Harry S. Dent Jr.'s Blog, page 142
August 4, 2015
The Fed: A Loose Cannon With a Lit Fuse
It’s August. The first interest rate hike in eight years by the Federal Reserve could be just a month away.
While the topic of when the Fed will raise rates gets a lot of attention, that’s the easy part of the equation. All they have to do is make a motion to implement policy changes that will try to peg short-term interest rates to 0.50%. It’s a snap!
But then comes the hard part… figuring out the mechanics necessary to make that happen.
This used to be a simple task. The Fed would set the rate at which banks lent money to each other overnight, called the Fed Funds Rate (FFR).
This is essentially the interest rate upon which all other U.S. interest rates are based. Raise it, and others tend to follow. But now, thanks to a different Fed policy, the FFR is irrelevant. That could make raising rates difficult.
By printing trillions of dollars out of thin air, and using them to buy mortgage-backed securities and Treasury bonds from banks, the Fed left those banks with buckets of cash. Left to their own devices, banks might’ve tried to lend out the extra bucks, potentially driving inflation to the moon.
To stop such a trend before it started, the Fed created an incentive for the banks to hold their excess reserves at the central bank – paying them interest, literally known as “interest on excess reserves,” or IOER.
The Fed already institutes a minimum reserve requirement that banks must hold with them. But compared to the excess reserves, the minimum reserves seem like nothing.
Before the financial crisis, banks held the bare minimum required at the Fed. Those reserves amounted to roughly $60 billion at the end of 2007.
Today, the minimum required reserves are closer to $100 billion, but banks hold an additional $2.7 trillion in excess reserves at the Fed, on which they earn interest.
By encouraging banks to store these reserves, the Fed achieved its goal of keeping the cash out of the banking system and therefore the economy, but there was a side effect: Banks no longer needed to borrow money from each other. That means changing the Fed Funds Rate – its primary tool for raising interest rates – will have a limited effect, if any, on banks and the banking system.
So the Fed has to try something else. To this end, they’ve trotted out a new policy: reverse repurchase agreements, or reverse repos.
In this transaction, the Fed will sell some of the Treasury bonds it owns for one day, agreeing to buy them back the next day at a slightly higher price. The difference in price equates to whatever rate the Fed is trying to achieve for short-term interest rates.
The key is that the Fed will open its window to a broader group than just banks, allowing institutions such as money market funds, large pensions, etc. to lend the Fed cash overnight in exchange for Treasuries at a preset interest rate. The system has been in test mode for the last two years, with banks as the only counterparties and a cap on the transactions set at $300 billion.
There’s no guarantee the new approach will work.
Looking at the financial climate around the world as well as here in the U.S., there’s a lot of uncertainty in the markets.
The U.S. reported 2.3% growth in the second quarter, which is sluggish at best. Unfortunately, it’s also a massive jump from the 0.6% revised level of the first quarter, and well ahead of most every other developed nation on the planet.
In Japan, “Abenomics” are failing to stimulate growth. Exporters are benefiting from the devalued yen, but everyday workers and consumers are getting pinched. At the same time, China’s economy is slowing down, which is reverberating around the globe in the form of falling demand for commodities.
Then in the euro zone, investors of all sizes have to deal with the European Central Bank, which is buying more bonds each month than all the countries of the area issue. This leads to a supply and demand imbalance where investors can’t find enough bonds to own.
These factors lead to increased demand for safe, short-term fixed income products like U.S. Treasurys.
That means it’s entirely possible that the Fed’s allotment of bonds to the reverse repo market will be scooped up quickly, failing to meet the demands of the marketplace.
In this instance, buyers would be willing to pay more, accepting a lower interest rate than what the Fed was offering. This would drive the overnight rates below the Fed’s target.
To overcome this issue, the Fed will have to offer even more bonds in the repo market, possibly up to $1 trillion. It might work, but no one knows for sure. It’s never been done. That’s the heart of the problem.
The Fed’s only in this mess because it ruined its own policy tool of adjusting the overnight lending rate by flooding the market with dollars.
Now, it intends to introduce a policy where the central bank itself is the counterparty to thousands of transactions totaling hundreds of billions if not trillions of dollars.
This move will only increase the Fed’s footprint in the financial markets, instead of letting the central bank step away. While the approach might work as intended, the possibility of unintended consequences grows along with the Fed’s exercise of control.
The Fed is a loose cannon with a lit fuse rolling around on the deck. We all know it’s going to go off, we’re just not sure who’s going to get shot.
Rodney
Follow me on Twitter @RJHSDent
August 3, 2015
Oil, Not Greece, Forces U.S. Stocks and Bond Yields to Stumble
Greece learned what happens today when a hungry group of sellers suddenly get a chance to plunge for the exits at once. Its markets re-opened this morning to a near-instantaneous crash of 23%, ultimately closing at a milder 16% lower. Whoever bid that market higher during intraday trading is either really brave, or really stupid!
Funny enough, this didn’t seem to have much impact on U.S. stocks.
The falling price of oil, however, sure did!
West Texas Intermediate crude actually fell below $45 in a 4% slide, and was hovering just above the $45 mark this afternoon. Even Brent slid below $50!
This is getting dangerously close to $42 – what Harry considers the point of no return for the price of oil and the fracking industry!
At least we get a little bit of excitement after a relatively boring week in which the Fed, yet again, left its policy unchanged.
No surprise, as usual. Stocks and bonds barely budged last week as the Fed brought nothing new to the table. Yields on the 30-year U.S. Treasury bond moved between just over 3.0% and about 2.9%. But today, they’re down to 2.85%. And yields on the 10-year bond hit a two-month low at about 2.15%.
Meanwhile, the Dow Jones Industrial Average fell 1% along the slump in energy prices.
At this point, more analysts think the Fed won’t raise rates in September than those that do, so any economic data that could change that could stir volatility in stocks and bonds.
Be on the lookout for Friday’s jobs report, particularly any changes in wage growth. And ahead of that, any news regarding personal income. These are crucial to the Fed’s decision to raise rates or not.
With the clock ticking fast on 2015, and the Fed backed into a corner, I expect bond traders like those who subscribe to Dent Digest Trader will have plenty of opportunities to profit from swings in the interest rate market.
Lance Gaitan
Editor, Dent Digest Trader
Why This Bubble Is Actually WORSE Than the Internet Tech Bubble
I’ve been invited to speak on many media outlets lately, hammering on and on about how this is another bubble. Worse, an artificial one!
A bubble occurs naturally when market forces converge. Trends come together and make the markets so hot that everyone starts piling in.
But it’s one thing when investors speculate on the fundamentals like demographics, rising technology, and falling interest rates. For example, like in 1925 to 1929, and 1995 to 1999.
It’s another when there are very few if any fundamentals at play! Like today.
Analysts still think the bull market’s just in its 5th or 6th inning. Economists continue to assure us the Fed will step in if the market or economy starts to go down.
Pretty soon, they tell us, we won’t even need endless QE or 0% interest rate policies! The economy will boom at a rate of 3%-plus. We’ll hit escape velocity.
Everyone wants to get rich speculating and not have to work again – like going to financial heaven!
This is wishful thinking and denial at its worst! It’s demented! What about supply and demand do these crazed economists not understand?
It doesn’t matter what causes a bubble. A shock in supply like the OPEC oil embargo. A surge in demand for real estate due to the rapid migration of rural Chinese to cities. The boomers in unprecedented numbers hitting their own peak in demand for homes. Falling interest rates shifting investor speculation into the stock market – whether naturally as in the Roaring ‘20s, or artificially as in now. Governments giving away land for practically nothing at super low interest rates like in the 1820s and ‘30s.
The result is always the same: a huge imbalance in demand vs. supply.
If supply gets cut off, prices skyrocket. Demands slows. Alternatives for that commodity or investment emerge rapidly.
If demand gets too high, market forces curb it. When prices reach a height that only the most affluent can afford, the market adjusts back downward.
The point is – extremes in supply and demand always rebalance themselves. That’s the brilliance of the free market system. It regulates everything by itself – without the help of pinheaded central bankers!
That includes the perverse and pervasive stupidity that allows bubbles to continue to extremes. When they escalate, investors get something for nothing. It’s like Santa scrapped the naughty and nice rule and started stuffing everybody’s sock with a huge heap of cash. Everyone’s on cloud nine! No one wants it to end.
Then everyone goes into denial and that further inflates the bubble – aggravating the extreme divergence in supply and demand.
Put the S&P 500 bubble from 15 to 20 years ago on top of today’s and what do you get? A damn bubble!
The trajectories are practically the same. Yes, the recent one started out a little stronger thanks to massive QE coming out of a deeper correction. But the correlation between the final three years is spot on!
Let’s do another! How about the Nasdaq bubble over a similar period compared to the biotech bubble today?
Would you look at that? Another bubble!
And again, no – they’re not exactly alike. But it doesn’t matter! Sure, the Nasdaq bubble had a steeper finish. Clearly. And like the current S&P bubble, the biotech one’s lasted a bit longer. It’s seen massive gains of 593%. The Nasdaq had even higher at 643%!
So what!? Who in their right mind can look at this and say: “today is different?”
In some ways, this one’s actually worse, and not just because it’s artificial.
For starters, between late 1994 and early 2000 we saw the mainstream adoption of some of the most radical technologies ever introduced to the globe. We hadn’t seen anything like it since the auto revolution of the Roaring ‘20s!
This bubble can’t hold a candle to that!
More importantly, the 2007 and 2015 bubble peaks have both occurred during an adverse geopolitical cycle we’ve been wrestling with since 9/11. The 2000 bubble inflated and then burst toward the end of a very favorable geopolitical cycle starting in 1983, when investors increasingly perceived little risk in the world.
Today, there’s risk everywhere! Valuations will never be as high in such a period. So anyone who’s saying this bull market still has some juice because valuations haven’t reached tech bubble levels is kidding themselves! Those valuations were an anomaly!
My research shows that valuations during calm geopolitical periods tend to be twice as high. But the valuations on this bad boy are already higher than every bubble or major bull market peak over the last century. The only real exception is the year 2000. And we’re not far off 1929. And that’s with the poor geopolitical period we’re in!
That includes the major bull market peaks of 1937, 1965 and 2007.
So don’t believe the “this is not a bubble” arguments. This is denial plain and simple – which has happened in every single bubble in history, especially near the top.
Even the German DAX bubble looks similar to the one past. China’s current bubble went up just as exponentially in one year as its last big one did in two.
If it looks like a bubble. Walks like a bubble. And quacks like a bubble. It’s a damn bubble.
Most will be surprised when it pops as every bubble in history has. Don’t be one of them.
Harry
Follow me on Twitter @harrydentjr
August 1, 2015
Be on the Lookout for This One Cancer-Battling IPO
The world’s richest doctor, Patrick Soon-Shiong, is back in the spotlight this week with an IPO of one of his spinoff companies, NantKwest Inc. (Nasdaq: NK).
Soon-Shiong owns a private conglomerate called NantWorks. It maintains a family of subsidiary companies specializing in advanced semi-conductor technology, supercomputing, advanced networks, and augmented intelligence. Each works within a larger scheme to diagnose and treat cancer patients.
But NantWorks is privately held, so before this week, the only real way to get publicly traded access was via a partnership they had with Sorrento Therapeutics (Nasdaq: SRNE), which saw its stock go from under $5 in December, to over $25 this month.
This week, when NantKwest went public, the company offered 8.3 million shares at $25. Investor appetite quickly swelled as shares
July 31, 2015
June’s Housing Spike Signals a Major Contraction
I’ve written about several leading, lagging, and coincident indicators for the economy over the last year.
Stocks, real estate, jobs, GDP – each says a different thing about the economy. People get confused by all these various indicators because they don’t understand the differences between them.
For example, how the hell do jobs keep growing, while retail sales go nowhere?
Some of the indicators are either lagging behind our economy’s path, or are so cracked up on financial drugs they’re no longer a reliable forecast of the future.
Others paint a clearer economic picture. But I warn you – it isn’t a pretty one!
Leading indicators are things like the stock market that normally look ahead for signs of growth or decline. They used to predict economic movement a whole six to nine months in advance – hence, a “leading” indicator.
But with artificial QE driving the economy, they’ve been leading by just two months at best. If that. It’s like offering a lift to a drug addict you meet on the highway and accepting directions from him. It’s no longer a reliable leading indicator – more of a coincident one thanks to Fed manipulation of the economy.
Then we have a host of coincident indicators that have been pretty much flat at best.
GDP still sucks at 1.45% for the first two quarters of 2015, lower than the mediocre 2% of the past six years. It was expected to be 3%-plus.
Durable goods, manufacturing output, corporate earnings, and exports aren’t much better.
And retail sales have been god-awful since last November – signs that the economy is slowing as we predicted.
But at least these indicators are more reliable – just reliably bad for the future.
Finally there’s the lagging indicators like hiring and job growth. But like its name suggests, they show where an economy has been – not where it’s going.
Businesses have been slow to hire since the economic downturn and waited for signs of more sustainable growth before making such major long-term commitments.
Though lately, jobs growth has been better. But this always happens into the early stages of a downturn. Businesses continue to hire until the next slowdown grits its teeth. By then, it’s too late.
Real estate developers might be the worst example of this. They build like crazy… freak out when things crash… wait until an upturn is obvious… then build too much again. Like clockwork.
Case in point: last month housing starts took a 9.8% jump. Huge! Unexpected!
But get this – the jump was almost entirely in multifamily and rental properties.
Those are in their prime now, but my demographic research shows demand for them will fall not too far ahead. That’s because the first wave of the echo boom generation is beginning to peak in its rental demand and will hit the summit between 2017 and 2018. After that, it’ll drop for seven years. Oops. Building too late again.
This chart shows how multifamily permits, the most leading of real estate indicators, tend to spike before a major contraction – every time!
That’s what happens. Real estate developers build the most when trends look the best – near the top – and/or when they want to lock in their loans at lower rates, fearing a rise in interest rates as the Fed starts tightening. And long-term rates have been rising over the last year, which is also a bad sign ahead.
I watched condos go up in Miami for two years after the great bust there. Everywhere there were empty condos. This lasted for years until the next bubble. And oh will that one burst too.
We’re in the midst of the last great bubble in real estate we’ll see for a long time. I promise you.
Think about what will happen as developers overbuild multifamily and apartment units and their rents and sales value flop in the coming years.
Imagine what that’ll do to single-family homes which have already struggled to come back. They’ll fare even worse in the coming downturn.
Don’t follow most of the classic leading indicators promising growth ahead. They don’t lead anymore.
Don’t listen to economists basing their growth projections on lagging indicators like real estate and job growth. They’re behind the eight ball.
Instead, look at the coincident indicators like retail sales that are saying a slowdown is already in progress…
Expect the second half of 2015 to be a bit slower than expected, again (maybe more)…
And expect 2016 to unveil a slowdown more powerful than QE can fight off as the more affluent baby boomers finally tail off sharply in their spending like the average household did in 2008.
The next perfect storm is building. Expect the great crash ahead to be worse than the one in 2008.
In fact, I suspect we’ll start to see a dramatic slowdown in stocks, and the economy to follow, by September of this year.
Stocks will crash first (as in China recently). Then real estate and jobs – the lagging indicators – will follow.
This should be the worst crash of our lifetimes, especially after such an extended debt and financial asset bubble sustained by artificial QE and money printing.
If you haven’t begun preparing your strategy to survive the financial meltdown ahead, it’s not too late to get your ticket for the Irrational Economic Summit in September.
We have an oil expert, a shorting expert, a demographic expert (me), a number of world-renowned economists, and several other financial geniuses we believe can help you devise a strategy to come out of this downturn virtually unscathed.
More and more people are sounding the warning bell so I suspect this event could sell out. Reserve your seat now before they’re out.
Harry
Follow me on Twitter @harrydentjr
July 30, 2015
GDP: 2.3% Is Pathetic, No Matter What Anyone Else Says
I’m happy to report that I’ve never been in prison. I can only imagine that the first few days and weeks are a terrible period of adjustment. There is no freedom, you cannot choose when to go outside or when to turn the lights off at night, and the food, I’m guessing, is awful.
But after awhile the newness probably wears off. It’s still jail of course, and people still go through your mail, but you fall into a routine that becomes the basis of your daily life. You acclimate.
July 29, 2015
Investment Strategy: Don’t Over-Rely on Stocks!
There are plenty of misconceptions about investment systems. It’s an esoteric field, so those on the outside tend to think of systems as mysterious, robot-driven, “black box” investment advisors.
Really, though, it’s not that complicated (or mysterious).
A systematic investment strategy starts with an idea… which turns into a hypothesis… which is then proven or disproven.
The idea can be as simple as: “I think cheap stocks beat expensive stocks in the long run.” (That’s the basis of value investing, and countless studies have proven it worthwhile.)
Of course, a keen observation about the markets can also be applied on a one-off basis. Take Kyle Bass – founder of Hayman Capital in Dallas – who, in 2006, created a hedge fund to exploit a single hypothesis: that the U.S. subprime mortgage market would implode.
That market did implode. And Kyle Bass was spot on and made a ton of money. But he’ll need to come up with a new great idea for his next fund, or “trade of a lifetime.”
That’s where a systematic investment strategy differs. Unlike Mr. Bass’ exploitation of a rare event, systematic strategies aim to exploit events that occur again and again, with a good deal of regularity.
Cliff Asness of AQR Capital Management (a quantitative/systematic hedge fund) explained the concept quite well when he was interviewed by Steve Forbes. He said (paraphrased):
With systems, you’re leveraging an idea… that cheap always beats expensive, or that low-volatility always beats high-volatility. And you’re applying that idea across hundreds of symbols… so that, in the long run, you’re exploiting the mathematical edge that’s contained in your idea.
To me, that’s the essence of a system. And that’s what I aim to do with
The Fed’s Not Stupid
July 28, 2015
Why the U.S. Treasury Really Took Over Fannie Mae and Freddie Mac
The year 2008 was full of nasty surprises. One of the biggest was the government takeover of twin mortgage giants Federal National Mortgage Association (FNMA, or Fannie Mae) and Federal Housing Lending Mortgage Corporation (FHLMC, or Freddie Mac).
The takeover happened almost overnight. Homes values were sinking fast. Between the two companies, they guaranteed most of the $7 trillion of home mortgages outstanding. At one point, almost 30% of homes with mortgages were underwater.
The situation seemed dire. So, the U.S. Treasury “offered” to lend the mortgage companies tens of billions of dollars, which later became an open-ended line of credit.
The Treasury demanded three things in exchange.
The companies would go into conservatorship – meaning they could continue to operate, but only with the Treasury there to offer support.
They would issue the Treasury $1 billion in preferred stock with a 10% dividend.
Finally, they’d issue warrants for up to 79% of the companies to the Treasury.
The boards had no choice. They agreed and were promptly dismissed.
All told the U.S. Treasury extended $187.5 billion in loans to Fannie Mae and Freddie Mac. Part of that was just so they could make good on their required dividend payment back to the government.
When housing turned up again, these two companies started earning profits. By the end of 2014 they had paid the U.S. Treasury almost $230 billion, or $40 billion more than the loans they’d received.
But here’s a little-known part of the deal – the mortgage giants still owe the U.S. Treasury the original $187.5 billion in loans. The government does not consider any of the $230 billion as repayment of debt or retirement of shares outstanding.
All of it is simply profit to the government. How convenient.
Now that it effectively controls the two entities, the government can decide how to treat the money that rolls in. Since it’s shown little interest in letting go of the cash cows, it will likely continue holding that $187.5 billion over their heads.
Treasury officials claimed that since they hold almost 80% of the stock through warrants which have not been exercised, they are free to change whatever terms they want. In fact, in 2012 the government changed the nature of the bailout from a payment of interest at a set rate to a sweep of all profits earned.
So now the two companies reconcile their books each quarter and cut the U.S. government a check for whatever used to pass for profit.
In the first quarter of 2015, Fannie Mae earned $1.9 billion and Freddie Mac earned $746 million. While $2.65 billion per quarter won’t make or break the U.S. government, an extra $10 billion per year can fund a fair number of pet projects.
With a cash flow like that, the government won’t take steps to shut them down, even though that’s exactly what they said they would do.
When the government first took over the companies, part of their stated purpose was to wind down their operations in an orderly fashion. The goal was to have private companies pick up the slack in the mortgage business once the economy recovered.
But there’s a problem with this goal. Right now Treasury officials claim that private lenders aren’t up to the task because they would charge borrowers higher interest rates than Fannie and Freddie.
Well, of course they would! Banks don’t hold onto the mortgages. They bundle them and sell them to investors.
When the securitized loans are backed by people paying their mortgages, then there’s some risk of non-payment.
When the securitized loans are backed by two wholly-owned government subsidiaries, which are in turn backed by the full faith and credit of Uncle Sam, then the investments are seen as risk-free.
This will never change. Which means the private sector will never be up to the task!
Besides, under the current model, the U.S. Treasury can just sit back and collect mailbox money once a quarter. Can’t beat that.
If all of this sounds fishy, that’s because it is.
