"Champagne Supernova" - IceCap Asks What Happens When The Bond Bubble Finally Pops

Submitted by Keith Decker of IceCap Asset Management

Don’t Look Back in Anger

ENGLAND (Knebworth Park, 1996) – Owning the front of the stage, Liam Gallagher closed his eyes and liked what he saw. Thousands of screaming, pushing and kicking fans positioning themselves for the what would be THE concert of the year.

For Liam, it was total chaos and he loved it.

Twenty feet away, Noel Gallagher also closed his eyes but what he saw wasn’t chaotic at all. Instead of small pockets of rebellious concert goers, Noel saw a sea of 250,000 people strong. They ebbed and flowed and sang together – all eyes and hearts were focused on the stage gifting Oasis the energy to make THE concert of the year.

For Noel, it was total harmony and he loved it.

The concert turned into an instant classic in the music world. Both Liam and Noel, strummed together one of the best evenings of 90s rock ever to be recorded. As for the evening being chaotic or harmonious – it really depended upon your perspective.

Today, the Gallagher brothers no longer speak to each other, let alone play music together.

Perhaps Liam was right after all – the entire Oasis experience was complete chaos. Or maybe, Noel was correct – when all of the chaos was combined, the ending was both harmonious and predictable.

As music imitates life, today many people are trying to make sense of the chaos swamping the world.

Yet, if one looked at the world from a slightly different perspective, perhaps you too will see a world of harmony and one with a certain outcome.

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Everything in the world is connected – political, social, economic, fiscal, monetary and financial markets are all intricately linked. Yet, what’s extremely interesting today is that for the first time in our lifetime, they are all converging toward extreme levels simultaneously. And once you see it, be prepared for a champagne supernova smile to wrap around your face and all your troubles to be half the world away.

Chaos or Harmony

To really grasp the enormity of the chaos around the world today, spend a few minutes on our Chart 1.

As we’re an investment management firm, we ultimately focus on the net effect of the chaos on financial markets. We must remain objective and remove any political or social bias and simply accept the current environment as is – anything less would be a failure on our part as fiduciary investment manager. After all, that’s the ultimate bottom line for all of our clients.

Investment managers must never fly with blinds wrapped around their heads – understanding how and why financial markets move will not only help protect your clients’ savings from losses, and provide opportunities for gains, but more importantly we can empower clients with the knowledge of how markets really work.

Nowhere in this publication will you find us referring to certain companies as being cheap, or just stay invested for the long term – that mouth speak only applies during markets with very specific dynamics. And unfortunately, those dynamics are from the 80s and 90s. Yes, those days were awesome but unless you are a hippie, it doesn’t pay to live in the past.

As we dive into the chaos you’ll begin to see and understand why you cannot rely upon your past experience and worse still the past wisdom of the big bank investment machines.

But first, most know that IceCap is fully expecting a crisis in the government bond market and it will have ripple effects around and within the world. As we inch ever closer to the crisis tipping point, we continue to see more and more evidence to support our view.

The other critical point to understand – and this precisely why the world has been jammed into this peculiar position - the majority cannot see and distinguish between the problems and the symptoms.

Sadly, this rather easy, simple concept has been completely lost in the industry. Time and time again, we hear a complete misdiagnosis of the world’s problems. Instead of identifying the problems, most only see the symptoms – and, they are unable to decipher the difference.

Our Chart 2, clearly shows the difference between the problem and the symptom. It’s rather to easy to see that the problems in the world today isn’t low growth, high debt and a rise of anti-establishment political parties. Instead, these are the symptoms of perceived corruption with the established political system and the horrible stimulus plans of deficits, zero/negative interest rates and money printing.

Ironically, today the main problem is that governments and central banks will not admit that they are the problem. Solve this and everything else will fix itself.

Yet as we hear more governments drone on about the need for the wealthy to pay their fair share in taxes and for companies to create jobs, as well as central bankers congratulate themselves for creating the wackiest interest rate environment this side of Mars, the odds of them admitting they are the problem are lower than England winning the next World Cup.

Understanding the difference between the problem and the symptom will now allow you to refocus and see why we have chaos that is clearly coming together to provide clarity and harmony.

Now, clearly the investment industry is chock full of very smart people. Everyone has very impressive credentials, and seemingly all have become a vice-president to some degree – yes, the degrees of success are unparalleled.

Yet, in spite of all the financial wizardry the industry still suffers from the inability to distinguish the difference between perception and reality.

Perception is that the world’s central bankers are super heroes who can influence the economy, jobs, inflation and markets at their whim.

Reality shows that Janet Yellen, Mark Carney, Haruhiko Kuroda, and yes, even the Italian maestro Mario Draghi are just plain, ordinary people with apparently no super powers at all. In fact, every time this fantastic four spun their money magic – it made things worse.

So, the next time your investment advisor and big bank proclaim that central banks are about to stimulate the economy and fix everything, know that this couldn't be any further from the truth.

Next up, perception is that professional economists are able to see into the future and predict with uncanny accuracy exactly how, when and where economies will move.

Yet reality shows that professional economists have predicted 0 of the last 7 recessions in the United States. Yes, collectively they have never, ever correctly forecast a bad time for anyone (source: Ned Davis Research).

So, the next time your investment advisor and big bank proclaim that their economists are forecasting a recovery and no recession, know that this couldn’t be any further from the truth.

And finally, perception shows traders on Wall Street, Bay Street and the City as being immortal, brainiacs who can create profits by merely rubbing two keyboards together.

Yet, reality shows that 85% of traders on Wall Street have only been working in the industry since 2000 or earlier. In other words, the majority of traders have never seen a rising interest rate environment. And in fact, nearly 66% of traders have spent their entire career in a 0% and negative interest rate environment.

So, the next time your investment advisor and big bank proclaim their mutual fund managers and traders have years of experience in all markets, know that this couldn’t be any further from the truth.

Now that we know the difference between the problems and its symptoms, as well as understand the investment industry’s blindness between perception and reality, let’s sort through the world’s chaos.

In the end, you too will see how the chaos is driving markets and capital towards a harmonious state.

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The full breakdown is in the note below, but here are the highlights:

Politics:

The world’s political arena has started to make very dramatic changes. In effect, the old guard is on notice and something very different will be the replacement. Seemingly everywhere today, countries have been thrown into complete chaos due to the rise of “extreme” political parties. Yes, it’s happening, this cannot be denied.

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Again, one has to ask not why would anyone vote for Trump, but instead ask why on earth would anyone vote for Hillary Clinton?

Yes, lifelong Democrats will always vote for their party, just as lifelong Republicans will always vote for their party. Yet, today there is a fast growing segment of the American population that has become completely disenchanted with the old, political establishment.

And unfortunately for the Democrats, Hillary Clinton represents this increasingly despised group.

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Social

While not often discussed within investment perspectives, social dynamics have suddenly become front and center in our daily discussions. And while each situation may appear chaotic on its own, when viewed in conjunction with other social tensions, it becomes easy to see how it is all connected.

The social reaction to the political establishment, and sluggish economy is deepening within certain countries as well as across different countries.

Americans are currently experiencing a disturbing trend of violence between the black population and the police. It is occurring across the country and tensions are escalating. In addition, Americans are also experiencing an enormous rise in income inequality. The rich are perceived to be benefiting significantly from everything happening in Washington, while the poor are left fighting over low paying jobs and declining standards of living.

Students meanwhile, have been encouraged to borrow to obtain university degrees only to discover that upon graduating, most cannot obtain jobs in their fields of study and many are finding themselves moving back home to live with their parents – all while holding thousands of dollars in student loans.

Europe is also experiencing social tensions. Similar to America, a significant number of youths are unable to find employment.

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Economics

Depending upon where you live, where you work and who you hang out with you are experiencing a different economy than many others. For many in San Francisco, London, and New York – life is very good. Housing prices have blasted through all-time highs. Bonuses are plentiful. And, local grass-fed beef and Nova Scotia lobster paired with Marcassin Vineyard Pinot Noir is simply called lunch.

Others outside of these super successful pockets are doing okay. Jobs are okay, housing is okay and there’s always a reason to enjoy an end of week margherita pizza paired with the usual Chianti. And then we have another, entirely different group of people who are nowhere close to enjoying the finest of fine meals, and the stability of a well-paid job.

Instead, this group is struggling right now. This group forms the majority of populations in Asia, the Americas, Europe and the Middle East.

We bring this to your attention because, again it’s important to view the world not from your own personal position – no matter how comfortable or uncomfortable it may be.

We talk and write frequently how the investment industry has an incredible knack for confusing the hats off investors. Countless big bank and mutual fund companies proclaim growth is booming and only their team of crack-analysts can identify incredible opportunities to make your money grow.

Instead, just know two things:

  1. Global growth is declining. Chart 3 (next page) shows falling trends in global manufacturing, global industrial production and global earnings.
  2. If this wasn’t the case – our central banks and governments would not be aggressively pursuing extreme stimulative policies, nor would the entire European banking system be on life support.

From this perspective, the global economy has certainly turned chaotic – yet considering the chaos everywhere else, this shouldn’t be a surprise at all.

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Fiscal Spending and Monetary Stimulus

We have been lead to believe that our economies can be controlled and influenced in 3 ways:

1. Governments can spend more money to create jobs
2. Governments can lower taxes to create jobs
3. Central banks can lower interest rates to create jobs

And, when packaged together it should really provide an incredible boost to our economies.

And, when packaged, wrapped, bundled and cobbled together it should provide a superhero-size explosion to our economies.

Sadly, we’ve been mislead.

And even more sadly, it’s the continuation of these superhero-sized rescues that has completed the chaotic loop – the one that is on track to cause an enormous shift in global capital that hasn’t been seen in quite a while.

The 2008-09 crisis was caused by the private sector. Regardless of the reason or the assigned blame, far too many people and companies borrowed way too much money and when the bubble eventually popped (they always do), millions of people and companies lost an awful lot of money.

The one important thing to know from those dark days is that governments were told (by the banks) that in order to save the world they had to save the banks. But what few people realise is that when they saved the banks, two things happened:

1. Tax payers and the most conservative investors from all over the world saved the banks – in other words, many who didn’t take the risk had to bailout those who took excessive risks.

2. The bailout and stimulus programs simply shifted the enormous debt crisis away from the private sector and straight onto the laps of the public sector.

In other words, the bubble has shifted away from the PRIVATE sector to the GOVERNMENT sector.

And when the government sector has a crisis, it is reflected in the GOVERNMENT BOND MARKET.

To put this government bond market crisis into perspective, we offer our Chart 4 (next page) which shows a relative comparison to recent crises from the private sector.

 

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To really understand how serious of a problem this is, just know that a mere 1% rise in long-term interest rates, will create losses of approximately $2 Trillion for bond investors. The fun really starts when long-term yields increase by 3%, and then 6% and then 10%. This is the point when certain government bonds simply stop trading altogether, and losses pile up at 50%-75%.

When long-term rates decline, it is usually in a gradual trending manner – such as what we are experiencing today.

For those of you shaking your heads in disagreement, we kindly suggest you research your history of long-term interest rates.

However, when long-term rates go higher – it is an explosive move. Long-term rates ratchet up VERY quickly making the sudden loss instant, while exponentially increasing the funding cost of the borrower.

Most investors today have no idea what is happening in the bond market today and have exposed themselves to incredible amounts of risk.

And more importantly, because a global crisis in the government bond market has never occurred in our lifetime – advisors, financial planners and big banks continue the tradition of telling their clients that bonds are safer than stocks.

As a result, the most conservative investors in the word remain heavily invested in the bond market and are therefore smack dab in the middle of the riskiest investment they’ll ever see.

Chaotic indeed.

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Full Icecap Presentation (PDF link):