Bitcoined to Death

September 2nd, 2017 Update:  Depending on when you read this for the first time, how ignorant do I sound as of today with Bitcoin having doubled from the original publishing date of this article?  Not to mention, all the other ICOs since then that are minting millionaires.  My knowledge and experience say this is one of the ultimate bubbles in history.  My brain and heart tell me to make hay while the sun shines.  My ego just calls me an asshole for continuing to miss out.

Have you had enough of Bitcoin and the awe-inspiring wonder of all things blockchain yet?  The blockchain not only cures cancer and AIDS but can make you fly…like Superman.  That’s the hyperbole surrounding cryptos.

“If only I’d just bought 10 bitcoins in 2009!”  Boo hoo.  So you didn’t get rich on Bitcoin.  You probably didn’t get rich on real estate in 2005 or tech stocks in 1999.  The investment world keeps turning.

Never invested in Bitcoin or Ethereum for that matter.  Maybe that makes my opinion irrelevant.

I have read a lot about cryptocurrencies though, specifically Bitcoin.  I missed that train along with the majority of people in the world.  I just can’t wrap my mind around something that isn’t universally accepted that has to be traded on potentially questionable exchanges where competing investments keep cropping up to defeat and dilute the entire concept of the limited-money.  Maybe I just don’t get it.

I do know that blockchain technology will stand the test of time.  The current crypto brands?  I’m not so sure.

My prediction, some sort of scandal or several will avail themselves quite soon causing a sell-off in Bitcoin.  It doesn’t matter whether it’s serious account-hacking somehow or exchange scams, because this sort of pricing will bring out the most intelligent criminals in the world.  And this latest maniacal move up will be entirely erased.  Hope I’m wrong.  Honestly.

Bitcoin YChart (5-28-2017)

Ever ridden the The Dragster at Cedar Point?  Bitcoin owners may be about to experience their own thrill-ride.

                      The Dragster - Cedar Point

If you haven’t hopped on the crypto-train yet and you feel the need to invest in one of the “currencies” in the current price environment, then by all means, indulge.  But consider having a read of these two articles.  One shares the opinion of an experienced player, the other about just one illicit way in which to have your profits harvested from you.

1. http://themacrotourist.com//macro/my-great-bitcoin-bungle

2. https://www.forbes.com/sites/laurashin/2016/12/20/hackers-have-stolen-millions-of-dollars-in-bitcoin-using-only-phone-numbers/#38bad65438ba

To current owners, I wish you well.

Should the Investing Public Be Worried if Some of the Biggest Banks are Genuinely Scared?

Questions of investing and speculating always require context within time-frame. Players in all asset classes, professional or not, approach the game from their own perspective.

Traders surfing the waves of volatility may be looking only days or weeks out. Investment managers overseeing a growth-oriented portfolio may be looking ahead months or quarters while a value-oriented portfolio manager may be looking years out. The 401k-watching worker bee may be wringing their hands at every market move and every ignorant headline despite the fact that they have 30 more income-earning years left before retirement.

The game is tougher than ever even for the professionals and it’s difficult to decide a course of action with the information overload coming at market players. Determining what’s noise and what is actually valuable information is critical in making the right moves within your portfolio.

I have long been pounding the table on building cash reserves while staying invested in the markets. I’ve also stated that I thought the downturn of late 2015 was the start of the next major bear market. I think that dip and recovery in 2015 was the bear waking up and the poor start in 2016 is investor realization of that bear. However, because everybody now sees it, the markets aren’t going to execute a full-frontal stage-dive. That’s not how these things work, right?

I think we get a recovery into new highs followed by another much smaller correction and consolidation potentially followed by another new high. After that, I suspect all the bull energy will be fully used up and the bear will begin in earnest. Remember, these are simply my suspicions based on behavioral observation of the markets; nothing more than forecasts of potential outcomes.

It’s been a long time since I’ve hit readers with some good old chartporn, but I’m in the mood to throw a bunch of squiggly pics out there to possibly help the reader better assess the market situation in 2016. Observe a 20-year, monthly chart of the S&P 500 along with some relevant indicators.

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Observe the long-term breakdowns in the indicators matching the actions of 2008 and 2000. Does that mean crisis is imminent? Nope, but I do think it reinforces my call that a new bear has started. Notice also in 2001 and 2008, we saw strong support and a bounce off of the 50-month moving average. Too many technicians are looking for that and thus too many algorithmic shops will be front running ahead of that signal, blowing out orders to drive the market higher.

I suspect this bounce we are currently in the midst of may be a bit stronger than people realize. Market players have been so used to the V-recoveries and yet they’ve already forgotten what they can be like. It appears that players are numb to the potential of a multi-week to multi-month V-bounce from the January 2016 lows. Despite what I surmise about a stronger than expected bounce, nobody can blame investors for either running for the hills or shoving their heads into the sand.

We’ve already seen the peak in net profit margins for this business cycle in the largest US corporates at the same time that markets continue to be overvalued, despite the corrective moves in December and January. Observe the following chart courtesy of ZH via Thomsen Reuters via Barclays. It depicts how the recession fuse has likely been lit.

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And with recession generally comes a bear market correction. Or is it the other way around?

Regarding overvaluation, have a look at this comparison chart from AQR depicting market returns based on various starting points of the Shiller P/E. AQR is the shop that Cliff Assnes, billionaire hedge fund manager, founded and runs.

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This coincides with GMO valuation models for future returns based on current valuations. There are plenty of Shiller P/E naysayers who believe that the indicator is bunk. The fact of the matter is that evaluating a normalized 10-year look at P/E ratios is a simple and intelligent way of quickly gauging valuation levels compared to prior periods. Of course every period in history possesses its own specific circumstances as the backstory of the valuation levels, but the raw Shiller P/E paints a clear picture for equity performance going forward.

Besides I don’t see or hear anybody calling Bob Shiller a dumb man. Despite what you may think of his ratio, Shiller is a respected academic even within the professional financial community.

Let’s take a look at a chart from one of every perma-bull’s favorite bear-shaped piñata, Dr. John Hussman. Unfortunately, Hussman catches a lot of flak. Less so after admitting to his analytical mistakes coming out of 2011 but I think he catches a bad rap for simply calling it how he sees it. Hussman’s analysis is based on a quantitative and thorough study of the markets. Can the same be said of a vast majority of the financial blogosphere? No it cannot, including myself. Observe the Hussman Hindenburgs. They nailed the current action coming into Q4 of 2015.

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The criterion of the Hussman Hindenburg is detailed in the upper left corner of the chart. Dr. Hussman’s Hindenburg indicators proved to be quite prophetic in 1999 while essentially nailing the top in 2007. For your own long-term holdings, ignore these signals at your own risk. Dr. Hussman, like Dr. Shiller, is respected amongst fellow financial professionals. Have a look at Research Affiliates’ (“RA”) own analysis on current valuation levels.

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In a research piece they published in July of 2015, RA evaluates the differences in relative valuation metrics (CAPE, Hussman, Tobin) and absolute valuation metrics. They came to the following conclusion.

Our answer to the question “Are stocks overvalued?” in the U.S. market is a resounding “Yes!” Our forecast for core U.S. equities is a 0.8% annualized real return over the next decade. The 10-year expected real return for emerging markets equity, however, is much higher at 5.9% a year. The return potential of the nondeveloped markets is so high, in fact, that the valuation models, warts and all, paint a very clear picture.

May want to rethink that lack of EM exposure going forward, depending on your time-frame.

Shall we move on to a couple of less orthodox indicators of potential trouble in the markets? Observe the two following charts which pertain to income as opposed to valuation or price action. In the first one, created by McClellan, we get an interesting correlation to total tax receipts for the US government as compared to US GDP.

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Notice that in 2000, the US crossed the 18% threshold and stayed there awhile before rising even higher at the beginning of the market selloff. For the GFC of 2007, America almost got to 18% but not quite and we still literally almost vaporized the entire financial system. Currently, we’ve reached 18% but that may or may not mean anything. In each previous occurrence, tax receipts stayed at the level for months or even years so this is an indicator worth watching but only in conjunction with many others.

Interestingly, federal tax receipts as a percentage of GDP currently reached 18% right before the markets began selling off last year. Repeat after me. Correlation is not causation, but the timing is still interesting.

The other chart that doesn’t get a lot of coverage but is very well known is net worth of US households and non-profit organizations as a percentage of disposable personal income. You can find it courtesy of our friendly Federal Reserve Bank of St. Louis and their FRED tool. The grey vertical bars in the FRED charts denote recessions.

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It’s been a clear indicator in 5 of the last 6 recessions and we also had that annoying fakeout in 1987. Much like the prior graph, this particular chart should be coincident with additional economic indicators if one is attempting to forecast potential economic as well as investment outcomes.

I want to move on to a particular area that everyone should be concerned about and that is nonperforming loans (“NPL”) at major banks. Not just at US banks but around the world. China’s commercial banks have raised fear levels in even the most seasoned professional investors due to their NPL levels increasing so drastically in 2015. I’ve long stated how debt levels in Italy have the potential to dismantle a good portion of the financial system because the Mediterranean Boot is such a key economic cog in the European Union. Some of the biggest commercial banks in Italy are on the verge of toppling during a period where now the ECB is less amenable to the previously used “bad bank” options. The pressure is beginning to mount for Italy’s leadership to formulate a strategy around potential bank failures.

You might be inclined to observe the following chart and think all is at least well for the US.

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But take a look at the following chart in commercial-only loan performance and begin to understand why the total situation looks toppy from the economy to the markets.

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For the record, commercial loans comprise approximately $2 trillion of the outstanding debt within the banking system. It is clear to see that a bottoming and an upturn occurred before the last 3 recessions and market dislocations. Now we are currently in the early innings of an upturn in NPL. If commercial loan performance behaviorally adheres to what we saw in the prior two recessions, we will see at least an additional 2% of total commercial loans become impaired assets. That’s potentially between an additional $40 billion to $50 billion at minimum that banks will have to provision for. No easy task in light of current leverage levels and collateral utilization across the repo and derivative space.

This is especially concerning because of the systemic importance of each bank to the entire financial system. Just look at the consolidation that has occurred since 1990.

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Couple this concentration with a lack of regulation allowed by Gramm-Leach-Bliley and you can see that debt impairment at the banks is not going to have a happy ending. And if you think Dodd-Frank was the answer to all of our problems, I might stop laughing sometime in March.

What would work to alleviate a lot of the financial pressures around the world in the short term is a weaker dollar. I don’t say that as a proponent of a weaker dollar. Rather, I am stating that currency exchange due to a weaker USD could help sugarcoat revenue reporting across international corporates. It would relieve pressure in the management of reserves for countries with an excess of US treasuries. The oil price could stabilize temporarily but it is well-documented that abundant supply and less-than-expected demand is still the story. Commodities could lift and thus commodity producing countries who are already fighting with their reserves issue could see a double-positive impact. All these effects would be temporary as world debt levels are at unsustainable levels and a bear market for all assets has potentially already arrived. It just has yet to completely sink its claws and fangs entirely into the world’s financial system.

Coming back to the initial question behind this post. Should the investing public be scared? Maybe not scared. Let’s call it aware. They should be aware of all the happenings that are occurring right now. Cash levels should be raised. Certain assets should be paired down depending on losses, gains, and risk exposure. More importantly it’s time to take stock in your own investing psyche. If you are building cash levels, will you have the courage to act at the appropriate time? That’s what raising cash boils down to. Do you have an understanding of the intrinsic valuation levels of specific asset classes that will motivate you to put cash to work?

Aside from brushing up on your ability to properly assess valuations, take a look inside yourself and evaluate your ability to deploy cash when fear is running rampant and the nadir of multiple markets appears to be nowhere in sight.

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Triple Top Into the Chop & Drop

I hate to keep writing about corrections and being a fear mongerer. At this point, it’s pretty useless as the S&P 500 stays constantly bid under all conditions. The last little correction lasted a week exactly and took the SPX down approximately 4%. Before that was the approximate 6% correction we saw from January 23rd to February 3rd. That was 11 days and a casual observer of the market would have thought the rails had come off of everything the way sentiment crashed so quickly.

Honestly, I’m getting tired of hearing myself with the correction talk, so this will be my last post regarding correction or downturn talk for a little bit. I’ll find something else to entertain and possibly inform you with, because this subject is tired. Especially, when you consider the following charts. I originally titled this post as I meant to write it several days back, when the SPX looked like this:

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However, we seem to have experienced a “clear” breakout so we’re not technically talking about a triple-top anymore…unless it’s a bull trap. Is it a bull-trap? Hindsight will inform us. In my humble and probably very ignorant opinion, I think it’s a bull-trap. There’s just enough buying power left to draw in some last suckers before corrective action. It’s not unheard of for a third top in a triple top to be higher than the first two. The tape shouldn’t be ignored but neither should the myriad of signals running counter to the tape.

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Of course, I could be wrong. I’ve been early to the short party before, and I took a couple lumps to my account and ego for being a wannabe, turn-calling notshot. I maintained tight stops so the damage was minimal, but top calling is a suckers bet that continues to be fun to make.

Complacency is the topic du jour around the financial blogosphere and professional commentaries. The VIX pushed under 12, as denoted by the blue line in the following chart. Recently, hitting or going sub-12 tends to be a precursor to a spike in volatility but it is far from indicating a definite, imminent move.

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Many commentators and “experts” have been turning to more esoteric signals to ensure that the S&P 500’s new highs are a “legitimate” breakout in a positive trend. For the record, I happen to really enjoy and appreciate the consistently insightful commentary put out by the three sources I’m about to list. All the same, have a look at these 3 articles:

1. Chris Puplava – http://www.financialsense.com/contributors/chris-puplava/further-signs-market-bottom-building
2. Bespoke – http://www.bespokeinvest.com/thinkbig/2014/5/30/long-term-vix-chart.html (no mention of unprecedented easing the last 6 years)
3. Tom McClellan – http://www.mcoscillator.com/learning_center/weekly_chart/equity_options_vs._index_options/

Maybe it’s my lack of statistical sophistication or inexperience in professional money management, but these 3 articles seem to be really stretching for evidence that a significant correction is not going to occur this summer and the breakout in the S&P 500 is 100% the real deal. I like to keep things simple, by observing the obvious signals. Market leaders at the time(biotech and small caps) broke down several months ago. Now they’re retracing to perfectly natural Fib. areas before potentially continuing downward which I think will have the effect of finally pulling the S&P 500 with them. Volume is anemic. The VIX is saying, “Wait a second here.” Is it because it’s the start of summer? All sorts of economic indicators have given a red light or at least a yellow light, despite all the cheer leaders. High yield fixed income keeps getting bid higher and higher with no downturn in sight.

So many signals are readily apparent but we still need a trigger. In my last post, I thought that the high yield bond market may be the catalyst for a downturn in the S&P 500, but maybe it just finally gets pulled down with the risk indexes without junk correcting. What will the trigger be? Who knows? It could be anything. Maybe we get some sort of sell-off in another asset class causing a fixed income dash to cash, with the best returns being locked in from their high yield segments. Geopolitical activity may induce fears, although nobody in the markets seems to give a damn about the chess moves conducted by Russia or China. The markets continue to confound even the savviest.

“YEAH, YEAH, YEAH! We’ve heard all this non-sense in your last post! How does this apply to AND what the hell is a “chop & drop?”

Well “chop & drop” is a pattern that is seen typically before major dislocations. John Hussman, Ph. D, who is consistently labeled as a perma-bear and broken clock, generates very good and widely read commentary that does skew to a negative outlook. He just calls it how he sees it based on his extensive research. Everybody’s got an opinion. It’s just a matter of whether you value it or not. I happen to value his commentary, but I don’t base my decisions on how I speculate by any one market commentator. It’s all about taking in as much as possible from as many credible sources as possible to assist one in firming up their own mental picture of the state of things.

Anyways, he put out a piece recently titled, The Journeys of Sisyphus. Have a read if you’re in the mood for some confirming of your bias to your own negative outlook. In the piece he produces several Dow Industrial Jones charts leading up to the major downturns of the last 85 years. For the record, he did not comment on any chopping and dropping in the post. I only reference his work because of the charts. My commentary is in no way affiliated with Dr. Hussman, nor has he endorsed this post in any shape or form.

The first chart obviously displays 1929. In it you can observe the pattern of a notable correction with a recovery into some sideways chop followed by another notable correction leading into a final, euphoric run-up. This pattern of “chop & drop” almost always occurs in the final two years.

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Before presenting the rest of the charts, I am fully aware of the human brain’s abilities in the area of pattern recognition. It’s one of the distinguishing factors of our intelligence as a species, and is a key differentiator from the unevolved brains of other species as well as machines…for now. These set-ups could just as easily be illusory conjunctions of patterns established by a biased mind attempting to create the ability to foresee market outcomes. In other words, I could just be full of it. Believe me, I get that. I’m still going to present the rest of the charts and you the reader can establish your own outlook.

Here in 1972, we have the “chop & drop” but with a pseudo final run-up to sort of fakeout speculators. Compare this to 1929 where the chop went right into the final drop.

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The action in 1987 lacked an initial heavy drop and recovery into the chop. Instead prices consolidated(or chopped) until that first drop before the extremely euphoric run-up prior to Black Monday.

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Finally, we’ve reached a time where a majority of readers may have actually had some money in play. The bust that started it all for a lot of us, the Dot.Com bust.

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In 2007, the action was tight with the chopping and dropping occurring in less than a year. The outcome was still the same, a mega bust. In fact, if you think about the action of the dislocation it was kind of tight, too. All the action was essentially squeezed into 2008. Yes it began in November of 2007 and bottomed in March of 2009, but the real gut wrenching, heart breaking action occurred in 2008.

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And finally we come to the present, 2014. Now remember this whole exercise is pure speculation, but what I think we saw in that 6% correction in February was the first drop. We already recovered and have chopped along since then. At some point in the summer we could then move into a more serious drop of at least 10%. I suspect this may signify the last major drop before recovering into the final euphoric run-up which could last into 2016 before a major dislocation.

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Of course I run the risk of being wickedly wrong. But as I provide these posts free of charge and I do not manage money professionally, I’m ok with sticking my neck out and assessing the cycles of fear and greed as such. There’s no career risk. As for reputation risk, I’ll wait till my small following of readers can no longer be labeled small before I worry about my street cred.

Just for kicks, here’s some statistics and notes regarding the Triple Top pattern from forex-tribe.com. It’s a good site to use for a little education into basic technical analysis patterns. However, they do not list where they obtained their data and how it was quantified. I was reluctant to even share it, but it’s just for kicks. If you’re relying on old school patterns without quantifying risk and reward ahead of time, well then shame on you.

Alleged triple top statistics:
– In 85% of cases, there is a downward exit
– In 50% of cases, the target of the pattern is reached once the neckline broken
– In 84% of cases, a pullback occur
– In 85% of cases, there is a pursuit of the movement once the neckline broken

May closed out at a one-year high for the S&P 500. This is a very, very infrequent event; which is why the cliché “Sell in May and go away” even exists. Don’t be surprised if May selling just gets pushed back to June and July. Do not take your eye off the ball for any reason out there if you’re aggressively trading. For you long money players, take some time to consider the charts we reviewed today.

Don’t discount that sovereign debts are at all-time highs across all the developed nations. Don’t discount that every major economy is monetizing debts or manipulating currencies via swaps or taking some other related action to sway economic activities. Don’t discount that credit derivatives exist in the hundreds of trillions with multiple collateral lines traced to multiple counter parties amongst the holders of said derivatives. Don’t discount negative GDP reads in developed nations. Don’t discount anything. Nothing is what it seems in the markets anymore and it could pay big to be prepared well in advance of what historical price action has already told us.

I’m signing off but before I go, the biggest laugher of the week has to be that Italy and Great Britain are including prostitution and illegal drug sales in their respective GDP calculations. Seriously, you just can’t make this crap up anymore. Good day.

Economic Distortions

Here at MarginRich.com, I mention Jeremy Grantham and his firm GMO quite a bit. That is for two very big reasons. Number 1, he and his firm manage in excess of $100 billion for the biggest institutional investors across the land. And number 2, he’s publicly nailed multiple bubble calls. Does he nail them to the day? Well no, but he’s been close enough and has effectively ensured his clients were positioned accordingly to mitigate the damage of the last two major stock market bubbles.

GMO came out with its most recent 7-year forecast for various asset classes and equities. It ain’t a pretty picture. These guys have consistently nailed their forecasts, especially for equities. They’re predicting negative returns essentially across the board of various sectors with pockets of relative strength in Int’l value, US high quality, and emerging markets. Observe the drilldown:

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Why do you think this forecast is so negative? It may be valuations, but I think it’s because they see a major dislocation occurring within the next 7 years. This dislocation will cause most sectors to lose money over the specified time period. And of course depending how one is positioned, losses can and will be a lot worse than what is depicted in the chart. GMO will never reveal the secret sauce, so to speak, behind their methodology in determining their 7-year forecast. It’s probably safe to assume they use an amalgamation of various data inputs involving valuation, macroeconomic outlooks, interest rates, monetary trends, geopolitical trends, and so forth.

You don’t need to be able to reproduce the forecast in order to trust it. Knowing that this is how GMO perceives equity market returns going forward, one really needs to be conscious with their long-money portfolios. This is a message I have been consistently sharing over the past few articles, so let’s visit a few severe distortions that may have a major effect on equity markets within the next 7 years.

The first distortion is excess reserves maintained at the Federal Reserve. This first chart is to show how ridiculously large this number has grown to, which is now in excess of $2.4 trillion. That’s the cumulative and collected excess reserves of the banks who collude conduct business with the Federal Reserve.

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Notice how before 2007, the amount was virtually zero. I realize this chart only goes back to the early 1980’s, so here’s a “Discontinued Series” chart that the Fed previously utilized to report the excess reserves. It goes back to the 1950’s and shows the same virtual zero in excess reserves as the normal course of business. That’s right, up until the Great Recession the amount of excess reserves held at the Fed was in the single digit billions. That’s basically zero. Since 2007, it has been a different story entirely.

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For the uninitiated regarding excess reserves, I want to provide a relatively brief explanation. For the reader with an already good grasp, I apologize for any redundancy. The excess reserves were at virtually zero for all those decades because the Fed never paid any interest on them. Then in response to the entire financial world sitting on the precipice of obliteration, a multi-part plan was instituted in order to maintain the status quo and keep the entire system intact. The federal funds rate was dropped to zero where it has stayed, interest began to be paid by the Fed on excess reserves, and the process of quantitative easing(“QE”) was illustriously birthed.

The federal funds rate was dropped to zero so as to stimulate the economy in the face of certain deflationary doom. The book is still out on whether the US has seen true economic improvement due to ZIRP. What we do know is that savers are being heavily penalized by this policy and investors of all ilk are being forced up the risk ladder in increasingly desperate attempts for yield. The paying of interest by the Fed for excess reserves is one of the Fed’s tools for maintaining interest rates where they want them. It also just so happens to be able to provide a colossal liquidity buffer for the so called balance sheets of the participating banks i.e. Wall St.

Between the erroneously valued derivative books across the entire industry and jumbled collateral chains, the participating banks and the Fed think they’ve built an adequate buffer to potentially withstand additional impairment to balance sheets. And why shouldn’t they? They’ve got everything under control because now they can taper QE. Quantitative Easing was established to fight both fronts of the policy as a tool to reduce long-term interest rates while also stimulating the economy. Do you feel like the economy is stimulated? I know one thing for sure that has been stimulated and that’s asset prices. Take a moment to yourself and remember how this story has played out for the Weimar republic of Germany, recently in Zimbabwe, and even more recently in Venezuela.

Wondering why it matters so much that the banks keep their excess reserves at the Fed instead of productively using them within the economy? It’s because the money is essentially free. When the Fed monetizes its debt and buys assets such as MBS, it creates an asset on its own balance sheet and a corresponding liability. That liability is the excess reserves that belong to the TBTF banks who are the Fed’s main partners in facilitating QE. The banks keep those excess reserves with the Fed because why would you give away your gravy train and expose it to more unnecessary risk? The Fed pays 0.25% on excess reserves. May not seem like much, but 0.25% on $2.4 trillion equals $6 billion for the biggest banks to collect risk free in interest income.

If you were a bank CEO and knew you had derivative exposure that could single-handedly dismantle the system, would you kill the golden goose provided by the Fed? The proof is already in the pudding as the velocity of money is cratering but has had no material effect on our economy thus far. There’s no velocity of the money supply because banks aren’t lending out to businesses and households. Sure large corporations have been able to finance buy-backs and special dividends but capital expenditures have yet to reach a point of acceleration where we know some good economic tidings are bound to follow.

In the chart below, I’ve overlaid the rise of the excess reserves vs. the velocity of the M2 money supply.

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If that’s not a chart yelling out for some mean-reversion, then I don’t know what is. So what are some triggers to increase velocity and why does it matter? An increase in velocity matters because that price inflation that everyone was so scared of during the beginning phases of TARP and QE, could finally begin to materialize. And this could hamstring any efforts to get the economy breathing on its own without the use of a respirator. As far as a trigger to generate velocity, it would take the Fed no longer paying interest(like they’ve almost always done) or even charging to hold excess reserves. The participating banks would immediately withdraw that $2.4 trillion in cash and put it to work. Where? Businesses and households. If those dollars hit the economy in a flood over the course of a year or two, we could see some scary jumps in asset prices that matter and not just fine art and collectible cars. Not to mention, there’s still all that cash that the mega-corporations keep parked internationally. If the US were to shift tax policy for this money and it were to be repatriated and spread around the economy, we could be talking about a doubly increase in money velocity.

The Fed knows this and you would think they wouldn’t be dumb enough to cut off their nose to spite their face but the Fed is backed into a corner. Additionally, the Fed has to answer to its political masters all while managing the world’s perception of America’s currency and economy. This is a dangerous game being played right now, as after 2008, Fed policy entered the realm of pure experimentation.

Would the Fed have maintained these policies this long, which are causing massive economic distortions, if the economy had really reached escape velocity or at least was well on its way? Let’s revisit interest rates, the second massive distortion. Gary Tanashian, with his Notes From the Rabbit Hole newsletter, provided an elegantly simple chart putting on full display the lack of efficacy of the Fed’s ZIRP policy to have any material effect on the economy. Below you’ll see the 3-month T-bill yield($IRX) overlaid against the S&P 500 index($SPX). You can see in the past 20 years that as the economy and markets picked up, the Fed would subsequently raise interest rates. That is completely normal policy and has been consistently used for decades.

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But as you can see in the chart, where’s the rise in rates? The correlation of the two are generally fairly strong. Oh, so our economy is not genuinely approaching a growth level that warrants a raise in interest rates? These are the results of the great financial experiment, of which we are all a part of the double-blinded no placebo study that’s about to have a phase 3 letdown in the next year or two.

The Fed has been able to subvert a normal business cycle by reflating on demand through interest rate policy and monetary policy. That last doozie back in 2008 should have seen the destruction of several industry giants and the Fed wasn’t ready to allow that to happen in America. I get it. The pain and suffering would probably have been unspeakable and potentially worse than the Great Depression. When you combine the fact that the developed countries are so interconnected, the US didn’t want to single-handedly bring down the entire world’s economies. All that being said, the tricks to perpetrate the subversion of normal business cycle forces have been used up. You can’t drive interest rates any lower. You can’t print even more dollars and expect sufficient potency. Hence, the notion that the Fed is backed into a corner.

As far as impact to the market, I read a simple statement over at Economicnoise.com, that sums up the good fortune the Fed has had in driving up market prices in an attempt to drive the wealth effect while building animal spirits. Economicnoise.com stated, “Within the last fourteen years, there have been two major market corrections, both of which saw drops of 55% from their highs. That, or more, is the potential for what lies ahead…but next time the government is unlikely to be able to re-inflate the stock market bubble. To put into perspective how lucky (investors have been), it took 25 years for the Dow Jones to recover to its pre-crash highs after the Great Depression. Likewise, the Dow hit an intraday high of 1,000 in 1962 but never closed above 1,000 until about twenty years later.”

These distortions are what the doomsday types, Austrian economics practitioners, goldbugs, and similar minded types have been seeing and simply can’t seem to shake off. The team at GMO has never been labeled as any of those types; only true professionals’ professionals in the game of capital allocation. Below is the other chart in their 7-year forecast and it covers multiple asset classes as opposed to just equities.

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The granddaddy winner for the next 7 years is timber, according to them. So forget about investing. Go cut some trees down. Chop’em up and store them in your house. Over the next 7 years that wood will have outperformed your 401k. Lame jokes aside, there are a few ways to easily make a play on timber. There are of course the biggest North American players such as Plum Creek (PCL), Weyerhaeuser (WY), Rayonier (RYN), and Potlatch (PCH). If you prefer ETF’s, there is iShares Global Timber & Forestry (WOOD) which focuses on North America and thus has significant positions in the largest players here. For more of an international flare to your timber exposure, Guggenheim offers its own Timber ETF (CUT). A cursory glance of CUT’s holdings will show that it focuses its holdings around the planet as opposed to N. America.

Since the average joe can’t simply invest in huge plots of timber like a hedge fund, endowment, or pension fund, then these are decent options to play the sector. PCL is the biggest of the N. American group and thus has a well established reputation on the street. However, friends and old colleagues will already be familiar with what is probably my favorite way to garner some timber exposure, and that is through Brookfield Asset Management. BAM! Remember though, at the end of the day these are still equities and have the potential to be pulled down with every other sector in the event of a sell-off or major dislocation.

Comparing Plum Creek to Brookfield Asset Management is not exactly an apples to apples comparison, as Brookfield is a massive asset manager focusing on real or hard assets with a portfolio approaching $200 billion. Plum Creek possesses the largest portfolio of timber acreage in N. America, so their market capitalization is justified. PCL carries a timber portfolio worth approximately $5 billion. Brookfield’s portfolio of timber acreage is significant in real terms but small compared to their entire portfolio. BAM carries approximately $4 billion worth of timber assets, and that is after selling approximately $2.5 billion worth of timber assets last year to Weyerhaeuser. BAM will monetize assets when appropriate. They don’t hold just to hold, however they’re considered some of the finest value investors in the world when it comes to real assets.

Let’s take a side by side look at long-term performance of each company since 1990. We’re using 1990 as PCL was founded in 1989, so I wanted to give it a year of operations under its belt for comparison purposes. The following chart compares the split adjusted values of each stock starting with an initial $5,000 and includes dividends but excludes the two spin-offs(BIP & BPY) from BAM.

clip_image014*Dividend data garnered from Dividata.com

You can see that BAM’s long-term performance speaks for itself. If you account for BIP & BPY, then to me it appears to be a no-brainer between the two for long-term exposure to timber. PCL’s dividend is vastly bigger, so if an investor needed that higher yield for whatever reason then it would make the decision of choosing between the two a little tougher. Overall though, if you want some timber exposure in combination with other world-class real assets then BAM is a heckuva way to play it.

Valuations matter. Momentum can be ridden, but in the end a stock’s price will revert to an appropriate valuation after momentum has made investors lose their collective minds. GMO’s forecast is not to be taken lightly. It’s just another recent indicator that should really make investors pause and think before allocating capital. I tend to concur with old Uncle Warren in that it’s not usually a safe bet to bet against America, so I promise that I’m not a total gloom & doomer here at MarginRich.com. These economic distortions, just a few of so many, are communicating a signal that America and really the world’s developed markets could find themselves in some pretty rough seas in the not too distant future. Invest accordingly.

Analogous Equities Markets – 1970’s & 20Teens

Secular bull? Or bear about to do its thing on “unsuspecting” market players? These are questions making serious rounds on the world wide interlinking-web. That’s because fear sells and nothing gets eyeballs and clicks for the user-ravenous financial sites like some market-topping bear talk.

If you were alive and investing in the 70’s, or like myself, have read up on the stock market action of the 70’s then one can see how similar the two time periods seem to be acting(at least in the S&P 500). Don’t worry, I’m not about to hit you with yet another comparison chart of some calamitous US financial event laid over current action. Instead, I’d like to share some work by Lance Roberts. For the record, I like those comparison charts but I also take them for what they are…entertainment. At best they’re another useful input and at worse they’re just noise.

If you’re unfamiliar with Mr. Roberts, he consistently writes compelling market pieces. I happen to think he’s one of the more under-appreciated financial commentators on the web right now. He’s the co-founder and general partner of STA Wealth Management. Earlier in the year, Mr. Roberts shared some graphs comparing current times to the secular bull formed in the 80’s and the fakeout in the 70’s. At STA they definitely have Austrian economic tendencies in their communications regarding the markets, and so obviously can lean toward a more bearish stance at times. Or as other Austrians call it, just being realistic in light of all the economic data readily ascertainable.

They have significant assets under management of approximately $500 million to $600 million, so these guys are the real deal. Specifically, they focus on the client who possesses low six-figures to approximately $5 million in capital, so they’re not exactly whale hunters. STA feels that market is an underserved niche of wealth management. I’m not trying to plug their services nor do I have any relationship with their firm. Like other commentators or service providers I include in my posts here at MarginRich.com, I’m fairly certain STA doesn’t even know this blog exists. I just want to share with my readers another financial blogger whose work I really enjoy. You can also find work by Lance Roberts at Advisor Perspectives, home of dshort.

Now back to the charts Roberts shared in January. The first one shows a direct comparison of the current period to the false breakout of the late 60’s into what looked like a new bull going into 1973.

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As we all know, The recession starting in 1973 was one of the worse times to be in the stock market in its history. The next chart shows the S&P’s performance and the realization of the false hopes for investors during those time periods.

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Sorta looks like the decade of the Oh-Oh’s, except the action up to 1973 produced higher highs. As opposed to what we experienced in 2000 and 2007 in the S&P 500 with virtually equal tops. The reason for that was obviously all the capital was pouring into the NASDAQ in 2000.

Moving on to the last chart. Roberts shows the total picture with the final washout in 1981 and the true beginning of the 18 year mega-secular bull market that helped to explode the growth of the mutual fund and retirement investing industries. Of course there were up’s and down’s during the real secular bull, but boomers blessed with the easiest time to make buy and hold gains during peak earning years helped to build the academic case of always investing in stocks for the long run. Not that I want to get into any philosophical debates on investment strategies or the level of difficulty of investing through the 80’s and 90’s. I use the term “easy” through the lenses of hindsight.

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The point of sharing these charts is to increase awareness that this 5 year run that America has been on off of the 2009 lows, may not be the start of a real secular run like we saw from 1982 to 2000. In 1982, the conditions were more like a final “cleansing”, so to speak. The new CEO of America was instilling a lot of genuine hope and assuaging genuine fears with genuine actions, not lies or baseless rhetoric. Valuations were exceptionally low with single digit P/E’s and very enticing dividend yields across the market. Price inflation had been beaten back by the last semi-responsible Fed head.

Simply put, these are not conditions that exist today. In fact, the exact opposite of each of those conditions exist today. I understand that the music is playing but do you want to keep dancing? Conditions are decidedly different due to deep distortions across the financial landscape. But hey, I’m only one voice of many and if you’re one of plenty of people(including professionals) who think we’re in the midst of a secular bull market, then by all means keep putting new money to work. However, even if you’re dollar cost averaging and you don’t believe in “timing” the market, now may be a time to build your cash levels.

Don’t just take my word for it. In a previous post I cited some thoughts shared by Seth Klarman and Jeremy Grantham. They each communicated their fears of the frothiness of these markets but that the markets will continue to move higher before an inevitable bust. Now the inimitable Howard Marks has essentially shared the same sentiment in his latest Memo From Our Chairman. Collectively, these 3 gentlemen help oversee more than $200 billion in assets under management. In addition to their combined multiple decades of experience, their respective savvy has made each of them billionaires. Now if scions of the investment world such as these fellas are telling you to be cautious, do you really want to be the rebel without a cause out there allocating your capital based on the premise that trees DO grow to the sky?

Look I know the path of least resistance for the markets is up and I’ve reinforced that in previous posts. It’s just that based on the distortions, it really feels like a reckoning is coming. And just some basic cycle research yields a time table of approximately 12 to 24 months from now for some potentially tough times as an investor. I’m not talking about exiting the markets entirely. I’m talking about raising cash levels to be prepared when the real values potentially present themselves and minding your stops. Next time I’ll share some hopefully enlightening charts and thoughts on those aforementioned distortions.