Wall St. Doesn’t Care About 800,000 Workers

Zach Scheidt

This post Wall St. Doesn’t Care About 800,000 Workers appeared first on Daily Reckoning.

Today marks the 27th day of the government shutdown.

In total, 800,000 Federal employees missed their first paychecks last week. And another 1.2 million government contractors are also estimated to be missing paychecks as well.

That’s 2 million Americans currently out of work and not collecting paychecks!

This boils down to a large portion of America’s middle class at risk of missing mortgage payments, student loan payments, and even spending less on necessities like food and clothing.

This is a big deal!

But for some reason, Wall Street seems not to care… So what gives???

Wall Street’s Eyes are Focused Elsewhere — Not on the Shutdown

The government shutdown is definitely a frustrating experience regardless of which side of the political arguments you find yourself on. The back and forth rhetoric from both parties is exhausting.

But while I don’t mean to dismiss the very real challenges that come with the government shutdown, one thing you need to realize is that as of now, Wall Street is NOT fazed by the current gridlock in Washington.

In fact, since the shutdown officially began at midnight on December 22nd, the S&P 500 is higher by 8.17%!

Seriously, this has been quite an impressive rebound with hardly any down days in the 15 trading days we’ve had since the market bottomed. That’s great news for investors — and hopefully you’ve been taking advantage of the sharp move higher.

But this begs the question — how can stocks go higher when 2 million people are potentially now struggling to pay their bills?

It’s simple.

The key issue that Wall Street is focusing on this week is not the government shutdown… It’s not the trade war with China… And it’s not even additional interest rate hikes from the Fed.

Don’t get me wrong, those things are important, but right now they’re taking a back seat to one driving force…

The REAL Reason Stocks are Moving Higher Despite 2 Million People Not Collecting Paychecks

Earnings season!

This week, we’re starting to see some of the biggest earnings reports come in — from big financial firms like the money center banks, from retail firms, from industrial companies with international customer bases, and of course from a myriad of smaller stocks that represent smaller businesses here in the U.S.

And so far they’ve been stronger than expected!

Take the big banks for example. Goldman Sachs (GS) generated $6.04 per share in profit for the fourth quarter of 2018 versus the $4.45 per share estimated by Refinitiv. While Bank of America (BAC) posted earnings of $0.73 per share vs $0.63 estimated.

This caused both stocks to spike after the reports were released.

In addition, major airlines like United Continental (UAL) and Delta Airlines (DAL) also reported blowout 4th quarters in the face of a stock market pullback. United’s revenue for each passenger it flies a mile, a key industry metric, rose 5 percent from 4Q 2017 and Delta’s revenue per mile rose by 3.2 percent.

This is the real reason why stocks are moving …read more

2 Simple Rules to Warren Buffett’s Success


This post 2 Simple Rules to Warren Buffett’s Success appeared first on Daily Reckoning.

Today I have two stock picks for you that I believe Warren Buffett would love.

As you know, Buffett is pretty widely viewed as being the greatest stock market investor in history.

Despite having given a massive $27 billion to charity over the past decade, Warren Buffett still sits on a net worth of $80 plus billion.

Eventually, almost every dime of that remaining $80 billion is going to be given back to society.

For that he is my hero.

Buffett built most of that that wealth through picking stocks. Not just one or two lucky homerun stock picks mind you, but by repeatedly making good stock market decisions.

The key to Buffett’s success? Two simple rules…

Buffett Rule #1– Don’t lose money!

Buffett Rule #2– Don’t forget rule number one!

Buffett has always made sure that he focuses on the valuation of what he is buying. By making sure to buy companies when the stock market is valuing them inexpensively, Buffett has made sure to not take on risk of permanent loss of capital.

For Buffett, investing has been all about minimizing downside risk.

That is why I think he would love these two reinsurance companies today.

Why Great Investors are Attracted to the Insurance Business

When you purchase insurance, you pay the insurance company an annual premium in exchange for a contractual obligation that the insurance company will cover you against specific future risks.

You give them cash today and somewhere down the line (1, 3 or 10 years) the insurance company provides cash if you suffer an accident, flood, or incur healthcare costs.

The insurance company generally aims to turn a small profit on the difference between what you as a customer pay them and what they eventually have to pay out to cover your insured events.

In the industry, the difference between premiums collected and the amount paid out is known as an underwriting profit.

On average, insurance companies don’t make much money on underwriting.

Where an insurance company really makes its money is through investing the cash that it collects from you as a customer before it has to pay that cash out to cover a specific event.

There are often several years between when an insurance company collects a premium and when it has to pay something out.

The insurance company gets to keep all of the investment income earned on that cash during those years.

A reinsurance company does the same thing. The only difference is that the reinsurance company sells insurance to insurance companies who are looking to lay off risk instead of selling policies to you or me as customers.

Since investment performance is what drives an insurance company’s profit over time, it is no surprise then to learn that great investors are attracted to the insurance business.

For example, Warren Buffett’s company Berkshire Hathaway (BRK.A) is heavily involved in the reinsurance business.

There are others, and today two of them are very cheap.

Two Dirt Cheap Reinsurance Companies

Typically an insurance or reinsurance company will trade at a …read more

The Date Stocks Will Reach New Highs


This post The Date Stocks Will Reach New Highs appeared first on Daily Reckoning.

The S&P recently tumbled 19.8% before finding its legs — coming within an ace of the official 20% defining a bear market.

Bet let us declare it a bear market and have done.

Based on history’s telling, when can you expect stocks to recapture their early October 2018 highs?

A) 11.4 months

B) 1.6 years

C) 3.2 years

D) 5.7 years

The answer shortly.

But first a progress report…

The Dow Jones marched 164 points forward today.

The S&P added 20; the Nasdaq, 49.

Meantime, we see today that Daily Reckoning associate John Mauldin is lacing into the Federal Reserve.

For what reason?

Scientific incompetence — conducting a “two-variable” experiment.

That is, for raising interest rates while simultaneously trimming its balance sheet.

Do one. Or do the other.

But not both at once, he laments:

No serious scientist would run a two-variable experiment. By that I mean, you run an experiment with one variable to see what happens.

If you have two variables and something happens — either good or bad — you don’t know which variable caused it.

You first run the experiment with one variable, then do it again with the second one. After that, you have the knowledge to run an experiment with both.

So disturbed is Mr. Mauldin that he labels it “decidedly the stupidest monetary policy mistake in a long line of Fed mistakes.”

A remarkable achievement, if true. It is a line already stretching horizon to horizon.

But we suspect Mauldin has hooked onto something here.

The fed funds rate — whose range the Federal Reserve’s “Open Market” Committee establishes — stands presently between 2.25% and 2.50%.

But when combined with quantitative tightening, the “true” federal funds rate may approach 5%… or double the official rate.

Explains analyst Michael Howell of the CrossBorder Capital blog:

In other words,[it is] equivalent to the Fed undertaking around 20 rate hikes rather than the nine it has so far implemented this cycle.

Twenty rate hikes since December ’15!

How can it fail to leave its impact?

We have further suggested that the fed funds rate may now have crossed the “neutral rate” of interest.

Above the neutral line rates no longer offer economic support. Nor do they merely hold the scales even.

They instead form an active drag.

Meantime, global liquidity is evaporating before our eyes… like a puddle in the searing equatorial sun.

Global central banks heaved forth some $2.7 trillion of credit growth in 2017.

And in 2018?

Global credit contracted $410 billion.

Never before in history, Atlas Research reminds us, has the world witnessed a $3.1 trillion reversal in central bank liquidity.

Do you require further explanation for the market’s negative returns last year?

Or for the bear market October–December?

It is said one picture is worth a thousand words. Here is an example brilliantly in point:

No one should therefore be surprised to find the global economy going backward.

Chinese exports have plunged to two-year lows. Imports are also reversing.

Export powerhouse Germany is now reporting its steepest industrial decline in a decade.

As we reported this week:

The world has …read more

My Private CES Tour Just Revealed the Future of Ford, GM

autonomous driving

This post My Private CES Tour Just Revealed the Future of Ford, GM appeared first on Daily Reckoning.

I heard an unsettling alarm as the screen in front of me flashed red.

“Keep your eyes on the road, Zach!”

The instructions caught me off-guard. I was getting scolded for looking at my instructor. And it was the car scolding me!

“Our dashboard sensor picked up on the fact you were looking at me instead of the road. It can also tell if your eyes are getting sleepy or if you’re not paying attention.”

I was midway through a private tour of Visteon’s booth during last week’s Consumer Electronics Show (CES), and enjoying every minute. Frankly, I’m amazed at the new auto technology we’ll be seeing in the next generation of new cars manufactured.

An Inside Look at New Auto Technology

Visteon is just one of the many technology companies revolutionizing the way cars will be driven over the next few years.

The company’s “booth” was actually a giant tent set up outside the Las Vegas Convention Center, chalk full of examples of dashboard displays, sensors, high-powered computers, and car simulators.

Not just anyone could get into the booth. Personal tours were given out “by appointment only” a sign stated out front. But the Visteon team was kind enough to make an exception for me, and one of the company’s executives personally walked me through the exhibits.

I literally could have spent an entire day in that tent learning about the possibilities for new car technologies in the very near future.

There were autonomous systems that would take full control of a car, warning drivers when their attention was needed, and allowing them to focus on other things until that point.

There were sensors that could pick up on whether a driver was tired or alert. (I must have been drained from visiting so many exhibits, because I actually triggered the fatigue sensor on one of the simulators.)

I even saw a 3D display that projected a warning that seemed to jump off the dashboard. No glasses needed!

All of these are systems and luxuries that are being integrated into the new cars manufactured right now. We really are at an exciting point in history where things that used to seem like science fiction are actually being built and sold.

If you were following me on Twitter, you probably saw the pictures I took of some of the dashboard displays the company is working on.

Click to enlarge on Twitter

For income investors, these new advances are poised to drive some big profits and generous cash payments.

Technology Drives Sales, GM Guides Higher

For years we’ve seen technology companies like Apple drive new sales by offering incremental improvements to their existing products. Think about all the people who bought the iPhone 5, 6, 7, 10, XR, etc.

These incremental advances are a great way to generate extra revenue from buyers who want to have the newest technology.

In the auto market, we’re about to see the same type of …read more

Jay Powell’s Gift to Markets

Fed Chairman Jay Powell (left) joined former Fed chairs Janet Yellen and Ben Bernanke

This post Jay Powell’s Gift to Markets appeared first on Daily Reckoning.

Fed Chair Jay Powell did not deliver any early Christmas presents to the markets last month, but he did pop the cork on a bottle of Champagne as a belated New Year’s gift on Friday, Jan. 4.

With just a few words, Powell sent the most powerful signal from the Fed since March 2015. Investors who understand and properly interpret that signal stand to avoid losses and reap huge gains in the weeks ahead.

First, let’s focus on Powell’s comments. Then we’ll explain what they actually meant.

The Fed has taken a March rate hike off the table until further notice. At a forum in Atlanta two Fridays ago, Powell joined former Fed chairs Yellen and Bernanke to discuss monetary policy.

In the course of his remarks, Powell used the word “patient” to describe the Fed’s approach to the next interest rate hike. When Powell did this, he was reading from a script of prepared remarks in what was otherwise billed as a “roundtable discussion.” This is a sign that Powell was being extremely careful to get his words exactly right.

Fed Chairman Jay Powell (left) joined former Fed chairs Janet Yellen and Ben Bernanke at a roundtable in Atlanta recently. Powell revived the word “patient,” which was last used by the Fed in December 2014. It’s a powerful signal of no rate hikes until further notice.

When Powell said the Fed would be “patient” in reference to the next rate hike, this was not just happy talk. The word “patient” is Fed code for “No rate hikes until we give you a clear signal.” This interpretation is backed up by the Fed’s past use of verbal cues to signal ease or tightening in lieu of actual rate hikes or cuts.

The word “patient” has a long history in the Fed’s vocabulary. Prior to March 2015, the Fed consistently used the word “patient” in their FOMC statements. This was a signal that there would not be a rate hike at the next FOMC meeting. Investors could do carry trades safely.

As long as the word “patient” was in the Fed’s statements, investors knew that there would be no rate hike without warning. It was like an “all clear” signal for leveraged carry trades and risk-on investments. Only when the word “patient” was removed was the Fed signaling that rate hikes were back on the table. In that event, investors were being given fair warning to unwind carry trades and move to risk-off positions.

In March 2015, Yellen removed the word “patient” from the statement. That was a signal that a rate hike could happen at any time and the market was on notice. If you had a carry trade on and were relying on no rate hike, then shame on you.

In fact, the first rate hike (the “liftoff”) did not happen until December 2015, but the market was on notice through the June and September 2015 FOMC meetings that …read more

REVEALED: When Recession Starts


This post REVEALED: When Recession Starts appeared first on Daily Reckoning.

Today we reveal the time frame of the next recession — to within three months.

The surprising details anon. But first to a far more immediate catastrophe…

We are informed the partial government “shutdown” has entered a record-extending 25th day.

It is information we must take on faith, and at second hand.

That is because we have suffered not the slightest disruption to our affairs… nor has anyone within our orbit.

We would prolong the calamity until the very last cow reports to the butcher… or the first honest politician reports to Washington.

That is, we would prolong the calamity permanently.

But those more publicly minded insist we are mistaken.

They claim the shutdown is already casting a shadow, broad and heavy, over the United States economy.

Over 800,000 federal employees have been thrown from the public payrolls, they argue.

Data technology company Enigma estimates the shutdown has “blown a nearly $5 billion hole in federal workers’ finances.”

And the economy is deprived of their labor’s fruit.

Private contractors who guzzle from the federal trough are likewise going thirsty.

In turn, so are merchants downstream of the central catastrophe.

Moody’s chief economist Mark Zandi says the shutdown will drain 0.5% from first-quarter GDP:

We estimate (the shutdown) will reduce first-quarter real GDP growth by approximately 0.5 percentage points. Of this, about half will be due to the lost hours of government workers, and the other half to the hit to the rest of the economy.

But we would remind the calamity-howlers:

All furloughed federal employees will be issued full back wages once the “shutdown” ends.

And all water drained from first-quarter GDP will go back in the tub.

Meantime, the paid vacationers can snooze deep into the day, laze before the television, munch popcorn… secure in the knowledge that all back pay is due them.

But to return to the question under consideration… the time frame of the next recession.

Global growth is coming to a crawl.

Chinese exports have plunged to two-year lows. December imports also dropped 7.6% — a portent of softening domestic demand.

Meantime, European factory output wallows at three-year lows.

If we use global industrial growth as a proxy for global economic health, Zero Hedge reminds us, the world has almost certainly sunk into recession.

The United States economic machine still runs forward. But at a reducing rate.

Morgan Stanley, for example, projects U.S. growth will slip to 1% by 2019’s third quarter.

All the while, growth of global central bank balance sheets went negative last August.

Bank of America reports global money growth (measured by M1 money supply) nears its lowest point since mid-2008.

And Morgan Stanley confirms that each time M1 money supply growth tips negative — as it presently is — trouble of some type is on tap:

So is recession dead ahead… like an iceberg in the North Atlantic night?

Here our tale gathers pace…

The Federal Reserve has essentially announced a halt to its rate hikes.

A March hike has already been removed from the card table. Later hikes are also in question.

But will it be enough to …read more

Introducing: The “Chinese Amazon” — Plus, 5 “Must Knows” for Monday, January 14th


This post Introducing: The “Chinese Amazon” — Plus, 5 “Must Knows” for Monday, January 14th appeared first on Daily Reckoning.

The time to start buying Chinese stocks is now.

Don’t let the trade war fears scare you. China has some of the largest and most innovative companies in the world, yet their stock prices in no way currently reflect it.

Your Editor Zach Scheidt and I saw firsthand some of their technology last week at the Consumer Electronics Show (CES) in Las Vegas. It was nothing short of incredible.

Drone delivery services, customizable batteries, wearable machinery to eliminate the strains of working in a warehouse… you name it. Chinese technology firms are innovating at the same rate as their U.S. counterparts, yet because of the ongoing trade war, these stocks are selling at a massive discount!

That’s why today, I want to talk about one particular Chinese company that exhibited in Las Vegas, and explain why now is an excellent time to start building your position…

Meet JD.com — The Chinese Amazon

JD.com (JD) operates a business-to-consumer online platform in China. There are two categories to their online platform — products which it buys and resells to consumers, and products it lets businesses sell directly to consumers.

This is a very similar business model to Amazon here in the U.S. And it’s the preferred model by investors as it allows JD to control its supply chain — no untrustworthy sellers here.

But more important than its business model — which Amazon has already proven deserves a high valuation — JD.com is one of the world’s most innovative companies.

In fact, I’d go as far as to say that JD.com is even more innovative than Amazon itself.


I saw this firsthand last week at CES. And I’ve got the pictures to prove it.

Drones Aren’t Futuristic — They’re Being Used Today!

I remember the first time I heard about Amazon’s plan to build flying drones to deliver packages.

I thought, “That’ll never happen.” And, “Yeah, that sounds great until some mischievous kids spot one when nobody else is around.”

But my initial reactions were proved wrong when I stepped into JD.com’s exhibit last week.

They’re already using drones in China!

That’s right. As you read this, autonomous drones are currently delivering packages to hard-to-reach provinces and to buildings in busy cities around China.

The drones come in various shapes and sizes, but the quickest ones can fly up to 100km/h and have a range of 100km, which broadens JD’s reach to rural towns that would be expensive to deliver to via truck.

Here’s an actual fixed-wing drone with additional propellers for vertical takeoffs and landings. These are used for long-distance trips to remote provinces.

The vehicle is completely autonomous and lands at a designated landing zone, where then the “last mile” is completed by a human.

But there’s more!

Here’s the newest version of a drone that’s been delivering packages around large cities since March of 2016.

With multiple compartments, this autonomous vehicle can deliver many packages before returning to the warehouse.

This is miles ahead of Amazon’s plans for a …read more

EXPOSED: the “Green” New Deal

This post EXPOSED: the “Green” New Deal appeared first on Daily Reckoning.

We took command of The Daily Reckoning fully aware of the bodily risk, reduced here to words by our co-founder Bill Bonner:

In our trade as newsletter publishers, hardly a day passes without a good laugh. Our only occupational hazard is a rupture of the midriff.

Each day tosses up a fresh roster of fools, scoundrels, frauds, knaves, rogues, ne’er-do-wells, world improvers, lunatics and pitchmen.

Sometimes — though rarely — they combine in the form of a single person.

The trouble with them all is that they are vastly amusing. Hence the constant threat of an abdominal tear.

Sunday night the odds caught up with us… our belly was ripped from its moorings…

For there she was on 60 Minutes, the latest political sensation, Alexandria Ocasio-Cortez — AOC from here forward.

A former waitress, AOC was serving food 1.5 years ago. As the newly installed representative of New York’s 14th Congressional District, today she is serving notice…

Notice that a New Deal is in prospect — a “Green” New Deal…

That every American is to be guaranteed productive employment…

That Medicare for all will cure the nation’s ailments…

That free college is as elemental a right as life itself…

And that the ultra-rich will pay all the freight.

AOC’s solution is a 70% tax on all income exceeding $10 million per year.

“There’s an element where, yeah, people are going to have to start paying their fair share in taxes,” said she in the Queen’s English.

We have no objection to a man paying his fair share.

But what is fair? And who decides?

“Render unto Caesar what is Caesar’s,” said Jesus our Lord.

But He never specified precisely what was Caesar’s.

Was it 5%… 20%… 60%… 99%?

For the United States government, the answer was 7% when the income tax went upon the law books in 1913.

This was the top combined tax rate for those earning $500,000 or more.

Incidentally… $500,000 in 1913 dollars equals $12,729,191.92 in 2019 dollars.

But America is a much fairer society today.

It is such a shame the AOC plan will never make it ashore.

It is fatally holed below the waterline… like the Titanic by its iceberg.

Any third-rater can see there aren’t enough super-rich to fleece.

Our agents inform us some 16,000 Americans earn over $10 million per annum — at least as of 2016.

What is the tax haul once the 70% rate kicks in?

According to Mark Mazur, former Treasury Department official now laboring for the Tax Policy Center — some $72 billion annually when all factors are considered.

But how will a slight $72 billion bump substantially fund a Green New Deal… jobs for all… universal Medicare… free college tuition?

And that is assuming the rich sit still, waiting for the tax man to seize them by the collar.

But the rich are moving targets

They tuck into loopholes within the tax code. They dodge into overseas tax shelters. They hide under shell companies.

Who knows how much money the tax would haul aboard once the accountants are done with it?

And as anyone who has looked …read more

Are Stocks Cheap Again?


This post Are Stocks Cheap Again? appeared first on Daily Reckoning.

Are stocks “cheap” again?

Is it time once again to cast your bread upon the waters… and buy?

Today we rise above the daily hurly-burly of the market… take the long view… and ransack the past for clues about the future.

The major averages were negative for 2018. And the stock market has just emerged from its bleakest December since 1931.

But the market has found a toehold, bleats the consensus. The way ahead is higher. It is time to hunt bargains.

There is doubtless justice here — in specific cases and in the short run at least.

But are stocks cheap overall? And what can you expect for the next 10 years?

In general terms…

If stocks are cheap today, you can expect — generally, again — lovely returns for the following decade.

The reverse obtains if stocks are expensive today.

So once again: Are stocks presently cheap? Is it time to buy?

Warren Buffett’s preferred metric is the TMC/GNP ratio.

That is, the ratio of total market cap to U.S. GNP (which approximates but does not equal GDP).

If the total valuation of the stock market is less than GNP, stocks are cheap.

If it is greater than GNP… stocks are dear.

Mr. Buffett claims this formula is “probably the best single measure of where valuations stand at any given moment.”

Any ratio below 50% means stocks are “significantly undervalued.”

A ratio above 115% means they’re “significantly overvalued.”

Stretching four decades, the TMC/GNP ratio was lowest in 1982 — at 35%.

Not coincidentally, 1982 marked the onset of the lengthiest bull market of all time.

In violent contrast, the TMC/GNP ratio was highest in 2000, at 148%.

The dot-com catastrophe was close behind.

What is the TMC/GNP ratio today, Jan. 9, 2019?


That is, despite the worst December since 1931… by this measure stocks remain “significantly overvalued.”

What does that 127.5% imply for the stock market over the next decade, based on the historical record?

Negative 0.5% returns per year, including dividends.

You can expect negative returns for the next decade — if you take this TMC/GNP ratio as your guide.

Is it an infallible prophet?

It is not. None exists this side of eternity.

But financial journalist Mark Hulbert tracks eight market indicators he deems most credible. And he ranks it among the better of them.

But could negative 0.5% returns per year for the next decade — including dividends — actually be optimistic?

John Hussman captains a hedge fund, Hussman Strategic Advisors by name.

Mr. Hussman is what is known as a “perma-bear.”

Yet his crystal ball occasionally yields frightfully accurate pictures.

For example:

In March 2000 he soothsaid tech stocks would soon plummet 83%. How much did the Nasdaq lose between 2000 and 2002?


He also forecast in March 2000 that the S&P would post negative returns the following decade. It did.

In April 2007 Hussman said the S&P could plunge 40%. His vision was only off slightly. The S&P lost 55% from 2007–09.

And what does Hussman’s crystalline sphere reveal for the decade ahead?

First another question…

Assume you bought the S&P in 1999. You have held ever since …read more

Here’s Where the Next Crisis Starts

This post Here’s Where the Next Crisis Starts appeared first on Daily Reckoning.

The case for a pending financial collapse is well grounded. Financial crises occur on a regular basis including 1987, 1994, 1998, 2000, 2007-08. That averages out to about once every five years for the past thirty years. There has not been a financial crisis for ten years so the world is overdue. It’s also the case that each crisis is bigger than the one before and requires more intervention by the central banks.

The reason has to do with the system scale. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses.

This means a market panic far larger than the Panic of 2008.

Today, systemic risk is more dangerous than ever because the entire system is larger than before. Due to central bank intervention, total global debt has increased by about $150 trillion over the past 15 years. Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.

Each credit and liquidity crisis starts out differently and ends up the same. Each crisis begins with distress in a particular overborrowed sector and then spreads from sector to sector until the whole world is screaming, “I want my money back!”

First, one asset class has a surprise drop. The leveraged investors sell the sinking asset, but soon the asset is unwanted by anyone. Margin calls roll in. Investors then sell good assets to raise cash to meet the margin calls. This spreads the panic to banks and dealers who were not originally involved with the weak asset.

Soon the contagion spreads to all banks and assets, as everyone wants their money back all at once. Banks begin to fail, panic spreads and finally central banks step in to separate winners and losers and re-liquefy the system for the benefit of the winners.

Typically, small investors (and some bankrupt banks) get hurt the worst while the big banks get bailed out and live to fight another day.

That much panics have in common. What varies in financial panics is not how they end but how they begin. The 1987 crash started with computerized trading. The 1994 panic began in Mexico. The 1997–98 panic started in Asian emerging markets but soon spread to Russia and the big banks. The 2000 crash began with dot-coms. The 2008 panic was triggered by defaults in subprime mortgages.

The problem is that regulators are like generals fighting the last war. In 2008, the global financial crisis started in the U.S. mortgage market and spread quickly to the overleveraged banking sector.

Since then, mortgage lending standards have been tightened considerably and bank capital requirements have been raised steeply. Banks and mortgage lenders may be safer today, but the system is not. Risk has simply shifted.

What will trigger the next panic?

Prominent economist Carmen Reinhart says the place to watch is U.S. high-yield debt, …read more

The Origin of the Next Financial Crisis

Corporate Debt Far Into Red Zone

But whom shall we blame?

As is our wont, we point an accusing finger at the Federal Reserve…

Year upon year of ultra-low interest rates hammered borrowing costs lower and lower.

Marginal corporations that would have been denied access to credit under normal circumstances took on debt.

And many corporations have issued bonds to raise funds rather than issue stock. It has proved less expensive given the bargain rates.

Did corporations use the borrowed money to increase productivity… increase research and development… or expand operations?

No, not particularly.

Many corporations have been using the money to purchase their own stock, which has artificially inflated their prices.

And as we have stated before, corporations have been the largest source of all stock purchases.

But interest rates have been climbing… like water in a flooding basement.

And the cost of existing debt is rising with it.

How will they meet their debts?

Bonds rated “BB” are considered “junk bonds.”

“BBB” is one level removed from junk.

MarketWatch informs us that the volume of the bond market rated BBB currently rises to $2.5 trillion — a record high.

That is, 50% percent of all investment-grade corporate bonds are presently one inch from junk status.

And once they start going over… watch out.

Explains Daily Reckoning associate John Mauldin:

This is the sort of thing that can quickly snowball into a financial crisis. Something similar happened with commercial paper in 2008, but this has the potential to be even worse… and, if it happens, could come at a time when the Federal Reserve and Treasury can’t help much. I see serious risk of a corporate bond crisis in 2019…

Analyst Jesse Colombo is similarly alarmed:

The U.S. corporate debt bubble will likely burst due to tightening monetary conditions, including rising interest rates. Loose monetary conditions are what created the corporate debt bubble in the first place, so the ending of those conditions will end the corporate debt bubble. Falling corporate bond prices and higher corporate bond yields will cause stock buybacks to come to a screeching halt, which will also pop the stock market bubble, creating a downward spiral. 

In conclusion:

There are extreme consequences from central bank market-meddling, and we are about to learn this lesson once again.

From where we sit… the only question is when.


Brian Maher
Managing editor, The Daily Reckoning

The post

This post The Origin of the Next Financial Crisis appeared first on Daily Reckoning.

Today, additional evidence that recession — or worse — is in sight.

But first, it appears the “Powell put” may extend the countdown clock…

Since Jerome Powell’s dovish comments on Friday, the Dow Jones has been up and away… as an addict thrills to the promise of additional stimulant.

It leaped another 256 points today.

Both S&P and Nasdaq have been similarly seduced.

The S&P ended the day up another 24 points; the Nasdaq, 73.

Thus Mr. Powell becomes the latest dealer to backstop Wall Street’s addiction to easy credit.

First came the “Greenspan put” after October 1987’s Black Monday.

The “Bernanke put” was on tap after 2008 — and was it ever.

This was of course succeeded by the “Yellen put.”

And now… Jerome Powell.

But the stuff at Powell’s disposal is far weaker his predecessors’.

The fed funds rate rose as high as 4.75% in September 2007 — as the foundations gave way on the housing market.

But it squatted at 1.50% when Powell came on station last February.

That is, he has far less space to cut rates.

Meantime, Bernanke and Yellen were able to inflate the balance sheet from a pre-crisis $800 billion to a delirious $4.5 trillion.

Powell could not possibly work an operation on that scale.

This at least partly explains why he has been withdrawing the narcotic since he came aboard — to rebuild his stocks for future use.

But Mr. Powell suggested last Friday that he is willing to call a halt “if needed.”

And so Pavlov’s dogs began drooling. And the stock market began its merry run.

But it is a false promise — as the promise of the needle is false — or the promise of the bottle.

It may put off reckoning day… but it only intensifies the ultimate and inevitable withdrawal.

Come we now to our evidence that recession is within view…

We have argued previously that sub-4% unemployment means recession is almost invariably close by.

Today we observe that recession is also close when corporate debt attains present heights.

U.S. corporate debt swelled a preposterous $2.5 trillion post-financial crisis… some 40% higher than its 2008 summit.

Corporate debt presently equals some 46% of GDP — the highest percentage on record.

And whenever corporate debt rises to present levels, recession is in the air… at least for the past 40-odd years:

But whom shall we blame?

As is our wont, we point an accusing finger at the Federal Reserve…

Year upon year of ultra-low interest rates hammered borrowing costs lower and lower.

Marginal corporations that would have been denied access to credit under normal circumstances took on debt.

And many corporations have issued bonds to raise funds rather than issue stock. It has proved less expensive given the bargain rates.

Did corporations use the borrowed money to increase productivity… increase research and development… or expand operations?

No, not particularly.

Many corporations have been using the money to purchase their own stock, which has artificially inflated their prices.

And as we have stated before, corporations have been the largest source of all stock purchases.

But …read more

2019 Headwinds Are Getting Stronger

This post 2019 Headwinds Are Getting Stronger appeared first on Daily Reckoning.

In 2017, every prominent economic forecasting entity was shouting from the rooftops about “synchronized global growth.” This was a reference to the fact that not only were certain economies growing, but they were all growing at the same time.

Chinese GDP growth had come down but was still substantial at 6.85%. U.S. GDP growth was posting solid gains of 3.0% in the second quarter of 2017 and 2.8% in the third quarter. Japan and Europe were not growing as quickly as the U.S. and China, but growth was still accelerating from a low level.

Synchronization was a big part of the story. Growth was not isolated and episodic. Growth was fueling more growth in what seemed to be a sustainable way. The world economy was firing on all cylinders.

Then in 2018 the global growth story came screeching to a halt. Japanese growth went negative in the third quarter of 2018. Germany also went negative. Chinese growth continued its drop (6.5% in the third quarter) instead of stabilizing.

The U.K slowed partly because of confusion around Brexit. French growth slid amid riots triggered by a proposed carbon emissions tax. Australian home prices declined precipitously because export orders from China dried up and Chinese flight capital slowed to a trickle due to Chinese capital controls.

The U.S. economy held up fairly well in 2018, with 4.2% growth in the second quarter and 3.5% growth in the third quarter. But much of that growth was inventory accumulation from foreign suppliers in advance of proposed tariffs.

That inventory growth will likely dry up once the tariffs are either imposed or abandoned early this year. Fourth-quarter growth in the U.S. is currently projected at 3.0%, continuing the downtrend from the second quarter.

What happened?

Much of the global slowdown has to do with the high degree of interconnectedness of the global economy and the extent of global supply chains. The flip side of synchronized growth is a synchronized slowdown. Just as growth in one economy can lead to increased exports for trading partners, a slowdown leads to reduced exports.

Still, why has growth slowed down at all?

The answer has to do with debt, Fed policy, political developments, as well as trade wars. Specifically, the U.S. and China, the world’s two largest economies, are discovering the limits of debt-fueled growth.

The U.S. debt-to-GDP ratio is now 106%, the highest since the end of the Second World War. The Chinese debt-to-GDP ratio is a more reasonable 48%, but that figure is misleading because it does not include the debts and guarantees of provinces, state-owned enterprises, banks, wealth management products and numerous other entities that the government in Beijing is directly or indirectly obligated to support.

When that additional debt is taken into account, the real debt-to-GDP ratio is over 250%, about the same as Japan’s.

Debt-to-GDP ratios below 60% are considered sustainable; ratios between 60% and 90% are considered unsustainable and need to be reversed; and ratios in excess of 90% are in …read more