Bubble, Bubble, Toil and Trouble!

"Double, double toil and trouble; 

Fire burn and caldron bubble. 

Fillet of a fenny snake, 

In the caldron boil and bake; 

Eye of newt and toe of frog, 

Wool of bat and tongue of dog, 

Adder's fork and blind-worm's sting, 

Lizard's leg and howlet's wing, 

For a charm of powerful trouble, 

Like a hell-broth boil and bubble." - William Shakespeare

I mentioned it in the last letter but it is worth mentioning again, by any metric that you can find we are in a bubble (apologies to Shakespeare as he says Double not Bubble but close enough for this blog).  Simple economic mathematics shows that the result of printing money and holding interest rates at below market values is the over-inflation of asset values.  It was just a matter of time before it happened but even the Federal Reserve has now mentioned that asset values “may” be a little high.  By the time they are saying this you can bet that we are in the final throws of the bull market.  That said they still have not learned their lessons and continue to believe that their money printing techniques (that have never worked) can magically manipulate market prices removing the chance of even the slightest drop in economic expansion.  Bernanke stated when he was the Federal Reserve Chairman that “we’ve never had a decline in house prices on a nationwide basis”, right before the property bubble burst.  Now we have Yellen saying that we’ll never have another financial crisis!  Wow the egotism and the ignorance is unbelievable and this is from the most powerful market manipulator in the world.

I have also mentioned repeatedly that economic growth can only resume at a healthy clip when you remove the shackles of debt.  While the Federal Reserve has stopped printing money the rest of the world’s central bankers took up the mantle and have bludgeoned forward mindlessly printing.  This has resulted in the massive run up in stock prices.  These stock prices require this fuel to keep them airborne so when you have Yellen and others start to talk of cutting back on their stimulus there is going to be a fall out, it is just a matter of time.  As with all fall outs the most egregious benefactors will be the hardest hit.  Think of say Tesla with a $60 billion market capitalization and losing $400 million a quarter, or Snap Chat (never made money), or Twitter (same) or a myriad of other stocks and you get the picture.

So, taking Yellen’s comments at face value (I assume that she was not joking although I secretly hope that she was) what will the Federal Reserve do when the market takes a nose dive?  Well for one they can drop rates from the lofty 1% mark that they raised (now that should be really helpful, NOT), or they can print more money and add to the $15 trillion of debt onto the global central bankers’ balance sheets (this has never worked and never will but I am sure that they will try once again), or congress could reduce taxes and increase spending right when they are talking about balancing the budget deficit.  This time around the tools at their disposal are significantly curtailed and while they will no doubt try all of the above the results will be even more feeble than those we have witnessed to date.  Not only has this been the weakest recovery in the history of the world but with the massive buildup of debt the next recovery will be even worse.

I am sure that this will not stop our egotistical maniacal leaders from proving once and for all that their strategies work.  This will mean tens of Trillions (billions will be SO 2010 darling) added to the Federal Reserve’s balance sheet plus negative interest rates (you will now have to pay the bank to place your savings there).  Once again this will kick the can down the road however the recovery will be even more anemic as massive increases in debt DO NOT STIMULATE AN ECONOMY.  Growth stimulates an economy and growth comes from innovation and entrepreneurialism not debt.  Debt becomes a yolk that must be dragged around slowing down the cogs of capitalism grinding the economy down to its knees.  This is why the economic expansion has been weak and why, given the policies of the central bankers around the world, we will suffer for decades to come.

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.