Weekly Economic Update 06-09-2017

When Credit Super Cycles Go Bust
I’ve been studying economic theory and classical charting over the past couple weeks; I find both fascinating in their own ways. Studying the history of economic theory helps us understand the macro view of the economy and what to expect going forward.

Before doing that it’s also important to know that the Federal Open Market Committee (FOMC) or Fed has a dual mandate: maintain price stability and full employment. To accomplish those objectives, they have a variety of monetary policies at their disposal such as injecting liquidity into markets, lowering interest rates and buying assets.

While the intent of these programs was to create a wealth effect, as I have discussed in the past, due to the low participation in the stock market by the average American, these programs have benefited the wealthiest in our country. The wealth effect has been felt by few and hasn’t stimulated our economy. The other problem with these programs is that if they can continue over a long period of time they lead to asset bubbles.

Easy money and credit policies have fueled the global economy causing an inflation of asset prices and malinvestment of capital. I keep hearing that this is a ‘new normal’ but in my opinion, to think things will be different this time is board line insanity.

You’d think that after three asset bubbles in the past sixteen years, two stock bubbles and one real estate bubble, that people would learn, including central bankers. Central bankers around the world have been pushing interest rates lower and flooding the global economy with money to prop it up. Asset prices increase in value and banks have lent against it. Savers have been forced out of safe investments into the stock market to find yield. And for brief periods of time this works, but at some point, it fails. At some point demand weakens, credit conditions tighten, the money supply falls and that triggers a recession.

In the meantime, as asset prices move higher until prices peak and it becomes apparent that something is very wrong with the system. Then asset prices fall. Delinquencies and defaults increase. Risky assets plummet in value. Banks fail. A financial crisis ensues.

Central bankers will have you believe that more debt and lower interest rates are the solutions. Little do they realize that debt is a tax on future growth. It pulls forward future demand until there is none. Then you reach the point of no return; no amount of money or lower interest rates can cure the economy.

Recessions are a normal and healthy part of the business cycle. We can’t avoid them, but what we can do as investors is minimize our participation in them. Just think about how much better you would be financially if you avoided the last two stock market crashes and the last real estate crash. There’s no doubt we’d all be better off!

What I do know is that at some point this credit super cycle will come to a head. I don’t know if it will be during the next recession or the one following. For all I know, central bankers will craft another way to stimulate the economy and kick the can down the road. But what I do know is that stock prices and asset prices are overvalued. They may continue to stay overvalued for some time, but when they do revert to their true value, it will present the biggest buying opportunity in several decades.

I mentioned last week that Warren Buffett’s Berkshire Hathaway is sitting on 100 billion dollars of cash, representing 40% of the portfolio. Warren is well known for buying low and selling high, but he started backing out of the market in 2014. When asked what he was going to do with all this cash, he replied that history was on his side. There’s little doubt that he will be right.

As investors, we must ask ourselves what the likely outcome is. What is the narrative – is the global economy going to boom or bust? Is Warren going to be wrong? Is Steve going to be wrong? If we are headed into a recession, will it be worse than the last two?
If you ask me, I think Warren’s going to be right. And as for me, I’ll probably be buying equities around the time he is. In the meantime, the opportunity lies in asset classes that go up during recessions. History and probabilities are on my side.
The only ‘new normal’ about this bubble is that the draw down will be bigger than the last three.

Interview with Billionaire Investor Jim Rogers
Jim Rogers spoke with Business Insider this week. Here are some of his comments:

  • A lot of printed money
  • Bubble [will] collapse
  • This year or next [for the recession to start]
  • Countries, governments, corporations, institutions, universities, financial services [will fail]
  • Will be the worst collapse in his lifetime
  • Second longest business cycle [it’s the third]
  • 2008 was the debt crisis, there’s more debt now
  • Fed will hike rates, then try to react, but it won’t work this time
  • He’s investing in Russia, China, Japan and Agricultural Commodities
  • Buy low, sell high. Why buy high expecting it to go higher?
  • No sign of a recession, but that is a dangerous sign
  • Fed has no clue what they are doing
  • Fed is setting us up for a disaster

Video Topic of the Week
This week I discuss inflation and deflation, along with out each affects the American consumer. I also discuss how “real yields” affect stocks, the US dollar, and commodities. Real yields also predict if the economy is likely to inflate or deflate and what it means to your money. Charts showing real yields versus stocks, the US dollar and gold are included in the video.

Chart of the Week – M&A deals versus the S&P 500
There is a high correlation between stock prices and merger and acquisition deals. Tune in this week to see where stock prices are headed based on M&As.

Client Update
No changes or updates to our positions. Still looking for the physical metal and commodity producers to bottom. May add to our agricultural commodity position as opportunities present themselves. I still believe the biggest opportunity, in the short term, will be to be short the major indices when momentum turns. In the meantime, I have specific target buy signals that I am watching when momentum turns.