Moody"s Considers Municipal Ratings Changes That Could Push Illinois Into Junk Territory

A few weeks ago, we expressed some level of astonishment that the rating agencies, in their infinite wisdom, decided to bestow an investment grade rating upon a new $3 billion bond issuance by the City of Chicago.  Of course, this wouldn"t be such a big deal but for the fact that the state of Illinois is a financial disaster that will undoubtedly be forced into bankruptcy at some point in the future courtesy of a staggering ~$150 billion funding gap on its public pensions, a mountain of debt and $16.4 billion in accrued AP because they can"t even afford to pay their bills on a timely basis.  Here are just a couple of our recent posts on these topics:

• Illinois Pension Funding Ratio Sinks To 37.6% As Unfunded Liabilities Surge To $130 Billion


• Illinois Unpaid Vendor Backlog Hits A New Record At Over $16 Billion


• The State Of Illinois Is "Past The Point Of No Return"

Alas, as Capitol Fax notes this morning, it seems as though Moody"s may finally be waking up to the farce that is their own municipal ratings system and is currently in the process of seeking comments from market participants on proposed changes for states’ general obligation credit ratings, which would include an increased emphasis on debt and pension obligations.  Of course, with their GO rating just one notch above junk, all of those long-only bond funds that have scooped up billions in "juicy" 4% Illinois paper over the past couple of months should probably take notice.

Under the proposed changes, debt and pension obligations will have a 25% weight on state credit ratings, up from 20% currently. The individual state’s economy, another factor in Moody’s ratings, will also have a 25% weight, up from 20%. Governance will fall to 20% from 30% and finances will be maintained at 30%.

 

The debt and pension factor “is critical because debt and pension obligations are the primary long-term liabilities that states have,” Moody’s said in an announcement on the proposed changes Tuesday. “As these liabilities grow, states face rising expenses to pay debt and pension benefits. High fixed debt service and pension costs can crowd out other budgetary priorities and force states to raise taxes in order to meet them. Debt and pensions can curtail a state’s budgetary flexibility and heighten the risk that it will seek to deleverage through a debt restructuring.”

Of course, the proposed changes come just after Fitch put out their 2017 State Pension Update which showed that Illinois’ pension crisis is the worst in the nation with an underfunding of more than $151 billion...or $60 billion more than second worst state: New Jersey.

“Six states have long-term liability burdens that Fitch considers elevated [in excess of 20 percent of personal income],” the report said, “with Illinois carrying the highest liability burden at 28.5 percent of personal income.”

 

Fitch Senior Director Doug Offerman said taxpayers should care because the burden takes up more than 28 percent of all personal income in Illinois, “which is essentially a proxy for the wealth level, the resource base of a given government.”

 

“For the last several years the [pension] increases did grow faster, and I would say do crowd out other spending that might have otherwise taken up organic revenue growth,” [Fitch Ratings Senior Director Karen Krop] said.

Meanwhile, State Senator Dan McConchie (R) noted, as have we on multiple occasions, that people are already fleeing Illinois in droves because of its financial crisis and resulting tax burdens.  “Whether it’s through their property taxes or because of the recent income tax increase, they just can’t afford to [stay here],” McConchie said. “This day of reckoning is fast approaching us. I don’t think we want to wait until the absolute last minute to try and do everything we can to really right the ship.”

Unfortunately, Mr. McConchie, we"re afraid your proverbial ship is taking on so much water at this point that it hasn"t a hope of surviving the crushing weight of your state"s mounting debts...perhaps it"s better at this point to simply seek a life raft and follow your constituents to Texas.

Staggering Chart Shows Your Personal Share Of Your State's Underfunded Pension

Back in March we shared the staggering results of a Bankrate survey which found that the average American household couldn"t afford to write a measly $500 check in the event of an unexpected emergency (see: "The Reality Is, Half Of Americans Can’t Afford To Write A $500 Check").  Of course, as we note frequently, while the talking heads of daytime financial TV shows love to reference surging economic indicators like unemployment figures, the fact is that the number of Americans not participating in the work force remains near all-time highs and wage growth, despite "full employment" levels, has been practically non-existent since the great recession. 

Given the above, we can only presume that the average person in New Jersey, Connecticut, Illinois, Kentucky, etc. is going to have a somewhat difficult time producing their $10,000 - $27,000 share of their state"s massive pension and debt obligations. 

As CNBC points out today via S&P Global Ratings, decades of budget mismanagement and hollow pension promises to public employees has resulted in a mountain of debt that many states are unlikely to ever repay.

New Jersey has set aside just 31 percent of what it needs to pay pensions costs. Kentucky, (31 percent) Illinois (36 percent) Connecticut (41 percent) and Hawaii (541 percent) are the worst off.

States with the best funding levels include Wisconsin (98 percent), South Dakota (97 percent), New York (93 percent), Tennessee (88 percent) and North Carolina (87 percent).

In New Jersey, the funding gap represents nearly 42 percent of the Garden State"s Gross State Product – or more than $27,000 for every resident, according to S&P Global Ratings.

Other underfunded states include Connecticut ($22,700 per person), Hawaii ($15,700), Illinois ($15,900) and Alaska ($18,200).

That compares with Nebraska, where the underfunding represents just $242 for every resident. Taxpayers in South Dakota ($598 per person), Idaho ($472), Iowa ($752), and Tennessee ($806) also face relatively low risk of having to make up for unfunded state liabilities.

Of course, we can"t help but notice that 8 of the 10 worst funded states in America just happen to be "deep blue" bastions of liberalism.  Could it be that perpetually higher taxes and overly burdensome regulations end up being negative for state budgets in the long term?

The Disturbing Trend That Will End In A Full-Fledged Pension Crisis

Authored by Shannara Johnson via HardAssetsAlliance.com,

Some experts think it will be the trigger for the next financial collapse. Others call it a “national crisis” of unprecedented proportions.

But what all of them agree on is that there’s no way US pension funds can keep their promises to the next wave of retirees.

Right now, millions of Americans are hard at work believing their pensions will be their saving grace for retirement. But the predicament pension funds across the United States find themselves in does not just spell trouble for the distant future.

The crisis is happening as we speak.

Though the challenges are well known by now, many believe that public-sector pension funds will be maintained and the gaps filled by strong investment returns, increasing employee contributions, raising taxes, or some combination of the three. They hope with these measures and ongoing strong asset returns, liabilities can be reduced and pensions salvaged. Unfortunately, this is wishful thinking at best.

Even though the facts are on the table, state and local governments continue to underestimate the crisis at hand. According to Hidden Debt, Hidden Deficits, a 2017 data-rich study of US pension systems by Hoover Institution Senior Fellow Joshua Rauh, almost every state or local government has an unbalanced budget - due to runaway pension fund costs that are continually chipping away at already inadequate budgets.

In 2016, Rauh stated, “while state and local governments across the US largely claimed they ran balanced budgets, in fact they ran deficits through their pension systems of $167 billion.” That amounts to 18.2% of state and local governments’ total tax revenue.

According to the 2017 report, total unfunded pension liabilities have reached $3.85 trillion. That’s $434 billion more than last year. Amazingly, of that $3.85 trillion, only $1.38 trillion was recognized by state and local governments.

The difference between funded levels under Governmental Accounting Standards Board (GASB) metrics and more realistic expectations reveals a massive amount of “hidden debt,” commonly referred to as unfunded liabilities. Under GASB metrics, public pension systems assume they will see annual returns of 7.5%. This assumption ignores the increased risks associated with stocks, hedge funds, real estate, and private equity to realize these returns.

Using that 7.5% annual return, unfunded liabilities for city and state plans are $1.38 trillion. However, when we use a more conservative return of 2.8% based on the Treasury yield curve, unfunded liabilities balloon to $3.85 trillion. Realistically, the truth probably lies somewhere between these two numbers, which still results in a huge increase in unfunded liabilities.

An Alternative Approach

Massive financial market losses in 2000–2001 and 2008–2009 led many pension funds to invest in high-fee and higher-risk alternatives such as hedge funds and private equity. But this strategy only exacerbated the funding gap over the past decade, failing to deliver expected returns.  

The California Public Employees’ Retirement System (CalPERS) is one of the largest public pension funds with over $300 billion in assets and nearly 2 million members. After years of poor performance—including a meager 0.6% net return in the most recent fiscal year—the fund is now embracing a lower-cost, diversified investment approach, including exposure to gold.

Failing to meet its 7.5% return objective for several years, CalPERS recently has adopted a “Funding Risk Mitigation” strategy to meet the challenges of a maturing workforce, negative cash flow, longer life expectancies, and underperforming investments.

The facts clearly show that the states’ pension systems are on a losing track and retiree benefits are at risk of being slashed.

South Carolina: Canary in the Coal Mine

The looming pension fund crisis could leave already cash-strapped Americans without a safety net for retirement.

Take South Carolina, whose government pension plan covers around 550,000 individuals. One out of nine residents are invested in the plan… which is $24.1 billion in debt.

According to the Post and Courier of Charleston, government workers and their employers have seen five hikes in their pension plan contributions since 2012, and there’s no end in sight. And this isn’t an anomaly but the norm for many states throughout the country.

The worst-funded US state is currently New Jersey, closely followed by Kentucky and Illinois. By the end of 2016, New Jersey had a $135.7 billion deficit in its pension funds—$22.6 billion more than the year before—while Illinois’ gap grew by $7.6 billion.

This disturbing trend is all too real, with nearly one million US workers and retirees covered by pension plans on the verge of collapse. As GDP growth remains minimal, the situation is less than ideal for those who are depending on these pensions for their golden years. And with the uncertain future of Social Security and Medicare hanging in the balance, it’s a scary thought that for many Americans, even this promised safety net isn’t guaranteed.

Corporate pensions, too, are “in the worst position to meet obligations in more than a decade,” states a recent Bloomberg article. Suffering from deficits due to an overallocation to long-term bonds with diminishing yields, corporate pensions are struggling to meet their ever-increasing obligations.

Demographics Don’t Help

Shifting demographics in the US and around the world only further complicate the pension crisis. We are living longer and experiencing lower birth rates than in past decades. This dilemma increases the number of retirees while decreasing the pool of workers. The population of Americans 65 years of age and older has grown by 35% over the last 50 years.

Americans born in 2010 can anticipate to live nine years longer than those born in 1960. Today, retirees are collecting pensions for up to 20 years. If the well runs dry, Social Security, at this point, is not the answer. This leaves Millennials and Gen-Xers in a financial bind. Even those who aren’t in line to receive a pension will be affected indirectly by the falling value of retirement assets worldwide.

Crisis Insurance for the “Golden Years”

As governments and corporate employers may no longer be able to step up to their promises, it is important to take your retirement savings into your own hands. A strong portfolio should include a mix of stocks, solid funds, and physical precious metals.

For many centuries, hard assets like gold have preserved wealth and will undoubtedly continue to do so. Unlike the dollar, stocks, bonds, or pension funds, gold is an asset without counterparty risk, that means its value doesn’t depend on someone else’s ability or willingness to keep their promises.

Financial professionals often advise investors to hold 5% to 15% of their investable assets in gold bullion—depending on age, risk tolerance, and available cash flow.

With the current state of pension plans in steady decline, now is a good time to consider hard and secure assets like precious metals.

Global Pension Underfunding Will Hit Nearly Half A Quadrillion Dollars In 2050

Earlier this week we highlighted "Six Terrifying Graphs That Summarize America"s Public Pension Crisis" which ranked state, county and city-level public pensions in the United States by which are screwed the most.  To summarize, the study concluded that public pensions in the U.S. alone are currently underfunded by nearly $4 trillion and that taxpayers in Illinois, California and New Jersey should probably be looking to move before getting drowned in their state"s coming pension-induced tax hike tsunami.

Of course, as we"ve argued before, the current pension underfunding levels are sure to only get worse over the coming decades as the world will have to contend with a wave of retiring Baby Boomers and a period of lackluster, volatile returns.  So how bad could the global funding gap get?  Unfortunately, the World Economic Forum (WEF) recently set out to solve that impossible math equation and it turns out the answer is about $400 trillion...give or take a couple trillion.

Not surprisingly, the WEF attributed their terrifying conclusion to an ageing population, lack of savings, low expected growth rates and financially illiterate citizens.

Long-term, low-growth environment: Over the past 10 years, long-term investment returns have been significantly lower than historic averages. Equities have performed 3%-5% below historic averages and bond returns have typically been 1%-3% lower. Low rates have grown future liabilities, and at the same time investment returns have been lower than expected and unable to make up the growing pension shortfall.

Inadequate savings rates: To support a reasonable level of income in retirement, 10%-15% of an average annual salary needs to be saved. Today, individual savings rates in most countries are far lower. This is already presenting challenges where traditionally defined benefit structures would have provided a guaranteed pension benefit. Now, as workers look at their defined contribution retirement balances, with no guaranteed benefits, they are realizing that the retirement income their savings will provide will be much lower than expected.

Low levels of financial literacy:  Levels of financial literacy are very low worldwide. This represents a threat to pension systems which are more selfdirected and which rely more on private savings in addition to employer- or government-provided savings.

Of course, ignoring that minor ~20 year increase in life expectancy over the past 60 years without raising retirement ages can take a toll on those present value calculations of future liabilities.

Oh, and turns out that politicians creating massive ponzi schemes to promise citizens that their government would take care of their financial needs in perpetuity, while never really bothering to explain the true costs of such programs, was probably a bad idea.

But luckily these politicians are exempt from being prosecuted for their financial crimes...so taxpayers will just have to deal with picking up the $400 trillion tab.

The full WEF study can be viewed here:

The Next Step In Europe's Negative-Interest-Rate Experiment

The European Central Bank (ECB) pushed its deposit rate to minus 0.4 percent in April 2016: Since then, euro area banks must pay 0.4 percent per annum on their excess reserves held at ECB accounts. This, in turn, has far-reaching consequences. To start with, banks seek to evade this "penalty rate," especially by buying government bonds. 

That inevitably pushes bond prices up and lowers bond yields. Moreover, the ECB keeps monetizing government debt as well. The result is a tremendous downward pressure on the yield environment. For instance, the real (inflation-adjusted) return on short-term German bonds currently stands at around minus 2.5 percent per annum.

Negative interest rates (both in nominal and real terms) contribute to lowering the debt burden of financially overstretched states and banks. In fact, negative interest rates force the ratio between outstanding debt and gross domestic product to shrink. Such a monetary policy benefits borrowers at the expense of creditors. The latter has to foot the bill.

At the same time, however, Eurozone banks’ businesses suffer from the ECB"s negative interest rate policy. On the one hand, they find it increasingly difficult to remain profitable in an environment of extremely suppressed interest rates. On the other hand, banks run into higher costs due to a negative ECB deposit rate (and the costs keep rising as the ECB creates more and more excess reserves in the banking system).

Banks are under pressure to impose negative rates on client accounts. Given negative deposit rates, however, clients are most likely to withdraw (at least part of) their deposits in cash, and banks could experience a (huge) cash drain, resulting in a funding gap. They are therefore likely to increasingly push the ECB to end the policy of keeping the deposit rate in negative territory.

A New Experiment

If the ECB relents (and it is likely that it does), it would presumably bring the deposit rate back to zero. This, in turn, would bring all bond yields back up and above the zero line. To prevent the interest rate from rising too much, however, the ECB would have to continue manipulating long-term bond yields. This can be achieved by continued bond purchases.

The ECB can set long-term yields at politically desired levels. It simply declares a certain minimum price for bonds. The market prices of bonds will converge towards the minimum price and will not fall below such a level. By monetizing debt, the ECB expands the outstanding quantity of money, driving up inflation at the same time.

The new regime will most likely look like this: Eurozone bond yields in nominal terms will go up slightly. Inflation will also go up, reaching or even exceeding nominal yield levels. This, in turn, will force real returns (that is nominal yields minus inflation) into negative territory. If inflation does not go up too much, most depositors and investors can be expected to stick to their fixed-income holdings.

The new interest rate regime would indeed be positive for ailing euro area banks: The yield curve would remain sufficiently steep, which should turn out to be profitable for banks in terms of lending. At the same time, the negative short-term interest rates help to debase their liabilities against depositors and investors. In fact, the ECB policy would amount to a large-scale bank bail-out program.

In the light of the political desire to keep the euro together, the ailing Eurozone banking industry can be expected — as a necessary condition — to be bailed out by the ECB. It seems therefore likely that the ECB will end its policy of a negative deposit rate sooner rather than later in favor of increasing inflation. Such a policy will entail an ongoing debasement of peoples" life savings in euro-denominated bank deposits and bonds.

This is the uncomfortable truth of the euro currency experience. As it seems, people in the euro area about to learn an old lesson: namely that unbacked paper money — which is what the euro represents — cannot be trusted. Or, as Thomas Paine put it: “Paper money appears at first sight to be a great saving, or rather that it costs nothing; but it is the dearest money there is.”

The Dallas Pension Fiasco Is Just The Beginning

Submitted by Jonathan Rochford via Narrow Road Capital,

The recent blow-up of the Dallas Police and Fire Pension System was entirely predictable. Whilst it is tempting to blame unusual circumstances for the recent lock-up of redemptions and likely substantial reductions to pensions for those still in the fund, many other American pension funds are heading down the same road. The combination of overpriced financial markets, inadequate contributions and overly generous pension promises mean dozens of US local and state government pension plans will end up in the same situation. The simple maths and political factors at play mean what happened at GM, Chrysler, Detroit and now Dallas will happen nationwide in the coming decade. So, what’s happened in Dallas and why will it happen elsewhere?

Background to the Dallas Pension Fiasco

The Dallas pension scheme has been underfunded for many years with the situation accelerating recently. As the table below shows, as at 1 January 2016 the pension plan had $2.68 billion of assets (AVA) against $5.95 billion of liabilities (AAL), making the funding ratio (AVA/AAL) a mere 45.1%. Despite equity markets recovering strongly over the last seven years, the value of the assets has fallen at the same time as the value of the liabilities has grown rapidly. The story of how such a seemingly odd outcome could occur dates back to decisions made long before the financial crisis.  

Source: Dallas Police and Fire Pension System

In the late 1990’s, returns in financial markets had been strong for years leading many to believe that exceptional returns would continue. In this environment, the board that ran the Dallas plan decided that more generous pension terms could be offered to employees and that these could be funded by the higher expected returns without needing greater contributions from the Dallas municipality and its taxpayers. Exceptionally generous terms were introduced including the now notorious DROP accounts and inflated assumptions for cost of living adjustments (COLA). These changes meant that pension liabilities were guaranteed to skyrocket in future years, whilst there was no guarantee that investment returns and inflation levels would also be high. Dallas police and fire personnel were being offered the equivalent of a free lunch and they took full advantage.

In the 2000’s the pension plan made some unusual investment decisions. A disproportionate amount of plan assets were invested in illiquid and exotic alternative investments. When the financial crisis struck these assets didn’t decline as much as the assets of other pension plans. However, this was merely a deferral of the inevitable write downs which came in the last two years after a change in management.

Recent Events

Throughout 2016 the pension board, the municipality and the State government bickered over who was responsible and who should pay to fix the mess. The State government blamed the municipality for the poor investment decisions. The municipality blamed the State government for creating a system that it could not control but was supposed to be responsible for. It also blamed the pension board for the overly generous changes they implemented. The pension board recognised the huge problem but offered only minor concessions arguing that plan participants were entitled to be paid in full in all circumstances. They asked the municipality for a one-off addition of $1.1 billion, equivalent to almost one year’s general fund revenue for the municipality.

As the funding ratio plummeted during 2016, plan participants became concerned that their generous pension entitlements might not be met. In other pension plans the employer might increase its contributions when these circumstances occurred, but in Dallas the municipality was already paying close to the legislative maximum. Police officers with high balances retired in record numbers, pulling out $500 million in four months in late 2016. Those who withdrew received 100% of what was owed, with those remaining seeing their position as measured by the funding ratio deteriorate further.

In November, when faced with $154 million of redemption requests and dwindling liquid assets, the pension board suspended redemptions. The funding ratio is now estimated to be around 36% with assets forecast to be exhausted in a decade. Litigation has begun with some plan participants suing to see their redemption requests honoured. The municipality has indicated it wants to claw back some of the generous benefits accrued since the changes in the 1990’s, though this is likely to only impact those who didn’t redeemed. The State has begun a criminal investigation. Everyone is looking to blame someone else, but not everyone has accepted that drastic pension cuts are inevitable.

The Interplay of Political Decisions and Financial Reality 

The factors that led to Dallas pension fiasco are all too common. Politicians and their administrations often make decisions that are politically beneficial without taking into account financial reality. A generous pension scheme keeps workers and their unions onside, helping the politicians win re-election. However, the bill for the generosity is deferred beyond the current political generation, with unrealistic assumptions of future returns enabling the problem to be obscured. As financial markets tend to go up the escalator and down the elevator it is not until a market crash that the unrealistic return assumptions are exposed and the funding ratio collapses.

This is when a second political reality kicks in. In the case of Dallas, there are just under 10,000 participants in the pension plan compared to 1.258 million residents in the municipality. Plan participants therefore make up less than 1% of the population. If the Dallas municipality chose to fully fund the pension plan it would be require an enormous increase in taxes from the entire population in order to fund overly generous pensions for a very small minority of the population. For current politicians, it is far easier to blame the previous politicians and the pension board for the mess and see pensions for a select group cut by half or more than it is to sell a massive tax increase.

The legal position remains murky and it will take some time to clear up. The municipality is paying 37.5% of employee benefits into the pension plan, the maximum amount required by state law. Without a change in state legislation, it seems likely that the pension plan will have to bear almost all of the financial pain through pension reductions. If state legislation was changed to increase the burden on the municipality years of litigation could ensue with the potential for the municipality to declare bankruptcy as a strategic response. The appointment of an administrator during bankruptcy could see services reduced and/or taxes increased, but pension cuts would be all but a certainty.

Dallas Isn’t the First and Won’t be the Last

It’s tempting to see the generous pension structure and bad investment decisions in Dallas as making it a special case. Detroit was seen by many as a special case when it went into bankruptcy in 2013 as it had seen its population fall by 25% in a decade. This depopulation left a smaller population base trying to fund the debt and pensions obligations incurred when the population was much larger. Growing debt and pension obligations are signs of what is to come for many local and state governments who have been living beyond their means for decades.

As well as building up pension obligations many US governments have been accruing explicit debt. The two are intertwined, with some governments issuing debt to make payments into their pension plans, often to close the underfunding gap. This is very much a short-term measure, as whether it is pension contributions or debt repayments both will either require high taxes and/or lower spending on government services in the future in order for these payments to be met.

Pew Charitable Trusts research estimates a $1.5 trillion pension funding gap for the states alone, with Kentucky, New Jersey, Illinois, Pennsylvania and California going backwards at a rapid rate. Using a wider range of fiscal health measures the Mercatus Center has the five worst states as Kentucky, Illinois, New Jersey, Massachusetts and Connecticut. The table below shows the five state pension plans in Illinois, with an average funded ratio of just 37.6%.

Source: Illinois Commission on Government Forecasting and Accountability

For cities, Chicago is likely to be the next Detroit with the city and its school system both showing signs of financial distress. Chicago is trying to stem the bleeding with a grab bag of tax and other revenue increases but in the long term this makes the overall position worse.

Default is Almost Inevitable as the Weak get Weaker

The problem for Chicago and others trying to pay their debt and pension obligations by raising taxes is that this makes them unattractive destinations for businesses and workers. Growth covers many sins, as growth creates more jobs and drags more people into the area. This increases the tax base and lessens the burden from previous commitments on those already there. Well managed, low tax jurisdictions benefit from a positive feedback loop.

For states and municipalities in decline, their best taxpayers are the first to leave when the tax burden increases. Young college educated workers with professional jobs generate substantial income and sales tax revenue but require little in the way of education and healthcare expenditure. This cohort has many options for work elsewhere and can easily relocate. Chicago and Illinois are bleeding people, with the flight of millionaires particularly detrimental on revenues.

Those who own property are caught in a catch 22; property taxes and declining population have pushed property prices down, potentially creating negative equity. But staying means a bigger drain on the household budget as property taxes are the most efficient way to raise revenue and therefore become the tax increased the most. If too many people leave property prices plummet as they have in Detroit, making it even more difficult to collect property taxes as these are typically calculated as a percentage of the property valuation. Bankruptcy becomes inevitable as a poorer and older population base that remains simply cannot support the debt and pension obligations incurred when the population base was larger and wealthier.

Pensions Will be Reduced, but Bondholders Will Fare Worst

The playbook from the Detroit bankruptcy is likely to be used repeatedly in the coming decade. When a bankruptcy occurs and an administrator is appointed a very clear order of priority emerges.

• Firstly, services must be provided otherwise voters/taxpayers will leave or revolt. There may need to be cuts to balance the budget but if there is no police force, water or waste collection the city will cease to function.


• Secondly, pensions will be reduced to match the available assets quarantined to meet pension obligations and the ability of the budget to provide some contribution. If the budget doesn’t have capacity or the legal obligation to contribute more to pension funding, pensioners should expect their payments to be cut to something like the funding percentage. For Dallas and the pension plans in Illinois this means payments cut by more than half.


• Third in line are financial debtors. Bondholders and lenders don’t vote and they are seen as a bunch of faceless wealthy individuals and institutions who mostly reside out of state. They effectively rank behind pensioners, who are people who predominantly reside in the state and who vote, even though the two groups technically might rank equally. This makes state and local government debt a great candidate for a CDS short as the recovery rate for unsecured debt is usually awful in the event of default.

The Next Crisis Will Trigger an Avalanche

At the risk of being labelled a Meredith Whitney style boy who cried wolf I expect that the next financial crisis will trigger a wholesale revaluation of the creditworthiness of US state and local government debt. I have no crystal ball for when this will happen, but it is almost certain that the next decade will contain another substantial decline in asset prices. This will impact state and local governments and their pension obligations in two major ways.

• Firstly, asset prices will fall causing underfunded pensions to become even more obviously insolvent. Most US defined benefit pension funds are using 7.50% - 8.00% as their future return assumption. Using a 7.50% return assumption for a 60/40 stock/bond portfolio, with ten year US treasuries at 2.50%, implies equities will return 10.8% every year going forward. In a low growth, low inflation environment this might be achievable for several years, but an eventual market crash will destroy any outperformance from the good years. The continued use of such high return assumptions is unrealistic and is being used to kick the can further down the road. The largest US public pension fund, Calpers, has recognised this and is reducing its return expectations from 7.50% to 7.00% over three years. This still implies a 10% return on equities for a 60/40 portfolio.


• Secondly, downturns cause a reassessment of all types of debt with the highest risk and most unsustainable debt unable to be renewed. State and local governments with a history of increasing indebtedness and no realistic plan for reducing their debts may become unable to borrow at any price. This will force them to seek bankruptcy or an equivalent restructuring process. Once this happens for one mainland state (Illinois looks likely to be the first) lenders will dramatically reprice the possibility that it could happen elsewhere. Those who think states cannot file for bankruptcy should watch the process occurring in Puerto Rico, it will be repeated elsewhere. Barring a federal bailout, an overly indebted state or territory has no alternative other than to default on its debts. Raising taxes or cutting services will see the city or state depopulated. Politicians and voters are strongly incentivised to default.

Conclusion

Chronic budget deficits, growing indebtedness, excessive pension return assumptions and pension underfunding all set the stage for a wave of state and local government pension and debt defaults in the coming decade. As Detroit has shown this century, once an area loses its competitiveness its financial viability spirals downward. As taxes increase and services are cut the wealthiest and highest income earners leave slashing government revenues and increasing the burden on the older and poorer population that remains.

The next substantial fall in asset prices will sharpen the focus on budget deficits and pension underfunding, with the most indebted and underfunded states likely to find they are unable to rollover their debts at any price. Remaining residents will be negatively impacted, pensioners will see their payments slashed and bondholders will recover little, if any, of their debt. As there is virtually no political will to take action to avoid these problems investors should position their portfolios in expectation that these events will happen.

City Of Dallas Looks To "Clawback" Ill-Gotten Pension Gains From Police

Almost exactly one month after taking the unprecedented step of suspending withdrawals from the Dallas Police and Fire Pension (DPFP), the Dallas city council is looking to "clawback" what it views as ill-gotten interest payments made to pensioners to the tune of roughly $1 billion.

Of course, we have followed the epic meltdown of the DPFP closely over the past several months after a series of shady real estate deals brought the fund to, in the words of Dallas Mayor Mike Rawlings, "the verge of collapse" and resulted in an FBI raid of one of the funds largest real estate investors (see "Dallas Cops" Pension Fund Nears Insolvency In Wake Of Shady Real Estate Deals, FBI Raid").  The discovery of the failed real estate deals led to a "run on the bank" as scared pensioners looked to withdraw as much as possible before the whole ponzi scheme collapsed (see "After A "Run On The Pension Fund" Dallas Mayor Demands Halt Of Withdrawals").  All of which culminated with the unprecedented decision last month to suspend withdrawals (see "In Unprecedented Move, Dallas Pension System Suspends Withdrawals") after nearly $500mm was removed from police accounts.

Now, according to a local ABC affiliate, the Dallas city council is frantically working with the DPFP board to close a $4 billion funding gap.  While the city has agreed to throw an incremental $1 billion of taxpayer money at the problem over the next 30 years, that additional funding comes with some strings attached, which includes a $1 billion "clawback" of what the city views as ill-gotten gains from Police DROP accounts.  The proposed "clawbacks" would come in the form of reduced future distributions for pensioners.

For those who haven"t followed this story as closely, DROP, which was created in the early 90"s, allowed police and firefighters in Dallas to retire while still on the job. Their monthly pension checks were then diverted into DROP accounts, which were guaranteed an 8-10% return regardless of how the overall fund performed.  Unfortunately for DPFP pensioners, the Dallas City Council now views those guaranteed returns as an effort to defraud Dallas taxpayers of billions...we would tend to agree.

The city has agreed to put in an additional billion dollars over 30 years, but they"re proposing a series of bitter pills to make up the rest of the nearly $4 billion shortfall.

The bitterest pill: A proposal to take back all of the interest police and firefighters earned on Deferred Option Retirement accounts, or DROP. That would amount to an additional billion dollars saved.

The city is calling it an "equity adjustment." Retirees call it an illegal "claw back."

Whatever you want to call it, it"s outlined in a draft legislation being hammered out by the city and pension fund leaders. Pension fund representatives and the city have been meeting almost daily to try to come to an agreement on proposed legislation that they can take to the state capital to fix the failing fund.

Of course, anyone with half a brain probably should have realized that this ponzi on steroids was doomed to fail from the start.  But, better late than never we suppose. 

To add insult to injury, for Dallas taxpayers at least, the City Council also notes that the DPFP"s artificially high annual cost of living adjustments have resulted in pension checks that are 20% higher than they would have been had they been tied to actual inflation levels instead. 

News 8 obtained a copy of the legislation which says accounts would be "adjusted to zero percent of interest."

"It"s very tough but the city wants to protect the monthly benefit," Kleinman said. "It"s a restatement of their accounts."

The city is also seeking to "equity adjustment" on cost of living increases. The city says that pension checks are about 20 percent higher than they would have been if increases had been tied to inflation.

The city"s proposing to freeze cost of living increases until it catches up to the inflation index.

DROP and the cost of living increases account for about half of the fund"s liability, the city says.

For those retirees who have already taken the money out of DROP accounts, they"d garnish their future pension checks to recoup excess interest. Worried retirees have withdrawn in excess of $500 million from DROP accounts in recent months.

Meanwhile, all of these discussions have Dallas" police predictably upset.

"We used the rules they gave us now all of the sudden they"re going to go back on the rules and say hey you don"t get any of that," said Charles Hale, a retired police officer. "That"s not fair."

Retirees promised they"d be suing if anybody tried to take back money they feel they"ve earned.

"It"s acting like it was an underhanded Ponzi scheme that we pulled," said Joe Dunn, a retired police officer. "It"s not fair."

Frankly, we too are shocked at the audacity of the Dallas City Council to suggest that public employees be forced to be compensated in a way somewhat more akin to private employees.  It"s just outrageous.

The Coming Bond Market Crash - An Interview With Eric Hadik

First introduced to the financial markets in 1979, Eric Hadik is a trader and analyst who has been intimately involved with commodities and investing for over 35 years. His work gained wide recognition from the outset, where throughout the late-1980"s Eric worked closely with and provided market analysis to major institutions such as BP, Arco, Occidental, Royal-Dutch Shell and Chase Manhattan as well as AMAX Gold and Handy & Harman. In the early 1990"s Eric laid the groundwork for what is now INSIIDE Track Trading - founded in 1994.  In that capacity, Eric publishes research, analysis and trading strategies with the expressed goal of teaching, educating and sharing his insights with thousands of individual and corporate traders around the world. His articles and interviews have been featured in major financial media over the years, including CNBC, Forbes, Inside Wall Street and Investor’s Daily.

E Tavares: Thank you for being with us again today. Last time we spoke we discussed some stock & commodity market calls you had made in terms of timing and magnitude which seemed to go against consensus and yet were remarkably accurate. You have recently followed suit calling for a major gold price correction, beginning in July 2016 at a time when the charts and indeed many renowned investors were suggesting that it was going higher. Before we get into the main topic, can you briefly remind us again of your methodology for trading the markets?

E Hadik: My approach to analyzing and trading the markets is a multi-stage process that begins with the more subjective cycles and indicators and then moves through to more specific and objective indicators that repeatedly hone this analysis and ultimately formulate it into a usable trading strategy.

I believe in approaching trading like a business, not a mere speculation or coin flip. Here are the building blocks of the strategy I have developed over 35+ years of trading commodities:

Foundation:  My cycle research (as well as some basic Gann and Elliott Wave techniques) provide the foundation for the rest of the analysis. They set the stage for the event that is expected to unfold, but that is only the first step and I constantly warn NOT to trade just off of the cycles or those other approaches.

First Stage:  Corroborating those cycles is the inclusion of my first stage of technical indicators - those that determine culmination in the evolving (waning) trend, the trend that is maturing, and setting the stage for an impending new trend. These are very specific indicators that first show when a move has reached an extreme and then when it is primed for a reversal. Those two phases - reaching an extreme and the ultimate reversal - are usually different and are best illustrated by the Elliott Wave Principle and the peaks of the ‘3’ and subsequent ‘5’ wave. (I should stress that these clarifying indicators are NOT Elliott Wave in nature although they do help filter wave counts.) The ‘3’ wave is usually the dynamic and accelerated move that pushes a market to an extreme - the penultimate peak. Once that occurs, a market usually pulls back before retesting the highs (the previous extreme, if referring to an uptrend). That retest, and or spike high, is the ‘5’ wave peak - the ultimate peak. 

Second Stage:  Those indicators help me to exit remaining (long) positions and then prepare for the possibility of new (short) positions in the future. That is when my second phase of indicators kicks in: after a top has taken hold (or after a bottom, if a downtrend has just reached fruition). Indicators like daily and weekly 2 Close Reversals TM, Double-Key Reversals TM and 2-Step Reversals TM signal reversals from those peaks. They are the initial triggers.

Third Stage:  In a valid, larger-degree reversal, those indicators will soon be reinforced by the next phase of indicators - the confirmation (lagging) indicators. These include my daily/weekly trend indicator (a proprietary pattern), 21 MAC and intra-period trends.

Final Stage:  Finally, the acceleration indicators should kick in and signal the impending escalation of the new trend - a time when the underlying market is expected to powerfully validate the cycles and preceding indicators and ultimately spur a drop to extreme downside objectives. These include specific applications of Hadik’s Cycle Progression (when it signals a shift from highs to lows), of the daily or weekly 21 MARC and of the daily/weekly trend pattern.  In many cases, I will wait for this time to enter a trade since I am looking to enter positions when the greatest synergy of factors are working in their favor and hoping to have my capital working most efficiently (as opposed to sitting idly while a lengthy topping or bottoming process plays out). It has often been observed that markets trend about 20--25% of the time and congest or consolidate (effectively trading sideways) the remaining 75--80%. I want to be in during the 20--25% of the time when a convincing and directional move is unfolding and out (but into other markets) when a market is choppy and volatile - often frustrating the majority of traders and consuming or distracting a lot of valuable focus and mental/emotional energy. In many cases, 70--80% of a market’s price move will occur in a very short period of time (sometimes 10--20%) within a given trend and that is when these culmination indicators should begin to materialize… toward the end of that accelerated move. 

Every market and every trend goes through these stages and analyzing them in this manner helps me to pinpoint some forthcoming moves. At each of the transition phases - from trigger signals to confirmation signals, etc. - the risk and money management factors shift, narrowing risk points and/or trailing stops in the prevailing trade. The culmination indicators also help identify when and where to begin exiting a position (taking profits) so that those funds can then be devoted to a new trade (in a different market) that is poised to enter a new trend or accelerated trend.

Sorry, that was probably not what you would call ‘brief’ - even though it is only a basic outline of my approach - but I wanted to give enough information to at least begin to grasp the approach. I strive to begin with the theoretical and subjective and then move that to the practical and objective - where the rubber meets the road, so to speak.

ET: The charts below come from a recent IMF report on the massive increase in debt around the world, in absolute terms and also as % of GDP. We note that since 2008 government debt has been the major driver of that increase, particularly in the developed world. Pursuant to your analysis of this debt super-cycle, what comes to your mind when you look at these graphs?

Note: “AE” means Advanced Economies, “EMEs” means Emerging Market Economies and “LICs” means Low Income Countries

EH: The first thing that jumps out at me is a perfect illustration of what I just described. The debt surge in 2007--2009 is like the accelerated or dynamic ‘3’ wave advance, in an overall wave structure. It is when debt surged to unprecedented extremes. However, it is NOT the ultimate peak, it is merely the penultimate peak. The debt levels subsequently consolidated in 2009--2014 before resuming their uptrend and heading to new highs. 

Those charts corroborate what I have been discussing and why I believe 2017--2021 will represent the end and reversal of that multi-decade trend - as the debt bubble bursts and bond markets begin to crash. They also validate what I have been emphasizing in recent years - the parabolic phase of the 40-Year Cycle and how it is portending an intensified battle between hard money and fiat currency (which is rapidly deteriorating in value, due to this governmental debt orgy).

Every 40 years - since the founding of America - this battle has raged. It began with the Continentals (America’s first experiment with fiat currency) - that quickly plummeted from 1776--1781 - and then moved ahead to 1816--1821 (2nd Bank of US charter, quickly followed by Panic of 1819). From there, it was on to 1856--1861 (devaluing and then suspension of silver and gold currency), to 1896--1901 (Election based on battle over Gold Standard, followed by re-implementation of Gold Standard), to 1936--1941 (affirmation of gold confiscation and subsequent loosening, then tightening of credit - leading to 1937 crash), to 1976--1981 (Jamaica Agreement, delinking all major currencies from gold; led to skyrocketing inflation as the corresponding value of US Dollar plummeted). 

2016--2021 is the next phase of this uncanny 40-Year Cycle and promises to resurrect this battle (intensifying in 2017) as the debt bubble bursts and the backing of fiat currencies evaporates.

ET: Focusing on those imminent long term cyclical changes, today there are over $10 trillion worth of bonds around the world trading with negative yields. Of course this is not sustainable. As such, the longer negative yields remain in place the higher the likelihood that a growing number of investors and financial institutions will lose money here, possibly badly, once there’s a recovery in yields, even a small one. Do you agree? And looking at yields specifically, are you anticipating any cyclical reversal to the massive decline we have seen over the last 30 years?

EH: Yes and yes. The negative yields are a perfect confirmation that this trend has reached an extreme: an uber-extreme.

This reaffirms that we are in the parabolic phase of a mania, very near the peak. However, just because a market has reached an extreme does NOT mean the trend will immediately reverse. It usually takes time. I have described long-term cycles - including the ubiquitous 40-Year Cycle AND a 70-Year Cycle (as well as a sequence of descending cycles) - that all project the culmination of a MAJOR bull market in Bonds, and bear market in rates and yields, for 2016/2017. I will then be looking for specific reversal signals - and corresponding evidence of a fundamental reversal - in the months and years that follow.

I am still convinced that one of my other primary outlooks - for an inflationary surge in commodities, metals and oil from 2017--2021 - could be the impetus behind that reversing trend as governments and policymakers are forced to bump up interest rates in reaction to those rising prices. Since the markets are built on perception, it would only take a convincing threat of that potential for the markets to unwind.

There is one specific year based on the greatest synergy of cycles in and out of the markets when I believe the accelerated phase will take hold… which is also when the debt bubble is most likely to burst. It represents the tipping point in almost all of my cycle work (not just in bonds).

ET: Let"s review some of those catalysts. We recently discussed how a major food crisis may be looming in the not too distant future, where you outlined an 80 year cycle that has governed such crises with stunning regularity. While our grain situation globally appears to remain healthy for now, this could change very quickly because of weather, water, diseases, human disruption or any combination thereof. And if indeed it does, what sort of magnitude move could we see and could this translate into higher inflation around the world?

EH: The Food Crisis Cycles are certainly one of the factors I am watching. But, I think that those cycles are likely to be fulfilled with a combination of natural and man-made stresses. That has often been the case, with a perfect example being the 1930’s - when worldwide drought and crop challenges like the Dust Bowl created shortages but governmental policies (in the USSR) led to one of the 5 worst famines in history in terms of lives lost - the Soviet Famine. 

A different form of global Food Crisis emerged in the 1970’s, exacerbated by the manmade debacle of fiat currency chaos (Nixon Gold Shock of 1971, the collapse of Bretton Woods in 1973, oil weapon and then oil de-facto backing of US Dollar in 1973--1975 and Jamaica Accord of 1976). Multiple global droughts in the early-1970’s culminated with California’s worst drought (until recent years) in 1976--1977.

Combined with a collapsing Dollar, all that sent food prices skyrocketing with many commodities doubling and tripling in price… in 1--2 year periods.

2016--2021 is the next phase of that recurring 40-Year Cycle of Food Crises that I have documented back to the 1770’s and even earlier and the corresponding cycle of commodity inflation. Ironically, or not so much, this natural cycle dovetails perfectly with the economic and currency crises cycle I just described.

So, whether it is Dollar/currency-triggered (man-made) or crop stresses (natural; including droughts, floods and/or freezes, disease or super-pests) or both - which I believe is the most likely scenario - the resulting, escalating price movement should be the same. And, yes, that is likely to impact interest rates.

To compound my assessment, there are other long-term natural cycles that are likely to play a role - including sunspot/solar storm cycles and volcanic eruption cycles. And they, too, focus on that one year when I believe acceleration is most likely… even though preceding and ensuing events are cyclically probable as well. It is a Perfect Storm of multi-year, multi-decade and multi-century cycles converging.

ET: Food crises tend to affect emerging economies the most for various reasons. However, we could see something different this time. Western Europe is already buckling under a mass migration influx, and a severe food supply disruption could expand it several fold. This would further deepen societal and economic impacts all over the Old Continent, particularly at the core. How would you view a food shock impacting both developed and emerging markets this time around?

EH: You touch on the manmade aspect of these recurring food crises. Complicating it is the evolving banking debacle throughout Europe, ranging from Spanish and Italian banks to those in Portugal and Germany. Some of those banking crises are so near the tipping point that they could actually represent one of the triggers for the debt bubble bursting - and also exacerbate a potential food crisis. Greece got a small taste of this potential in 2014/2015.

Historically, banking, economic and/or currency crises have repeatedly spurred massive strikes and social upheaval that could disrupt the distribution of food and other necessities, if the pattern is repeated. But that is just one possibility. I do NOT want to sound like I am yelling ‘the sky is falling’, because I am NOT, but I am also not willing to stick my head in the sand and ignore some ominous developments across the globe. Intensifying cyber-attacks could provide another contributing factor as they have already done on a smaller-scale and shorter-lived basis.

Paraphrasing the immortal words of Patrick Henry, I don’t want to listen to the song of the siren until she transforms us into beasts. I would rather recognize the threats looming on the horizon and to prepare for them.

ET: What about an energy shock? Do you see any cyclical factors that could spark a massive crude oil price rise and thus also cause a spike in inflation? The disinvestment in new production infrastructure resulting from the recent significant price correction could play a role, along with increased economic instability.

EH: Eventually, I do expect a new energy shock… but not just yet. Oil prices plummeted to downside extremes - in early-2016 - but were/are expected to undergo a 1--2 year bottoming process before a sustained uptrend is expected. One particular energy market is projecting a multi-month peak for late-Oct.--late-Nov. 2016 and that could usher in a final decline (a type of ‘5’ wave to the downside) - leading into early-2017.

Ultimately, I expect the oil markets to corroborate - and probably lead - Middle East Unification Cycles that I have discussed the past 10--15 years. Those cycles come into play in 2018--2021 and are expected to lead to some form of Arab or Middle East Union, as has been attempted a few times in the past century. I discuss that in related articles and reports.

ET: There is an important economic interplay here. When we talk about the 2008 financial crises we often forget that the large spike in crude oil prices beforehand certainly helped to flip over the world economy. A recession normally keeps yields in check, but there are some cyclical factors that suggest otherwise this time around. The graph below shows historical US corporate funding gap as % of GDP (smoothed) and high yield bond yield spreads (versus AAA credit rating) on a quarterly basis. We can clearly see that the former tends to lead the latter by some quarters, and as such we should expect higher spreads going forward at this juncture. Does your analysis support this?

EH: At this point in time, my analysis does not support OR contradict it. It is ambivalent. Until trigger signals are activated, it is hard to determine the expected width of the yield curve. Due to other analysis - in other arenas - however, I suspect that could be the case. I am just not comfortable giving any definite answer at this time.

‎ET: The modern financial system and its interplay with the wider economy are inherently deflationary. As long as there is some slack production, logistical and financial capacity anywhere in the world there will always be arbitrage that mitigates some of these price increases. This could help manage any transmission effects into the bond markets via higher inflation (except if these occur in the form of a shock of course). However, national trade balances and related currencies could be severely affected. What are your thoughts here?

EH: The relationship between currencies and bonds is certainly expected to play a key role. However, the question becomes more of a ‘chicken or the egg’ syndrome… which comes first and/or which leads the other. I have very distinct expectations for currencies - particularly the Euro and US Dollar - but I always analyze each market on its own before assessing any possible causal relationships.

Once I have reached specific conclusions on individual markets, I will certainly consider the potential correlations but it can be dangerous to become too tunnel-visioned on one specific correlation (since it often blinds us to recognizing a more imminent and ominous - but unexpected - correlation). The markets are notorious for throwing curveballs, which brings up an important point.

Out of 11 Trading Axioms (in my Tech Tip Reference Library), the one I quote most often - and the one which I emphasize most frequently to my readers - is the Axiom on Market Correlations (which I can make available to anyone who contacts me via my website). The crux of that Axiom is that inter-market correlations are fickle and ever-changing and should not be relied upon as the primary signal for trading. There is always a new and more urgent correlation right around the corner that ends up usurping or overtaking the first one and pushing related markets in unanticipated directions.

ET: You also talk about another recurrent crisis cycle which relates to the European Union and also the UK. ‎And this one may already be upon us. How does this relate to a possible bond market crash in light of what we discussed above?

EH: For the last decade I have laid out the case for why I expected a developing and intensifying Euro Crisis (and EU crisis) from 2008, more so from 2011, even more so from 2014 and that reaches a tipping point in 2017 (note the 3-Year Cycle that has governed the Euro). My conclusion has been that Europe was destined to undergo multiple crises that would push the EU to the brink and force dramatic concessions from the nations that would ultimately be a part of the (new) EU moving forward.

I identified 2018--2021 for the time when I believed the EU would undergo a Major transition and a re-unification that yields a significantly different EU than what it was in 2008. Leading into 2016, and right up into June 2016, I explained how an uncanny 8-Year Cycle was projecting another meltdown in the British Pound and how that was likely signaling that Brexit would be approved. That was projected to be the next ‘straw’ flung on the back of the staggering EU.

That ‘8-Year Cycle of Pound Pummeling’ timed Sterling crises in 1968 (8 years after France and Germany surpassed the UK as the economic leaders of Europe), 1976 (Britain forced to go to IMF for Pound bailout), 1984, 1992 (George Soros sunk the Pound and forced the UK out of the EU Exchange Rate Mechanism), 2000 (inflationary meltdown in Pound led to fuel crisis and brief food rationing) and 2008 (35% plummet in 14 months). The Pound was projected to do the same in 2016, stretching into 2017.

Sure enough, Brexit was approved, the Pound plummeted and the Euro is under renewed selling pressure (even as other nations seriously contemplate their own EU-exit). At the same time, Europe is plagued with intensifying banking crises - in Spain, Italy, Portugal and Germany - with Deutsche Bank recently named (by the IMF) as the greatest risk to a global crisis. 

Considering the enormous levels of debt, and the rapidly deteriorating value of that debt, one can envision a scenario where a crashing debt market enters the fray and the EU is thrown into chaos - at least for a time.

ET: If indeed we see that major bond price correction, if not outright crash as everyone runs for the exits at the same time, could central banks absorb it for instance by purchasing a huge amount of bonds? Any type of bonds, even equities at that point perhaps. They certainly seem omnipotent these days…

EH: The big problem is that they are already doing that. They print more money to buy debt and then repeat the process… over and over. The culmination of Draghi’s debt-buying binge keeps getting extended but there is a tipping point in the future (perhaps the not-so-distant future) reinforced by the deteriorating value of the Euro throughout this process. It is nothing more than a giant, debt-based Ponzi scheme. The last ones in are really going to regret it.

The deflationary environment is one thing masking this craziness… as are the consolidating equity markets. But, there are slowly developing signs of that transitioning as well. Since early-2015, I have explained why I was convinced that US equity markets would enter a 15--18 month topping process (with sharp 2--3 month drops and strong 1--3 month rallies) before entering a serious bear market in late-2016. Nov./Dec. 2016 has been my primary focus for that shift… and we are almost there!

So, what happens if/when the next shoe drops in global equities and then some price inflation returns shortly after?! It could be a form of ‘Stagflation’… and is not a pretty picture.

ET: So what should investors do? If the bond market goes down hard this will affect everything, starting right in the financial institution where they deposit their cash. How can you protect yourself in that event?

EH: First of all, I should stress that we are not at the acceleration phase. First, we have to complete the culmination phase (which is expected to reach fruition in Dec. 2016/Jan. 2017). I suspect that a final spike high could be a flight-to-quality if equity markets see a sharp sell-off in late-2016/early-2017.

Then, we have to go through the initial trigger phase. And then, eventually, we get to the acceleration phase. Here again, I am looking at one specific year when I believe that acceleration is most likely… but we have a little time. I do think that gold and hard assets play a key role in that protective approach but there are complicating factors, this time around. 

In the interim, I think 2017 is going to see a battle between deflationary forces (as paper assets like stocks and bonds begin to rollover to the downside) and inflationary forces (as deteriorating currency values and natural resource challenges steadily push commodity prices higher) - the next stage of this multi-generational seismic shift.

ET: Final question. Do you have any plans to publish a book with your methodology one day, or will you just keep on focusing on www.insiidetrack.com and your INSIIDE Track and Weekly Re-Lay publications?

EH: I do have the skeletons of two books compiled - one on cycles and one on my trading approach - but time is the elusive factor. Ultimately, yes, that is my goal. But I cannot tell you when that goal will reach fruition. In the interim, I do provide a ~100-page trading manual (Eric Hadik’s Tech Tip Reference Library) as a bonus with several of my subscription packages. That explains the 11 Trading Axioms I cited earlier, as well as detailing the published indicators I use and key aspects of my cycle approach. (There are a couple proprietary indicators, whose calculations are not revealed.)

ET: Eric, as always many thanks for sharing your thoughts. Fascinating how you bring so many technical, historical and inter-market factors together.

EH: It’s my pleasure. Thank you.