Lacy Hunt On The Unintended Consequences Of Federal Reserve Policies

Authored by Mike Shedlock via www.themaven.net/mishtalk,

The Financial Repression Authority interviewed Lacy Hunt, Chief Economist at Hoisington Management on Fed policies.

The interview below first appeared on the FRA website along with a video.

The emphasis in italics is mine.

FRA: Hi, welcome to FRA’s Roundtable Insight. Today, we have Dr. Lacy Hunt. He’s an internationally recognized economist and the Executive V.P. and Chief Economist of Hoisington Investment Management Company, a firm that manages over $4.5 billion USD and specializing in the management of fixed income accounts for large institutional clients. He also served in the past as Senior Economist for the Federal Reserve Bank of Dallas, where he was a member of the Federal Reserve System Committee on Financial Analysis. Welcome. Dr. Hunt.

Dr. Lacy Hunt: Nice to be with you, Richard.

FRA: Great. I thought we’d have a discussion on a variety of topics relating to the economy and the financial markets. You recently mentioned that you thought this was the worst economic expansion recovery in U.S. history since 1790. Wow. Can you elaborate?

Dr. Lacy Hunt: If you calculate the average growth rate in the expansions since 1790, this is a long-running expansion, but it’s the slowest and in the last 10 years the household sector lagged very, very badly. The rate of growth in real disposable household income per capita is only 0.9 percent per year. And in the last 12 months, we’re up only 0.6 percent per year. So it’s a long-running expansion, but it’s been a poor expansion. There are certainly problems with some of the earlier data, but this appears to be the slowest expansion since the turn of the 18th Century and our households are the main problem for the growth rate lag.

FRA: And do you point a finger for this cause as primarily on the Federal Reserve or do you see structural changes happening to the economy?

Dr. Lacy Hunt: I think that the main element suppressing growth is the heavily leveraged U.S. economy. We have too much public and private debt, and this debt does not generate an income stream for the aggregate economy. As a result of the prolonged indebtedness, which is on the verge of going much higher because of problems in the governmental sector, the economy is now experiencing very poor demographics. We have a baby bust, a household formation bust, and the lowest birth rate since 1937. These demographics are exacerbating the problems because we have too much of the wrong type of debt and thus the velocity of money has been falling since 1997. Velocity this year is only 1.43 percent, which is the lowest since 1949. Furthermore, the debt creates a situation where monetary policy capabilities are asymmetric. In other words, a lot of action is needed to provoke even a muted impact on the economy, whereas the slightest monetary tightening goes a long way in depressing economic activity. So the root cause of this underperformance is extreme indebtedness.

FRA: And what about the Federal Reserve? How has it undermined the economy’s ability to grow?

Dr. Lacy Hunt: The Fed’s most serious mistake was made in the 1990s up until 2006 during which they allowed the private sector to become extremely over-indebted with the wrong type of debt. And, in essence, I think that quantitative easing, through the push for higher stock prices, created more problems than it has solved for the economy. QE caused the corporate executives to switch funds from real capital investments into financial investments through the paying of higher dividends, buying shares of their own companies, and buying back their shares from others. While this type of action does produce a higher stock market; it doesn’t generate a higher standard of living. And so, Federal Reserve policy has not improved the economy, although it certainly has well served components of the economy.

FRA: And due to that do you think that there’s been too much financial investment versus real economy investment in terms of diverting the economic financial resources away from the real economy?

Dr. Lacy Hunt: I think that’s the principal problem. Business debt last year reached a record high relative to GDP. As I said earlier, Fed policies have created a higher stock market but have not generated an improved standard of living. When the Reserve undertook quantitative easing, it was a signal to the corporate executives that the Fed preferred and would protect financial investments. But that meant financial assets were preferred over real side investments. And so QT is intermingling with the growth-depressing effects of too much debt. And the debt levels are getting ready to move substantially higher in our governmental sector. Government debt is already approaching 106 percent of GDP, a record high with the exception of a brief period during World War II. And by 2030, federal debt will be approximately 125 percent of GDP. For a long time, we’ve known about the issues that would inflate the entitlements — such as the prior-mentioned demographic problems — but there is an increasing likelihood that new federal programs with expenditure increases will further accelerate the growth in federal debt. I think there is clear evidence that increases in federal debt at these high levels relative to GDP over any measurable length of time, reduces economic activity. Thus, the multiplier is not a positive but negative figure, or otherwise exactly what economist David Ricardo hypothesized in his 1821 work. I have looked at the relationship between per capita changes in real GDP and government debt per capita and the relationship is negative, not positive. And so, we’re trying to solve an indebtedness problem by taking on more debt. You can get intermittent spurts of economic activity and inflation, but ultimately the debt is a millstone around the economy’s neck.

FRA: So would you say that we have migrated to a sort of financial economy?

Dr. Lacy Hunt: Let me give you a couple of examples. There’s so much liquidity in the financial markets, particularly the stock market, that a lot of the economic news is constructively interpreted even when it’s unconstructive. Virtually the world believes that the United States is experiencing large job gains and the idea that such productivity may be incorrect is hardly considered. But the rate of growth in payroll employment on a 12-month basis peaked at 2.4 percent in early 2015 and for the last 12 months, has sunk to 1.4 percent. What is even more critical — if you look at just the expansions and don’t include the recessions since 1968 – is that the average growth in employment in an expansion year was 1.9 percent. And in the last 12 months, we are half a percentage point under that figure. Yet, given these numbers, there is an erroneous perception that the employment gains are strong. And this view undermines the improvement in the standard of living. And because of the liquidity and the need of some investors to fully participate in the rising stock market, investors tend to overlook other important developments. If we go back to the 12 months ending November of 2015, real average hourly earnings were up about 2.5 percent. And in the latest 12 months, real average hourly earnings gained a miniscule 0.2 percent. The liquidity tends to push the focus away from the more realistic interpretation of the economy for certain types of assets.

However, the weak performance overall and the deceleration in some of the indicators that I just referred to is not unnoticed by the bond market. So, we have a dichotomy in which the stock market is strongly up but the long-term bond yields are down. Now, the short-term yields are up because they are under the control or heavy influence of the Federal Reserve. The Federal Reserve is in the process of raising the short-term rates and winding down their portfolio. They sold 20 billion dollars of government agency securities in October and November, pushing up the short-term rates. Erstwhile, the long-term rates — which look at some of the more important economic fundamentals — are actually declining.

Another element not in the public understanding, since the Federal Reserve no longer produces this sort of monetary analysis, is a very sharp slowdown in the money supply’s rate of growth, bank loans, and within important credit aggregates. Last year, the M2 money supply was up 7 percent. In the latest 12 months, it decelerated to less than 4.5 percent. The rate of growth in bank loans and commercial paper, which topped out on a 12- month basis about 9 percent, is now under 4 percent. So the Fed is raising the short-term rates, reducing the monetary base, and causing a tightening in the financial side of the economy. Some investors understand what is happening and yet it’s not in the general psyche because such monetary analysis is increasingly rare.

However, another more public indicator is the very dramatic flattening of the yield curve. And when the yield curve flattens in such a way, first of all, it’s a symptom that monetary restraint is beginning to bite. Now, the slowdown in money supply growth and the bank credit flattening of the yield curve will occur well before there is any noticeable impact on a broad array of economic indicators or long lags in monetary policy. But when the yield curve starts flattening, that intensifies the effect of the monetary tightening because it takes away or, at the very least, greatly reduces the profitability of the banks and all those that act like banks. Banks make a profit by borrowing short and lending long. When those spreads recede, bank profitability is hurt, particularly for the higher, riskier types of bank loans since not enough spread exists to cover the risk premium. So the banks begin to pull back, further intensifying the restraint pressing on economic growth. To the vast majority of investors, we have an economy that is apparently doing well, but in fact there are elements right beneath the surface that strongly suggest to me that the outlook for 2018 is considerably more guarded than conventional wisdom implies.

FRA: And do you see the potential for an inverted yield curve in the near future?

Dr. Lacy Hunt: I’m not sure that we will have to invert because the economy is so heavily indebted and the velocity of money is its lowest since 1949. Now, a number of people have pointed out that we typically invert before a recession and historically such inversions have been the case most of the time — but not always if you go back far enough in time — and you should since this is not a normal economy. For example, money supply growth since 1900 has averaged about 7 percent per annum, whereas, currently, the rate of growth in M2 is about 36 percent below the long-term average, indicating a very weak growth rate. And the velocity of money is lower than all of the years since 1942 — with the exception of 7 years — and the economy has never been this heavily indebted. And so the yield curve could possibly approach inversion, but it may or may not occur or stay there very long because at that stage of the game, the flattening of the yield curve will greatly intensify all the other effects — the reduction in the reserve, monetary, and credit aggregates, as well as the weakness in velocity. And when this reduction becomes apparent, the Federal Reserve will not be able to reverse gears quickly enough to ameliorate the impact produced upon future economic growth.

FRA: So do you still see a secular low in bond yields on the long into the yield curve remaining in the future sometime?

Dr. Lacy Hunt: The lows have not been seen. The path there will remain extremely volatile. We will have episodes in which the long yields rise. My attitude is that the long yields can go up over the short run for any number of causes. While many elements work out of the system in the long end, yields cannot stay up. When yields go up — especially now that the yield curve is flattening — this intensifies monetary restraint, which puts downward pressure on commodities. This puts upward pressure on the value of the dollar and cuts back on the lending operations. Something I think has been somewhat overlooked in general euphoria over the strength of economic indicators, is the that commercial and industrial loans for all of the banks in the United States are now only up one-tenth of one percent in the last 12 months. There are forward-looking elements that have historically been very important for signaling that change is ahead. They don’t tell us the timing — timing is always difficult — but they are flashing signals that should be observed.

FRA: And as this plays out, do you see monetary policy and fiscal policy is changing, like will we get fiscal policy stimulus? Will there be a change in monetary policy and how will that look like?

Dr. Lacy Hunt: Here’s my attitude: the new federal initiatives, whether tax cuts or infrastructure or otherwise will not provide a boost to the economy if they are funded with increases in debt — that’s where we’re at. And by the way, it’s been that way for some time. If you go back to 2009, we had a one-trillion-dollar stimulus package that was said to be inflationary and was going to boost economic growth, but yet we still had this very poor expansion and little inflation except for intermittent bouts here and there, largely from highly-priced inelastic goods. All the while, the inflation rate has trended lower.

For example, when President Reagan cut taxes, government debt was 31 percent of GDP and now that’s 106 percent on its way to 120-125 percent. And so if you go back and if you read Ricardo’s great article in 1821, he was asked whether it made a difference as to whether the Napoleonic wars were financed by taxes or by borrowing. Ricardo said that, theoretically, either way private sector activity was going to be suppressed. Now we have a lot of evidence, including some that I produced, that the government multiplier is negative, not positive, over a three-year period. Thus, the tax cuts may work for a very short while, but not on balance. And if the tax cuts were revenue-neutral and financed by reductions in government expenditures that would be a positive since the evidence shows tax multipliers are more favorable than expenditure multipliers. Such a theoretical proposal would provide greater efficiency for private sector spending and government spending. There’s also evidence that you would lower the cost of capital, but that’s not what we’re talking about is it? We’re talking about a debt-financed tax cut and we’re not talking about a revenue-neutral infrastructure plan, just as we were not talking about a revenue-neutral stimulus package in 2009. We’re talking about the debt-financed variety of tax cuts and at this stage of the game, this will make us more vulnerable, except for a few fleeting instances.

I will say this: when you have a debt-financed infrastructure program or tax cut, there will be pockets within the economy that will benefit, but the aggregate economic performance will not benefit and so fiscal policy, as I see it, is not really going to be helpful. The risk is that the debt buildup will add to the problems. There is extensive academic research indicating that when government debt rises above 90 percent of GDP for more than five years, this trend will reduce the economy’s growth rate by a third. Remember, we’re at 106 percent debt to GDP and there’s evidence these higher levels of debt have a non-linear effect. In other words, we use up growth at a faster pace. And there’s a lot of evidence from the available data that we’re even losing a half of our growth rate from the trend. For example, GDP has risen at 2.1 percent per capita since 1790. The latest 10 years produced a reduction to 1.0 percent. And so we should have lost only seven-tenths or come down at 1.3 over 1 but we didn’t and this is a consequence that we have to deal with. We’re not in a position to ignore the debt levels. Fiscal policy can be talked about, we can debate about it, and we can proclaim its benefits, but I don’t see them in the current environment just as I didn’t see them in 2009. I would change my tune if they were revenue-neutral, but that’s not the issue here.

To me, inflation is a money-price-wage spiral not a wage-price spiral as with the Phillips curve. The way inflations begin is by money supply growth acceleration not being offset by weakness in velocity, which shifts the aggregate demand curve inward. Remember, the aggregate demand curve is equal to money times the velocity by algebraic substitution as evidenced in all the leading textbooks on macroeconomics. So you have declines in the money supply and velocity, which will make the aggregate demand curve shift inward over time. This shift gives you a lower price level and a lower level of real GDP. It doesn’t happen every quarter or even every year, but it’s the basic trend. Thus, monetary policy is in the process not of decelerating money supply growth and by a significant amount. If the Fed adheres to their schedule of quantitative tightening, I calculate M2 will grow by the end of the first quarter – it’s currently running around four and a half percent – and the year over year growth rate will be down to less than 3 percent. And so monetary policy is taking steps to lower the reserve monetary and credit aggregates, and these actions will further flatten the curve because they can press the short rates upward. But I think the long-term investors will understand that the inflationary prospects on a fundamental basis are weakening not strengthening.

FRA: And do you see these trends as being exacerbated on the emerging government pension fund crisis? Could there be more debt used to solve that like for bailouts? Do you see that potentially happening?

Dr. Lacy Hunt: Well the main problem with government debt is that we’re going to have approximately one million folks a year reach age 70 in the next 14 to 15 years and we’ve known that this was coming, but we didn’t prepare for it. We’ve made a lot of promises under Social Security Medicare and the Affordable Care Act and government debt will have to be used to fund the entitlement benefits — I don’t see any other way around it. Another overlooked problem is that the actual federal fiscal situation is much worse than these surface numbers. For example, in the last three years, the budget deficit worsened each year. If you sum the budget deficits for 2015, 2016 and 2017, the sum is 1.2 trillion, but a lot of what was previously called “outlays” have been moved off budget — we call them investments (such as student loans) and there are other examples. The actual increase in federal debt in the last three years is 3.2 trillion. So the budget deficit is actually greatly understating what is happening to the level of federal debt which wasn’t always the case. Furthermore, the deficit was made worse by a 2015 bipartisan deal between Congress and the White House. And while neither party is blameless — they both agreed on the deal — yet it doesn’t change the fact that the federal situation is deteriorating and at a much worse rate than the deficit numbers themselves indicate.

FRA: And what about for state and local jurisdiction locales, in terms of their government pension funds? Could there be federal level bailouts at that level?

Dr. Lacy Hunt: Again, what are they going to bail them out with? You’re going to have to sell Federal Securities. And one of the multipliers on new sales of Federal debt is negative, not positive. Forget what was taught you in your macroeconomic class 30, 20, or even 15 years ago. When I was in graduate school, I was taught that the government multiplier was somewhere between four and five percent. Now, it looks like the multiplier is at best zero and even possibly slightly negative.

FRA: Great insight as always. How can our listeners learn more about your work, Dr. Hunt?

Dr. Lacy Hunt: We put out a quarterly letter as a public service. Write to us at hoisingtonmgt.com and we’ll put your name on the subscription list. We don’t spam you with marketing so please go ahead and subscribe.

FRA: Okay, great. Thank you very much for being on the Program, Dr. Hunt. Thank you.

Dr. Lacy Hunt: My pleasure Richard. Nice to be with you

Economics as Taught

Note Lacy"s comments on what he learned in graduate school. Lacy once told me that he had to "unlearn" nearly everything he was taught in school about economic.

Multiple generations of economists have been trained to believe inflation is a good thing, saving is bad, that there are no consequences for piling up debt.

 

In An Unexpected Outcome, Trump Tax Reform Blew Up The Treasury Market

Over the past week we have shown on several occasions that there once again appears to be a sharp, sudden dollar-funding liquidity strain in global markets, manifesting itself in a dramatic widening in FX basis swaps, which - in this particular case - has flowed through in the forward discount for USDJPY spiking from around 0.04 yen to around 0.23 yen overnight. As Bloomberg speculated, this discount for buying yen at future dates widened sharply as non-U.S. banks, which typically buy dollars now with sell-back contracts at a future date, scrambled to procure greenbacks for the year-end.

However, as Deutsche Bank"s Masao Muraki explains, this particular dollar funding shortage is more than just the traditional year-end window dressing or some secret bank funding panic.

Instead, the DB strategist observes that the USD funding costs for Japanese insurers and banks to invest in US Treasuries - which have surged reaching a post-financial-crisis high of 2.35% on 15 Dec - are determined by three things, namely (1) the difference in US and Japanese risk-free rates (OIS), (2) the difference in US and Japanese interbank risk premiums (Libor-OIS), and (3) basis swaps, which illustrate the imbalance in currency-hedged US and Japanese investments.

In this particular case, widening of (1) as a result of Fed rate hikes and tightening of dollar funding conditions inside the US (2) and outside the US (3) have occurred simultaneously. This is shown in the chart below.

What is causing this? Unlike on previous occasions when dollar funding costs blew out due to concerns over the credit and viability of the Japanese and European banks, this time the Fed"s rate hikes could be spurring outflows from the US, European, and Japanese banks’ deposits inside the US. Absent indicators to the contrary, this appears to be the correct explanation since it"s not just Yen funding costs that are soaring. In fact, at present EUR/USD basis swaps are widening more than USD/JPY basis swaps.

According to Deutsche, it is possible that an increase in hedged US investments by Europeans could be indirectly affecting Japan, and that market participants could also be conscious of the risk that the repatriation tax system could spur a massive flow-back into the US, of funds held overseas by US companies

In fact, one can draw one particularly troubling conclusion: the sharp basis swap moves appear to have been catalyzed by the recently passed Trump tax reform.

• Corporate tax reform in the US

The United States House of Representatives and Senate recently passed a tax reform bill that lowers the corporate tax rate from 35% to 21% starting 2018. Lowering corporate taxes would likely accelerate the pace of Fed rate hikes, which could trigger a shift from dollar deposits to Government MMFs. Revisions to interest tax deductions would encourage companies to repay corporate bonds and could spur a decrease in dollar deposits (however, demand to bank loan could also weaken).

• Repatriation tax system

The tax bill also includes the abolishment of taxation (currently 35%) on dividend payments from overseas subsidiaries. However, overseas subsidiaries" retained earnings would be subject to a one-time tax. It is expected that this repatriation tax system would result in reserves held overseas by US companies (we estimate 90% are USD-denominated) flowing back into the US. This could create tighter conditions for USD financing outside the US.

Which leads to a bizarre outcome, that while the GOP tax reform may benefit corporate America, it appears set to punish America itself as buyers of US Treasurys suddenly require far greater yields to offset the surge in funding costs!

* * *

Whatever the cause behind these sharp funding shortages, one thing is clear - dollar funding costs (FX hedging costs) for both Japanese and European insurers and banks to invest in US Treasuries are surging (with Japanese buyers and reached a post-financial-crisis high of 2.35% on 15 Dec. And in terms of practical implications for the treasury market this means that, all else equal, marginal demand for US paper is about to plunge for one simple reason: the FX-hedged yields on US Treasurys have plunged to (negative) levels never seen before (unless of course foreign investors buy US Treasurys unhedged).

To demonstrate this point, the chart below from Deutsche Bank shows the yields on currency-hedged US Treasuries from the perspective of Japanese investors. Japanese financial institutions tend to use 3-month FX forwards when they invest in hedged foreign bonds. Annualized hedge costs have recently risen to 2.33%, which means that investments in 10y US Treasuries result in virtually no yield. Furthermore, yields from investment in shorter than 10y US Treasuries would be less than JGBs and result in negative spreads. This means that unless funding costs slide, Japanese buyers will simple pick JGBs over TSYs, eliminating one of the biggest sources of Treasury demand in receng years.

There is another consideration: as Deutsche Bank notes, whenever it is time to roll over a hedge, financial institutions need to decide whether to (A) sell US Treasuries or (B) hold them as unhedged foreign bonds. Engaging in (B) on a large scale would be difficult unless the institution"s outlook calls for yen depreciation. After implementing (A), institutions should then choose to invest in high-yielding US MBS (high interest rate risk), medium- to low-rated corporate bonds (high credit risk), European and other sovereign bonds, or to reinvest in JGBs.

Moving away from Japan, and looking at Europe one finds an even more dramatic slide in hedged TSY yields, which net of hedge costs have plunged to -0.6%, by far the lowest - and most negative - on record, something we highlighted yesterday in "There"s Never Been A Worse Time For A European Investor To Buy US Treasuries" .

The conclusion is that as a result of the recent surge in funding costs, seemingly in response to the nuances of Trump tax reform as explained above, suddenly buying US Treasurys is no longer an economic option for virtually all foreign buyers! Needless to say, something will need to change because if funding costs stay where they are, yields across the curve will have to jump for US Treasurys to once again be an attractive purchase for foreign buyers, which as a reminder comprise the majority of TSY buyers in recent years.

What is the outlook? Some parting thoughts from Deutsche, which writes that according to the chart below, fundings costs will likely continue widening as the Fed raises interest rates.

DB then also warns that the repatriation tax system that was just passed into law, coupled with ongoing Fed rate hikes, will indirectly result in the widening of dollar funding conditions in and outside of the US. And the punchline: if these indeed continue to widen, and US long-term interest rates stay at a low level, "this would restrict investments in US Treasuries by Japanese financial institutions relying on short-term dollar funding." This could then lead to a sharp move higher in US yields - and rates- as the US finds it needs an aggressive increase in foreign demand to finance the widest US budget deficit in years. 

In other words, by pounding the table on - and recently passing - tax reform, Donald Trump appears to have sown the seeds of the equity market"s own destruction, because remember that the one thing that can bring the house of manipulated cards down faster than you can say covfefe, not to mention burst the equity bubble, is a sharp move higher in long-term yields, rates, and ultimately - inflation.

Is This The Most Important Chart In The World?

"This is possibly the most important chart in the world..." As 13D Global Strategy and Research noted:

A breach of the top-line of the channel could signal a major reversal in the multi-decade downtrend in UST bond yields."

So the question is - is an event engineered to slam rates lower, in order to avoid interest expense soaring beyond US government capabilities; or is the event a reaction to over-exuberant bubble-fueled positioning in risk assets?

What is perhaps most worrisome for that channel breakout is that speculative traders have almost never been more net long the long-bond...

In 1998, 30Y yields jumped from under 5% to almost 7% in the next year.

In 2004, 30Y yields extended their drop after peak positioning (from 5% yield to 4%) in the next 3 months.

In July 2016, 30Y yields spiked from 2% to well over 3% in the next 4 months.

So what will happen this time?

Even after one of the worst 3-day steepenings of the yield curve last week, specs failed to cover...

And today bonds are bid further.

"Wealth Effect" = Widening Wealth Inequality

Authored by Charles Hugh Smith via OfTwoMinds blog,

Note that widening wealth and income inequality is a non-partisan trend.

One of the core goals of the Federal Reserve"s monetary policies of the past 9 years is to generate the "wealth effect": by pushing the valuations of stocks and bonds higher, American households will feel wealthier, and hence be more willing to borrow and spend, even if they didn"t actually reap any gains by selling stocks and bonds that gained value.

In other words, the mere perception of rising wealth is supposed to trigger a wave of renewed borrowing and spending.

This perception management only worked on the few households which owned enough of these assets to feel wealthier--the top 5%, the top 6 million out of 120 million households. This chart shows what happened as the Fed ceaselessly goosed financial assets higher over the past 9 years: the gains, real and perceived, only flowed to the top 5% of households earning in excess of $200,000 annually.

Spending by the bottom 95% has at best returned to the levels reached a decade ago in 2007.

By focusing on boosting financial assets to the moon as a means of goosing spending, the Federal Reserve has widened wealth and income inequality to the breaking point. Perception management doesn"t actually boost the inflation-adjusted wages of the bottom 95%, which have stagnated for decades. Nor does boosting assets do much good for the vast majority of households which have modest holdings of stocks and bonds, usually in IRA or 401K retirement accounts they can"t touch without paying steep penalties.

As the charts below illustrate, the Grand Canyon between the top 5% and everyone else is widening. Let"s say a househould has $12,000 in retirement funds and $5,000 in a savings account. (Many households have less than $1,000 in savings, so this example-household is doing pretty well to have $17,000 in cash and financial assets.)

Thanks to the Federal Reserve"s Zero Interest Rate Policy (ZIRP), savers have lost ground after adjustments for inflation. The stock market has more than doubled, and most bond funds have appreciated, but precious metals and other commodities have not performed as well. So let"s say the household"s retirement portfolio rose by a hefty 75%, or $9,000, to a total of $21,000.

Does this modest gain actually change the financial foundation of the household to the point that the household can now afford to buy a new vehicle, college tuition, etc.? The short answer is no; the gains are simply too modest as a percentage of income to make any difference.

Compare this to a top 5% household with hundreds of thousands of dollars of financial assets: gains registered in the hundreds of thousands do indeed move the needle on household wealth and perception management. The top 5% haven"t just reaped outsized gains in Fed-goosed assets; they"ve also reaped the vast majority of any wage gains generated in the past 9 years of "recovery."

As this chart shows, the bottom 90% lost ground, and the really substantial gains have accrued only to the top 1%.

Note that widening wealth and income inequality is a non-partisan trend. The political and financial elites have feathered their own nests while the bottom 95% have lost ground.

The Federal Reserve"s perverse policy of perception management has exacerbated wealth and income inequality: "wealth effect" = widening wealth inequality.

*  *  *

I"m offering my new book Money and Work Unchained at a 10% discount ($8.95 for the Kindle ebook and $18 for the print edition) through December, after which the price goes up to retail ($9.95 and $20). Read the first section for free in PDF format. If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

"As Good As It Gets" - What A Difference 11 Months Makes

Authored by Robert Gore via Straight Line Logic,

What a difference eleven months make.

Shortly after Donald Trump was inaugurated he fired Michael Flynn.

What’s become the conventional subtext is that the intelligence agencies have launched a “soft coup” against Trump, he has been significantly weakened, and the Deep State has scored a major victory.

“Plot Holes,” SLL, 2/26/17

Rejecting that subtext, SLL developed in “Plot Holes” and later articles a series of interrelated hypotheses. We posited that Trump was smarter and the Deep State weaker and more incompetent than generally reckoned. Also, that the Deep State’s animus towards Trump was based chiefly on fear of exposure and prosecution for its long history of corruption and criminality, not policy differences, notably concerning Russia. Finally, we suggested Trump is chiefly motivated by a drive for power. These hypotheses yielded testable predictions.

As predicted, the Russiagate investigation, based as it is on nothing, is now recognized as a monumental blunder. It forced the Deep State into the open and revealed its prosecutorial forbearance towards Hillary Clinton, its effort to help her and hinder Trump during the election, and its attempt to depose Trump afterwards. The FBI has been exposed as the antithesis of a concept implied by the word investigation: impartiality. Holdovers from the Obama Justice Department have been compromised.

The tables are turned. As the Russiagate investigation fades, Trump is left with investigatory gold mines: Uranium One, Fusion GPS, FBI and Department of Justice political meddling and obstruction of justice, Hillary Clinton’s emails, and the Clinton foundation. Trump could fire Robert Mueller with only a minor political uproar, but Mueller’s making a fool of himself to Trump’s political benefit. Why stop him?

As for those gold mines, Trump will decide if the threat of an investigation or an actual investigation best satisfies his leverage and power calculations and proceed accordingly. There has been no general swamp draining, nor will there be. Trump uses investigatory threats as a Machiavellian tactic to extract what he wants from compromised political actors in useful positions. The Clintons and James Comey, no longer in power and thus, no longer useful, are the most likely to be investigated and prosecuted.

In foreign policy, recognizing Jerusalem as the capital of Israel emphasizes Trump’s pronounced tilt toward Israel. Acquiescing to Saudi Arabia’s hapless war against Yemen and Mohammed Bin Salman’s recent purge confirms his support of that regime. In return, Israel and Saudi Arabia have sat still for Trump’s discontinuance of the US policy of supporting Islamic extremists to further regime changes (see “Powerball, Part Two”). This has meant accepting a de facto victory for the Russian-Shia alliance in Syria. US support for the Middle East’s Sunni bloc and Israel as Russian backs the Shiite bloc may lead to a standoff that brings a reduction in violence in that troubled region. It has already begun to reduce refugee flows from the area to Europe.

This is not to say that Trump’s rhetorical broadsides against Iran will stop, but the claims that the US is on the verge of war are overblown. Such a conflict would lead to a Middle East conflagration and the third officially recognized world war.

Trump’s blasts against North Korea are more problematic. His task there is more difficult than Iran; North Korea has nuclear weaponry purportedly able to strike most of the US. Trump has two options: a military strike designed to wipe out North Korea’s nuclear arsenal and Kim Jong-un’s regime, or negotiations that ratify the status quo, with Russia and China applying continuing pressure to enforce Kim’s compliance. At this point Trump may not know what he’s going to do, other than more verbal shots at North Korea and continuing displays of military strength in the region.

Trump has started no new wars. His administration has rolled back some regulations and he just won a legislative victory on tax reform. That may give him enough of a headwind to readdress Obamacare, which has neither been repealed nor replaced. He has his enemies on their back feet. Only fringe elements are still talking about impeachment. The government’s statistics indicate growth is running at above 3 percent, better than trend Obama growth, and the stock indexes keep making new records.

In 2017 SLL made contrarian, optimistic predictions for the president and pessimistic predictions for the economy and stock market (see “Hard Core Doom Porn”) We’ve been more right on the former than the latter…so far. For 2018, we’re with the minority who see clouds and thunderstorms, not silver linings. This is about as good as it gets for Trump.

Deft—by this analysis—as Trump has been, his biggest challenge lies ahead. The government is bankrupt, and demographics will push it ever-deeper in the hole. The global economy is struggling under monstrous and unsupportable debt. Fiat money something-for-nothing has a sell-by date, sooner or later the stock market and economy will head south. Historically, there’s been a tight correlation between stocks, the economy, and presidential popularity.

“Is Trump Winning?” SLL, 8/6/17

Debt has been Trump’s siren song his entire career, and more than once he’s crashed on the rocks. Big triumphs have been followed by big disasters, hubris undoubtedly playing a role.

Stock market and cryptocurrency pyrotechnics have obscured an incipient bear trend in a much more important market, bonds, which in the US apparently topped out in July 2016. Falling bond prices mean rising interest rates. The world has never been more indebted; a global bear market in bonds would be toxic to equity markets and economies (and perhaps cryptocurrencies). Tellingly, high yield bond prices are diverging from rising stock prices, indicating increasing credit stress. According to David Stockman, tax reform will increase the government’s borrowing to $1.25 trillion in fiscal year 2019. Rising rates would add more to the government’s interest bill, and hit indebted businesses and individuals as well. They would offer relief to savers long abused by the Fed’s interest rate suppression tactics, but savers are a much smaller group than borrowers, and they spend less.

Rising debt and ever-expanding government are in large part responsible for a long-term decline in trend economic growth rates across the developed world. Much of what growth there has been was funded with debt. If you buy $100 dollars worth of good or services on credit you have not increased your income, your personal “gross domestic product.” If the government does the same, it registers as an increase in the gross domestic product. Back out such debt-funded “growth” and it’s unclear if there’s been any growth at all since 2009.

In the US, real incomes have stagnated since the turn of the century. Rising equity markets and falling growth rates mean that corporate valuations are in the stratosphere. Joined with off-the-chart measures of optimism and declining central bank support, equity markets are poised for a fall. That it hasn’t happened yet doesn’t mean it won’t. It’s never “different this time.” Given the leverage and speculation embedded in the market, the fall could be breathtaking, a quick drop of 50 percent or more.

As noted, falling stock markets and economies generally take the popularity of incumbent politicians with them. Trump, the most polarizing political figure since Franklin Roosevelt, is not all that popular to begin with. The Deep State that has ruled this country since World War II is down; it would be unwise to count it out. It will certainly capitalize on financial and economic turmoil to launch a counterattack against Trump.

Next year’s silver lining may be that it marks peak government. Governments have coopted much of the world’s resources and put a gigantic lien on its future production. In a severe economic contraction, the wherewithal from taxes and credit markets that would allow them to grow even bigger—and thus more intrusive and repressive—simply won’t be there.

A financial and political focal point will be pension and medical funds. Many such funds are visibly under stress. Widespread insolvency is inevitable, especially if equity and credit markets head south. The resultant fear and fury will be uncontrollable, obliterating today’s widespread, quasi-religious faith in government and its works. The upheaval would make present discord look like a picnic in the park.

It would be unwise to rely on anything but one’s own resources, family, and friends during the coming turmoil. It would be wise to shore up those defenses, and soon.

3-Month Bills Turmoil Ahead Of March Debt Ceiling Showdown: Bid To Cover Plunges To 8 Year Lows

Despite the GOP"s tax reform victory, over the past few weeks, Congress once again punted on a formal decision how to keep government funded and what to do with America"s debt ceiling and as a result US legislators simply kicked the can on the agreement of raising the nation’s borrowing limit for another few months. However, with the Treasury expected to breach the ceiling as soon as late March, today"s $45 billion 3-Month Bill auction was closely watched as it serves as a fresh gauge of investor anxiety about the ongoing impasse.

As a reminder, in the first week of December, the Treasury deployed a series of extraordinary measures to stay under the debt ceiling cap since it was reinstated on December 8. But T-bill investors, in both the primary and secondary market,  remain especially wary given questions over what’s known as the debt ceiling’s drop-dead date. Today"s Bills mature March 29, within the Congressional Budget Office’s late-March to early-April window for when Treasury will exhaust the extra capacity it’s using to keep below the $20.5 trillion limit.

Quoted by Bloomberg, Justin Mandeville of Inveso said that the late-December bill auctions “speak volumes to investors being cautious as to when the potential drop-dead date will be,” adding that “we saw it back in July when we had concerns about the October bills.”

And sure enough, having just concluded, the 3M bill was especially ugly, pricing at 1.445%, or a 3bps tail to the 1.415% When Issued, with Indirect Buyers fleeing, and taking down just 20.1% of the finally allotment, down from 30.8% in the last 6 auctions, while Primary Dealers had no choice but to step up aggressively from 61.9% in the 6MMA, to 74% as Direct interest also fizzled from 7.3% in the last 6 auctions to just 5.9%. But nowhere was the revulsion quite so visible as in the bid to cover, which plunged from 3.04 in the past 6 auctions to just 2.71 on Dec. 26: this was the lowest Bid to Cover since January 2009.

As Bloomberg reminds us, at the government’s July 24 auction, the US Treasury sold $39 billion of three-month bills at 1.18 percent, then the highest rate since 2008. The bid to cover for that particular sale also matched the lowest for the maturity since 2009. Congress wound up passing a three-month debt-ceiling suspension Sept. 8, weeks before Treasury Secretary Steven Mnuchin estimated the government would run out of cash.

However, revulsion to paper that could be impacted by the debt ceiling was not just in the primary market: it also hit the secondary Bill market, as the previously noted kink that has emerged in the bill curve between securities maturing in late March and those in early April, has gotten even more pronounced. For several days after the Dec. 18 auction of bills maturing March 22, the rate on these securities was higher than debt maturing a week later. Since then, the rate on securities expiring March 29 has climbed to 1.44%, exceeding those on bills due the following week by nearly 10 bps as shown in the chart below.

And so, looking at the debt ceiling fight that refuses to go away despite the can being kicked every few months, while there is still a chance the issue could be resolved without going down to the wire, it is unlikely: while lawmakers hammered out a spending bill this week to keep the government open through Jan. 19, they didn’t include a provision to lift or suspend the debt ceiling. The longer a resolution remains at the bottom of Congress’s to-do list, the larger the T-bill dislocations could grow. Sooner or later, the bond market - which has been crying wolf on a technical US default - will eventually be right.

Uninvestable Tesla

Tesla is an uninvestable stock for me, not just because of its high valuation but also because it fails our fairly basic quality test, which I shamelessly borrowed from Warren Buffett: Would I still buy this stock if right after the purchase the stock market were to close for ten years? If you are a big Tesla car and stock fan, before you start throwing rocks at me, pause and wait till you finish this article – the rocks and I will still be there.

Think about the next ten years. But before you start mentally drawing upward-sloping lines from the current environment into the next decade and drooling over the rosy vision of Tesla’s future that Elon Musk has painted – produce half a million model 3s and bunches of semis and roadsters, and then send a roadster to Mars (I kid you not; that is in his 2018 plan – I’d like you to think about another version of the next ten years: higher (maybe much higher) interest rates, a recession in the US and around the globe, and a less promiscuous bond market where Tesla would have pay a substantial premium to US Treasuries (as would any other company that loses over a billion dollars a year in a highly cyclical industry). And now answer this question: Would Tesla survive this change in economic weather if it happened next year or even three years out? And the answer is … a weak “maybe” at best, and “unlikely” at worst.

The counterargument I’d get: Yes, but we are not going into a recession. Actually, we are. I (and nobody else, for that matter) just don’t know when. After nine years of appreciating stock markets and tepid economic growth, we tend to forget that recessions are a regular  economic fact of life, usually arriving every four to five years (so we are overdue for one). Most Millennials have yet to experience adulthood (have a job and a family) through a recession. They have also never had to borrow at high interest rates – but that is liable to happen, too.

Recessions are usually caused by expansions. Recessions are like the hangover that comes after the wild college party (economic expansion). It’s hard to have a good, fun college party with lots of booze and then not experience a hangover. (I am not speaking from recent personal experience but rather am trying to communicate in language to which Millennials can relate). During the expansion party, companies may build up too much inventory or erect too many factories, and consumers may overconsume.

If you own high-quality companies, ones that meet Buffett’s “ten-year stock market closed rule” (as we do), you don’t have to spend a lot of time and energy thinking about when the recession will hit (we don’t). However, if you own Tesla you’d better have a very clear, shiny crystal ball that will reveal lots of detail about the direction of interest rates and the global economy.

Recessions are tough for deeply cyclical companies: The bulk of their costs are fixed, and thus lower sales usually result in significant declines in net income and often lead to losses. This is why car companies and their deeply cyclical brethren don’t trade at high price-to-earnings levels when the economy is doing well. That is when their earnings are high. The market doesn’t usually take these high earnings at face value, knowing full well that there are lower earnings (or losses) around the corner when recession comes. Tesla, however, doesn’t have to worry about this low price-to-earnings problem, because in spite of its $50 billion market valuation, it has no earnings, just losses. It trades at whatever price-to-future Elon Musk tells you it does.

If you own Tesla stock and you only see one rosy (Musk) version of the future, you are ignoring the very real risk that the benign economic environment of today will not persist indefinitely into the future . Good luck – you’ll need plenty.

One additional but very important point. In the past I was dismissive of traditional automakers’ ability to compete with Tesla. I felt their hundred-year past of producing internal combustion engine (ICE) cars was going to hold them back, the same way Nokia’s dumb-phone past prevented it from effectively competing against Apple’s iPhone. Nokia tried to take the dumb-phone operating system Symbian and turn it into a smartphone operating system. It had a lot of engineers who knew the Symbian operating system, and thus it seemed a logical path at the time. The right approach would have been the more difficult one: Hire new engineers and create a brand new operating system. There was absolutely no reason why Nokia could not have developed its own Android-like OS, even if doing so would have required either retraining or, more likely, laying off Symbian engineers.

For a while it looked like I was right about cars, as the Big Three took a hybrid (Symbian-like) approach to electric cars – they were having a hard time saying goodbye to ICE. However, as we look at the future lines of electric cars coming from  US and German automakers, we now see them severing the connection to their ICE past and embracing electric.

Disclosure: I am an unsecured lender to Tesla through my $1,000 deposit on a Model 3. 

So, how does one invest in this overvalued stock market? Our strategy is spelled out in this fairly lengthy article.

Vitaliy Katsenelson is chief investment officer at  Investment Management Associates  in Denver, Colo. He is the author of “Active Value Investing” (Wiley) and “The Little Book of Sideways Markets” (Wiley). Read more on Katsenelson’s  Contrarian Edge  blog.

Yes, Virginia, There Is A "Santa Rally"

Authord by Lance Roberts via RealInvestmentAdvice.com,

Yes, Virgina, There Is A Santa Claus

Every year, at this time, I republish the story of 8-year Virginia O’Hanlon who asked the most important of questions. I encourage you to read it as it reminds us of the importance, meaning and the “Spirit” of the Christmas season. 

*  *  *

Eight-year-old Virginia O’Hanlon wrote a letter to the editor of New York’s Sun, and the quick response was printed as an unsigned editorial Sept. 21, 1897. The work of veteran newsman Francis Pharcellus Church has since become history’s most reprinted newspaper editorial, appearing in part or whole in dozens of languages in books, movies, and other editorials, and on posters and stamps

THE EDITORIAL

DEAR EDITOR:

I am 8 years old.
Some of my little friends say there is no Santa Claus.
Papa says, ‘If you see it in THE SUN it’s so.’
Please tell me the truth; is there a Santa Claus?

VIRGINIA O’HANLON.
115 WEST NINETY-FIFTH STREET.

“VIRGINIA, your little friends are wrong. They have been affected by the skepticism of a skeptical age. They do not believe except they see. They think that nothing can be which is not comprehensible to their little minds. All minds, Virginia, whether they be men’s or children’s, are little. In this great universe of ours, man is a mere insect, an ant, in his intellect, as compared with the boundless world about him, as measured by the intelligence capable of grasping the whole of truth and knowledge.

 

Yes, VIRGINIA, there is a Santa Claus. He exists as certainly as love and generosity and devotion exist, and you know that they abound and give to your life its highest beauty and joy. Alas! how dreary would be the world if there were no Santa Claus? It would be as dreary as if there were no VIRGINIAS. There would be no childlike faith then, no poetry, no romance to make tolerable this existence. We should have no enjoyment, except in sense and sight. The eternal light with which childhood fills the world would be extinguished.

 

Not believe in Santa Claus! You might as well not believe in fairies! You might get your papa to hire men to watch in all the chimneys on Christmas Eve to catch Santa Claus, but even if they did not see Santa Claus coming down, what would that prove? Nobody sees Santa Claus, but that is no sign that there is no Santa Claus. The most real things in the world are those that neither children nor men can see. Did you ever see fairies dancing on the lawn? Of course not, but that’s no proof that they are not there. Nobody can conceive or imagine all the wonders there are unseen and unseeable in the world.

 

You may tear apart the baby’s rattle and see what makes the noise inside, but there is a veil covering the unseen world which not the strongest man, nor even the united strength of all the strongest men that ever lived, could tear apart. Only faith, fancy, poetry, love, romance, can push aside that curtain and view and picture the supernal beauty and glory beyond. Is it all real? Ah, VIRGINIA, in all this world there is nothing else real and abiding.

No Santa Claus! Thank God he lives, and he lives forever. A thousand years from now, Virginia, nay, ten times ten thousand years from now, he will continue to make glad the heart of childhood.”

Merry Christmas, and may this new year bring you joy, laughter, and prosperity.

From all of us at Real Investment Advice, Real Investment News, and Clarity Financial.

*  *  *

Santa Rally?

With the market now back to overbought conditions, it is now or never for the traditional “Santa Rally” between Christmas and New Year’s Day.

If we go back to 1990, the month of December has had average returns of 2.02% with positive returns 81% of the time. Over the past 100 years, those numbers fall slightly to a 1.39% average return with positive returns 73% of the time.

For the month of December, so far, the market has risen 1.33% which is in-line with the historical norm.

As discussed over the last couple of weeks, this is not to be unexpected as portfolio managers and hedge funds “Stuff Their Stockings” of highly visible positions to have them reflected in year-end statements. 

However, come January, it is potentially a different story. As I have been laying out over the last several weeks, the “tax cut” rally may well come to an end as portfolio managers, being reluctant to sell before year-end which would put them under the 2017 tax code, will likely sell in January to lock in gains under the new tax code when they pay taxes in 2019.

While “this time” is never exactly like the “last time,” there is a reasonable precedent that a sell-off in January is a likelihood. With the outside gains this past year, and now extreme overbought conditions as discussed last week, the odds of a correction are high.

This next week, as close to the end of the year as possible, we will likely be adding two positions to portfolios to hedge against a potential “tax gain” related sell off.  The first position will be a short-S&P 500 index combined with an intermediate-duration bond position.

Given that IF a sell-off occurs money will rotate from “risk” to “safety.” In this case, the S&P 500 should fall while bond prices rise as rates head lower. As shown below, with the stock-bond ratio at extremes, this trade is fairly low risk.

(The current stock/bond ratio is at the highest level in history. Also, note that the correlation “broke” in 2013 with QE 3. That gap will likely be filled at some point.)

If I am wrong, and the markets continue to rise, our existing long-positions, which outweigh the hedges by a large percentage, will continue to advance with the hedge only slightly inhibiting performance. If a sell-off does occur, the hedges will mitigate some of the downside risk while we evaluate our next potential moves.

We will keep you apprised of our actions next week.

Dot Com 2.0

by Michael Lebowitz, CFA

On May 20, 1999, eToys.com became a publically traded stock, offering shares to the public at a price of $20 per share. Lurching to $76 per share on the first day of trading and then over $80 a share by mid-August of that same year, investors were blindly optimistic about the prospects for this internet retailer. In early January 2001, after a weaker than expected holiday season, the company laid off half of its staff. By late February, eToys.com stock traded at meager 0.09 cents per share and filed for bankruptcy in March. The bubble had burst on eToys.com and hundreds of other tech companies selling investors on the promise of a new economic paradigm and internet fantasies.

By late 1999, when eToys.com was flourishing, the NASDAQ stock market was in the midst of a ten-year run in which it gained over 2,700%. Valuations, especially those in the tech sector but also in the broader-based markets, rose well above every prior instance. Caution and conservatism were thrown out the window in place of greed and rampant speculation. A decade of impressive market gains resulted in a high level of complacency.

We are now 18 years beyond the tech bubble, and we find ourselves in similar shoes. Most measures of equity valuation are currently higher than just about every other equity market peak including even some from 1999. The market has produced a constant stream of winners seemingly coming in waves over the last few years. Among the more popular is the FANG stocks and their valuations that assume perfection in perpetuity.

Further reminding us of the late 90’s tech bubble and the eToys.com era are Bitcoin and blockchain related stocks. Longfin Corp. (LFIN) for instance, just completed an initial public offering (IPO) at $5 per share on December 13th. On December 18th LFIN announced the purchase of Ziddu Coin a business lender dealing in crypto-currency loans. Following the announcement, the stock rose as high as $136 a share producing a 2620% gain for those investors that sold at the highs. As we pen this note, the stock trades at $41.

Instead of using “dot com,” companies like LFIN, Overstock, Riot Blockchain and other companies are seizing on investor greed by telling a grand story of Bitcoin and blockchain riches. It is, to be sure, the new-new paradigm.

Another recent example is Long Island Iced Tea Corp. which was a purveyor of bottled drinks with a stock price languishing around the $2 range. Well, that is until the company changed its name to Long “Blockchain” Corp. which sent investors into a buying frenzy running the stock price up nearly 500% in one day.

The instances where anything related to Bitcoin and blockchain is instantly deserving of massive valuations is a mirage; here today and gone tomorrow. The current era serves as a gentle reminder of the greed and wild speculation of the latest bubble. In early 2000, the markets topped with no-name (and no-profit) companies capturing the wild hopes of investors. The NASDAQ took over 16 years to re-capture the prior high water mark representing precious years that investors lost.

Whether LFIN and the like are signaling that we are in the bottom of the ninth of the latest bubble or still have a few innings to go is up for debate. What is important, however, is to retell yourself the story of the tech bubble and how investors ignored the glaring signals. Does today’s price action sound familiar? If so we recommend that you continue to remain cognizant of the patterns of prior market bubble episodes and proceed accordingly.

Rules For The Road

If you are long equities in the current market, we continue to recommend following some basic rules of portfolio management.

“It is through following these basic rules that, with the markets overbought, underlying fundamentals stretched, we continue to suggest some portfolio actions be taken to reduce, not eliminate, overall risk.

1. Tighten up stop-loss levels to current support levels for each position.


2. Hedge portfolios against major market declines.


3. Take profits in positions that have been big winners


4. Sell laggards and losers


5. Raise cash and rebalance portfolios to target weightings.

Notice, nothing in there says “sell everything and go to cash.”

As I noted in last week’s missive on the current bubble, our job as investors is pretty simple – protect our investment capital from short-term destruction so we can play the long-term investment game.

In case you missed it, let me repeat for you the most important lines:

Our job as investors is actually quite simple. We must focus on:

• Capital preservation


• A rate of return sufficient to keep pace with the rate of inflation.


• Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4%)


• Higher rates of return require an exponential increase in the underlying risk profile.  This tends to not work out well.


• You can replace lost capital – but you can’t replace lost time.  Time is a precious commodity that you cannot afford to waste.


• Portfolios are time-frame specific. If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

With forward returns likely to be lower and more volatile than what was witnessed in the 80-90’s, the need for a more conservative approach is rising. Controlling risk, reducing emotional investment mistakes and limiting the destruction of investment capital will likely be the real formula for investment success in the decade ahead.

This brings up some very important investment guidelines that I have learned over the last 30 years.

• Investing is not a competition. There are no prizes for winning but there are severe penalties for losing.


• Emotions have no place in investing.You are generally better off doing the opposite of what you “feel” you should be doing.


• The ONLY investments that you can “buy and hold” are those that provide an income stream with a return of principal function.


• Market valuations (except at extremes) are very poor market timing devices.


• Fundamentals and Economics drive long-term investment decisions – “Greed and Fear” drive short-term trading. Knowing what type of investor you are determines the basis of your strategy.


• “Market timing” is impossible– managing exposure to risk is both logical and possible.


• Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.


• There is no value in daily media commentary– turn off the television and save yourself the mental capital.


• Investing is no different than gambling– both are “guesses” about future outcomes based on probabilities.  The winner is the one who knows when to “fold” and when to go “all in”.


• No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

As an investment manager, I am neither bullish or bearish. I simply view the world through the lens of statistics and probabilities. My job is to manage the inherent risk to investment capital. If I protect the investment capital in the short term – the long-term capital appreciation will take of itself.

Elderly Couple On Cross-Country Trip To Vermont Busted With 60 Pounds Of Christmas Marijuana

An elderly couple from Clearlake Oaks, California were busted by Nebraska sheriff"s deputies with 60 pounds of marijuana, edibles and marijuana concentrates while on a 3,000 mile cross-country Christmas trip to Vermont, police said.

Patrick Jiron, 83 and his wife Barbara, 70, were planning to give the pot to family as Christmas presents when Nebraska police smelled a strong odor of marijuana coming from their Toyota Tacoma during a traffic stop for going over the center line and failing to signal, said the York County Sheriff"s Office. The smell was confirmed by their drug dog, Dundee. 

When they initiated the traffic stop, deputies could immediately smell the strong odor of raw marijuana. Dundee, the county’s drug dog, alerted to the presence of a controlled substance and a search was conducted.

 

The Jirons acknowledged that the marijuana was in the back of the pickup, under a topper, and deputies found 60 pounds of marijuana inside boxes. Because the marijuana was such high grade, the street value was equally high. -York News Times

The marijuana was found in boxes stowed underneath the pickup topper.

Patrick Jiron

Patrick Jiron was booked into York County Jail on felony charges of possession of marijuana with the intent to deliver and having no drug tax stamp, however Barbara was only cited "due to some medical issues" according to York County Sherriff"s Lt. Paul Vrbka. Mr. Jiron posted 10% of his $100,000 bond and has been released. 

The Jirons told Nebraska deputies that they didn"t know it was illegal to transport marijuana in Nebraska. 

China Admits To Fake Data (Again) - Hidden Debt & Inflated Revenues

It"s not the first time (and it won"t be the last), but a recent nationwide audit found some local governments inflated revenue levels and raised debt illegally, once again crushing China"s credibility on the global stage when it comes to economic performance.

As Bloomberg reports, ten cities, counties or districts in the Yunnan, Hunan and Jilin provinces, as well as the southwestern city of Chongqing, inflated fiscal revenues by 1.55 billion yuan ($234 million), the National Audit Office said in a statement on its website dated Dec. 8.

The inspection, which covered the third quarter, also found that five cities or counties in the Jiangxi, Shaanxi, Gansu, Hunan and Hainan provinces raised about 6.43 billion yuan in debts by violating rules, such as offering commitment letters.

 

The findings are a blow to China’s bid to rein in data fraud, which has been widespread in some of the poorer provinces where officials were incentivized to inflate the numbers as a way of advancing their careers.

 

Concern from investors wanting to be able to trust data out of the world’s second-largest economy led to the government trying to crack down on the practice, with President Xi Jinping saying in March that data fraud “must be throttled,” according to the state-run Xinhua News Agency.

While historically investors would rapidly shrug this news off and buy more stocks, with Chinese sovereign bond yields near their Maginot Line of 4.00%, losing credibility could be critical.

A new supervisory body was set up within China’s statistics office in April to bolster and ensure data authenticity and quality.

The country is also shifting to the latest United Nations-based statistical standard and using computers -- rather than local reports -- to calculate provincial gross domestic product, the chief economist said in September.

Forget The Phony Pension Accounting, Here"s How Much Your State Pension Is Really Underfunded

The phony assumptions that go into calculating public pension underfundings in the United States are a frequent topic for us.  As our readers are aware, state pension administrators are given fairly wide leeway to simply pick a discount rate out of thin air.  Of course, since pensions are nothing but a massive stream of future liabilities that stretch out into perpetuity, every 100 bps increase can substantially, and artificially, lower the fund"s reported underfunded level. 

In fact, we estimated the impact of higher discount rates on underfunding levels in a post entitled "An Unsolvable Math Problem: Public Pensions Are Underfunded By As Much As $8 Trillion"...here was the result:

Fortunately, we"re not the only ones that see through the ridiculously phony assumptions that go into duping retirees and taxpayers as the team at American Legislative Exchange Council (ALEC) has just dropped a report which reviews the financial health of public pensions all over the country if you toss out their 7.5% discount rate and replace it with a risk free rate...

Faulty accounting and reporting methods obscure the magnitude of unfunded liabilities. Partly in response to the devastating impact of the Great Recession, the Governmental Accounting Standards Board (GASB) made two significant changes in 2012 (Statement No. 67, Financial Reporting for Pension Plans and Statement No. 68, Accounting and Financial Reporting for Pensions) to the methods used for measuring the financial health of pension plans. GASB intended these changes to increase transparency, consistency, and comparability of pension information. Public pensions are now required to report their assets and liabilities using a standardized actuarial cost method, to disclose investment returns, and to include unfunded pension liabilities on state balance sheets.

 

Unfortunately, states have found ways to work around these requirements and paint an unrealistically rosy picture of their pension funding status.

 

The Center for State Fiscal Reform at ALEC analyzes the annual official financial documents of more than 280 state-administered pension plans using more realistic investment return assumptions in order to gain a clearer picture of the pension problem. The unfunded liabilities of each pension plan are revalued using a discount rate equal to a risk-free rate of return, best represented by debt instruments issued by the United States government. This year"s study uses a risk-free rate of 2.142 percent, derived from an average of the 10- and 20-year U.S. Treasury bond yields over the course of 12 months spanning April 2016 to March 2017. Based on these revised investment return assumptions, we report on total unfunded pension liability, unfunded pension liabilities per capita, and the funding ratio of these plans.

...and as you might expect, the results are fairly bleak.  In terms on aggregate underfunding, ALEC figures our taxpayer-funded pension ponzis are roughly $6 trillion underfunded, or roughly 2-3x worse that the often-quoted $2-$3 trillion underfunding calculated by state pension administrators.  Meanwhile, using ALEC"s discount rates, the state of California is nearly $1 trillion underfunded by itself.

So, what is your personal share of these massive public liabilities?  Well, if you"re in one of the 10 bottom states it"s anywhere from $25,000 to $45,000.  Of course, that"s the liability for every man, woman and child so the typical American household (with 2.57 residents) in those states is on the hook for $67,500 - $115,650.

Finally, and perhaps most shocking of all, ALEC found that when using a risk-free discount rate only 1 state pension in the entire country was more than 50% funded.

ALEC"s full report can be reviewed here: