Rate Hike Ahoy!

"If ye thinks ye be ready to sail a beauty, ye better be ready to sink with her!" - Pirate saying  

There is so much talk about the next rate hike.  According to the “experts” there is a low probability of a rate hike in November but a high probability in December!  I guess at some point they will get it right but the last time the Federal Reserve raised rates was a year ago and by now we were supposed to have had four more.  Furthermore, they have not raised rates other than that once in a decade!  Their European, Chinese and Japanese brethren continue on with measures that should ensure that their yields continue to fall even though they are below zero in many instances.  The reasons for the continued “stimulus” is due to a continued weak global economy which is hurting the revenues and profits of multinational companies around the globe.  S&P 500 revenues and earnings have been shrinking for more than a year but somehow with more “stimulus” there will be a magical hallelujah moment that will magically reverse years of perverse policy decisions.

As you can tell I am not at all in favor of the measures being taken and when you factor into the equation the choice of bad or worse presidential outcomes I find it incredibly hard to see any chance of a rate hike this year.  In fact should they throw one out it will be much like a life raft from the Federal Reserve to show their independence more than due to economic strength. 

So let’s assume that they do raise rates another 0.25% to 0.50% I would have to imagine that the markets will take it on the chin.  How ridiculous that a second quarter point move twelve months removed from the last one is so feared.  At that level we will have interest rates at 0.50% people!  If half of one percent can cripple an economy, how weak is that economy?  Well as I have mentioned above, the world economy is in dire straits.  China (although they will not admit it) is on the brink of a recession and Europe, post Brexit, has massive problems of its own.  Japan may remain stagnant forever particularly when you factor in the ever growing government intrusion into business and the markets.  So yes a mere quarter point move when the world has a massive hunger for yield will cause a huge spike in the dollar undermining revenue and profits further and could easily drag the economy into a recession.

To me the obvious place to look for reasons why things are so weak almost a decade after the Great Recession is the Federal Reserve itself.  They have been on a massive debt binge and have managed to convince their cohorts around the globe that this is the only way to stimulate.  Pile more debt onto the world economy and viola everything will be fixed!  Anyone who has read this last sentence can immediately see the folly in that but for some reason they cannot.  Amazingly neither can their peers who not only have embraced the policies but have expanded “stimulus” beyond our wildest imaginations by taking rates to below zero and concocting ever more ludicrous ideas.  Why not start paying all the unemployed to not work, now that would be a winner!

In fact it is not too bad of an idea as it would stimulate demand for products which is what the world needs desperately.  The current use of “stimulus” has crowded the private sector out of markets and is manipulating global markets that used to be free to correct on their own.  The drag created by the overzealous central bankers is now a noose around the neck of global growth and until it is removed it will continue to slow to a halt.  At that point, and it is not very far away, no matter how much more “stimulus” is thrown at the problem all it will do is drive it further into the quagmire.  It is at this point that markets will lose faith in the central bankers of the world and watch out below.

For these reasons I am very comfortable staying out of the markets and waiting patiently.  Once the markets are at a level where there is true value, I plan to jump in and ride the wave of euphoria that will be the relief to be rid of the shackles of the Federal Reserve.  Where that number is will be seen at some point in our future but if I had to place a bet I would say that the lows of 2008 will be taken out.  Take this as a warning and position yourself accordingly.

The Good Old Days

"Wish we could turn back time to the good old days;
When our momma sang us to sleep but now we're stressed out." - lyrics to the song Stressed Out by Twenty One Pilots

I know I have been off the air for a month but it is summer and time for a break right?  In all honesty while it was partially a break, the lack of correspondence was more a factor of too much work on my plate so something had to give and I chose to let the blog go for a month.  That said not a lot has changed in the last month; more hot air from the central bankers of the world, more stimulus and a couple of very poor candidates to chose from to run the country.

I was reminiscing over the last few weeks about what life used to be like in the "good old days".  It is hard to even remember a time before 1995 in the investment world but it seems that with the advent of the Internet everything changed.  To me those were the good old days when central bankers of the world operated in a relatively insulated bubble, focusing on their local economies.  Stimulus was left to tinkering with interest rates and bank reserves with limited open market manipulation.  Recessions came and went as a normal course of business.  Companies were valued on their balance sheet strength, growth opportunities and profitability.  Global debt (businesses, consumers and government) according to The McKinsey Global Institute stood at around $30 Trillion.

Fast forward to today and global debt is north of $200 Trillion or roughly $27,000 per person!  Furthermore the central bankers of the world have decided that $130 Trillion in 20 years is not even close to enough so they are pushing even more debt out into the market.  Just this month the BOE, Bank of Japan and the ECB have announced additional stimulus amounting to more than $50 billion a month!  What are we supposed to do with all this additional debt?

The idea is that we spend it on useless things like another iPhone or a new car (both of which are direct direct beneficiaries) however all that this stimulus does is bring future sales forward stealing economic growth from the future.  An example is China who reduced the tax on automobile purchases to 5% from 10%.  This stimulus increased automobile sales in China to north of 26 million units in the quarter but this incredible run will surely end when the stimulus ends at the end of the year.  People do not need new cars every year and looking forward the result of the stimulus will be to destroy automobile sales in China next year.

The issue is that adding more debt is not helping but is crowing out the normal private market and economic growth.  This crowding out is cutting heavily into GDP growth rates but is shown in its stark reality when you look at Wall Street.  In 1998 when "stimulus" had just begun under Greenspan, the number of companies publicly traded peaked at just over 8,000.  Since then the effect of all of this debt has been to crowd out the public markets and the number of listed companies is now half of what it was.  Some of this has to do with poor management however the bulk of the change has been from companies using debt to acquire other listed companies or management teams taking companies private using debt as the lever.

Not only have companies been using debt to acquire each other, they have also been turning to debt to juice their poor results.  Issue debt, buy back shares and hey presto you have better than expected earnings per share!  In fact companies are so awash with debt that some of them have massive negative tangible book values.  Remember that tangible is something that is real like a desk or a car whereas intangible is imaginary like Goodwill.  In the case of IBM as an example removing $42 billion of goodwill and intangible assets results in a negative book value of $25 billion!  Broadcom is not much better with a negative tangible book value of $22 billion.  Who would ever buy these shares and why are they even listed?

Looking at the balance sheets of some big names it just amazes me that more attention is not given to the balance sheets of businesses.  Microsoft now has $55 billion where not too long ago it had zero, Oracle has $43 billion, Apple has $85 billion, Intel $24 billion, IBM $44 billion and Cisco is at $29 billion.  Now while these companies are large this debt burden is enormous.  Heaven help them if at some point int he future interest rates rise and they cannot repay the debt!

But while interest rates are low the party continues and my analysis points to low interest rates for a while to come.  Not that I think that interest rates should be low, they should not, but because the central bankers of the world are going to continue to manipulate them for as long as possible.  They will also continue to print money in a vein hope that one of these dollars will eventually stimulate the global economy.  How ignorant and blind are they?  This is the biggest experiment known to man and one that has no chance of working out well.  The problem is that while ALL of the central bankers of the world continue to push money into the pot together there are no real repercussions.  Everyone's interest rates remain low or continue lower and everyone's currency weakens at the same rate.  No-one gains the upper hand so they try even more "stimulus".  Bond yields continue to wilt and it is just a matter of time before helicopter money policies are used (by passing the banking system and sending money directly to people).  Already there is talk of a perpetual bond (one with no end) and other crazy schemes but the results are all the same - nothing but a large pool of debt!

In this world of unbelievable craziness comes the demand for social policies and walls from the electorate.  Voters are turning to politicians who are promising things that are not only detrimental to long term growth but to the viability of capitalism.  It will not be long before capitalism is pointed to as the root of the problem.  However, it is not capitalism that is creating the problem it is the manipulation of the very fabric of free markets, the heart of capitalism, by the central bankers of the world, the supposed protectors of capitalism, that is at fault.

So while it is impossible to bring back the good old days it is possible to protect yourself and your portfolio by extracting yourself from debt and moving into gold or other assets that are antifragile.

There's Gold in Them There BREXITs!

Yesterday Britain voted to exit the European Union the so called BREXIT.  As expected the decision was close but the result was unexpected and threw global markets into a frenzy.  The European markets took the brunt of the selloff with Germany down more than 8%.  US markets reacted in less of a panicked fashion but were still off more than 3% at opening.  The initial knee jerk reaction will probably be muted in the short run as the actual exit will take a number of years to effect and it remains unknown as to what sort of impact this will really have on the UK and the rest of the European Union.  Certainly the press and the economists of the world are having a field day predicting a catastrophe but as we all know these predictions are more often than not vastly exaggerated.

I for one am not even going to try (in this blog at least) predict the long term fall out of this decision but there is a chance that other European countries try to exit as well causing the downfall of the EU.  This may well happen but the main question is whether the core group of nations remain and I believe that there are sufficient benefits for the 6 largest economies to remain unified regardless of whether smaller outlier countries exit (not that the UK is a small economy but the UK has sat on the fence of the EU since it was created so the result of an exit should be less impactful than one of the core group of nations exiting).   So while the markets of the world gyrate wildly to the unexpected news it is my thought that in the long run the overall impact will be muted.

That said the vote exposed just how annoyed the world is with their various political bodies.  Not only did the UK snub their noses at the incumbent party leading to the resignation of the Prime Minister, but now there is renewed talk of Scotland leaving Britain.  The United States is no different in that Trump has achieved a level of success that few believed would be possible without a population that is resentful of their leaders.  With the vast majority of Americans feeling that their politicians are out of touch with their plight plus the increasing divide between the have and the have nots it is clear that a change is inevitable.  It is just a shame that this desire for change was not directed towards a candidate with real leadership qualities that could infect rational change rather than a crass bully but unfortunately the desperation has been misdirected.

The other thing that should be clear is that precious metals and particularly gold are a hedge against the current malaise of the world.  Gold spiked more than $70 an ounce after the BREXIT was announced.  As opposed to the collapse of the global markets gold rallied more than 6%!  Gold stocks also went into orbit with some names up more than 10%.  It is amusing to me to listen to gold haters argue about what a poor investment gold is when during times of crisis it has repeatedly proven its worth as a hedge against disaster.  If you believe, as I do, that the world is clearly on the wrong path then owning gold, gold stocks or gold ETFs is a must.  Even if you hate the idea of owning gold today should be a signal that gold will provide downside protection for your highly overvalued stock portfolio.

So take note and realize that there’s gold in these BREXITs and other global catastrophes particularly when you have the world’s central bankers determined to destroy any kind of fiat money value.  Take this as a warning and position yourself accordingly.

A Recipe for Stagnation

"Agitate! Agitate! Ought to be the motto of every reformer.  Agitation is the opposite of stagnation - the one is life, the other is death." - Ernestine Rose

As has been widely broadcast the minimum wages across the country are heading higher.  It seems like the States are in a race to see who can force minimum wage to $15 an hour in the shortest amount of time.  The theory is that if you can move minimum wages higher, the people at the bottom of the wage scale will be moved to a position of financial strength improving their spending power and benefiting all.  Politicians look at it as a transfer of wealth from those that can afford it to those that need it most.  On paper this seems to make sense but digging a little deeper and it is clear that this is another government intervention that will have unintended consequences.

I certainly understand the political agenda behind raising the minimum wage.  I also understand that without some form of government  intervention wages at the lower end of the spectrum would stagnate forever.  That said the problems with the most recent round of forced increases are the timing and the rapid acceleration of the base wage. 

First let's look at the timing of the wage increase.  Were the economy booming companies would be competing for workers and the natural order of business would result in pay rates rising to attract workers.  Currently the economy is on such weak footing that the Reserve Bank is hesitant to raise interest rates even a 1/4% higher.  Furthermore as long term readers of this blog will know, while the unemployment rate is relatively strong, the labor participation rate and the U6 unemployment rate is pointing to anything but strength.  Had the politicians waited for economic strength the market would have been resilient enough to handle the increases however this is not the case today.

The second issue is that the wage rates will increase pretty much every year through 2020 by which time most if not all States will have a minimum wage of $15 an hour.  This rapid acceleration will impact earnings significantly and will be a factor that needs to be considered before starting any new business or expanding into new areas.  This will slow down hiring and make companies reduce expansion affecting job creation.  Furthermore the wage increases are not limited to minimum wage earners but has been extended to lower management as well. 

By the end of the year salaried employees earning less than $48,000 a year will be required to be paid overtime.  This impact will be the largest of all as companies will scramble to reduce these key employees' hours or remove the position completely by consolidating the position into one higher paying position.  It will also impact the upwardly mobile as these go getter's will have to reduce the hours worked thereby negating their advancement opportunities as they will not be able to showcase their can do attitudes without costing the company money. 

The biggest impact of these new policies though is that this is yet another barrier to entry for small and start up companies.  To these companies a high level of pay would be $40,000 a year and that would equate to a senior manager.  Making this position cost more is akin to putting a bullet in the heart of small business and business start ups.  As you would have read in last week's blog there is already a major slow down in net company formations and this slowdown is one of the largest causes of anemic GDP growth.  Raising the cost to starting a company even further will have a massively negative impact on small company start ups which will kill any idea of GDP expansion. 

The results of all of this is that the economy will stagnate.  GDP growth will be anemic until such time as all of these wage increases can be factored into the price of goods and services and given the weakness of the global economy this will take a long time.  In the meantime during this adjustment period the divide between those that have and those that do not will widen even further in complete contrast to the desired impact.  This new law has effectively placed another golden spoon in the hands of large business at the expense of the job and GDP growth engine, small business; their moat is even more secure and this is a huge problem if you want to see GDP accelerate.  Better get used to the stink of stagnation!

Two out of Three Ain't Bad?

"And all I can do is keep on telling you, I want you, I need you; But there ain't no way I'm ever going to love you; Now don't be sad, 'cause two out of three ain't bad" - Lyrics to the song Two Out of Three Ain't Bad by Meatloaf

If there is one metric that tells the true story of the state of the economy it is the labor statistics.  Or does it?  As I have repeated in previous blogs, pretty much every statistic from inflation to the labor market numbers are fudges, guesses, estimates stabs in the dark; call them what you will but they are manipulated and the labor statistics are no different.

As an example take the monthly labor reports.  Each month the Bureau of Labor Statistics adds a fake 75,000 jobs to the labor force from their Birth/Death computer model to account for new company births.  This is based on the range of new company start ups from the previous 20 years prior to the financial crisis.  During this period on average the net number of new firms (that means more firms opening than closing per year) ranged between 75,000 and 200,000 a year.  To account for this the BLS blindly adds 75,000 new jobs per month to their reported numbers.  Well according to the US Census Bureau the number of net new company openings since the financial crisis is just 33,000 a year, less than half of the prior period so this fake number of new jobs is vastly overstated.

Even though we know the numbers are wrong they do tell a story.  If they are consistently wrong each month then at least we have a benchmark to work with.  Taking this benchmark as being overly optimistic (based on the above analysis) means that the printed numbers are far worse than what is published.  To offset some of the errors adjustments are made to reflect miscalculations and these result in revised numbers that are possibly closer to the true number however most people ignore the revisions but their story tells a clearer tale.

Therefore taking today's published May job figures (prior to revisions) of non farm payroll increasing by 38,000 and private sector payroll increasing by 25,000 regardless of the how wrong they are they are still anemic.  Consensus was for them each to increase by 160,000 so these are truly disastrous figures.  On top of this April and March's numbers were revised downwards even further to fall well below the 160,000.  This 160,000 number is Wall Street's current "required" number to show economic health.  This number has also been revised lower as the economy was sputtering so badly that they had to reduce the number in order to print bullish headlines.  Were the economy truly healthy this "required" number would be in the range of 250,000 a month but as that is not even remotely possible, Wall Street analysts have quickly reduced their number of economic stability.

The next interesting statistic comes from the unemployment rate which fell to 4.7% versus 5.0% in April.  Wow, so magically the unemployment rate is falling even as less firms are added to the pool of companies AND as hiring falters.  In an economy the size of the United States you need to increase the number of jobs by roughly 150,000 a month just to remain at status quo in terms of the unemployment rate.  The reason for this is that the population is growing so the economy needs to suck up the additions to the work force to maintain equilibrium but magically the unemployment rate is falling.  How is this even possible?

Well when a person goes on unemployment benefits they are logged as unemployed.  As long as they remain on benefits they are counted.  If their benefits run out before they can find a job then they are magically "employed" according to the count!  This is how the number is improving.  Taking a look at the U6 number which includes people working part time but want full time work the number quickly balloons to 9.7%.  This number is stuck at roughly the same level as where it ballooned to during the 2002 and 2003 recession; hardly something to sing about.

The most telling number of all to me is the participation rate.  This number basically takes the total number of people working divided by the number of people in the population (not quite as simple as that but you get the idea) and this results in another metric.  This number FELL to 62.6% from 62.8% and is well BELOW where it was at the height of the recession!  Yes back in 2009 this number was around 65% so 5 trillion dollars of money has managed to make this number worse by almost 4%!  And to think that they are actually considering an interest rate hike because the economy is "strengthening"; what a joke.  I guess the rate hike is based on the lyrics of the song that, "two out of three (employed) ain't bad'!

Upwardly Mobile

"It is good to follow one's own bent, so long as it leads upward." - Andre Gide

One of the bedrocks of economic theory is that labor will migrate towards areas where there are higher wages and a better quality of life.  The theory goes that if you remove all borders then workers will naturally flow to areas flush with job opportunities.  This is one of the reasons behind creating the Euro Zone or the North American Free Trade Agreement.  Furthermore there is proof that children who are moved to areas with better education, lower crime and where there is a preponderance of two parent families earn more than 10% than their peers.  With this as proof one would think that the theory would hold as what parent doesn't want the best for their children?

A new study however has shown that the theory may not hold true specifically for those reliant on government subsidies.  Unfortunately these are the people that would benefit most from an improvement in living standards and are the demographic of people that are assumed most likely to move with their relevant industries.  The finding is that not only can these people often not afford the expense to move but they are tied to their subsidies.  If they move they lose their subsidies such as housing and food stamps which is often their major source of financial sustenance.

Now moving from one town does not mean that the subsidies are lost forever but it often means that they are lost for a period of time.  This period of time is more than most are able to handle and so they stay put.  Changing the way that the subsidies are issued would be a big step in the right direction however society has found many ways of blocking the needy from entering the upper class halls.  One is to restrict low income housing or change the building specifications to effectively stop the building of any space that would allow cheap units to be rented.

In addition to these issues America has long had a love of the automobile.  This love has created a system where moving large bodies of people around the country is expensive and time consuming.  Public transportation while improving is still far behind Europe and most of the rest of the modern world so spending money on these infrastructure projects would not only create work for those needing it but would bolster the economy far more than throwing more money at banks.

Creating a truly mobile work force should be a priority in the United States.  Spreading the burden of subsidies evenly would assist those cities that are struggling to handle the draws and creating mobility would give everyone the ability to find work at a decent wage.  The result would be a truly upwardly mobile economy and one that would worth celebrating and investing.

Measuring GDP

"Not everything that counts can be counted and not everything that can be counted counts." - Albert Einstein

The above quote is so true but humans have a natural tendency to try to place a value on pretty much everything.  When it come to the world of economics, counting is a virtual impossibility because in most instances the things being counted are so vast and changing so regularly (if not every millisecond) that even after time and effort is made to calculate the number it is guaranteed to be wrong!  The thought in economics is that even though it is well known that the number is incorrect it is better than no number at all.

There is no number more relied on and more wrong than GDP.  The estimate of changes in GDP is used to assess whether the economy is growing too slowly or too fast (or not at all) and to gauge whether inflation is rampant, in line with targets or deflationary.  It is used to determine whether we are in an overheated booming economy or a stagnant spluttering economic recession.  Central bankers rely on it to create their strategies for stimulating or cooling down the economy and governments are held to account, particularly at election time, for the their ability to provide good GDP growth.  Currencies swing higher and lower reflecting the strength or weakness of the underlying economy's GDP growth in comparison to everyone else, and interest rates depend to a large extent on the outlook for GDP growth or lack thereof.  To say it is an important number is an understatement however to calculate it is all but impossible.

Created in the 1930s GDP was initially relatively simple to calculate.  Take a basket of goods and services and then revalue them a year later and there's your answer/  Economies in those times were based more on manufacturing and farming than it was on services so computing the change in the inputs was relatively simple.  Fast forward to today and the complexities of the modern world make a mockery of the number.  Examples abound but I will mention only a few:

1. The smart phone in your pocket has more computing power than a PC had in the 90s and the price is lower so is that deflationary or should there be an adjustment for improved productivity?
2. The new smart phone is more pricey than last year's version but it comes with a number of new features so is this inflationary or should the price be adjusted lower so that it incorporates the technological advances that make your life easier?
3. What about the use of your car to take passengers for a paid ride (Uber) or that extra room in your house that is rented to travelers (AriBnB) or all the free entertainment that is available on YouTube or Facebook?  How should this be included in GDP?
4. What about the billions of dollars that are flowing through the black markets of the world?

The case for the basket of goods capturing a change in GDP is so rife with problems that it is starting to make the number of little relevance.  When you start to consider the inflationary aspects of the number and the adjustments that are made for technological advances it becomes even more haphazard.  How can you compare the change in price of say a fax machine and the use of email or crutches with prosthetics or vinyl records with streaming digital music?

The issues are so complex that whatever number is calculated it is far from reality.  This is why everyone should calculate their own inflation rate particularly when it comes to determining a real rate of return on your investment.  Without it you cannot get a clear indication of real portfolio returns and this will have a tremendous impact on your retirement planning.  But for all its problems having a number is better than having no number at all but basing your financial future on this number is akin to failure.  Use it as a loose gauge of economic activity and follow any large swings but do not hang your hat on this number.

Desperado

"Desperado, why don't you come to your senses, you've been out riding fences for so long now;
Oh your a hard one, I know that you've got your reasons, these things that are pleasing you will hurt you somehow>" - Lyrics to a song by The Eagles

Is it just me or is the world filled with a lot of Deperados?  The central bankers of the world are desperately doing their best to convince the world that more debt is the solution to our problems and are considering more desperate measures to pump more useless money into a flagging economy in a desperate attempt to stave off the inevitable.  The general population is not convinced and is showing its frustrations at the polls by desperately buying in to the rhetorical garbage that is coming from the mouths of the Presidential candidates.  Not only will the policies of either candidate not solve the man in the streets woes, but some of them will create a far larger mess but we will see who takes over in November and deal with that then.

Through all of this the stock market continues to toy with new highs but has yet to print any for over a year and we are now into the May to October low volume trading period so anything can happen.  To me it is truly amazing that the stock market is up at all for the year; corporate sales and earnings are continuing to decline (GAAP earnings were down 15% in 2015 and were down another 8% year over year in Q1 for  the S&P 500), two thirds of the companies reporting earnings cut guidance for the second quarter, GDP growth in the first quarter was only 0.5% and business investment in Q1 was the lowest since the 2009 recession.

With all of these negative data points plus rising oil prices and poor economic activity being reported across the globe I firmly believe that we are entering the end game in terms of the stock market.  As I have mentioned repeatedly though the Federal Reserve will come to its rescue with more support in the form of rate cuts (possibly going negative to join the global party) and money stimulus.  The issue is that the impact of further rate cuts and monetary stimulus will be muted and the results of trillions of dollars of stimulus is weak economic growth and a faltering labor market.  The next step will more than likely be the "helicopter" method coined by Ben Bernanke.  The idea is to go around the banks and directly to the consumer by throwing money out the side of a helicopter!  Sounds like a great and well thought out plan like the rest of the central bank's policies!

All of these desperate attempts at stimulus are not providing the economic windfall that was predicted and more stimulus will not magically create jobs or increase productivity.  In fact productivity has continued to lag as the burden of debt is creating an economic drag that has crowded out the private sector (and more importantly the small business and middle class) resulting in continued lackluster growth and fractions within political parties.  Adding more debt will not magically solve these issues but will create a larger problem.  In this highly volatile environment if you are not posturing yourself for the inevitable then you are opening yourself up to enormous risk.  My advice is to look to gold stocks and alternative investments or go to cash but either way exit as soon as possible.

The Retirement Equation

In life one of the most if not THE most important equation that needs to be solved is how much do I need for my retirement.  The equation is not as simple as it seems as there are numerous variables that will undermine even the most detailed analysis.  As we all know the inputs are; the size of the asset base, the annual returns on that asset base, the remaining life span of the investor and the annual expenses.  These variables change constantly and therefore make it even more complex to determine the amount needed but financial planners like to assure investors that they are covered when often times they are not.  I thought it would be useful to open pandora's box to show you how hard it is to determine the appropriate number and to make you consider in far more detail the inputs and the outputs before you make too bold a step into the world of retirement.

The first variable is the size of the portfolio.  On this front it is always better to have more than not enough.  To me the size of the portfolio needs to be of a size that will be resilient regardless of the market gyrations.  There is no doubt that should you live another 20 years, the market will throw a spanner into your engine of returns and the draw down will destroy the supposed smooth line of returns that you are expecting.  Just take the current market for example.  For those that have followed this blog for some time you will know that I believe the market to be manipulated and over priced but the alternatives are producing such low rate of return that you are almost forced to take on too much risk to produce a meaningful number.  This means that even now (or should I say especially now) the returns to your portfolio (if you want low risk which most retirees do) are too low to support any "normal" expenditure.  One way around this is to invest outside the box but the other way is to have a portfolio that is so big that it does not matter.

Well as this is not a solution for most of us the next alternative is to delay your retirement as every year that you work not only adds to the size of the portfolio but also reduces the amount of time that the portfolio has to support you by one year.  The less time that the portfolio is required to provide support the lower the size of the nest egg and/or the return requirement both of which are a huge benefit to your portfolio and its ability to achieve its goal.

The next thing to consider is the average annual return.  As I have mentioned, achieving a meaningfully positive real rate of return (that is the portfolio return less inflation) is virtually impossible at present unless you take on far too much risk.  Risk here is defined as the probability that your portfolio will suffer a large draw down from which it can never recover.  Most people that I talk to seem to be in this camp as they are not considering the alternatives for the simple reason that their investment advisor is not able to sell them the alternative investments.  This is a flaw in our investment system; the people that need the alternatives the most are "protected" from them so that they are not exposed to losses.  In the meantime they are lead to the slaughter like lemmings but those are the rules and I pity those that are forced to follow them.

The next point regarding returns is that they will change year in and year out.  The idea of a smooth line is almost impossible to achieve so the portfolio has to be able to sustain a draw down and recover.  This is why the average planner suggests that retirees only withdraw 4% of their portfolio each year.  This small amount protects the portfolio but often reduces the amount that the retiree can withdrawal to such a small amount that it does not benefit the retiree at all.  Assume you retire on $500,000 and you can withdraw 4% a year, that is only $20,000 a year or roughly $1,800 a month.  While not a small amount it is not big enough to support most active lifestyles and most retirees do not even have half this amount saved!

Looking at life expectancy tables shows that the older you are the longer you have to live.  So for example at 50 the tables show that you have roughly 35 years to left live but if you are 85 the tables do not show zero years to live but show roughly 10 years left.  The probability that you will live longer is higher the older you get and therefore to plan your retirement requires a constant adjustment to your life expectancy all the while your portfolio size is finite (other than the returns on it).

The final input is the monthly expenses.  While we all know that 95% of our medical expenses are incurred in the last 5 years of life what most planners do not factor is that spending habits change with the size of the portfolio.  People are not going to blindly spend the same amount of money each year particularly if the portfolio size diminishes rapidly due to unforeseen market forces.  People will adjust their spending down as the fear of outliving their income will quickly place a crimp on the spending.  The main issue here is that the catch all, annuities, are not factoring a lot of these inputs as there simply has not been enough time (and here I mean enough years to have past to produce data) to capture the data required to factor in all of these inputs with a sufficient level of understanding to underwrite the majority of the risks.  Not that I expect the annuity world to blow up but it is something to consider when you are told that you are covered because you have an annuity.

So with all of this said it is really clear why you need to constantly review your investment portfolio as there are no constants even if your planner assures you that they have it covered!

Controlled versus Free Markets

Having no trade restrictions; not subject to government regulation; not subject to restriction or official control. - one of the definitions of Free in the Webster Dictionary

During the week I spend a lot of time reading to keep up with the ins and outs of the markets and the macro-economic environment.  I do so to try to assist me in planning my next move but as most macro-economic moves take time to develop I am not in a rush to change things.  It has been my contention that the United States and the world are in a predicament that will lead to severe pain so for the past five years I have been slowly implementing an investment strategy that I believe will benefit from my macro-economic outlook.  Most people do not want to hear my views as they are contrary to what the talking heads want you to believe and the results, if I am right, are painful but in this game you need to do your research and follow your findings in order to succeed.

This week I have been reviewing a number of articles associated with the idea of a free market.  When I first started trading back in the early 80's the markets gave you ample opportunity to prosper from good solid research.  Since then almost 40 years later those days are long gone.  With the advent of the massive control that the Federal Reserve and other central bankers now have over the markets the game has changed.  So the idea of a free market no longer exists.  As the rules of the game have changed the investment strategies need to align themselves with the new playing field so let's look at the playing fields.

A free market as the definition above shows is one where there is no government intervention.  Markets are left to their own devises.  They will move to the beat of the economic environment and the perceived opportunities available to the companies that operate in their various sectors.  When there are good times stock prices run higher as the outlook is solid and profits rise.  During these times more and more companies enter the space eventually stealing market share from the incumbents and hurting the bottom line of all businesses in that space.  The effect of this competition is lower prices to the consumer and expanding employment.  Eventually though when the profits are too thin the weak are weeded out, layoffs and bankruptcies become the norm.  Once these are cleared out the cycle repeats itself.  Market forces take care of the good times and the bad times.

Fast forward to today where there is a shrinking pool of large companies that control larger and larger portions of the global market.  Profits are spent not on research and development but on securing their position in the world by creating, as Warren Buffet terms, a "moat" around their business impregnable to others.  The result is higher prices to consumers and lower employment opportunities. These companies can handle the down turns but due to the lack of competition during recoveries there is little in the way of employment growth.  The only growth that is seen is profits.

In addition you have a Federal Reserve that is becoming more and more like the central planners of Russia and China.  They are not content to let the market operate in a vacuum but tinker with its very existence by lowering rates to juice returns to investors and providing cheap capital to the too big to fail companies.  The result is that the rich who benefit from these interventions get richer and the poor feel no effect of the "stimulus".  At present there is an ever wider dispersion between the wealthy and the poor and this disparity is creating massive problems for growth and political stability.

This intervention is not limited to the United States but has expanded across the globe.  In Japan the BOJ has not only issued debt but now owns around 40% of all the exchange traded funds on the Japanese stock markets.  Furthermore they are demanding new funds be made up of socially responsible companies (read companies that benefit the Japanese people) so they are not only providing capital but are controlling the intricate workings of the stock market itself.  China too has manipulated their markets more aggressively than the Federal Reserve but it is clear that they all have their arms firmly grasped around what used to be a free market.

In the volumes of historical documentation about the central planners of the world it is clear that any time a country pursues a path of central control, or control among the few, it never succeeds in the long run.  There may be some short term gains but eventually it all craters.  Russia blew apart, China is showing signs of instability and needs to open up to a freer market.  Japan is still struggling to stimulate inflation.  The issue is that the worse things get the tighter the central bankers' control over the market.  I have written much since the 2008 crisis and a lot of what was written was the question why, after the crisis was averted, did the Federal Reserve not move to the side?  Their job was done and it was now up to the markets to take over and sort the balance of the problems out themselves, freely; but they have continued to meddle and try to control the markets and their continued tinkering is creating the massive market instability that we face today.  

The result is going to be a very bad market collapse.  The issue is that this will stimulate them to try to control the market even tighter than before.  At some point congress will have to step up and remove the ridiculous powers of the Federal Reserve and restore them to their previous mantra of fighting inflation and lowering unemployment, freeing the markets from their grasp.  Until then my thought is that the global economy will continue to dribble forward on life support with longer recessions and little in the way of any economic recovery, forever.

The Obesity Index

"This is what people don't understand: obesity is a symptom of poverty.  It's not a lifestyle choice where people are just eating and not exercising.  It's because kids - and this is a problem with the school lunch right now - are getting sugar, fat, empty calories - lot's of calories - but no nutrition." - Tom Colicchio

Well the world's central bankers could learn a thing or two from the above statement however their "obesity" is in the form of debt.  A recent article published in the CFA magazine highlights that global debt has risen by $57 trillion between 2007 and 2014.  That is more than $8 trillion a year added or roughly $700 billion a month!  This puts global debt at more than 286% of global GDP.  The sad part is this number only counts the debt that has been issued and does not include what is referred to as "off balance sheet" debt.  These are debt obligations that are owed but have not yet been paid and have no formal debt associated with it.  Examples of this kind of debt would be the unfunded Social Security benefits, pension liabilities and entitlement programs.  If we were to include these obligations the number would be far greater.  Just taking the pension obligations the estimate is $50 trillion more pushing debt to global GDP over 300%.

This has not deterred the globe's central bankers from issuing more debt.  The reasoning seems to be that if the world has taken on this much debt what does it matter if we take on more?  Furthermore, without this infusion of capital in the form of debt the global economy would not be growing and we would be in a world of trouble, so the central bankers say.  But there are two main problems associated with this continued increase in the debt burden; the first is that borrowing no longer generates growth and the second is that instability is increasing.

Taking the first issue regarding the lack of growth, I do not know how much more of an example is required than the post Great Recession's anemic recovery.  As the debt level rises more and more money is spent on servicing the debt and ultimately it crowds out productivity.  Back in the 80's when debt was first added as a stimulant each unit of additional debt resulted in roughly a unit increase of productivity.  Today that marginal productivity has all but evaporated.  Adding more debt is have no impact on growth which is why no matter how much money is thrown at the problem or how low interest rates go there is no economic expansion.

The second issue is that as you pile more and more debt onto the world it results in shorter boom periods and longer periods of bust and recovery.  Defaults are becoming more and more common and people are becoming more and more angry at the establishment and the rules; just look at the mess created by the massive obligation of student loans in the United States.  This instability is feeding into politics as angry voters throw their weight behind people like Trump.

To me adding more debt to the global economy is like piling more sand onto a sand castle, eventually it will buckle under its own weight.  A reverse strategy would be far more effective and stimulating.  Imagine if the United States wrote off all of the student debt in one go.  All of that money would be spent on housing, cars, vacations and the like.  The stimulus would be huge.  Any consumer knows that removing the burden of debt brightens your whole day, the outlook is not cloudy and your are excited to buy something new.  Unfortunately the world has burdened its citizens with the yoke of debt and until this is lifted global economic growth will remain anemic.

If growth therefore is anemic (as it has been) and good paying jobs hard to find (as they are), the world's middle class will continue to shrink as people roll backwards.  In order to stave off the debt collector families are cutting expenditure (creating slow to no economic growth) and, according to the quote above this is one of the main causes of obesity.  Hence the birth of a new index, the Obesity Index.  If obesity continues to grow economic "stimulus" is not working.  Once there is true economic growth you should start to see obesity come under control.  As it is now a growing global problem it would point to continued poor economic growth and a disconnect between the policies of the central bankers of the world and the impact of their "stimulus" on the global economy.

Until such time as there is true global economic expansion, not growth based on fictitious money that is blindly thrown at banks, but real expansion based on growing consumer spending derived from wage increases and jobs, I guess the world will continue to consume the $1 Big Mac and deal with its waistline!

Tapped Out

Lisa Simpson, "What happened?"
Homer Simpson, "Difficult to say sweetie.  The town blew up, I built our house and you showed up.  All we know for sure is, I'm completely blameless."  
An excerpt from the video game Tapped Out featuring the Simpson's television show characters in which Homer has just blown the town up through his negligence at the nuclear power plant.

Reading about the EUs next attempt to stimulate by printing more money and the Federal Reserve's discussion on possibly moving to negative interest rates it seems that the central bankers of the world are rapidly becoming tapped out.

Looking at Japan it seems that they are finally reaching their breaking point as more monetary stimulus is having no impact other than to make the world start to wonder if they will ever be able to pay back their current debt.  The loss of confidence is not only affecting their currency but is also having a negative impact on their consumers and this is feeding into negative consumption reports.  China too is having limited success mainly due to the fact that large swathes of money that is being forced into the economy is ending up with deadbeat state run companies.

As I have repeatedly written about in this blog, debt does not solve a world's economic woes.  Taking on debt is at best a short term solution that should be used in cases where budgets are temporarily unbalanced or to put a stop gap under a financial crisis but it is not a long term solution.  Piling ever more debt onto an already massive pile does nothing other than sink the economy.  When that economy is large like the United States, it takes a lot of debt weight to sink it however, when it is small like Zimbabwe it does not take much.

One way that countries escape from this burden is to let their currency devalue and this creates opportunities to grow through exports however it also has the effect of creating inflation as global goods like oil become more expensive.  This inflation makes the overall debt level become more manageable assuming that the debt is based in the local currency and not in dollars.  For countries with debt based in dollars this depreciation can be the final death knell as has been witnessed in some South American economies but in developed nations currency depreciation is frequently used.

One way to depreciate a currency is to lower interest rates.  The result of this is that investors leave the country and move their money to countries where currency appreciation is expected along with higher interest rates.  So lowering your interest rate below zero should therefore do the trick however even this is not working as everyone is now playing that game at the expense of savers and investors the world around.  The idea that negative interest rates will stimulate by forcing investors to make their money work or by channeling debt to companies so that they can grow is not having any impact as companies and consumers are either already awash with debt, cannot obtain it or have no place to invest it; so adding more debt is never going to have the impact that the Federal reserve thinks it will.

So if lowering interest rates is not working and adding debt has not worked essentially the world is rapidly waking up to the fact that the central bankers of the world are tapped out.  And while the markets rallied today on the back of the US's stimulus package it is once again false hope.  Until there is some form of global inflation based on capacity constraints due to sustainable global growth as opposed to fictitious growth from monetary stimulus, these market rallies will be short lived and are a sucker bet.

Sell The Rips!

"Buy the dips and sell the rips." - Wall Street trading adage

In a bull market an old trading strategy that is often referred to in the press and on television is to "buy the dips".  This works well when stocks are trending higher as has been the case since 2009.  Each time the market takes a breather buyers step in adding to their positions and profit from the continuation of the bull market rally.

In a bear market the opposite holds true and that is "sell the rips".  That is when the market rallies you take advantage of the rally to either exit more of your long positions or put on new short or put options to take advantage of the next leg lower.  This is not for the faint of heart as most of us are wired to make money when things grow or go higher.  To bet that things will fall in price normally is beyond the scope of most amateur trader's mental capacity so most shun this trade as too risky.  Rather they let their positions lose money with everyone else.  There is comfort in knowing that you are not alone in losing value whereas taking a stand as a bear can be lonely and, if the market runs against you it takes a lot of mental strength to hold your ground.  So selling the rips sounds easy but in reality it is a scary proposition.

That said if past bear markets are anything to go on then this "bear" market is just warming up.  The reason I put "bear" in quotations is that until the market falls more than 20% from its highs it is not an official bear market.  As we have recently rallied back to 2000 on the S&P 500 we are a long way from a bear market but in studying bear market trends most bear markets last roughly 2 years and the vast majority of the bear market collapse happens in the last six months of that time frame.

So the first question is if we have entered a bear market then when did it begin?  If you look at the high back in May 2015 then we are barely beginning this downward cycle however some economists have placed the beginning of the bear market as the last time the Federal Reserve added money into the banking system.  This would take the beginning of the bear market back to November 2014.  If this is correct then the bear market is getting quite long in the tooth and that could mean that the bear claws are about to come out and rip a new hole in the market sending it tumbling lower within the next six months.  As an example the last bear market lasted 17 months and the Dow fell 7700 points, 5000 of which occurred in the last five months!

So why would we be entering a bear market?  There are numerous numbers to look at but I will only mention the 10 most definitive reasons:

1. At the end of bear markets stocks indices are dragged higher by a smaller and smaller number of must have stocks.  This occurred with the FANG stocks (Facebook, Amazon, Netflix and Google).
2. Volume is far lower on days that the market goes up than when it falls.
3. While the oil price might be a benefit to consumers, sovereign wealth funds in oil exporting countries are selling large swathes of stocks to meet obligations at home ($220 billion last year with more than double that expected this year).
4. China has used more than $800 billion of its wealth to support its crumbling economy and more selling is expected.
5. While China has reported economic expansion its economy may not be growing at all if you look at the dismal export numbers reported by their largest trading partners all of whom have seen their export numbers crater.
6. Domestic equity fund outflows have exceeded the level recorded right before the 2008 sell off.
7. Profits at S&P 500 companies declined 12.7% in 2015 the worst decline since 2008 and a further decline is expected in the first quarter of 2016.
8. Warm weather this winter has brought forward economic activity so there will not be an uptick in GDP later in the year as has occurred in previous years.
9. According to Warren Buffet and other leading CEOs, the economic headwinds are stronger than they have experienced in a long time and some have said EVER.
10. The Federal Reserve will not be able to come to the market's rescue until there is a significant sell off as the numbers coming from unemployment and inflation do not warrant stimulus.

For these reasons I believe that the best option that you have right now is to sell the rips, of which we are experiencing one as the market has roared upward more than 10% from the lows.  The next sell off should take out the recent lows and at that stage we could be in to the final capitulation phase of the bear market so get ready and don't say that you haven't been warned!

Strong Enough?

"All that is gold does not glitter, Not all those who wander are lost;
The old that is strong does not wither, Deep roots are not reached by the frost." - J.R. R. Tolkien

There is a lot of debate going on at present about whether the Federal Reserve considers the United States economy strong enough to handle a second interest rate increase.  The number out today seem to indicate that the economy is more robust than was previous thought as Q4 GDP was revised up to 1.0% from 0.7%.  While this is a significant increase 1.0% is hardly robust.  Both consumer income and spending ticked higher in January pushing inflation higher than expected.  All of these data points are positive and should give teh Federal Reserve some much needed credibility for raising rates last year however are they strong enough to force their hand in increasing rates next month or even alter this year?

Were the global economy in a stronger position I would have anticipated an increase in the near future but the issue is that the United States is rapidly becoming the only shining star providing light for a gloomy global economy.  Since the announcement of the data points the dollar resumed its ascent and this will continue to erode not only emerging markets with debts tied to the dollar but exporters in the United States.  While this may not be a catalyst to cause a recession in the United States it may have the impact of taking the growth of the rest of the world lower.

I have to say that I am relatively surprised at the continued success of the United States economy and am hopeful that it can continue.  Certainly I do not see a deep drawn out recession on the horizon but I also do not see robust growth either.  I expect that the Federal Reserve will leave interest rates alone at the next meeting and unless there is a dramatic improvement in the global growth story or inflation in the United States starts to really take hold I doubt that there will be more than one more 1/4% increase in rates this year.

As far as the stock market goes then it may end up being a market full of gyrations and little upward or downward movement, sort of a barking dog situation.  This would not be a bad outcome when you consider such an extended bull market.  During this time it will be interesting to see how the Federal reserve acts and whether companies can somehow stem the slowdown in earnings however this will become harder and harder the higher the dollar climbs. For this reason I continue to expect weakness in the stock market but the damage may be limited to less than a bear market but that will be determined by the direction of the Federal Reserve as while the economy may be able to weather another rate hike I do not think the stock market has the backbone.

Range Bound

"Home, home on the range.  Where the deer and the antelope play.  Where seldom is heard a discouraging word and the skies are not cloudy all day." - A Scout Song

After the recent market draw down it appears that the market is now range bound and waiting for more stimulus from a central banker to break out higher or more poor economic data points to dive lower.  In the chart below I have drawn in blue lines showing the range.  As you can see from the chart there is real resistance against moving a lot higher and I would expect any upward move to be short lived and a selling opportunity.

The recent rally was created by the ECB when Mario Draghi hinted that further stimulus was on its way in the form of negative interest rates and more cash infusions.  This is all in an attempt to stave off deflation in Europe.  With the added stimulus the dollar continued on its path of strength and the 10-year yield fell to one of its lowest on record and is now around 1.7%.  While low this is still a big number compared to the rest of the developed world so I could see rates going lower from here.

In contrast to Europe in the United States the CPI (inflation) numbers for January were recently released and they are showing upward pricing pressure.  Total CPI was up 1.4% while core CPI was up 2.2% year over year.  This is far higher than the numbers expected particularly when you factor in a continued slide in the price of oil.  The two largest contributors were apparel and medical services but I have to say that outside of these two components I have been witnessing bumps in prices across the board from Starbucks to Rubios.  It will be interesting to see whether this upward trend is signalling an economic expansion or desperation of companies to maintain profits in the face of a weakening economy but what it will do is keep the Federal Reserve from lowering interest rates in the near term.

This means to me that the market will mark time and bounce around within its range until a clearer indication of the state of the global economy comes to light.  One thing that is not helping all of this confusion is that there is no clear indication of who will take over the White House.  I have to say that once again it looks like the candidates are less than optimal to deal with the economic crisis that they will face at home and abroad and this lack of leadership will not help the markets.  So for now sit tight and let everyone else fight over these meaningless gyrations in the market.

Hard Boiled?

When I was a student there was a ridiculous game that we used to play with eggs.  In a box of 6 eggs one was raw and the rest were hard boiled.  It was effectively a game of Russian roulette as you had to choose an egg and smash it on your head.  The loser was the unlucky person that selected the raw egg as it would break spattering egg all over them.  Typical students, anything to entertain ourselves rather than study!

The reason for my story is that the Federal Reserve has used five of their 6 eggs and all were hard boiled.  So we all know that the next step is to smash a raw egg on their heads and get it all over themselves.  Of course I am referring to Janet Yellen's testimony where she said that using negative interest rates to stimulate the economy was now not off the table.  Hold on a second, she is now talking about lowering rates to negative less than two months after the momentous increase in rates of 1/4%!  So it is looking as if the rate increase will not only be reversed but will be pushed into negative territory.  The United States will then be joining the rest of the developed world with negative rates.  Talk about egg on your face!

These negative rates are going to make earning any kind of a return on savings next to impossible.  Prudent savers and retirees will be hurt as the stimulus is targeting risk and higher returns at the expense of safety.  Furthermore I would expect that they will kick start the stimulus of pouring more money into a system already awash with money.  If this is not a recipe for inflation then nothing will be and the price of gold is starting to reflect this.  After years of languishing the metal has broken to the upside and seems to be on track to recoup its losses of the previous years.

Now while I expect inflation to show up it may not be for a while.  Oil continues to fall and with the poor earnings from Wall Street will come layoffs, taking the heat off the tightish labor market. That said personal inflation rates are far higher than the Federal Reserve numbers even with the benefit of lower gasoline prices.  In fact when you look at the price of gasoline while down to around $2.50 a gallon it is still significantly higher than the sub $1.00 a gallon that it was the last time oil was down at these levels.  Inflation is here and although not reflected in their numbers is causing problems for a consumer that has not received any form of a meaningful pay increase in a decade.  This will impact consumer spending so don't expect a resurgence in the economy even if they do try to "stimulate" again.  That said it may put a floor under an already overheated market but that is another story.

While I still do not expect much of a move from the Federal Reserve in the next month or so they are certainly not going to raise rates any time soon and if the market enters a formal bear market they will once again step into the fray and "save" the market.  Unfortunately their methods of saving are not helping but are in fact going to hurt even worse in the future so my advice is to take your chances on the gold front as that, in my mind, is the only place to turn.

A Blended Return

"But with a rate of return of 1.6% or less, or a negative rate, our children and our grandchildren, if we do not make changes, will in fact not have a secure retirement.  Indeed they will not have the funds when they go to retire to even minimally get by." - John Shadegg

One of the biggest conundrums facing investors today is a blended rate of return.  Since the Federal Reserve raised rates, rates have fallen to their lowest levels since April 2015 which at the time was one of the lowest levels on record.  Furthermore the stock market is clearly in correction mode and appears to be heading for a bear market (down 20% from its highs).  Typically in a bear market the rates of return on fixed income investments are higher as the Federal Reserve raises rates to cool an economy however this time around interest rates are at historic lows and the market is rolling over so the blended rate of return for stock / bond style investors is dismal.

Reading over my blogs of the past few years I have been warning investors of this problem and now it is a reality.  Those of you who have not heeded my warnings are now facing a problem particularly if you are only invested in those two assets.  Those of you who have learned from this blog should have divested into alternative assets that are taking advantage of this market but for the rest of you I believe time is against you.  It appears that low interest rates are here to stay, at least for the foreseeable future, and the stock market with the lack of support from the Federal Reserve will not provide the kinds of return of the past seven years.

This is not only causing a problem for investors but pension funds and endowments are really feeling it.  Consider that they have factored in a blended rate of return of 6% to 8% and those returns have been achieved only because of the stock market movement.  Removing that arrow and in fact coupling low interest rates with a bear market will result in massively underfunded pensions plans.  The result will be that companies will have to fund the shortfall with rapidly eroding income which will lead to losses.  Poor earnings will drag the market lower and around we go.

So at some point, and I do not expect it to be much later than the middle of this year, the Federal Reserve will have to kick in some more quantitative easing (which as we know will not do anything other than kick the can down the road).  This might take the heat off the stock market temporarily but by then I would expect the markets to have fallen by at least another 20%.  Regardless of whether I am right or not it looks like a rocky road ahead and investors should still be looking at alternatives to stocks and bonds not only for the present but for the long haul as it is my prognosis that these two investments will not serve investors well for a number of years to come.

Heaven help us if inflation rears its head but unless oil makes a sudden resurgence or unemployment strengthens considerably it should not remain much of a factor and this should provide some solace for the beleaguered investor however that said your best bet is to look for alternatives.

Around the World in 5 Minutes

"A well used minimum suffices for everything." - Jules Verne, Around the World in Eighty Days

This week's blog takes a very quick look at the big picture and what headwinds the market faces.  It will have to be brief as there is so much news floating around that to make sense of it can be overwhelming so below is my summary of the main economic events that should impact the markets.

The Federal Reserve left interest rates unchanged and hinted that another hike may be off the table.  This is significant due to the fact that (as I have mentioned repeatedly throughout my blog posts) they have backed themselves into a corner and the rest of the world's weakness is now forcing their hand.  A continued downward spiral in the stock market will negate another interest rate hike particularly if the economy starts to feel the headwinds of slow global growth.

Fourth quarter GDP growth was far lower than anticipated coming in at 0.7%.  This is anemic to say the least.  Another quarter like that and you will start to see the unemployment numbers start to ratchet back up as companies try to protect their bottom lines by cutting costs.  Once again no interest rate hikes will be made if weakness continues to spread.  Furthermore, continued weakness may even lead to the reversal of the 1/4 point that they so proudly unveiled a few months ago.  Now that would be egg in the face!

Japan joined the growing throng of countries moving into negative interest rate territory.  So another country where you now have to pay to lend money to a government that is essentially broke!  NICE!  In a desperate attempt to shore up an economy teetering on the brink of recession they moved yesterday to lower interest rates below zero.  At first the Nikkei rallied but then reversed course as the Japanese equity investors finally worked out that low interest rates do not necessarily mean growth and in fact this lowering of interest rates is more a sign of weakness and a coming recession than of impending strength.

The result of the Japanese move is a burgeoning dollar which will cause further problems for the struggling emerging economies.  At around a 2.00% yield the United States 10-year treasury is looking like something of an outlier in the world of bond investing and, as interest rates trend lower around the globe, I would anticipate more and more money flowing into the United States pushing the dollar far higher.  The upshot of this is that the Federal Reserve, unlike China as you will see below, has the ability to use this influx of capital to stimulate the economy but the issue is that their preferred methods are not and will not work.

China is grappling with an outflow of money into dollars and other currencies.  This outflow is causing them problems as their foreign reserves are transferred away from government control and into the hands of investors and business owners who are moving money off shore at an alarming pace.  Welcome to the world of global currency markets.  In joining the global basket of currencies one of the mainstays of that club is that members have their currency freely available and this loss of control is moving economic control away from China's central government.  It will be interesting to see how this plays out but I would guess that currency controls will soon be put back into place and this could destroy an already weakened economy as international investors shun a country whose fiscal policies are inward looking.

Taking the above main issues and placing them in context of a central banker what are you able to really do?  Interest rates are essentially zero to negative, money printing has not worked, inflation will not be your savior as crude oil remains at depressed levels and as the world's economy sinks countries are increasingly turning inward rather than opening up their borders to trade.  Well there are a couple of prongs left.  One is to lower taxes and the other is to spend money directly on infrastructure and other projects.  These may have the necessary impact of stimulus but in an election year neither of these are on the table so I expect that the market will continue to take it on the chin in 2016.

Are we having fun yet?

"Never, ever underestimate the importance of having fun."

I'm going to keep having fun every day I have left because there is no other way of life.  You just have to decide whether you are an Eyore or a Tigger." - both quotes by Randy Pausch

I have to say the last few weeks have been interesting to say the least but it has been nice to see a lot of green on my screens for a change.  That said it does feel as if the market is working off some steam rather than capitulating.  Gold has barely budged off its lows and the VIX, while up significantly from 12 to 23, is hardly showing signs of panic.  Looking back through history when true panic hits the streets the VIX can spike to well over 50 so while it is slightly elevated it is not signalling any kind of panic.  Even so the broader Russell 2000 index is already into bear territory being down more than 20% from its highs in June 2015.  This index often leads the others both up and down so it is interesting that it has been in a downward spiral while its large cap brethrens are more than 7% higher and holding onto "just" a correction. 

It is interesting that the market seems to be trading in tandem with the price of oil and certainly the press has latched onto this as the main culprit for the draw down but I ask you, what is the correlation between a low oil price and a technology company?  It is certainly loose at best and non existent normally, so what the market must be sensing is that the weakness in oil is more about a lack of demand rather than a glut of supply.  This would indicate that the world economy is weaker than anticipated which would feed into technology earnings and therefore impact the stocks.  That said in the commodity world there is a wonderful saying that low prices end low prices and high prices end high prices.  This will be true of the oil price as at some point the price will be so low that producers will close down slowing the supply while consumers will be ramping up the purchase of large fuel guzzling trucks and the price will swing to the upside.  This day however I feel is some way off.

According to the oil industry estimates, the glut of crude will be here for at least another 12 months and that is based on some pretty rosy projections by the IMF for global growth in 2016.  While the IMF has already cut its global growth forecast by 10% to 3.4% (and we are only in January) I suspect that there are more cuts to come and that we could end the year with global growth well off this number.  In this scenario of weakening global growth it would appear that any short term market rally is an opportunity to sell your remaining positions rather than a signal that the good times are back.

There is one caveat though and that is the Federal Reserve.  While they are almost forced to sit on the sidelines at present, if the market falls apart they will step in and that could be a short term buying opportunity.  I say short term because at some point the market will wake up to the fact that their efforts are not repairing any of the world's economic problems but are creating a larger ones.  The sad part is that they have managed to export their poor economic solutions to the rest of the world and that is the real problem!

At present though it looks like we may escape a recession which would mean a relatively short sharp draw down in stocks to a level more commensurate with the economic outlook and current company earnings forecasts.  This level though is still at a minimum another 20% from here so I would expect more pain ahead in the coming weeks and months.

The Fed to the Rescue?

With the markets in full correction mode it will be interesting to see what the Federal Reserve does going forward.  I would doubt that there will be an interest rate hike in March as it is should now be clear to the Federal Reserve that the market is completely reliant on their support and without it a bear market will begin.  As we wait for their decision market participants like to point at something as a cause for their woes and present it is China and the price of crude oil that are being blamed but the problems run far deeper than that.

Certainly the low price of crude oil is playing havoc in the economies of those reliant on crude oil exports but outside of that it is a win for companies like Ford who will sell more large trucks (the bedrock of their profits), airlines and commuters around the globe who are feeling some relief at the pump.  Outside of these headlines is the high yield (or junk) bond market which is reeling as many loans were to the fraking industry which is highly over leveraged.  No doubt there will be numerous defaults and bankruptcies to come from this industry but that alone is not enough to undermine the market to this extent, particularly as crude prices have been low for over a year.

China's problems are of a larger concern because they have become an economic power and a major part of the global growth story.  With their growth dropping precipitously and with a lot of their growth reliant on poorly performing state run businesses it is clear that their growth will languish well below 7% for the foreseeable future and this will cause a significant drag on global growth.  The results of this fallout are being felt throughout the developed world as companies like Apple are discovering that without meteoric growth in China sales growth is hard to come by.  For this reason the S&P 500 companies will earn more than 20% less than what they earned in 2014 and combined with a market that has stretched to one of the highest price to earnings ratios in history, the result should logically be a bear market.

The questions that should really be asked are, 1) will the Federal Reserve reverse course and come to the market's rescue and, 2) will a bear market cause a recession in the United States?  To answer the first question one need look no further than the actions of the Federal Reserve since the Greenspan era.  Yes they will come to the aid of the markets but the question is will the markets react to the stimulus with enthusiasm or despair?  If one thinks about it rationally despair should be the answer but stock investors will look past the "Hail Mary" pass from the Federal Reserve and will more than likely rally the market. Should the Federal Reserve do this then, as I have repeatedly explained throughout the years of this blog, the future fallout will be even worse than it would be if they left things alone.  How many more times do we have to witness this folly?  But, amazingly they continue to believe in their methods and have even managed to convince the rest of the world's central bankers to follow suite.  Next time around though they will have to double down so it is likely that we are looking at $10 trillion more of wasted money rather than the trifling $5 trillion that has been spent to date and this should create a much larger problem!  Well done them!

The main issue to me though is will we enter a recession in 2016?  As a small business owner it finally felt in 2015 that the whole "trickle down" theory had finally started to reach the man on the street.  There was more money being spent on consumer items and profits started to appear.  For the first time since 2009 the small business owner was making headway!  A recession would undercut this grass shoot recovery and that would be a real tragedy as the middle class rely on small businesses for their survival.  Already the Great Recession has created a massive imbalance in the structure of United States society by wiping a large swath of the middle class away.  Should this class continue to contract the economic repercussions would be deeply felt and would create a massive disturbance in the force (I couldn't help myself)!  The force that I refer to is the United States economy which would take years if not decades to recover if the middle class contracts much further.  Furthermore, with large businesses feeling the effects of a global slow down it is imperative that small business pick up the slack; they are more insulated from global market shifts, they are the job engine of the United States and the middle class's last bastion of hope.  A recession would undermine this and would result in a true economic disaster.

Unfortunately, unless the selloff in the stock market is quick and sharp the effects of this will feed into the public's outlook and consumer sentiment will crater.  With it wallets will close and the first to feel the impact will be the small business owner.  My hope (and as all readers of this blog will know hope is the worst of all four letter words) is that we have a 30% to 40% market sell off in a swift three to six month period followed by a steady recovery based on proper fundamentals but the chances of that happening are slim to none, but we can always hope!

Now what?

"And now we welcome the New Year. Full of things that have never been." - Rainer Maria Rilke

I'm back from a few weeks off and I have to say I had a great time and I hope that you did too.  But now it is back to business and I have to say that I cannot resist bashing on the Federal Reserve.  I have to wonder what is going through their minds now that they have made their first rate hike since the iPhone was invented and have watched the market fall almost 10% from its November peak. Since November 3rd, 2015, the S&P has fallen (as of the close today) by 8.6%.  This is not quite an official correction but well on its way to one.  In fact if calculate the percent drop from its all time high in May then we have officially entered a correction.  It certainly appears as if the market could head a lot lower in the near term as there are really no catalysts that I can see to propel a rally; earnings should be weak this quarter, the Federal Reserve has backed itself into such a corner that to come out to rescue the market so soon after a mere 1/4% rate increase would be to admit a complete failure of their policies and globally economic growth is absent.  So I was asked the question, now what?

Well as long time readers of my blog know I have been expecting this for some time and while I was calling for the markets to collapse a while ago it should have given you plenty of time to scale back your holdings in equities.  By now I would expect that you are holding minimal equity positions but if you are still holding on for dear life I would plan to sell at any rally as to me this weakness is far from over and, as I have been repeatedly saying, printing money has never and will never fix the global economic woes.  The more money that is printed the bigger the disaster that will befall us and as equities have risen almost unabated for an unprecedented number of years the selloff should be sharp and deep. While timing a market top or bottom is impossible there is still time right now to exit at healthy gains so I would take any market rally to sell positions that are causing you sleepless nights.

The next step for those of you willing to play the game is to go short or buy put options.  One problem with both of these strategies, particularly now, is that they will be expensive and you can lose even if you are right and the market falls further as once you feel the burn in your most precious of body parts it is incredibly hard to stay the course.  Plus of course there is the Federal Reserve that can change its course and throw the market one more lifeline reversing the natural trend of the market and once again creating a fictitiously buoyant market at the expense of those of us short.  Believe me that is no fun and I have the blisters and burns to prove it.  So for most of you this strategy is off the table.

The next strategy would be to move into a cash position.  There is little wrong with this strategy other than for most people money tends to burn a hole in their pocket meaning that they move back into risky positions way too early and get burned anyway.  This is also a timing strategy and as I have proved with this blog, trying to time a market top or bottom is incredibly tough to do which means that unless you are anticipating another bear market (as I am) sitting in cash is going to also prove hard to bear and you will probably miss the entry point.  That said I quite like this strategy as long as you can remain patient and accept meager returns (but no losses which is key) while you wait for a sign of an economic recovery or an entry point.  That said I would expect that this blog post will provide you enough signals as to when things are overdone, not that I am expecting to call the end of the fall as that is impossible but I can give you advance notice that you should start to slowly dip into the long positions that you crave.

The next strategy is one I have been employing for the past few years in anticipation of these events and that is to invest in positions that should benefit from the fall.  While I am short the market in various forms and I have a decent cash position, the majority of my portfolio is invested in an underlying strategy that should continue to benefit from both the market's fall and the continued low interest rate environment.  This strategy took years to develop but is gaining in strength each day.  Not that I plan to reveal my strategy here but there are plenty of investment strategies that you can deploy that do not require an allocation to the stock market but continue to provide you with an excellent rate of return.  Some ideas are buying written off debt, finding rental properties, investing in privately held businesses, learning how to create a career in the bankruptcy and turnaround markets to name a few.  The problem with these strategies is that you should have been entering them years ago rather than piling into one of them today but if you would like to learn more feel free to drop me a line and we can discuss these ideas in more detail but suffice it to say as I did in the last blog I wrote before the holidays, THIS IS NOT A BUYING OPPORTUNITY!