Weekly Article 04-25-2018
The big news as I start to write this article is that the 10 year US Treasury note yield has hit 3% for the first time since 2014. While this may not be some line in the sand it may be a psychological barrier in my opinion, that many may take as a reason for a yield-curve inversion to be imminent.
Many who don’t follow markets closely- most people actually- may be unaware that an inverted yield curve is one of the most reliable indicators of an upcoming recession. Many “experts” will say that a recession may begin within 90 days to a year when the yield curve inverts.
A yield curve inversion means that short-term money has a higher yield than longer term money. As an example a 10-year note is currently yielding 2.9% and a 30-year note is yielding 3.1%. That means that if you are willing to lock your money up for 20 years longer you will make an extra .2%. Not exactly an enticing offer! If the 10 year note were to rise to 3.2% and the 30 year yield was at 3.1 there would be an inversion.
Of course, I believe that we have been in a recession/depression since at least the year 2008 and possibly since the year 2000 and the only reason almost everyone is oblivious to it is that, in the past 10 years over $100 trillion in new debt has been added and counted as growth to GDP globally. (Bloomberg- Global Debt reaches $237 trillion in 2017).
This is one reason why the inverted yield curve may or may not hold the same clues as it has held in the past and may or may not be a valid leading indicator.
While the yield CURVE is one story I believe that rising interest rates overall is THE story. When a world is as over-indebted as we are- actually HISTORICALLY over-indebted- like never before in history- rising interest rates are the pin that can pop the bubble.
Already, since 1981 the velocity of money has fallen by 67% (currently at a 60-year low) while the money supply has risen by 16 times in that time period. (Board of Governors- Federal Reserve) In the meantime, international debts have risen over $200 trillion.
My opinion is that the velocity of money has fallen because economic activity has fallen. “Printing” money provides one transaction (buying) and many purchases are longer-term purchases so buying and selling is not taking place- only buying. All of this “printing” creates no wealth- only an illusion of demand where far less actually exists and leads to artificial prices of all assets being manipulated in this way.
This “printing” also leads to less economic activity over time as more and more productive capacity is being used to service the expanding debts that accompany the “printing” for not only purchasing assets but providing for less productive members of society in a manner that could not be afforded by taxation or any other reasonable means.
This is likely another reason for mis-reporting economic numbers like unemployment, inflation and virtually all other numbers that members of society use to determine our economic well-being. If the numbers were reported in a similar manner I believe the 1970s misery index would be substantially worse today than it was in the late 1970s. For those of you who are too young to remember the misery index it adds the rate of inflation plus the unemployment rate. The higher the number- the worse things are.
It appears that all of this “printing” and purchasing of assets has just made the imbalances that caused the 2008 meltdown to take place larger and far more dangerous. If the cliff was high I 2008 it is far higher today- over a $100 trillion in debt higher- and that is probably low-balling it. This doesn’t take into account the derivatives that may be up to $2 quadrillion dollars.
According to Egon Von Greyerz in a King World News article:
“If printed money could create wealth, we could all stop working and just print more”. “Since 1971 total US debt has gone up 47x from $1.5 trillion to $70 trillion, while GDP has only gone up 19x”. My statement- What would GDP actually be if debt was counted as debt rather than growth?
Back to von Greyerz “Thus, in the last 48 years it has taken $2.50 to create $1.00 of GDP. This means the US is running on empty. The country can’t even grow by printing money. How can the US grow when QE stops and QT (tightening) starts, combined with higher rates? The simple answer is that it can’t”.
The last 48 years is a long time and my research shows that it costs far more than $2.50 to produce $1.00 of GDP growth at this time. Actually, 48 years ago we may have actually gotten more than a dollar of GDP growth for each dollar spent and the effectiveness of deficit spending has been decreasing over time.
As I always say- every intervention has to be larger than the last to have the same effect. To me, this is the proof right here.
It appears that we are on the cusp of major changes. The numbers are truly astounding when we take into account the propping up of the bond markets. What would interest rates actually be without tens of trillions of purchases by central banks? What would a willing buyer and a willing seller say a real fair price is? I doubt a European junk bond would have less of a yield than a US Treasury note in that situation. Only in a central bankers fantasyland could that take place.
What would the state of the world’s largest banks be without the $16 trillion bailout in 2009 and the $24 trillion overall to give them the illusion of solvency? How many other trillions of dollars have been “printed” and handed out that we have no clue about? ($21 trillion “missing” from DOD and HUD)
To me, all assets are mispriced and we are on the verge of a major “reversion to the mean” a quote I first heard from Jeremy Grantham of GMO. Basically, after all of the interventions, the markets will eventually find fair value. Many times the corrections overshoot in the opposite direction of the prior move. The only question in my mind is “when”.
I expect that stocks, bonds, real estate, art and other assets that have been propelled higher are in for a sharp correction. Other assets that have been artificially held back are likely due for a sharp correction higher. On that list I would put gold, silver, and most commodities. Don’t forget that the cure for low prices in commodities are low prices. The reason for this is that low prices lead to less exploration, less profits and less production over time. Eventually, this leads to shortages of materials and higher prices which will lead to more exploration, more production and eventually, lower prices again- assuming the currency you are buying the commodity in is stable.
Just because all appears to be normal on the surface there are great gyrations taking place under the water in virtually all asset classes right now as central banks are trying to keep the illusion of normalcy alive and the markets are attempting to do their only job- determine fair value.
It is a fight that appears may only have a few more rounds to go- we’ll see!
Mike Savage, ChFC, Financial Advisor
Securities are offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc.
Any opinions are those of Mike Savage and not necessarily those of RJFS or Raymond James. Expressions of opinions are as of this date and are subject to change without notice. The information in this report does not purport to be a complete description of securities, markets or developments referred to in this material. The information has been obtained from sources deemed to be reliable but we do n ot guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.
Commodities are generally considered speculative because of the significant potential for investment loss. Commodities are volatile investments and should only form a small part of a diversified portfolio. There may be sharp price fluctuation even during periods when prices are overall rising. Precious metals, including gold are subject to special risks, including but not limited to: price may be subject to wide fluctuation, the market is relatively limited, the sources are concentrated in countries that have the potential for instability and the market is unregulated.
Diversification does not ensure gains nor protect against loss.
Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. Raymond James is not affiliated with and does not endorse the opinions or services of any of the quoted professionals/ authors or their respective firms/ publications.