Debt Opportunities

-the trade of a lifetime

Topics: the big risk to markets and the economy is in corporate debt. What does it mean for stock prices and gold?

Discussion: the recession is in effect already here (employment, bank stocks, yield curve etc). A recession would trigger an avalanche of downgrades among corporate bonds, effectively neutering the only active buyer of stocks, thus causing stocks to crash back toward their fundamental value.

Why now: The IOER rising above the Fed Funds rate signals a hoarding of dollars, meaning banks are seeing something ugly at the horizon and thus don’t trust each other. It’s a very clear sign of danger when the Federal Reserve loses control of the price of money (The Fed has one job, and that’s it)

Implications: Gold is going to crash upward (possibly after a short term dip, but why would you ever try to time such a thing?); bitcoin could show a similar pattern. USD should spike in the short term, and just might hold its ground after that. US treasuries (stronger dollar, rate cuts, more QE) should be the preferred trade for all who just won’t buy gold, but over time there’s bound to be leakage from bonds to gold as it’s clear massive monetization of debt is the US’s only way forward.

Possibly, there will be a “re-set” of sorts, changing the price of gold overnight in a new global monetary accord. When the dust settles, junk bonds could be the trade of a lifetime (sell your gold and buy bombed out corp debt at cents on the dollar), but don’t go catching that particular knife too soon.

Key assumptions: Recession signals (bank stocks, emplyment revisions, yield curve) are for real. Four times as much near-junk debt as ahead of 2008 is a relevant risk. There is no buyer of last resort for stocks when a corp debt freeze halts stock buybacks. Central banks will pull out all the stops and investors will seek refuge in first US treasuries and then gold. The IOER/FF situation says the timing is pretty soon.

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What’s not to like?

So, the central banks are turning dovish again and stock markets are reacting favorably. What’s not to like? Money printing in the face of a weakening economy has worked (=increasing stock prices) like a charm for a decade now.

Well, the problem is that the US is finally losing its control over the price of money. What’s happened is that US banks are hoarding cash, and are using the “Excess Reserves” possibility to park their currency overnight, despite there being an arbitrage opportunity in placing it in the Fed Funds system at a higher rate instead.

Banks ignoring risk free arbitrage means they aren’t trusting each other. Hence, they must be seeing something very dark at the horizon, if they are willing to decline a perfectly good arbitrage. The Fed Funds system is supposed to be risk free, and yet the banks won’t take IOER money and place at the FF rate.

Too few dollars, due to QT, budget deficits and less international demand for treasuries

The root of the problem is a lack of USD due to the large and increasing US budget deficit, while there’s been less demand for treasuries among foreign buyers (not least China which has actively sold some of its dollar reserves). The US Fed might soon need to pick up the slack in treasury demand, by more quantitative easing, but that would definitely signal a loss of control, so the Fed will most likely hold off from QE as long as it can – on a hope and a prayer.

The SX7E is broken

European banks have issued a lot of dollars, and they’re being pressured by both the negative yield curve and the stronger dollar. The problems are evident not least in Deutsche Bank’s woes and crushed share price. But UBS, SocGen, BBVA and many more aren’t far behind. The European bank index looks almost completely broken, and if it were to fall just slightly more, technically it looks like it’s going to zero (as Raoul Pal says in his excellent piece on Real Vision).

European bank investors apparently are sniffing something out, and the banks themselves are hoarding as much cash as they can, to create a buffer for whatever iceberg is coming up ahead. Hoarding dollars by one bank means less over for the others, which creates a bidding war for dollars pushing the exchange rate upward, making dollar debts increasingly expensive. The hoarding of dollars among those that can hoard thus makes matters even worse for those that can’t.

A dollar spike could trigger a bank crisis

One possible “resolution” is through a quick dollar spike that breaks the weakest link in the European bank chain. One bank is likely to pull the others with it as falling dominos (just like in the 2008-2013 period of recurring bank rescues)

The low yield for US 10 year treasuries as well as the German 10 year Bund spells doom for bank profitability, and the resulting negative yield curve signal recession. European banks (and to some extent even the US BKX index) are acting accordingly and showing extreme weakness over all time horizons.

Negotiator In Chief at the helm of the ECB is a harbinger of doom

In an interesting turn of events, the former lawyer and head of the IMF, Christine Lagarde, the woman who’s made more for the sunscreen business than any other human alive, has been appointed the next quiet assassin of the nation state, i.e., head of the ECB. Her background is as if bespoke for negotiating wide-ranging bank bailouts, capital control, new regulation, tighter EU bank integration and so on.

It’s almost as if the powers that be for once know what they’re doing ahead of time. Well, they should, they caused it, and they’ve had more than a decade to think about it.

…and here comes the crisis, and they plan to use it to push one step further in their plan for a United States of Europe – against the will of most people, under the auspices of need, lest a systemic crash will wreak unfathomable havoc on the continent. “Give us all the power or you will lose everything!

According to people like Jeffrey Snider, a resolution could happen quite soon, as early as by the end of summer 2019 (chart pack here). How does September 2019 sound? It’s a nice round number and historically rhyming year. By the way, Mr Snider thinks The Fed will lower rates very soon. If they lower by 50 points right away, which they probably need to do, it’s a strong crisis signal (and very reminiscent of January 2001).

Recession is coming

Why is this happening? Simple: an economic downturn, if ever so slight, is straining the economy in proportion to the amount of outstanding debt and other imbalances. It’s happening now. The signals of recession are multiplying. After 5 years on artificial life support, it’s getting increasingly difficult for authorities to sustain positive growth for the economy.

Again, it’s about time, the imbalances are worse than ever, and the signals are already here

One of those signals is revisions to employment numbers. Once the revisions turn negative, the actual numbers are soon to follow. Employment statistics are first collected at one date, and then subsequently analyzed, complemented, refined and revised with more data on several occasions. Now we’ve had three months in a row with negative revisions, clearly indicating that the first stab at the number is too positive.

Among several recession signals, the New York Fed probability of recession (POR) chart stands out. It’s currently at a level which in 100% of the previous cases have been followed by a recession. The actual chart says around 30% POR, but that level has always led to recession.

Nobody died of a recession, right?

But, come on, what’s wrong with a little recession? Nothing a little Fed easing can’t handle, or?

Well…, the problem is that the financial system is in so much worse shape this time round, than, e.g., in 2008, you know, right before the great recession. Not least the level of corporate debt have exploded since 2008. Corp debt, according to the IMF, is now at 75% of GDP in the US, or around 10Tn USD vs 5Tn USD in 2008. Even more worrying the amount of near-junk debt has quadrupled from 1Tn to 4Tn.

There are two issues here. One is that a lot of that new corporate debt has been used for stock buybacks. Actually buybacks have been more or less the only net positive inflow for equities. That means that if the corporate debt market can’t keep expanding there are no stock buyers left. And if people and institutions didn’t want to buy stocks before, why would they start doing so at these levels while facing a weakening economy?

Again: No equity buyers left.

The other issue is that there aren’t enough junk bond funds to handle all the extra volume once the downgrades hit. Bond funds have rules; some can buy junk bonds, others can’t. If 4Tn of near junk start turning into junk (once enough are downgraded the others will follow, since they are all connected through the economy and the liquidity of the bond market) and trying to enter the relatively small 1Tn junk bond market, yields will explode higher (junk bond prices crash through the floor).

No junk bond buyers either

Lower cash flow or higher yields beget more of both

There are several ways to trigger this doom loop. One starts with higher yields which adversely affect cash flows, which in turn leads to downgrades, followed by (forced) bond selling from investment grade funds to junk funds, even worse cash flows and so on. No matter what the reported profits are, bond ratings are based on cash flows, meaning there really is no escaping the doom loop once it starts.

Higher yields, lower profits, downgrades, higher yields…

Should the primary bond issue market freeze up, like it did temporarily late in the fall of 2018, the tail spin will be more or less immediate. That’s how the Powell pivot late last fall came about. That particular Fed ammo, however, has already been spent.

Demographic doom dead ahead

The more or less bankrupt US pension system has been sucking up a lot of bonds, including corporate debt for the yield pick up. The process is procyclical: when the economy is growing and total income is increasing, there’s more tax money over for bond buying (due to low treasury yields, an increasing portion of pension money has been put into corporate debt).

When the cycle turns south, there’s less available funds. Sure, in the short term there could be some rotation from stocks to bonds. However, probably not that much (read: nothing) into junk or near-junk bonds. By the way, it’s exactly the rotating out of stocks you should be wary of as an investor (even if you as a citizen should be really worried about the consequences of a freezing bond market)

A bit longer term, albeit still relevant in the decade-long horizon, the large boomer generation is retiring. Due to zero interest rates on their bond holdings, and too much risk holding a large proportion of stocks as they grow older, they’ll need to (and want to) sell securities to fund retirement.

Boomers retiring is more of  a long term partial drag on the system, both for bonds and equities. However, in terms of rate of change, up until now boomers (pension funds) were buying corporate debt for the yield pick-up, due to too low yielding treasuries, but now they’ll start selling. Combined with all of the above, that spells double doom for corporate debt prices and issuance, which in turn means much less equity buybacks than the market has become used addicted to.

What about Trump and a China deal, wouldn’t that save the markets?

Sure, Trump will most likely get to a deal, some deal, watered-down as it may be, but no doubt hailed as a triumph. However, as soon as the above doom loop manifests itself, and it will, since the trade deal won’t be enough to jump start an engine with an empty gas tank, Trump will wield his tariffs wand again, and we’re back to square one, or rather minus one.

As a final thought on geopolitics, many countries have tired of Trump’s and the US’s antics, including the weaponizing of the dollar. Those countries could band together and seize the opportunity a financial crisis entails, to design a new monetary system based on gold (priced at a much higher number per ounce).

Investment implications

A dollar spike could be in the making soon, and that might mean a short-term downturn for gold (albeit that might in effect already have happened). A flight to safety from anything European and into dollars should mean both stronger US treasury prices (falling market yields) and higher stock prices (what works works, until it doesn’t). A dovish Fed could temporarily add to these developments.

Fed easing. After the initial knee jerk reaction, the more or less inevitable economic downturn leads to weakening cash flows, corp debt downgrades, higher yields, forced selling and freezing up of new debt issuance and stock buybacks. With both bonds and stocks in free fall, the Fed has to respond by cutting rates aggressively as well as turn on the Quantitative Easing taps more than ever (already prepared for by their “slope” and “effective” lower bound language).

Gold to shine. Once the flow into dollars is exhausted and the Fed is in full panic mode, the dollar can weaken again, although hard to say to what extent, given the sad state of Europe. In any case, no matter the relative movements of USD vs EUR, JPY and RMB, gold is set to shine, owing to unlimited moneyprinting and the prospects and need for a global financial and monetary system re-set, a Beijing Accord of sorts.

You never forget your first coin. More and more seasoned investors are recommending gold as the place to hide from all the turmoil. Sam Zell, e.g., a 75-year old legendary investor known for rare but bold and successful calls, said in January that he started buying gold for the first time in his career. Maybe it’s time for your first gold purchase too?

And on July 17, Ray Dalio, the head of the world’s most successful hedge fund ever, published a long article on Linked In about shifting financial paradigms over the last 100 years. He concluded that the current state of affairs regarding not least debt and market positioning, points to gold as a preferred asset:

…those that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweighted in such assets…

I would add that sometime deep into the mayhem, maybe after 18-36 months of carnage, there’s bound to be amazing opportunities among junk bonds. Forced selling can only last so long, and once probabilities of default are more than priced in, while new junk bonds are set up, the trade of a lifetime could be found there. I almost wish I were in Howard Marks’ shoes a few years down the road. If I still were a professional investor that is.

P.S. this is all for entertainment purposes and is not a recommendation of any kind, least of all to engage in financial activities such as selling or buying securities or other assets.

Have you ever been shocked by your own behavior?

That’s how Robert Sapolsky begins his book “Behave”.

“No”, I thought, before I realized you were supposed to say “yes” and thus be enticed to read the book to find out why humans do things they can’t explain or feel ashamed of.

I just don’t see it. Why would you do things that shock yourself?

Pull the trigger if you want to. Go to the gym if it’s good for you. Party if you like, but don’t do it if you feel bad afterward — that is, bad-er than you expected.

HOW DO YOU TRADE?

Talk about being shocked, some stock traders surprise themelves – and me – again and again, when they keep trading on emotional impulse during reporting season instead of according to set parameters within a proven strategy. If you were that guy or girl the last four weeks, don’t be in April.

I hope this doesn’t come as a shock to you, but since daytraders create exactly zero value (negative even, due to the false liquidity they provide, and the exaggerated price swings they cause as they react to other people’s moves), a trader without a superior strategy will lose money over time. That’s before commission and fees.

In the corporate world, profit is of course created by providing goods and services to the client that have a higher value than they cost to produce. A daytrader is only trying to do one better than his or hers counterparty. It’s a zero sum game less commission for them, and a negative for the market and society in general. The more people engaging in non-research based trading the less real products and services are made available, and the poorer the society.

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Completely off topic, I caught the song Bloodline when partying about a week ago, and I just had to listen to it A LOT OF times.

However, when a song is that good and instantly catchy, it’s almost bound to fall out of favor just as quickly. Not completely unlike the current stock market rally for cyclicals, based on explosive credit in China and The Fed’s sudden dovish U-turn. Well, with the best start to the stock market in 30 years behind us, you know it’s not time to buy shares.

On the other hand, gold is really picking up some speed, despite s strong dollar and a stock market rally. I’m happily holding on to all my types of gold, including Nueva Granada and Gran Colombia. If you’re Swedish, you really should listen to my and Anna’s talk with gold and precious metals investor extraordinaire Eric Strand here.

Anti-elite clicks at your peril

Topic: gold, societal unrest, Davos, the credit cycle, macro reasoning

Summary: grab your gold and run for the hills when you see the Yellow Vests gathering

Reading time: 5 minutes? 10?


Kan du svenska? Är du intresserad av de praktiska tips om värdebaserade investeringar som jag sammanställt från mina 20+ år som analytiker och hedgefondförvaltare? Då är mitt veckovisa nyhetsbrev Finansbrevet värt att kolla upp. Ja, det är gratis.


When the Fed turned dovisher-er again last week, in order to stimulate the supposedly weak economy, expectations for economic growth in the US strengthened and the dollar consequently strengthened. A stronger dollar means cheaper imports and a lower trade deficit, and yet a stronger economy, reinforcing the stronger currency.

Alternatively, in the little longer run, the massive monetization of US deficits and debt leads to increasing inflationary pressures. More money chasing fewer goods in a stagnating economy, where the focus is turning toward finance instead of production, gradually leads to higher consumer prices and demand for higher wages.

It all comes to a head when the Yellow Vests of the world have had it with “the elite” leaving ordinary people behind.

Reasoning vs. the real world

Macro reasoning can take you in any direction you like. Financial market reasoning is even worse. There the logical jump from good is good to good is bad due to eventual overheating to good is good since the bad that comes from over-gooding will lead to policy measures that will turn all things good again is done in an instant.

The real world, however, doesn’t care about your reasoning, reflexivity be damned.

A Lööf in the eye of the storm

For now, we are enjoying a pause of sorts. We are in the eye of the storm, with more or less sensible political leaders like Trump, Macron and Löfvén-Lööf (the Swedish socialist leaning government that took five months of bickering to form) at the helm. Yes, sensible, moderate. Relatively speaking.

Just you wait and see what comes after if these boys and girls next door were to fail. Well, with “were to” I mean “when they will fail”. A deeper, more disturbing, nuance of populism is bound to color the political landscape in the wake of an increasing sense of injustice, where the crony-elite is perceived to be living off of the backs of ordinary citizens.

This is not a crisis of capitalism

There is nothing wrong with capitalism, nothing wrong with adults willingly agreeing to sell goods and services to each other, nothing wrong with the best producer, best satisfyer-of-wants, amassing huge wealth.

What is wrong, however, is when the banking elite is first allowed astronomical gains from risking other people’s money, and then after the inevitable crash are saved by the political elite in return for political funding in the next round. We are not experiencing a crisis of capitalism, what we’re seeing is a particularly nefarious brand of of socialism.

Crony central banking at the center

It may sound conspiratorical but it’s all the central bankers’ fault. Without their wanton manipulation of interest rates blowing bubbles in the economy and on the financial markets, and their setting the stage for subsequent crashes, politicians and central bankers wouldn’t be able to play the game they do.

Politicians want to win elections, so they promise more than they can keep. Central bankers willingly fund the difference between dreams and reality. The unrestricted money printing drives asset prices, which drives borrowing, which drives lending, which drives bank profits.

It doesn’t take many decades before the debts are too high to allow for a normal correction. Politicians and central bankers (as if they weren’t all politicians) then vow to do whatever it takes to salvage the situation they themselves created. And their solution is always the same: keep doing exactly what caused the problem — just at a bigger scale.

After longer time than a single human investor usually can or do care, the system re-sets. A new power, a new currency regime, new relative positions and prices. It’s not that the cycles are aeons, but half a human life is long enough to be forever on the financial markets.

You’re much too young boy

I personally know people who haven’t seen a single market crash and yet consider themselves market veterans. Imagine having only invested in stocks since 2009. You’d look upon ten years as a long time in the market, and twenty as looking back toward a completely and irrelevant era.

I first started talking about stocks sometime in 1985 when a friend told me about his investments. Around then I actually inherited a stock portfolio with some really old holdings: Aga, SKF, Asea, Sandvik and similar stocks. That’s 33 years ago. I have to look back an additional 33 years, to 1952, in order to feel what today’s newbies feel about the turn of the millennium.

Oz wizardry a case in point

Australia hasn’t seen a recession for 26 years. The continent has been riding the rising tide that is China, but that era might be coming to en end now. Imagine the unpreparedness of investors, banks and house buyers when a recession finally hits.

Try to imagine the repurcussions when one panicky domino hits another. Overleveraged consumers and house owners losing their jobs, banks failing, dividends being cut, pension funds falling underwater, selling begetting selling on the stock market, and cost cuts causing unemployment, in a vicious cycle not seen in more than a generation.

Try to imagine the policy response and the saving of the elite on unprecedented scales. Try to imagine the populism that ensues. That’s one more geographical win for the Yellow Vests.

The credit cycle is a cycle

Artificially low interest rates and money printing create a seemingly benign feedback loop over a handful of decades. But it’s just as misleading as the inflation leads to a stronger dollar narrative mentioned at the top of this article. Sooner or later the credit cycle shows why it’s called a cycle.

Healthy growth that was turned into a speculative boom and followed by stagnation and monetary magic morphs into deflation. Deflationary impulses are met with increasingly desperate fiscal and monetary policies that lead to a combination of populism and inflation. The latter wreak havoc with living standards and justice, not to mention financial markets, exchange rates and asset prices until a strong enough leader can set things “right” again.

Right meaning high enough interest rates to force fiscal prudency and a stop to rampant inflation.

At that point risk aversion peaks and liquidity (cash availability and willingness to lend and borrow) troughs.

At that point assets might be “cheap”, but only because you 1) truly can’t know how it will end, and 2) you don’t have any cash to buy assets for, and 3) banks won’t lend it to you. That’s the meaning of “it’s not your father’s market but your grandfather’s”. No matter, that‘s the starting point of another bull market, not the current multi-year topping process.

I hope. You never know. Perhaps buying stocks at 5x earnings won’t work. Perhaps social and political reasons force them to 3x before it’s over. Perhaps dividends will be illegal.

As Grant Williams pointed out in the latest Macro Voices podcast episode, what garners the most journalistic clicks these days are articles from Davos pointing out how much richer the elite has become since before the financial crash of 2008.

Pitchfork time

It’s all fun and games as long as the money illusion makes everybody feel rich. But when the wheels stop turning and you realize your increase was but a fraction of the increase in true prices, not to mention the multiples of that that befell the elite, then it’s pitchfork time.

The anti-elite clicks are accumulating. Populism is rising. You may not like what you see today, or support Trump, Macron and Lööf. But if they fail, Mordor and the winter of the seven kingdoms would be preferable outcomes to what’s in store.

The question is: will your holdings of physical gold (and mine) be a good or a bad thing in that environment?