to roost long after he is gone from the spotlight he cherished. When forming this website in 2006 I was sure to include his infamous 2002 speech “ Deflation- making sure it doesn’t happen here” and advanced the notion that it was no mistake he was selected for Fed chief as the Washington elite knew he would combat the looming paper asset bubble with just the relief the Washington elite wanted- unabated printing ad infinitum.
For sure he did not let those down who chose to label him as “Helicopter Ben”, a moniker sure to highlight his NY Times obituary. Throughout the greatest financial crisis since the 1930‘s he was as cool as the other side of the pillow and unflappable in his long standing conviction that radical monetary policy was justified as the best solution. In the end Bernanke was all that and more, a rare breed who lived up to his billing determined to overcome a deflationary economic winter the way by he was hard wired -with electronic keystrokes. History and my intuition however tell me such an approach isn’t likely to succeed.
KW preview for 2014: Deflation
Epic battle pits central banks vs. Kondratieff Winter
US stocks surged to new highs in the final days of 2013 capping a remarkable rally that likely exceeded the hopes of most bulls and surely frustrated bears and those skeptical of the ultra loose easy money policies of global central banks. While some recent economic data has been encouraging, overall economic conditions reflect very much the attributes associated with a Kondratieff Winter, albeit one that hides in plain sight and is not yet visible to most. Since 2008, global fiscal and monetary stimulus since the financial crisis has been spectacular in scope, exceeding $30 trillion combined. The Fedʼs balance
sheet recently eclipsed $4 trillion and will exceed $5 trillion in late 2014 at the current pace. Yet in 2013 global economic output was tepid at best. The worldʼs largest economy, the Eurozone, grew at a fraction of 1% and China the once roaring BRIC economies including China have slowed dramatically. The US averaged just under 2% when you remove the flukish inventory build seen last quarter. So despite these spectacular levels of global stimulus in effect the vast majority of global economic output performed poorly and far worse when compared to similar points in past economic cycles following a major downturn.
So is this muted growth the new normal?
Likely yes given the deflationary implications coming from the overhang of so many trillions in debt that must be serviced by individuals, corporations and local, state and federal governments all over the world. K-Wave theory holds that sustainable growth and prosperity cannot begin or endure until most of the excesses of the previous credit cycle have been extinguished and we are now a very long way from achieving that. Sadly, global central banks and sovereign governments decided in 2008-9 to ignore the lessons held in long wave economic theory and instead chose to re-lever and add significantly more debt (tens of
trillion) in hopes of igniting a sustained recovery. They have succeeded in boosting corporate profits and stocks but is it sustainable and at what price? But their easy money policies have failed to spur the so-called “escape velocity” in large part because of the law of diminishing returns from the folly of QE to infinity now perceived by investors. Japan knows this all too well as they have endured the longest economic winter on record yet they still insist in doubling down on a QE path that has never succeeded. A closer look at the economic data reflects true distortions not sustainable, i.e. car sales booming from so much sub-prime credit extended, the large inventory build accounting for the flukish GDP data for Q3, etc. The reality is this- much of tomorrowʼs demand has been brought forward from the future in so many industries and this has created a condition today that is a hallmark feature of any Kondratieff Winter- overcapacity. Also known by jargon as slack, overcapacity occurs when excessive credit has been in place for some time and thus present demand cannot keep pace. The troubling condition of overcapacity now prevails and can be seen in several areas. The prolonged discounting by retailers are a good example as is the numerous ghost towns and giant building towers and entire cities in China that are empty, all dressed up with nowhere to go. Much of the global growth seen in recent years at the tail end of this economic winter has been derived from some of the most inefficient applications of capital ever seen. Capital doesnʼt chase its highest utility during periods of indiscriminate and capricious spending that is a hallmark of the easy money policies advanced by global central banks. Yet now at the tail end of this debt super-cycle the global markets continue to rally while overcapacity reigns.
Hence the elephant in the room that deserves our attention- the glaring gap between the US and global stock markets and the underlying global economic conditions. It is generally believed by most that much of the gains in stocks have come directly from the real and perceived boost coming from the multi-trillions in QE printing by the Fed and other central banks and this is true to an extent. Their policies have no doubt pushed investors out on the risk curve to buy stocks in lieu of no other alternative in a mad chase for yield compliments of a zero interest rate policy (ZIRP) environment. But the sheer economic benefit of ZIRP to firms could be considered just as significant because in effect the central banks have for years successfully manipulated by far the single biggest cost input into any economy- the cost of money. So ZIRP has translated into hundreds of billions in cost savings for US corporations and this more than anything accounts for corporate profits are exceeding 12% of GDP, an extreme level that is several standard deviations removed from the historical average of 4-6% of GDP.
The significance of ZIRP cannot be overstated; because while it has helped US corporate profits enormously since 2009 it is also likely that even modest increases in the levels of interest rates going forward will adversely affect corporate profits much more than is generally perceived. Some fallout from the spike in rates is already coming to light in recent months as the activity in mortgage refinancings has slowed substantially with even just a modest rise in mortgage rates that can still be seen as dirt cheap in historical terms. My belief is that the significance of this event is being discounted too much by investors because there is no historical precedent for the prevailing ZIRP environment and thus the modeling for any disruptions is likely to be quite unreliable.
Even modestly higher rates will also impact any floating rate debt very negatively, including the tens of trillions in US Treasury debt among other toxic liabilities. Larger spikes would be or even modest rises in rates will worsen our budget deficit and increase the percentage of our tax revenue needed to service already high debt levels. Some have argued that a rising rate environment signals a recovery and should be welcomed. Those arguments may have held weight in previous cycle periods but not in 2014 at the tail end of the largest debt supercycle ever seen. I believe the vast majority of investors, central planners, and citizens are underestimating the debilitating effects of a rising yield environment coupled with outright deflation. Such a combination is likely sooner or later.
What does this mean for the global economy and the markets in 2014? I expect the global economy to continue at stall speed until at some point the present condition of disinflation morphs into outright deflation. The tipping point for such an outcome could be one of many things — a series of default events (think Puerto Rico, China corps, and banks i.e. Monte Paschi), an unforeseen geo-political event, or a failure in Washington to resolve the looming debt ceiling extension of some $4 trillion in a matter of weeks. Any of these events could upset the fragile nature of the interconnected global markets. However I still hold to the notion that the end game of this economic winter, now very long in the tooth, will take shape from a rising yield deflationary bust.
In recent days, yields on all maturities of US treasuries have spiked much higher and are now close to breakout levels. Consider that the trajectory of the recent explosion of US Treasury yields in the past month- 2 year note from .28 to .38, the 5 year note from 1.37 to 1.74, and the 10 year note form 2.75 to 3.03, and the 30 year from3.81 to 3.97%. This pattern reflects much sharper rises in the shorter maturities which supports my notion there is a decent chance this rising yield environment could be lead by the short end of the curve dragging the longer end higher. This notion would be baffling to most and one completely at odds with the consensus given the special pronouncement made by Chairman Bernanke recently that the Federal Reserve would maintain near zero rates for much longer than expected.
I am watching with great interest the yield on the six month bill in particular. Its yield is now poised to break out of a 4 year range if it can exceed .10 % and if so it would be really worth watching to see how much higher it would reach and if that breakout could cause disruption on longer dated maturities. Since the Fed decision, this notion I have advanced has taken shape with yields on the 30 year bond relatively unchanged and yields on the 2,5, and 10 year notes much higher. While it is still too early to call that a trend, it is something to keep an eye on given how caught off guard investors would be at such a development under the mantra of “In Fed we Trust”.
It is possible that any event that could be considered truly unexpected (defaults, debt ceiling, rate spike, etc). could be particularly destabilizing to the markets given the full boat leverage now being applied by investors. Last week total aggregate margin debt made another new all-time high and bullish sentiment is peaking as it did when the last two bubbles burst in 2000 and 2007. For anyone who follows long wave theory such as the Elliott Wave, the primary count for these markets is quite foreboding. The primary count remains that this spectacular rally of well over 200% since March 2009 does not entail a new bull market but rather the most spectacular bear marker rally of all time (by far) and is corrective and not impulsive by nature. The inflation adjusted all-time high was reached in early 2000, just as this fourth K- Winter began and has since seen two major down waves (2000-2003, 2008-9) with the more powerful third wave down just ahead.
It also implies that an ending diagonal pattern is setting up and if that were to play out the markets would likely suffer a much larger decline in a much shorter period that most would expect. Ending diagonals historically come after extended moves to the upside without a major retracement (check), low and ever slowing volume over time (check) and poor breadth (check). Just keep this in mind. If a major correction or a crash does occur in 2014 as I expect that the culprit would clearly be the evil beast lurking over the horizon for so many years deflation. Deflation is the motherʼs milk of any Kondratieff Winter and while its worst effects have been muted in recent years by the aversion of a systemic global meltdown, itʼs wrath has still been evident to those who are tuned in. Global economic growth has been muted much unlike the trajectories of other recoveries, gold has plunged as the fears of inflation have subsided, and overcapacity reigns. Letʼs remember that Bernanke earned the Helicopter Ben tag with his magnum opus speech in 2002 titled Deflation: Making sure it doesnʼt happen here. He was sure as heck determined to see that through but the jury is still out. His core theme for that speech was that his research on the Great Depression led him to believe that it could have been avoided if the Federal Reserve had implemented unconventional policy tools such as QE, etc to combat the deflationary forces.
But that approach of course contradicts the canons of K-Wave theory which holds that these deflationary forces are naturally occurring and necessary evils that must be mitigated and not exacerbated. The flaws of such an approach to
battling deflation are multi-fold: It adds too much debt, it enables too much mal-investment, its virtues lend themselves to the laws of diminishing returns, it is untested with potentially severe consequences, among others. It can be determined by most intuitively that sustained periods of manipulation of such critical forces such as the cost of money (interest rates) and the QE programs that debase our currency are not good for long term prosperity. They may juice markets for a period but there is no evidence supporting their sustained benefit since it has never been attempted.
We are today witnessing the end game of an titanic struggle between two very large forces- the naturally occurring economic winter and the aggregate firepower of the global central banks. Only one will triumph, and some would say that with the threat of a systemic meltdown averted that the central banks have indeed won. However global debt loads are much, much higher today than just a few years ago and the Fed and other central banks have tied themselves into one huge Gordian Knot that they cannot free themselves. They are now “all in” as they have no other choice but to keep supporting markets. The real tell I suspect will be when they lose control of the bond markets. The initial symptoms, while inconclusive, are now becoming evident as the 10 year bond has risen well over 1% since May despite the Fed purchasing 70% of the total Treasury issuance.
Large foreign buyers like Japan and China have scaled back purchases dramatically in recent months and this creates a potential vaccum at future treasury auctions. In the coming months and years, the saga of this heavyweight prize fight will play out before us, and it is sure to be a spectacle to behold.
Ponzi in Peril
Not your daddy’s yield curve
How fitting it is this week to have the trials of the second (Madoff) and third (Sanford) biggest ponzi schemes in history begin just as the largest one ever comes under scrutiny like never before. The epic battle in Washington over the debt ceiling followed by the Yellen confirmation hearings before the Senate Banking committee will see to that. In each of these battles one theme is sure to resonate- the threatened sustainability of long standing policies that are now seen as suspect and under siege.
It is useless to try to forecast how this current standoff in Washington will be resolved so I won’t even try. It could be resolved in a grand bargain or a patch for the short term or at worst a stalemate. Kondratieff Wave theory holds that it matters not so much. Debt deflation today is a runaway juggernaut that is more omnipotent and ubiquitous than we know. There is only one certainty about the end game now playing out in Washington- the final outcome will exacerbate the prevailing deflation either through the carnage of a pure default or more likely the attrition coming from new deflationary pressures through hundreds of billions in reduced spending that is likely to compound a recovery already so precarious.
Debt deflation, the mother’s milk of any Kondratieff Winter, is evident everywhere and accelerating, choking off growth all over the world. You know a theme like debt deflaton is quite real when it prevails everywhere at the same time. I know of no country with accelerating growth except Japan, the most indebted nation on earth whose growth has been fostered entirely through adding trillions of debt. Japan has suffered through this deflation for over twenty years and their fleeting prosperity of recent has been offset almost entirely by wholesale depreciation in the purchasing power from their plunging yen. Their stock market has soared but so has their cost of energy and other imports. Just like the US, their middle class suffers at the expense of those who hold paper assets under a rampant QE policy. There is just no free lunch in any Kondratieff Winter.
Last week their leader Mr. Abe announced he would increase the national sales tax to help reduce their massive debt levels in hopes that the improved budget deficits would help prevent their bond market from crashing. But then he also announced a stimulus program to help mitigate the negative impact the tax hike on the economy. Yet that would increase their debt and thus offset the entire purpose of the tax increase. This is absurd, but no one has called them on this-yet. I cannot make this stuff up. One day this farce will be told in a long series on the History Channel or A&E to showcase the absurdity of these times.
Such a policy by Abe smacks of a ponzi scheme, plain and simple, much like the Federal Reserve purchasing most of the maturing Treasury debt with newly printed money from a few digital keystrokes out of thin air with no recourse. There is little distincttion between this and a blatant ponzi scheme. It is all based upon confidence by market participants and beware if that is ever lost. Please note that every ponzi scheme in history had two things in common- they all failed but amazingly yet they all worked perfectly for their entire duration just until the very end. It works until it doesn’t. With these two major trials now underway I suspect the notion of ponzi schemes will become more prominent in the consciousness of most Americans in the near term and that’s a good thing.
But debt deflaton, though essential for future prosperity, is unfortunate for the near term. Nearly every national, regional and municipal govenment on earth is deeply indebted at levels that are unsustainable and perilous. Puerto Rico is on the brink of default of some $70 billion in muni bonds that are owned by almost 80% of US muni bond funds. The second largest corp in Brazil is expected to soon default and declare bankruptcy. And two of the most promising nations of the past ten years- Brazil and India- are now mired in steep declines in GDP and prodcutivity with surging interest rates and inflation resulting from a substantial plunge in their currency. Since May, most emerging market nations have suffered huge outflows of capital from foreign investors coming from the sudden realizaton in May that QE policies could not last forever. The fast money that invested there to chase yield is now gone with the wind.
It is possible that the initial snowballs of this late stage economic winter are now beginning their descent down the proverbial hill. If they continue to gain steam, their mass will become snow boulders hurtling downhill at breakneck speed. I had hoped for so long our leaders would appreciate the lessons of long wave economic theory and that the damage that global aggregate debt could reap was substantial and worthy of meaningful reform. But the drumbeat goes on- debt doesn’t matter, only profits matter. I beg to differ. You can’t assume that either can be rolled over or maintained. We have already eclipsed peak debt and peak profits. The student loan and government spending bubbles are now busrsting before our eyes furthering the notion that defaltionary economic winter is still working overtime to mop up the excesses of a very long wave credit cycle.
We may now have yet another Minsky moment at hand whereby the marlets pivot from euphoria to profit taking to panic. Yet there are no meaningful short positons in this market to speak of and in fact the net longs are margined like never before, pledging their faith in the salvation of the powers in Washington to act rationally and for the Federal Reserve to provide unlimited support. Although possible I suppose, they are both very suspect. In keeping with my theme above though, even if those in Washington act rationally and the Fed remains committed to QE and ZIRP for many years, it won’t matter so much in defeating a long wave credit cycle now long in the tooth (over 60 years) and quite bloated with hundreds of trillions in aggregate debt. Global debt deflation at this stage of the long wave credit cycle is just too imposing to be contained with central bank stimulus that amounts to only a few trillion, only a tiny fraction of the the aggregate debt outstanding of which much is entirely unpayable. Can’t shoot big game like debt deflation with tiny pellet guns from impotent central banks.
It is also becoming clearer all the time that the Fed’s QE policy is incoherent. By its very design it could never achieve any level even close to the 4-5% level that is deemed to be full employment. Yet no one called them out on this over the years as it was revealed that millions of Americans were just dropping out of the workforce and stopped looking for work. Fed policy has persisted to fail year after year but amazingly at their September meeting the Fed concluded that since economic condions were not satisfactory (meaning hence their QE and ZIRP for five years had failed ) that they had no choice but to continue their QE. As a result of their mangled policy, their mangled exection and their mangled communication, the incoherence of Fed policy is now more pronounced than ever and even less likely to work given the prohibitive loss in confidence seen in the Fed since last May. There may be no headlines evident announcing such an event but nonetheless it it’s relavence is very real indeed.
So naturally, newly appointed Fed chief Janet Yellen may have her hands full next month defending QE before a Senate Banking committe having four Republicans who are opposed to the easy money policies of the Fed. Hopefully Senators Shelby,Coker, etc will rise to the moment and provide the public trial for QE that is so needed. I expect her to be confirmed but not before a heated debate on the entire premise of a policy that looks more desperate each day. Although I believe she is qualified and dignified, she is still nonetheless the living embodiement of an institution that has not served most US citizens very well. I hope she is flexible and proves me wrong.
I suppose the biggest question for investors, policymakers, and the public at large is this- is it possible to extricate ourselves from this global debt contagion that threatens to disrupt the very fabric of most western free market nations? I think it is only possible through decisive action immediately on several fronts with clear and tangible benchmarks that are reasonable to attain. But that will take leadership and consensus building and that is just not evident. My biggest fear is that we could soon reach a tipping point where confidence plummets across the board that impacts consumers, investors, and the US public at large.
I have advanced in this column for over two years a very radical framework on how this winter engane could take shape. I must give credit to the founders of the site www.danericselliottwaves.com for the origin. Many times I have alluded to this theme- A RISING YIELD DEFLATIONARY BUST that would manifest in the most unlikely way- short rates dragging the entire yield curve higher. Such a scenario would be unprecedented but rational to me considering the staggering global debt levels. Such a move would be quite unlike the garden variety spike in rates seen in the years past. The yield curve of tomorrow I foresee is not your daddy’s yield curve. Unlike the past, this yield curve flattens from short rates exploding higher, not from long rates coming down to flatten the curve. It just makes too much sense, especially given that most investors would be flattened by a truck if this were to unfold. I wonder if Blackrock, Fidelity, JPM, etc are hedged in any way to such a scenario. Please consider this potential outcome.
It is worthy to note that if this were to ever unfold, the discloations to the capital markets would be so draconian it would be hard to fathom. Today there is so much leverage today based upon the very idea that the Fed can and will control rates, especially in the short term with their implicit guidance they will not direct rates higher for a long time. So it is reasonable to suggest that several trillions in wealth could be destroyed if this unprecedented inversion of rates ever occurred. But a rising yield scenario coupled during a pure deflation period has never happened and is hard for most to take seriously. After all, interest rates have typically plummeted in the past when economic conditions sank. But could this time is different?
Don’t look now but this may have already just begun, albeit in a flukish way.
Last week, investors panned the weekly auction of one month T-Bills, an auction that has typically featured all the drama of watching paint dry. But not this time. Fidelity recently announced they would not buy any of these T-Bills because there was no certainty of repayment and they could not risk liquidations to their money market accounts whcih total in the tens of billions if not more. So the boring T-Bill auction in early October failed and the prevailing yield on this T-Bill that matured in one month was .35%, some 25 times the yield from last week. Although the yield on thisT-Bill did recover, it wasnonetheless still a major capital market discloation courtesy of our friends in Wash, DC. and it may not be the last.
Why is this so crucial? Because global aggregate debt has never exceeded hundreds of trillions together untold derivatives to boot. Any sudden or even marginal rise in rates would upset the precarious state of a global bond market and could destroy the arithmetic needed to maintain interest coverage. Beware if yields on other T-Bills or short term treasuries follow suit and spike higher despite such implicit cover from the Fed. There is no doubt interest rates have been too low for too long but investors have feared most the dreaded the perils of a spike in yields on longer dated bonds but I disagree. At least those maturities provide some yield to speak of. But T-Bill rates have been at near zero for years and that is madness. Look out most for that heavily owned two-year benchmark.
Why not short them all with leverage- where is the risk in that? These yields won’t breach the zero level they are now so close to. Why have such implicit faith in the Fed’s forward guidance on keeping rates at zero until at least 2016? Assume one that that is toast when they lose control of the bond markets. Why believe the hunk of BS from the Fed who never saw any bubble coming and has always been woefully wrong (too optimistic) in their economic forecasts? If investors ever were to agree with this line of thinking we will indeed witness the comet of a rising yield deflationary bust. It is not certain, but quite possible.
Debt Deflation Denial
‘Pavlovian’ markets ignore long-wave cycle
The divergence between global economic conditions and stock prices has never been higher. The Dow and the S&P both reached all-time nominal highs in recent weeks despite higher interest rates and ever slowing economic activity all across the globe. China and the emerging markets have continued their steady slide in growth since 2011 and the bulk of the Eurozone has been in a recession since early 2012. The dramatic downward revisions in GDP growth announced recently revealed that even the US has averaged barely over 1% for the past year. This is awful given the tens of trillions in combined fiscal and monetary stimulus over the past several years. Federal Reserve liabilities are now fast approaching $4 trillion with no end in sight yet these these trillions have done little to achieve their mandate of full employment or sustained economic growth.
Let’s not kid ourselves- anyone can see that central banks policies, actions and rhetoric have pushed this long wave credit cycle farther out than ever before. Chairman Bernanke has led the way on this and today his peers in Japan, Europe, and all over the globe are in harmony with a full steam ahead approach that has removed contagion risk as an immediate threat but has also promoted leverage and risk taking to new highs likely to be seen one day as the apex of the largest credit cycle the world has ever known.
The markets now seem to care only about just one thing- the promise of continued printing by the Federal Reserve. In June, Chairman Bernanke said explicitly the Fed would be tapering their QE by essentially slowing down from the equivalent of 100 MPH to around 90 MPH and the market hissed, sliding over 1000 Dow points in a matter of several days. Fittingly, several Fed governors then came out swinging in the following days to walk back Bernanke’s proclamation. One Fed governor even held his own impromptu press conference, a first. Even Ben himself recanted days later in hearings before Congress. The Fed then felt it’s first hangover from just from the mere mention of reduced monetary stimulus and it wasn’t so pretty. Naturally they are now just content to put that day off as long as they can. But interest rates have moved much higher despite all their mighty QE efforts to corner the bond markets. Thus the excesses built up over this long wave credit cycle have exploded higher than ever.
These new market highs have come from a juicy cocktail- leverage from margin balances now at all-time highs, corporate financial engineering in stock buybacks and of course most of all the perception that QE will remain in place. After all, real revenue growth has been trending negative for three quarters and real profit growth peaked in the first quarter. Since then corporate profits have been goosed much higher by corporate stock buybacks which have been escalating because most CFO’s know they can’t continue to grow profits without these gimmicks. But this rousting of earnings, along with QE and low interest rates all have one thing in common- their nature does not allow them to be sustainable over long periods.
Since early May investors have sold bonds on a very large scale that has caused yields to rise farther and faster than any point I can ever remember. This trend could be very upsetting for the capital markets if it continues unabated. I expect this is just the beginning of a major shift away from paper assets that have been in favor for so many years from excessive monetary stimulus. So much savings was invested at the peak in bond prices in recent years it’s safe to assume there will be ample wealth destruction as rates revert to their historical mean. But other wealth destruction is also evident but hasn’t been fully digested.
For instance, US taxpayers have lost tens of billions from the additional interest needed to pay on our tens of trillions of debt outstanding. This fallout affects every single US taxpayer and consumer, not just those who have been so bold in buying US Treasury or junk bonds in recent years at or near all time highs. Every point higher in rates makes our fiscal budgets become all the more unbalanced. The US is at least fortunate to have the largest GDP in the world and isn’t now in immediate peril of a vicious cycle where the cost of financing our debts spirals out of control. But many other nations, most notably Japan, italy, and Spain are susceptible to a possible spillover contagion given how fragile those markets are to any unforeseen disruptions. The debt outstanding in the current budget deficit is only a mere 108% of GDP as compared with Japan with a ratio over 220% now deploying the radical policies of Abenomics to spur growth.
So how bad are the fiscal and monetary challenges Japan faces from two decades of deflation denial? Japan has been suffering through a deflationary Kondratieff Winter since 1990 despite keeping interest rates near zero and deploying QE on and off for over two decades. As we have advanced here before, Japan’s plight best exemplifies the quandry of fighting a natural deflationary cycle with cheap easy money with no strings. Their QE gimmicks have forestalled the true reforms needed to make them competitive and able to begin a new cycle of growth not burdened with onerous debt loads. But sadly Japan may be soon approaching a point of no return. Recently, the IMF issued a warning that unless Japan soon implements proposed consumption tax hikes from 5 to 10% they risk losing control of their $11 trillion bond market, the second largest in the world. The IMF warned that their debt to GDP would escalate from 220% of GDP to over 250% of GDP by year end if these rebalancing measures weren’t approved.
The benchmark threshold for sovereign debt capitulation in most countries has empirically been around 120% of GDP but Japan has been able to elude a bond market crash for so long because much of their sovereign debt is owed to it’s own people. It is likely that long term rates in Japan will eventually spike much higher and this could rattle global credit markets. It’s the most likely path to a true Kondratieff Winter because Japan is in its last throes of the futility of fighting a deflationary winter with half-baked easy money solutions so look for the real drama to come from Japan. In July the Nikkei Index crashed over 20% in less than two weeks, only to stage a huge rally that hit a brick wall recently leading to a two day plunge approaching 1000 points or almost 7%. How long can such volatility remain without shaking investor confidence?
Japan has major problems in the near term in rolling over their massive debt and also in the intermediate term in that their demographics are very troublesome given most of their population is aging and are producing less and less. They will be net sellers of Japanese bonds going forward as they sell existing bonds and naturally choose not to reinvest maturing bonds. They are older and need the money. Are we to believe Abe can coax them through more QE to spend their savings despite this? I think not. I choose to emphasize Japan’s plight because their case study best highlights the nature of K-Wave theory in the modern era.
But this is even more troubling- the WSJ reported recently that Japan now pays out over 24% of all their tax receipts for interest payments on their debt and that’s despite paying less than 1% to borrow. That 24% level is alarmingly high for any nation, let alone for a country who has the highest relative debt load of any developed nation with such an enormous bond market. Even more alarming is the fact that the WSJ also stated that if their long term rates rose even modestly to 2.2% their interest payments would comprise over 80% of their tax receipts. So it is fair to say that Japan could default if their interest rates rose even just a bit to levels considered to still be far below normalization for a country so indebted. This arithmetic is so sobering and provocative it boggles the mind. But given the recent market highs it seems however that investors could care less.
I see the great disconnect between the capital markets and global growth in terms of a scale with both sides way out of balance. On one side there’s an abundance of negative headwinds that would prove to be challenging to economic growth and the continued escalation of paper assets. These would include anemic wage growth and labor participation, outsized government spending, a widening gap in wealth among the people, but above all enormously high debt loads that provide a natural ceiling for sustained growth. The other side has two features I call the twin tower tailwinds- strong corporate profits in recent years and easy money policies that are on scale unprecedented and astronomically accomodative. Since 2009 these two tailwinds have trumped the sum effect of the other headwinds because they were sufficiently large in scale to prevail. Has anyone considered these tailwinds are an outlier but the headwinds are more enduring?
The problem I see is this- the one side of this scale that includes the headwinds of debt, etc. have components with very tangible momentum. Their relative strength is growing and just can’t reverse course so soon. This is much unlike Fed policies of low rates or QE, which can be reversed instantly through a mere proclamation. These trends have been developing for many years and sadly their very nature does not lend itself to such a swift resolution. It may be unreasonable to expect any meaningful change on those entrenched headwind fronts in the near term although I certainly hope they will improve over time.
Most troubling of the headwind front components is the pure arithmetic on the global debt loads now in place. Certain global sovereign IOU’s will eventually default, namely Greece, Portugal, etc. Some of them can still access the credit markets today, albeit in small amounts at higher rates. Most investors seem ignorant of the perils coming from the scope of this debt issuance and really can’t really can’t fathom it’s scale now measured in the tens of trillions of dollars. Accordingly, risk has never been so mispriced across the spectrum.
Now let’s look closer at the goosed corporate profits. They have risen since 2009 from a historical average of 4-6% of GPD to now over 12% of GDP and this is an outlier that is just not sustainable. In fact, don’t look now but corporate profits have already peaked in aggregate terms in Q1 of 2013. The WSJ recently stated that with 95% of S&P companies reporting total profits for Q2 in 2013 are down almost 3%. But the markets have ignored this and instead expanded the multiple on the S&P much higher. EPS (not total earnings) has risen to peak levels due to the flood of stock buybacks that mask the true weakness in profit growth.
The bulls have coasted and toasted on these two substantial twin tower tailwinds for many years but they are both getting long in the tooth so to speak. SInce late 2012, some of the best US corporations have flopped in performance- IBM, Microsoft, Fed X, Google, McDonalds, and the list goes on. Even more disturbing is the fact that the majority of earnings growth in recently announced earnings from Q2 have come from financials, the most goosed sector of all. If one were to remove the gains coming from the reduction in reserve losses from the banks and account for their real losses in long term bonds they hold the current earnings season would be disappointing. The dependence upon these gimmicks is more apparent than ever before. They have no doubt pushed stocks higher but don’t provide the best foundation for sustained gains going forward.
And more evidence has surfaced last month that a new storm is brewing. Staggering debt loads have cancelled some several corporate and government global bond offerings around the world in recent weeks. The shadow banking system in China is cracking from unchecked credit expansion that has peaked, forcing short term interest rates in the shadow economy to rocket to over 30% briefly before slowing a bit recently. Interest expense has exploded higher on all forms of debt and that amounts to a major tax on global growth that is not so transitory. The fallout from no single headwind sticks out by itself to be so debilitating to crush the markets but taken in their sum they could provide for a sustained and debilitating erosion in economic conditions and paper asset prices under long wave theory. Credit is not peaking, it has already peaked.
Given all that has been recounted above, let’s try to frame the backdrop of this unfolding Kondratieff Winter. Long wave economic cycles over the eons have typically lasted 52-64 years on average with the model long wave at 56 years with four seasons lasting 14 years. But given the outsized influence from the Federal Reserve and their central bank peers, this long wave cycle and its seasons have endured longer than normal. Simply put, massive global fiscal and monetary stimulus has usurped the long wave structure in an incipient fashion. Naturally, this long wave credit cycle is now stretched out further than at any time ever.
This fourth Kondratieff Cycle of the modern industrial age began in 1949 when aggregate debt levels began to normalize after hitting all-time highs after World War II. Since then we have seen four seasons of approximately 14-16 years play out and we expect this cycle is expected to run its course around 2016. This winter season began in 2000 when stock valuations peaked in real terms and this K-Winter has lived up to it’s billing despite the frenzied headlines each week announcing new nominal highs in the Dow and S&P averages. The S&P today would have to rise to near 2000 to be equal on an inflation adjusted basis to the high of 1560 or so set in 2000. The S&P is not really setting new highs each day because the purchasing power of US dollars in 2000 is so much higher than today and that is the tragic fallout of ongoing monetary debasement of our currency.
Contrary to most observers, Kondratieff Wave cycle theory relates entirely to global economic credit and the global economic output coming from the credit cycle and not the performance of the capital markets. But over the eons, stocks have on balance traced the K-Wave cycle and that is why so many relate an economic winter with a market crash. Yet this current winter cycle is quite unlike any other because central bankers have been more determined than ever to usurp the naturally occurring long wave cycles by implementing their own visions to combat the natural ebb and flow of the economic progress over time. It seems clear to me this approach has not worked so well for the reasons stated above. The net increase in total debt over the ages has provided more excesses that will be difficult to manage and will tax our nations prosperity for some time to come.
It has been established over the centuries that no country could ever hope to attain prosperity through a debasement of their currency or monetization of their debt. Many empires, most notably Rome among others, learned this universal truth the hard way. Capricious and arbitrary debasement does not make common sense and history assures us that such a pipe dream it is indeed a farce. Please visit the Fiat currency tab within the Taboo section our site to see a feature highlighting this crucial theme showcasing the destruction of several fiat currency schemes over the past 2500 years. We felt it was important to disclose to our readers this evidence given it’s importance in undermining the sanctity of the gospel manifested by global central bankers in recent times.
While the K-Wave theory is not so concerned with predicting the long wave cycle trends of the capital markets, unlike the Elliott Wave model for instance, it is fair to say that we can expect severe declines in paper asset prices during the extended periods of credit contraction that are the hallmarks of K-Wave theory.
Unlike the previous winter cycle that lasted from 1930 to 1949, this winter phase has unfolded quite unlike the last one that saw the capital markets, economic output and bank failures peak early in the cycle and then stagnate for so long. This winter cycle phase however has experienced two unprecedented counter- trend expansion cycles occurring from 2003-7 and also in 2009-13 within the same winter cycle phase, a first. You could view these past two winter cycles as bookends replete with near inverse patterns. In the last winter, stocks and the economy both moved in lockstep. In this winter, monetary policy has attempted but failed to ignite economic growth sufficient to foster sustainable growth.
However this current winter cycle phase has yet to play out and it appears that unlike the 1930’s we may see the worst damage in this cycle at the end of the winter cycle phase. The answer why is obvious — Bernanke and his peers have decided to overwhelm the long cycle by printing tens of trillions of fiat currency in a shock and awe display designed to overcome the natural long wave through sheer force. It has helped goose paper assets for a few years but it has also added trillions of debt that were transferred from private hands (corps) to public hands (taxpayers). The illusion is clear to some but not most. Some influential investors are well aware of this and are prepared to sell is see any signs of a breakdown in confidence in the ability of central banks to maintain their ruse.
We must now shout at the rooftops about something that hides in plain sight. This prevailing Kondratieff Winter is real and has been on full display for many years. The deflationary aspects at the core of our theory are more evident than ever despite the tens of trillions in printing and the new market highs. Global debt deflation is now eponymous- from Detroit’s recent record breaking municipal bankruptcy to the millions of foreclosed and still vacant homes to the lowest job participation rate seen since 1979, etc. Since this winter began in 2000 most assets classes have been declining. Stocks topped in real terms in 2000, home prices topped in 2006, oil topped in 2008, gold topped in 2011, bonds topped in 2012 and I expect stocks will top nominally in the fall of 2013. It is this rolling top of the basic asset classes over so many years allows a subtle generational top in asset prices to hide in plain sight for so long. The last holdout is US stocks, and I suspect they are now the most overvalued of all assets.
The intelligent design of the Kondratieff Wave theory is based upon the universal laws of nature. A core theme of this theory is that a new cycle of prosperity can’t begin until the bulk of the excesses from the previous cycle are removed. That occurs through a painful process known as deflation which has not been abated because it has just been swapped from private to public hands since the financial crisis. Debt deflation is really just another euphemism for a K- Winter- they go hand in hand. And debt deflation is now very much alive and well because these excesses have escalated in recent years to unthinkable levels. These excesses of debt will be removed either through via force (default) or more naturally through mutual forgiveness (jubilee). Since the days of the ancient Hebrews, the end of these long waves has occurred though forced defaults. All evidence we have today is that the same will occur as this long wave debt cycle, the largest ever by a mile, implodes under its own unsustainable weight of trillions of debt that will default because it is un-payable.
These excesses have escalated exponentially over the years and this explains best the futility why the Fed nor Japan can’t seem to overcome a naturally occurring economic winter by just issuing trillions more in debt. This Neanderthal approach reminds me of the Capital One commercial a few years back featuring a catapult of cash to overcome everything. But complex problems can’t be healed by oversimplified solutions. I expect one day the markets will fully account for these truths. I would not be the last bit surprised if the Dow lost over 1000 points in one day before the end of 2013. The conditions today best resemble the 1987 market that saw several years of gains evaporated in a few hours. Total leverage and stock margin balances are both much higher today and so is complacency.
The easy money approach now in vogue commits an original sin- it does not allow private capital to chase its highest utility. How can it when fiscal and monetary policy now engulf over 35% of our economic output? This is why so many trillions of private capital are now on the sidelines and not funding economic growth. That can only occur from poor fiscal and monetary policy which promotes chasing each new speculative paper asset bubble under an implicit cover that rolling asset bubbles aren’t so bad.
But they are bad. As we come to see this universal truth in the coming years I expect expect the prices of paper assets to better reflect the risk inherent with unchecked credit expansion from Keynsian style economics supported by the cover of unchecked monetarism. Both have endured and become so entrenched but sadly they reflect an ideal squarely opposed to natural law and they are not suited to foster enduring prosperity.
A spectacle to behold: Markets usurp central banks
K Winter Endgame now playing out in Japan
Mark May 23rd of 2013 as a potential key date in the unfolding of this fourth Kondratieff Winter of the modern era. In the afternoon session of trading in Tokyo that night, at approximately 7:30 PM EST, everything suddenly changed. The juggernaut that had propelled the Nikkei average up almost 90% since early November took a bit of a breather by plunging almost 10% from its peak hours earlier, settling down over 1140 points from the previous close. As of yesterday it had declined 2343 points (15%) in just one week. With one more day like Thursday the Nikkei would have achieved the impossible- a 90% gain in six months that turned into a bear market (20% down) in just one week. Ho, hum, just another day in the life of a world distorted with tens of trillions of central bank intervention.
I suspect this will become the new normal going forward in the next few years that will mark the twilight of the winter cycle phase of this present Kondratieff cycle that began in 1949. Our theory holds that paper assets have never been more overpriced because there’s too much unpayable global debt that will default. Is there a day in our future when our Dow will also plunge over 1000 points in a grand mal seizure from too much debt?
What was so transformative that occurred in that Thursday session in Japan, one that was preceded hours earlier by a sudden whipsaw in US markets? Simple- too much volatility. This grand experiment by central banks is much like a ponzi scheme because it has absolutely no room for error that could undermine confidence. Yet that is what is occurring right before us. Could this be the beginning of the endgame scenario I have promised here for over two years- a dreaded deflationary bust caused not by an economic slowdown but instead by rising yields?
It’s very possible this may be the case given the scale and speed of the move higher in yields all across the globe. Don’t forget here that the entire premise of these massive QE programs by all the global central banks is to keep rates DOWN, not up. They are failing miserably in their primary objective and I implore our readers and all investors to sit up and take notice. It seems the bond vigilantes have now finally emerged from many years of hibernation.
Remember the Apple bonds floated a few weeks ago in the biggest corporate offering in world history? It was way oversubscribed as everyone wanted them so badly. They are now down over 4% in a matter of days losing investors around $700 million in no time on this “safe” investment. Given that global bond markets are 4-5 times larger than stocks the potential for even a small rise in rates would be very devastating. Few may appreciate that nothing could cause more wealth destruction than a large and sustained rise in interest rates.
It seems that peak euphoria was being tested in the US last Wednesday as unfettered exuberance mid-morning gave way in the afternoon to discontent and outright scorn over Fed policy by the end of the session, one that saw the indexes plunge more than 2% on a single day after making an intra-day all-time high that same day. That has only happened twice before and both times (2000 and 2007) marked major cycle peaks in the markets. Could this be true again?
Cycle theory and common sense both say yes in prohibitive terms. Why can we advance this notion? Because if one were to peel back the layers of what has been unfolding recently in many other financial markets you could only come to one conclusion: global central banks have lost control of their mandates. The end must be near when the confusion over the meaning of one or two words from Chief Bernanke could cause such an uproar in the financial markets. Has it really come to this? Valuations are determined through hyper-parsing of nuanced words that are so carefully prescribed as to not achieve that effect?
The unintended consequences caused by policy decisions that could be called quite extraordinary has caused many individual asset classes to have a mid life crisis recently. They have seen explosive moves in all directions in degrees several standard deviations removed from their historic benchmarks. In other words, all hell is breaking loose just about everywhere. Everywhere except in the US, of course, where investors from Japan to Timbuktu have blindly reallocated so much capital since last November.
The action resulting from these audacious central bank moves has been dramatic across the board. The third largest stock market in the world (Nikkei in Japan) has rallied almost 90% in just over six months while their currency has declined against the USD by over 25% in the same period. Both of these moves are so enormous they can hardly be explained in a cogent manner without an overload of superlatives that would understate their true meaning. In the month of May we saw many strange events- gold plunging over $200 in a matter of hours, no fewer than 17 mini flash crashes in five NYSE stocks and silver halted four times in one session due to a lack of bids in a disorderly marketplace to say the least. And as of Thursday the Nikkei had plunged over 15% in just one week. Just another day in the parallel universe created by the global central banks.
These moves are alarming at best and who knows at worst. They are the best evidence yet of true parabolic moves one could expect to see at the end of grand super-cycles of credit such as the tail end of a Kondratieff Winter. And much like the geometric explosion of global debt, they are just not sustainable. My gut tells me two things- 1) markets are out of control,; and 2) very few investors agree these markets are out of control. This can be seen by tame levels of the VIX index and the release this week showing that margin debt had reached an all-time high. It all sounds a bit frothy to me and could signal the end of an era.
But the ludicrous nature of the these awesome moves in certain paper assets just keeps coming. Greek bonds sure to default have tripled in the past year. The Dow Industrials as of the end of May 2013 will not have seen a three day decline for the longest period since 1900 and that defies all sensibilities. It seems to many that there is some force or entity out there (the Fed ?) that’s not willing to allow such an event to occur, perhaps to create a myth that the markets will nudge ever higher. Incredibly, many now think that is the case as they believe the Federal Reserve and other central banks are in complete control. Or so it seems.
Our theme here today is that there is abundant exculpatory evidence hiding in plain sight that indicates the opposite- that central banks are losing control of the markets. In last month’s comments I noted the disturbing explosion of yields in the JGB’s (long term Japan bonds) that sent their prices crashing overnight, beginning a period extreme apprehension over a more serious bond crash could be looming. That worry has only worsened since then as the yield on 10 year JGB is now a whisker away from the 1 % level that is seen as crucial to hold to maintain the appearance that the world’s second largest bond market is not spinning out of control.
One thing that bulls and bears and nearly everyone can agree on this this- bad consequences will occur if global bond yields rise fast and far worse will happen if they rise too fast. The reason for this is that when volatility spikes and endures, leverage is taken off the table and that means lots of securities will be sold. So what are the chances yields could spike higher (making bonds plunge) given this universal belief of the consequences of such an outcome?
I believe the chances of such an outcome are quite underappreciated by investors today all along the the spectrum. This would include brokers, money managers, hedge fund managers, CFO’s managing billions of corporate cash coffers, pension fund managers, individual retail investors, sovereign wealth fund managers, and so many more. Their worldview could be soon shattered if global bond markets usurp the collective actions of global central banks. It would only take one of these markets to crash to induce a large global sell-off. Such an event would finally showcase the folly that rampant global central bank printing is beneficial to modern industrial economies. The central theme of Kondratieff Wave theory holds that the long term credit cycle cannot continue unabated and the excesses of this cycle must be removed. Clearly this is not the case.
Most investors and investment pros are still beholden to a worldview that puts no premium on long wave credit cycles. They insist on owning paper assets such as stock, bonds, and derivatives,etc. These instruments have on balance have been performing well since 1982 but not so well for the past 13 years. They subscribe to the same worldview that emphasizes yesterday’s metrics- PE multiples, PE expansion, cash on the sidelines, nowhere else to put your money other than stocks, and this chase for yield has pushed them into more risk and leverage than they otherwise would have deployed. Such an approach did not work too well in 2000 or 2007 when yields were still historically very low, so this mindset makes even less sense today now given the tens of trillions in global debt that has been added in the past few years.
But a closer look at the performance of money managers over that period since 1982 clearly shows a persistent underperformance by them over time even in bull markets? How can this be? Even in 2013 it is all too clear that hedge funds and professional money managers on balance are prohibitively underperforming the S&P index. Such statistics are meaningful in gleaning what could be missing from their equations. I advance that a coherent appreciation of the existence and the significance of long wave super-cycles would be a good place to start.
If they had an appreciation of the higher truths offered by the K-Wave theory perhaps they would be more likely to realize compounded gains over time from their acumen in the day to day, month to month decisions on asset allocation they are well suited to execute. Typically their lack of performance over the years can be attributed to poor decisions made during those critical inflection points in the the markets that seem to always occur when there is universal agreement upon the near term direction of the market (up in 2000, down in 2002, up in 2007, down in 2009 as recent examples). If they could only avoid the pitfalls at these junctures then I suspect most fund managers would instead outperform the broad market averages. Bubbles are not black swans, they hide in plain sight and lend themselves to distinct patterns that can be useful in making decisions.
Many are bewildered that the market has surged so much higher despite any meaningful help from retail investors. It is worth noting that a key element in the overperformance of the US market in recent years has been the collective impact of corporate stock buybacks by the healthiest US corporations. These buybacks have served to satisfy shareholders over employees or their local or national communities. The end result has been a historic drop-off in cap-ex and R&D and a dramatic increase in layoffs for even the best companies. The mandate of the modern corporation has never been more evident- making profits at any cost. Yet empirical evidence suggest these buybacks occur when stocks are relatively expensive. You wanna bet that some of them may regret this down the road? But why have they been so prevalent lately despite price levels that are so rich?
Large corporations have been for many years enduring the pitfalls of this deflationary Kondratieff winter that assures very low or negative growth rates globally that make it very difficult to grow the top line. So what to do if you are a CFO? Just resort to financial gimmicks such as stock buybacks so that your reduced operating profits during this winter period can be better cloaked with higher EPS through reduced shares outstanding. This behavior, much like the hoarding of cash by commercial banks unwilling to lend but dying to speculate in paper assets tells me the recent new highs in the S&P do not reflect a new bull market, only desperation to please investors at any price. They are creating less and less and investing less and less. Several studies have concluded that perhaps as high as 40% of the rally in recent years can be attributed to these buybacks. At any rate these buybacks I believe have cloaked more serious problems in the financial performance of corporations and their stocks. Global aggregate demand is slowing despite central banks accommodation and exponential increases in the population base. You just can’t hide from deflation.
The gains in stocks have diverged from the macroeconomic landscape for many years now and that trend has really accelerated this year. And we all know why- controversial central bank policies that range from keeping rates too low for too long during the mid- 2000’s to outright destructive ones such as printing several trillions to create a wealth effect whose benefits do not trickle down to the middle class and serves in effect to cushion political leaders from making unpopular structural reforms that are sorely needed. Today developed countries in the western world are staring down the barrel of a gun of their own making that can still be dismantled.
But sadly we have not taken the necessary steps to deconstruct our debt warheads to prevent the collateral damage they could cause. I suspect soon we will reach the brink, stare into the abyss, and determine once and for all if we can thrive in a world dominated by debt. I hope that our financial. corporate, and political leaders can find the will to reign in the central bankers before it’s too late. They may have good intentions but their approach has proven to be a failure and they should be called out on this at once. But time is running out, and several key market metrics described above are now flashing red lights. And remember the long wave chart of the US market still sports and ending diagonal bearish wedge that implies a severe plunge once key support is broken.
Threading a needle that will burst a bubble
US stocks levitated in recent weeks to all-time nominal highs recently courtesy of unabated debt monetization by a sugar daddy Fed that promises not to let up for some time on their draconian printing scheme. And the markets have responded in true Pavlovian form despite so many headwinds- the Cyprus default, record Eurozone unemployment, and so on. It seems the bulls and bears both agree the Fed and the other central banks are omnipotent. This type of sentiment is what one would expect at the peak of a 70 year super cycle in credit. The world is awash in debt and credit like never before as central banks attempt a high wire act of promoting growth without destabilizing the global financial system with too much cheap money. So the real question is this- is the Federal Reserve threading a needle that will one day burst the debt bubble?
History has shown that just when a prevailing worldview forms, such as universal belief the Fed will prop up the markets, it is often upended quite abruptly. New realities that hide in plain sight such as too much unpayable debt suddenly get a second look. Don’t look now but deflation is rearing its ugly head again. Global growth is slowing to a crawl despite massive monetary and fiscal stimulus by nearly all of the developed countries. Investors have ignored this and so many other fundamental problems and have chosen to bid the market higher so long as they feel that massive monetary stimulus will remain in place. Global markets surged higher in April after the Bank of Japan announced plans for monetary policy so grandiose it even surprised even the most optimistic bulls. Japan is now all in on a scale even more ambitious than the Federal Reserve. Such a scale would make even Bernanke blush with envy.
All this cheap money has helped corporate profits to peak on a log scale as they now comprise over 11% of US GDP. This number is absolutely staggering when you consider that the historical average for profits is just 4-6% of GDP and thus the 11% number represents a level several standard deviations removed from the norm. This implies that this level isn’t sustainable for an extended period. Corporations have wrung out all the efficiencies possible for this cycle and wages that have plateaued or declined for decades will begin to rise. Hence the current PE multiple of 14 is far too ambitious and this is why I argued last month that the Shiller equation of a ten year average should be used for computing the present PE multiple. Today that PE multiple would be 22-24 if measured by the Shiller method and that’s not cheap, especially considering the tens of trillions of debt hanging over the market. A PE of 5-7 sounds about right to me considering how constrained the world has become with all this debt.
It’s been quite lonely being a bear the past several months as the stocks have confounded most bears and even surprised many bulls. But I still maintain that the Kondratieff Wave theory will get its due soon as much of this debt defaults. Our theory insists that a new cycle of prosperity cannot begin until much of the excesses of the past cycle have been removed yet in fact those excesses have ballooned even further since the 2008 global financial crisis. For those who believe in K-Wave theory but feel it came and left in 2008-9 I say this- I cannot fathom that the entire pain coming from a 60-70 year super-cycle of credit could be expelled in a mere three quarters of declining stocks and GDP. Just can’t be.
The case for a market top forming today is made easier by comparing the present conditions and sentiment to other recent bubble peaks. In the spring of 2000 it was hard to find anyone who didn’t believe in the new paradigm that assumed fantastic valuations of internet technology ventures weren’t warranted or could not be sustained. Never mind that most had no revenues and were burning lots of cash. Instead investors chose to whistle past the graveyard until their bubble burst in mid March of 2000. The S&P peaked around 1550 and the index measuring those high fliers plunged over 80% in the next two years and that one NASDAQ index is now still off over 70% inflation adjusted ever since. Bubbles and ponzi schemes are nice for a little while until they’re not.
In 2007 another bubble top was formed in stocks (peaking at 1565, a tiny 1% fake-out technical overthrow from the previous high) and US home prices and the fallout from that is quite historic. Once again investors had the audacity to believe and support a ponzi scheme hiding in plain sight. The pitfalls of the securitization of the US housing market are now legendary in their foil but of course such a disaster was apparently not evident to thousands of investors who lost so much on the grand housing scam predicated on financing by those who could not afford to buy homes. Eventually the system could not find enough new buyers so when housing prices began declining in 2006 the system crashed because it was designed to succeed only upon the idea of infinite sustainable growth, a theme directly in conflict with the K-Wave theory that advocates economic contraction is needed in certain periods of the long wave growth cycle.
In the spring of 2013 and can now measure the $7 trillion in fiscal and monetary stimulus enacted specifically to levitate paper assets above their true clearing price. The US stock market continues to rise despite ever growing signals that these draconian fiscal and monetary measures have not and can not sufficiently stimulate growth here in the US or abroad. Stocks seem to rise on good news, bad news, or no news much like the peak of the bubble periods in 1999-2000 and 2006-2007. As always, cheap money from US and global central banks are the culprit and as always they promise us there are no bubbles forming and if one were to develop they would take measures to prevent any disaster.
But don’t forget that Bernanke famously promised that the sub-prime bubble was contained in 2007 and that the Fed over the years has been notorious for failing to see potential land mines hiding in plain sight. This is precisely why our website is rooted in history. Long Wave economic theory provides the optics we need to see how responding to the same patterns were so insufficient over time. Sadly most investors today are ignorant of economic long wave theory altogether and instead choose to measure the market’s arc through yesterday’s metrics such as PE multiples, etc. I suggest a worldview more replete with historical benchmarks that have proven to be very reliable over time. And the bottom line from our Kondratieff Wave theory is all too clear- there is just too much unpayable debt that has accrued in the world today that is likely to default at some point in the near future. These defaults could be enormous and very painful for investors oblivious to the pitfalls of the implications of the bigger macroeconomic picture. Perhaps it’s prudent to take this notion to heart- don’t sweat the small stuff of corporate profits but instead look out for the big stuff such as global sovereign defaults. Massive and unprecedented debt will trump everything once the dust settles on this winter cycle phase. Debt deflation and defaults from global sovereign, corporate and municipal entities are coming to the fore soon enough. I expect one day soon it will become self evident to most that a global financial system underpinned by fractional reserve central banking is a threat instead of a benefit to global growth and stability.
One important person who shares this sentiment recently took the opportunity to weigh in to the world on this crucial matter. Outgoing Japan central bank chief Masaaki Shirakawa made several comments at his final press conference after being dumped by new Prime Minister Snzou Abe. Shirakawa said there was no quick fix for taming deflation and that deploying monetary policy to induce inflation expectations was like punching air. He said the link between inflation and the monetary base has declined considerably over the years. That notion jibes very well with Kondratieff Wave theory that holds that any attempts to fight back the natural forces of deflation coming from super-cycles of credit expansion is a fool’s game.
Shirakawa was a 39 year veteran of Japans central bank and he helped Japan avoid the worst of the global financial crisis a few years ago with tame and reasonable policy directives. But now there is a new sheriff in town in Japan (Abe) who is perhaps even more radical than Ben Bernanke. He undermined BOJ political independence with incendiary comments preceding the ouster of Shirakawa and now the BOJ is printing over $100 trillion yen per year in their great experiment (gamble) to tame deflation. This policy in incredibly risky and could lead to a total panic flight of capital out of Japan for fear of a significant currency devaluation. Such a prospect is quite possible if the markets get ahead of the central banks. In that case the law of unintended consequences would be quite severe as investors in Japanese bonds could flee to protect the purchasing power of their holdings that had been perceived safe until recently.
To some extent this has already occurred as the yen has declined almost 30% vs. the USD since Abe was elected in November. Such a large move by a major currency in such a short span is unprecedented and could showcase what is to come in the coming months and years. Our readers know that I have advocated since 2011 a specific end game to this final stage of the Kondratieff Winter coming in the form of a rising yield deflationary bursting of the global debt bubble. I have advanced the idea that this trend was most likely to take place in Japan since it has in fact been experiencing a deflationary Kondratieff Winter for over two decades since 1990. In fact the era of Japan’s deflation since 1990 will be the stuff of legend one day and a prototype case study for promoting Kondratieff Wave theory into a more prominent role in college textbooks and maybe even also into federal government policies. The next cycle is likely to better heed these lessons.
Japan as a case study is very intriguing and has several features that make it the most likely market to lead a global meltdown. It is the world’s third largest economy, it floats the world’s second largest bond market at over $12 trillion and the world’s highest debt to GDP ratio among all industrialized nations. In January I suggested that Japan would be known one day as the land of the rising yields instead of the land of the rising sun. In the past few days this process may have already taken shape. On the same day in early April the BOJ made the infamous announcement to print $100 trillion yen each year the Japanese 10 year bonds rallied to all-time highs in just a few minutes.
At their peak, their 10 year bonds yielded .31 % in mid session but then a dramatic reversal took shape and they sold off to a yield of .60 that night and have remain elevated at those levels today. Such a reversal represents several standard deviations removed from the norm and tells me something is rotten in Denmark. The takeaway from this is quite grim- it appears that the capital markets are now ahead of Japan’s central bank. The tail is wagging the dog, not vice-versa. Expect more of the same here in the US and anywhere there is blatant debt monetization and currency debasement. Too much of a good thing is in fact not a good thing. Look out below when the markets figure that out, because there is so much leverage in one direction at the moment. Let’s see how that plays out.
In Fed we trust?
And the beat goes on. As the major US indexes approach nominal all-time highs the desperation by investors in the search for yield recently has reached epic proportions that are patently absurd. Since the beginning of 2013 investors have snapped up record levels of debt among the most credit unworthy sources including Greece, Spain and scores of risky European corporations. How does this square with Kondratieff Wave theory?
The central canon of K-Wave theory is that there are distinct patterns of long term credit super-cycles that provide a boom then bust scenario over time. We can argue that the end of the prevailing super-cycle of credit began in 2008 in many areas- consumer credit, home mortgages, and business loans. But since then another form of credit did accelerate considerably with the explosion of untold trillions in global central bank printing. They can collectively defy the K-Wave cycle for a while by granting themselves credit out of thin air through electronic keystrokes. If they had to apply for this credit like you or me they would of course be denied. Who would lend them these trillions to buy bonds at all-time highs from deeply distressed governments running unsustainable deficits? Would Amex give you a platinum card if you were a reckless spendthrift? Of course not.
Interest rates are certain to rise substantially in the coming years and the prices of all these global government bonds will decline accordingly. This certainty is now being called to light by the few hawkish members of the Federal Reserve. In the past two Fed meetings the minutes have showed a marked increase in the anxiety that several Fed members have over the Fed’d bloated balance sheet that is now over $3 trillion and rising one trillion each year. And even more remarkably, even Bernanke stated Friday that he expects long term interest interest rates to rise to over 5% in just a few years. This was the first time to my knowledge he has ever warned about rising rates or proffered a projected target.
This trend and the common sense notion that the Fed cannot print ad infinitum suggests that investors may decide to front run the inevitable and sell in anticipation of these events. So in effect market forces could essentially usurp the Fed and force their hand sooner than they want. I do expect this to happen. After all, markets have been known to price in today what is expected to happen later. The markets at present seemingly believes in Fed we trust and that easy money will be core policy for the foreseeable future. But beware of such a mantra. My belief is that once the market gets the first whiff that the Fed is beginning to gradually taper their purchases the markets won’t respond with a gradual decline. They may choose to react instead to the magnitude and duration of the “great unwind” which promises not to be so kind. I think investors today are entirely complacent to the implications coming from even the slightest hint of a bona-fide reversal in Fed policy.
As a proponent of the K-Wabe theory I believe we are now very close to a generational peak in credit and the price of paper assets such as stocks and bonds. The draconian policies of the Fed has destroyed true price discovery in markets because they have so radically tipped the scales with trillions in printing. These policies have also enabled sovereign governments to continue to amass record deficits without any pressure to enact the needed reforms to restrain runaway spending. Here in the US this is more true than ever. I see peak credit, peak corporate profits, and peak assets prices all at once present today.
There are other signs of a classic top in the markets. Insider selling is rampant with levels of selling to buying at 9 to 1 in recent weeks. The WSJ recently noted that the level of aggregate market valuations compared to GDP are among the highest ever, matched only by those levels in 2000 and 2007. We all know what then happened next. And while some argue that the current PE of 14 looks cheap that may be deceiving. The PE is 22 when using a perhaps more appropriate 10 year average constructed by Robert Shiller and that is not cheap. And also there are the divergences. Despite being a whisker away from a new all-time high in the Dow and the S&P, the Nasdaq 100 is still off 5% from it’s multi-year high last fall. You still have three major sectors that are not participating in the rally- financials, technology, and materials. You just cannot expect a new bull market to begin without substantial moves higher in all of these sectors.
There is much drama ahead. A March 27 deadline looms for the continuing resolution just to keep our government running and then the big one in mid-May- the debt ceiling. This will prove to be quite a battle and all the chips are on the line here. I sure hope they can reach an accord that is balanced and provides very large reductions in federal spending that are carefully considered and implemented over a long period. These cuts must include substantial reforms in Medicaid, Medicare and Social Security or we risk another downgrade from the rating agencies. This week Moody’s cut the United Kingdom’s AAA rating and that leaves just a few left with the top rating. More downgrades are expected for most of the troubled southern European nations whose economies continue to implode. And let’s be sure to keep an eye on three outliers that hardly anyone is talking about- Egypt, Cyprus and Argentina. All three are set to default very soon and these could provide more shocks to the global markets.
We may be entering soon a new paradigm- one more based on reality. In 2000 we all drank the Kool-aid that the internet was providing a new paradigm where company valuations were independent of revenues or profits. In 2008 we drank a different flavor in that home prices would rise forever. We’re now drinking another flavor- that easy money printing by the Federal Reserve will sustain asset prices forever. Investors may want to consider if they are indeed drinking a new flavor the same old rancid Kool-aid.
2013 Preview: The Waterloo of casino capitalism
A new breed of the “irrational exuberance” once lamented by Alan Greenspan may have taken hold in recent weeks as the S&P rose to multi-year highs last Friday despite so many headwinds that have been evident for years. The bulls are gloating and the bears are licking their wounds. So what is really happening?
To me one thing is clear- investors, citizens, and consumers all seem to agree that our enormous debt levels just don’t matter one bit. Despite all the grumbling and headlines we see each day relating to the exploding deficits, there is no passion on behalf of the American public to reduce government debt or its freebies. The recent agreement reached in the 13th hour near on New Years Day sets forth a plan that allows for only tiny gains in tax revenues but maintains runaway spending and nets us another $4 trillion in deficits in the next few years.
Yet stock markets around the world have rallied because another temporary disaster seemingly has been averted. It seems to me that something quite perverse has taken hold in the psyche of today’s investor. Above all, investors loves debt more than growth or fiscal sanity. They are convinced it’s foolish to bet against a system that rewards deficit spending without limits so they are “all in” with risk and reach for yield like never and to hell with the risk. They seem content to ride each asset bubble, smug in knowing they can just cap hop off the train in time before it crashes. Stock prices are inflating right along with debt levels- but can it last?
I believe the current market sentiment is long on hype and short on wisdom. The prevailing worldview in recent years is that the combined aggregate fiscal and monetary stimulus tools will always be sufficient to overcome any weakness in our economy in the near to intermediate term. Here I disagree strongly because I advocate that under the K-Wave theory that efficiency and dysfunction do matter and by natural law must be remedied through the market forces. But since the global financial crisis the prevailing market sentiment disagrees with this core theorem because their belief is “In the Fed we do trust” above the natural laws of the universe. I am wary of any mantra’s that put money changers ahead of nature so color me skeptical that the Fed can keep this up for much longer. We must keep in mins that since the march 2009 lows the stock rally has added over $10 trillion in wealth but that is exceeded by the increase in fiscal and monetary stimulus over the same period. Ultimately that debt has to be repaid at interest rates likely to be much higher than current rates.
A formidable storm has been brewing for decades relating to global aggregate debt levels that is now approaching a tipping point. Soon it will become evident to investors that the current interest rates for debt across the board are far too low and that risk has been severely mis-priced for many years as investors have been chasing yield without proper considerations for the inherent risk. Just days ago new all-time highs were eclipsed in the riskiest of assets such as small caps and junk bonds despite the risk underlying those assets. Such a distortion of risk in the pricing of asset valuations can only occur when extraordinary influences are at work in the capital markets. To date, I would estimate those forces to have accrued to over $30 trillion in global aggregate fiscal and monetary stimulus in the past few years years and this fact has no doubt served to numb investors to the most obvious land mines in plain sight. This would include the exploding fiscal and monetary deficits among sovereign fiscal governments in the Western world (US, UK, Japan, etc). The aggregate effect of this doubling and tripling down of debt in such a short span means that the global capital markets are in for quite a wild ride in the next few years. I expect several crashes coupled with a few large counter rallies too.
One thing is sure- the age of unsustainable debt is over and the age of austerity has already arrived. It will be mitigated eventually through the wonderful advancements in technology and human innovation on display to us across the board but we must realize that in the 2013-2016 period we ‘re experiencing both the tail end of the last K-Wave cycle (1949-2105) and most notably the last quadrant of that cycle (2000-2016, the winter phase). Yet we are also likely seeing first hand the initial stages of the next K-Wave spring cycle (2015-2030) that is sure to be marked by dramatic advancements in technology and human innovation of that technology. It can be argued that this has already begun and thus the pivot has already begun from into the cycles in 2015.
The years from 2013-2016 are the inflection point of the K-Wave cycle where debt must be purged and the floodgates of innovation of the spring cycle must be released. Who will accomplish this necessary feat? A brand new Treasury Secretary? A lame duck President who has no passion at all for fiscal restraint? The leaders of a Congress now sporting all-time lows (9%) approval ratings? No, it’s more likely that pure market forces will be the final arbiter that purges the excesses of this credit cycle. The current long wave cycle began in 1949 and has become over extended through excessive support from the easy credit policies of global central banks, especially in the past thirty years. Can’t imagine this purge will be too pretty.
Investors will be faced with a dilemma in the near to intermediate term- stay the course and hope corporate profits can remain at all-time highs or flee the markets because the headwinds from the aggregate global debt are so daunting they render most everything else irrelevant. To advocates of long wave economic theory such as myself, the latter argument supercedes the former. It renders other meaningful measures to be distant cousins of relevance such as PE multiples, book value, GPP growth, etc. Any investment today in most paper assets (stocks and bonds) is a pure play that could be upended in a big way by any revolution in the appetite for debt. Such a revolution is fully expected to happen as a hallmark of our K-Wave theory.
Other signs point to a potential collapse in stocks for 2012. Investor sentiment and margin balances are at pre-crash highs. Given the recent highs we have front loaded most of the gains coming from the hype of QE and may have exhausted marginal buyers of stocks. I suspect investors are sure to be disappointed with the trajectory of future monetary and fiscal stimulus over the next several years because we have just accrued too much debt already.
It will be quite a tough feat to break though the 2007 all-time highs of 1565 on the S&P or the Dow high of 14,200 or so. There have been a few times since the fall of 2010 that the markets were set to crash (May 2010 flash crash, August 2010 and August 2011) but each time disaster was avoided through unprecedented and incredibly spectacular and dangerous intervention by global central banks, namely the Fed and the ECB. Each time the same thing occurred- the policy measures were decisive and quelled market fears for a brief period but these measures never solved the structural maladies inherently at the root of the problem. They only offered a solution (debt) to solve the same problem (debt). Any fool knows that won’t work yet the markets are placated for the time being.
But the canons of K-Wave theory hold that soon enough a tipping point will be reached that will mark the end of an era of easy money that has fueled our economy and asset bubbles for so long. Never mind the drumbeat of headlines touting new multi-year highs in the market. The primary long wave count still sports an ending diagonal pattern that suggests that once this tipping point is reached the markets will fall much further and much faster than most think.
Japan: The land of the rising yields
To fully appreciate the enduring global economic winter before us, the fourth in the Kondratieff cycle of the modern industrialized era, we must first look to the amazing developments now coming out of Japan.
Japan is Exhibit A for the Kondratieff cycle in modern times among western industrialized nations. It enjoyed a prolonged boom from the 1950’s through the 1980’s but since 1990 has suffered the worst economic malaise of any economy in modern times. Japan may be the best example showcasing the ignorance of long wave cycles They developed the prototype model for monetary easing that Fed chief Bernanke now imItates ableit on a much grander scale. Japan also wrote the source code proving the futility of fighting long wave economic cycles with monetary policy measures designed to goose performance in the short term with disregard for the potential consequences down the road.
It’s very clear these policies have failed to ignite sustainable growth for over the past 22 years and been ineffective at best. Last week Japan reported two consecutive quarters of negative GDP growth and it’s official- Japan,along with the Euro-zone, is now in a recession. Their currency has plunged for the first time in many years and they are now facing a trade deficit for the firm time in decades.
And now they are getting desperate. The clear favorite to be the next premier is Shinzou Abe and he has advocated unlimited monetary easing combined with even more heated rhetoric on the stump in recent weeks. For decades the monetary easing policies in Japan have been historically grand but were implemented at a relatively gradual pace to dilute their shock value. That is about to change, and here’s why.
The problem is this: Japan is by far the most indebted country on Earth but has been able to limit the fallout of their indebtedness mainly because most of their debt is owned by their own citizens. By their nature they are very conservative and are OK with the tiny returns offered by Japanese government bonds. But Japan now faces its own fiscal cliff as their financing needs remain as high as ever but their people are too tapped out to continue to finance the substantial aggregate debt of their government. For two decades Japan has been able to run massive fiscal deficits for one reason- the people of Japan are savers by nature and have always sucked up government bonds. But the times- they are a changing.
I expect soon a sea change in the perception of risk among all investors for Japanese government debt and this is a huge problem. For many years in this blog I have championed one path that I believed will become the hallmark of this Kondratieff Winter- a crash in most paper assets brought forth this time (unlike the 1930‘s) by a rising yield deflationary bursting of the ponzi debt bubble. But where would this begin? How would it unfold? For a time I thought the global bond ponzi may burst through a contagion effect coming from fallout in Spain and Italy. But ECB chief Draghi was able to convince his peers and investors last summer that that the bond markets in Italy and Spain had to be saved because their collapse threatened the very existence of the Euro-zone. Here perhaps Draghi was ultimately correct in this assessment and hence he went “all in” on July 25, 2012 when he said he would support the Euro-zone through whatever means necessary and also said “it will be enough”. I suspect no matter what the outcome that utterance will be on his tombstone.
So in the recent months since this Draghi declaration global markets have rallied and the yields on government iou’s from heavily indebted nations such as Italy and Spain have fallen just because one man in an ivory tower has proclaimed his digital keystroke is mightier than the sword. Since then the capital markets seem to believe this, but are investors in for a rude awakening?
My thesis is simple. The Japanese bond market- the second largest in the world- will plunge and yields explode higher as the realization sets in that there is not enough savings left in Japan to sustain the current low yields and that foreigners will demand much higher interest rates to roll over debt in the world’s most indebted country. If this were to occur in even a modest way then in would still upset the applecart of the global debt markets. Soon it will become clear just how poorly mispriced risk is the sovereign bonds markets of the most countries, especially those of large developed western nations such as the US, the UK, etc. The pinprick is more likely to come not from Spain or Italy but from Japan.
The real question may be this- does the global banking system have a firewall for higher rates? The answer is a resounding no. Few can really appreciate just how much leverage is currently in the global monetary and banking system. It is one now predicated on the belief that interest rates won’t spike higher because central banks won’t allow it. The herd mentality so abundant today makes me wince because the outcome from such a universal worldview in economic policy rarely occurs. If interest rates around the world were to rise some 150 basis points (1.5%) then it would upset the delicate ecosystem of the global financial system because that balance now is more precarious than at any other time.
But the stress tests that the Federal Reserve and other central banks use to to insure banks can handle this leverage all have the same flaw- the test every major threat to banking except the largest and most likely one- a sudden rise in interest rates. Coincidence? I think not. They know full well the implications of exposing the true state of nature in the murky world of global reserve banking system concentrated in a just a few institutions that are clearly still too big to fail.
The point of the above argument is to amplify the notion that we may soon be approaching a tipping point of global debt and leverage from which there is no salvation. The Kondratieff thesis that aggregate global debt must be purged is more true now than when the global financial crisis began over five years ago. This week the WSJ reported that since then that global central banks have added over $11 trillion in monetary stimulus yet growth rates in nearly all developed countries are either flat or negative. This is evidence of the futility of staying the course, yet nearly all global central banks in recent weeks and months have done the opposite. Instead they have doubled down on their efforts to insure that their monetary debasement will solve the problems inherent in the global system. But there is too much debt and their effectiveness and relevance is fading fast.
The coming years of 2013-2015 could a watershed period for retrenchment in the financial system like no other. The unsustainable forces of monetary and fiscal stimulus have encouraged mal-investment that has gone unpunished for too long.
The US has continued to get a free pass with investors based on our dominant role in global finance and by enjoying the fruits of the lowest cost of capital of any nation from the dollar as the world’s reserve currency. But as the WSJ reported last week the current debt obligations of the US are $16.308 trillion and the debt ceiling is $16.394 trillion which means that by February the US will default on our obligations unless a new extension of this debt is passed in Congress. This could be even more difficult to overcome than the present fiscal cliff negotiations now dominating the news each day. Investor confidence is sure to be tested again very soon to uphold the worldview that these low rates are manageable for the unforeseen future. But my “spider senses” tell me to look to the land of the rising sun for the first rays of light for the long overdue turnaround in rising yields around the globe.