Great Depression

One of the best bond traders on Wall Street said this recently:  “Get ready for The Great Bond Shortage in North America.  If it has a cusip and it is rated, it is going higher/tighter.” The compression in bond spreads since the Fed started all of their “made-up/newly printed money for free” antics is the root of all of this and we do not expect a change anytime soon. There are various estimations for the 2013 net new issue supply in all sectors of Fixed Income but I peg it around $400 billion.  Around $800 billion will be paid to bond holders during the year in coupon payments and, if reinvested, will cause a supply deficit of about $400 billion for the year.  Exacerbating all of this is the Fed, who will buy around $500 billion in MBS this year and perhaps the same amount in Treasuries which could take $1 trillion out of the market all by itself. Consequently we face a lack of bonds denominated somewhere between $900 billion and $1.4 trillion, depending upon the Fed, which will increase the rolling train of compression, lower interest rates further in all likelihood and cause great angst for investors who will find very little of value left in the Fixed Income markets. Safety; yes but yield; no. Inflation and Deflation, it should be noted, only work in operative systems; but it is not Inflation or Deflation that are going to matter in the short run, though it will later; it will be the lack of bonds of any sort to purchase and a stock market that may be dangerously out of sync with the fundamentals opening the possibility of a crash. If so much money is printed and so little regard is placed upon fundamental economic principles then the Real Estate crash of several years ago will look like child’s play by comparison. “Systemic Breakdown” would be the functioning words.

The United States is more than four years into its current form of economic purgatory. The government pronounced the recession over in June of 2009. That announcement does not conform with reality or even subsequent government suspect data. To believe the recession ended requires a bizarro interpretation of economics where bad is actually good and good is actually bad. 21st Century politics sees no need for truth. When government believes itself to be responsible for the economy and convinces the people of that, it has put itself into a box. The reality is that government does not create wealth or economic abundance. (They can create poverty, however.) The country’s economic problems began decades ago. In trying to cover them up with economic interventions (stimuli), government actions prevented the economy from correcting the imbalances that caused slow growth. After decades of such interventions, the economy no longer is able to function efficiently. We are coming off the biggest boom in the history of the world. Thus far all the Keynesian dollars expended have had little effect other than to make this country poorer. We are set up to have a Depression greater than the one in the 1930s. A Depression is not a good thing. Yet in this case, it may be the one event that can prevent a chapter in future history books entitled “The Demise of the Great American Empire.” The “greatest generation” handed us a gift and we fumbled it away by allowing government to run wild.

Doug Casey often gets letters from angry readers who accuse him of hating America, disloyalty, and perhaps even treason. The truth is that he loves the idea that was America. It's the United State it has become for which he has nothing but contempt. Where to begin? ...the US Constitution was essentially a coup; the delegates to what we now call the Constitutional Convention were not empowered to replace the existing government – only to improve upon the Articles of Confederation between the then-independent states. The framers of the Constitution drafted it with the notion of a national government already in place, but calmed fears of loss of state sovereignty by calling the new government the "United States of America" – a verbal sleight of hand that worked for over half a century. Then the southern states decided to exercise what these words imply, their right to leave the union... and as the government becomes more powerful, it's completely predictable that everything – including the justice system – will become ever more politicized... As great as a US citizen's risk is in the marketplace these days, the greatest single risk to their wealth and health is the government.

As of late there has been a flood of commentary written about the housing recovery pointing to the bottom in housing and how the revival in housing will drive economic growth in the years ahead. It is true that the revival in the housing market is a positive thing and is certainly something that everyone wants.  However, the hype surrounding the nascent recovery to date may be a bit premature. Much of the current buying in the housing market has come from speculators and investors turning housing into rentals.  This, however, has a finite life and rising home prices will speed up its inevitable end as rental profitability is reduced.  Furthermore, the majority of home building has come in multifamily units, versus single family homes, and that segment has been growing faster than underlying demand. It is important to understand that housing will recover - eventually.  However, the reality of that recovery could be far different than what the current media and analysts predict. The point here is that while the housing market has recovered - the media should be asking "Is that all the recovery there is?"

Or Maybe the Biggest of All Time ...

After 40 years of boozing on easy money and feasting on fantastical asset price inflations, the global monetary system is approaching catharsis, its arteries clogged and instant cardiac arrest a persistent threat. ‘Muddling through’ is the name of the game today but in the end authorities will have two choices: stop printing money and allow the market to cleanse the system of its dislocations. This would involve defaults (including those of sovereigns) and some pretty nasty asset price corrections. Or, keep printing money and risk complete currency collapse. We think they should go for option one but we fear they will go for option two. In this environment, how can people protect themselves and their property? Our three favourite assets are, in no particular order, gold, gold and gold. After that, there may be silver. We are, in our assessment, in the endgame of this, mankind’s latest and so far most ambitious, experiment with unconstrained fiat money. The present crisis is a paper money crisis. Whenever paper money dies, eternal money – gold and silver – stage a comeback. Remember, paper money is always a political tool, gold is market money and apolitical.

One of the most commonly cited 'bullish' memes for stocks is the so-called Fed Model (or Equity Risk Premium) or more simply - the fact that earnings yields are not catching up to Treasury yields (i.e. why put your money in government bonds at such low rates when there is a smorgasbord of yummy equities with 'attractive' dividend yields). There are three key problems with this perspective: 1) No concept of 'risk' is imbibed in this return-based differential (as we have discussed before here and here); 2) Longer-term historical context is critical (as we discussed here - must read); and most importantly 3) Financial Repression breaks the 'Fed Model'. As Barclays shows in the following three charts (and we pointed out recently) normalization of the equity risk premium will not occur until Financial Repression ends. Brings a whole new meaning to 'Don't Fight The Fed' eh?

Markets, you see, always live in this “day before” where the bend in the highway never comes, where the path is always straight and fixed and where it is generally thought that nothing of consequence will happen. Then some event takes place, something magical or wonderful or awful occurs and the world is turned on its axis and nothing is ever the same again. We are in danger, “clear and present danger” and the strategy of the “day before” is no longer appropriate. $400 billion has poured into bond funds this year, an all-time record, with yields at depressed levels indicating a quite real flight to safety. The United States lost thirty-six percent of its wealth during the American Financial Crisis and, people or institutions, the song rolls across the landscape, “We won’t get fooled again!”

"Around the year 2005, a sudden spark will catalyze a Crisis mood. Remnants of the old social order will disintegrate. Political and economic trust will implode. Real hardship will beset the land, with severe distress that could involve questions of class, race, nation and empire." Strauss & Howe wrote these words in 1997. They understood the dynamics of how generations interact and how the mood of the country shifts every twenty or so years based upon the generational alignment that occurs as predictably as the turning of the seasons. The last generation that lived through the entire previous Crisis from 1929 through 1946 has virtually died off. For those who doubt generational theory and believe history is a linear path of human progress, I would point to the last week of chaos, disarray, government dysfunction, and misery of those who didn’t prepare for Superstorm Sandy, as a prelude to the worst of this Crisis. The lack of preparation by government officials and citizens, death, destruction, panic, anger, helplessness and realization of how fragile our system has become is a perfect analogy to our preparation for this Fourth Turning. The regeneracy of the nation will occur during the next presidential term. The mathematical impossibility of sustaining our economic system is absolute.

It would be easy for me to dismiss Obama supporters as mentally defective but for one inconvenient fact: my mother, sharp as a tack at 92, is voting for him. And so is my sister, a San Francisco attorney who is no slouch in the brains department.  I’m not sure where my brother, a municipal employee, stands, but neither am I eager to find out. There is no bridging the political gap between us, and so we simply avoid discussing politics.  The same goes for old friends, although newer ones are another matter.  One of them walked out on our dinner together in a huff when an innocuous remark I’d made about Abe Lincoln evidently bruised his self-righteously liberal, morally perfect heart . Good riddance. It is far better friends than he that I am worried about. Will they draw the line when I let slip my support for the right to bear arms, even concealed?

"Obama/Romney, Romney/Obama – the most important election of our lifetime? Fact is they’re all the same – bought and paid for with the same money. Ours is a country of the SuperPAC, by the SuperPAC, and for the SuperPAC. The “people” are merely election-day pawns, pulling a Democratic or Republican lever that will deliver the same results every four years. “Change you can believe in?” I bought that one hook, line and sinker in 2008 during the last vestige of my disappearing middle age optimism. We got a more intelligent President, but we hardly got change. Healthcare dominated by corporate interests – what’s new? Financial regulation dominated by Wall Street – what’s new? Continuing pointless foreign wars – what’s new? I’ll tell you what isn’t new. Our two-party system continues to play ping pong with the American people, and the electorate is that white little ball going back and forth over the net. This side’s better – no, that one looks best. Elephants/Donkeys, Donkeys/Elephants. Perhaps the most farcical aspect of it all is that the choice between the two seems to occupy most of our time. Instead of digging in and digging out of this mess on a community level, we sit in front of our flat screens and watch endless debates about red and blue state theologies or listen to demagogues like Rush Limbaugh or his ex-cable counterpart Keith Olbermann."

Today's personal income and spending report for the month of September was just the latest datapoint confirming that the US consumer is once again massively cash-strapped and is eating, literally, into their savings. While Personal Income rose at the expected pace of 0.4%, Spending in the last month came well above expectations of 0.6%, printing at 0.8%, which meant that on a net basis Consumers, always hopeful, outspent themselves by a margin of 0.4%. This meant that the savings rate declined from 3.7% in August to a tiny 3.3% in September. This was the lowest Savings print in 2012, and higher only compared to last November's 3.2%, which in turn was the lowest print since the start of the second great depression. In other words, overeager consumers saw their nominal incomes increase... and decided to outspend said rise at double the rate of increase! At this pace, by the time Thanksgiving rolls out, US consumers will have no savings at all left to tap and living will be strictly a month to month activity. But wait, it gets worse. As the second chart below shows, the real story was that of the Real, not Nominal, Disposable Income, adjusted for the cost of living, which declined for the second consecutive month, and shows that the peak this year took place in July, having declined consistently ever since. In other words, even real incomes are now consistently declining, spending aside.

The government may have been instrumental to the US economy growing in the third quarter (did we say may: generating over 30% of the annualized 2.0% "growth" in Q3 probably qualifies as was absolutely instrumental in this impartial, apolitical datapoint), but the bottom line is that there was a cost. There is always cost. And a number: the number is $15.776 trillion, which was the absolute GDP number as of September 30, 2012 (to be revised lower in one month). This means we can now calculate what total US Debt-GDP was as of 3 weeks ago. And with the DTS reporting that debt was $16.16 trillion as of the day the third quarter ended (net of the SSN funding adjustment, which of course is always reported the first day of the next quarter for window dressing purposes), it means that total US Debt-to-GDP was 102.4%. And obviously rising much faster as since the Second Great Depression it takes well over $2 in debt for every $1 increase in GDP. Because there never is such a thing as a free lunch, especially when the government is operating the soup kitchens...

The Department of Labor's WARN (Worker Adjustment and Retraining Notification) website may have been exempt from layoff notices related to the fiscal cliff, but it still provides a sufficiently (bleak) complete picture about the real nature of layoffs and business cycle in general in America's busiest city. Which is why it was precisely using the WARN website that we learned that one of New York's most historic steakhouses, "NY's Prime Steakhouse since 1927" Gallagher's, located on 52nd street, and which survive the great depression, is shutting down on January 16. Surely neither the surging price of meat, nor the ability of patrons to spend charge $46.95 for an 18 ounce sirloin, has had any impact on the decision to close this iconic restuarant which survived the Great Depression, but failed to survive Tim Geithner's "recovery".

ConvergEx's Nick Colas dusts off a golden oldie of stock market valuation – the "Rule of 20." The basics of this heuristic are simple: the addition of the U.S. equity market’s price/earnings ratio and the current inflation rate as measured by the Consumer Price Index should trend around 20.  If the current inflation rate is 2%, for example, then stocks should trade to an 18x current multiple.  That may sound too simplistic, but since 1914 the average of this summation is 19.3 – pretty close to the catchier “20.” But, as Nick explains, what the “Rule of 20” handily captures is the essential relationship between corporate earnings (a.k.a. cash flows) and discount rates (primarily driven by marginal inflationary expectations.) Here is where the current “Rule of 20” math takes a surprising turn.  With CPI inflation at 2%, the market should be trading for 18x current earnings.  We, like Nick, see the reasons for this shortfall: either the market is worried that corporate earnings are about to tumble or inflation is much more of a threat than a Fed-supported yield curve currently indicates.  Or… gulp… both.