Wednesday, September 21, 2016
I called the Wells Fargo ethics line and was fired
Millions of phony accounts. Fake bank card PIN numbers. Fictitious email accounts.
Wells Fargo admitted to firing 5,300 employees for engaging in these shocking tactics. The bank earlier this month paid $185 million in penalties and has since apologized.
Now CNNMoney is hearing from former Wells Fargo (WFC) workers around the country who tried to put a stop to these illegal tactics. Almost half a dozen workers who spoke with us say they paid dearly for trying to do the right thing: they were fired.
Ruined my life," Bill Bado, a former Wells Fargo banker in Pennsylvania, told CNNMoney.
Bado not only refused orders to open phony bank and credit accounts. The New Jersey man called an ethics hotline and sent an email to human resources in September 2013, flagging unethical sales activities he was being instructed to do.
Eight days after that email, a copy of which CNNMoney obtained, Bado was terminated. The stated reason? Tardiness.
HR official describes 'retaliation'
Retaliating against whistleblowers is a major breach of trust. Ethics hotlines are exactly the kind of safeguards put in place to prevent illegal activity from taking place and provide refuge to employees from dangerous work environments.
Wells Fargo CEO John Stumpf made precisely that point on Tuesday when he testified before angry Senators.
"Each team member, no matter where you are in the organization, is encouraged to raise their hands," Stumpf told lawmakers. He mentioned the anonymous ethics line, adding, "We want to hear from them."
But that's not the experience of some former Wells Fargo workers.
One former Wells Fargo human resources official even said the bank had a method in place to retaliate against tipsters. He said that Wells Fargo would find ways to fire employees "in retaliation for shining light" on sales issues. It could be as simple as monitoring the employee to find a fault, like showing up a few minutes late on several occasions.
"If this person was supposed to be at the branch at 8:30 a.m. and they showed up at 8:32 a.m, they would fire them," the former human resources official told CNNMoney, on the condition he remain anonymous out of fear for his career.
CNNMoney spoke to a total of four ex-Wells Fargo workers, including Bado, who believe they were fired because they tipped off the bank about unethical sales practices.
Another six former Wells Fargo employees told CNNMoney they witnessed similar behavior at Wells Fargo -- even though the company has a policy in place that is supposed to prevent retaliation against whistleblowers. CNNMoney has taken steps to confirm that the workers who spoke anonymously did work at Wells Fargo and in some cases interviewed colleagues who corroborated their reports.
"I endured harsh bullying ... defamation of character, and eventually being pinned for something I didn't do," said Heather Brock, who was fired earlier this month as a senior business banker at a Wells Fargo branch in Round Rock, Texas.
One such former employee was fired after flagging issues directly to Stumpf, according to Senator Bob Menendez.
At the Senate hearing, Menendez read the New Jersey woman's 2011 email to Stumpf, where she described improper sales tactics she felt were "wrong."
"Did you read that email?" Menendez asked Stumpf.
"I don't remember that one," Stumpf replied.
"Okay, well she was fired. ... So much for the safe haven," Menendez said.
Several senators spoke about the plight of the mostly 5,300, low-level employees who were fired related to the scandal.
The firing certainly took a huge toll on Bado's life. It put a permanent stain on his securities license, scaring off other prospective bank employers. Today, the New Jersey man's house is on the verge of being foreclosed on and he's working part-time, at Shop-Rite.
"You wonder where the justice is," Bado said.
Ken Springer, a former FBI agent who runs a firm that offers a whistleblower hotline service, was alarmed by the allegations made by former Wells Fargo employees.
"That's retaliation. It's a big problem -- and a perfect example of what shouldn't happen," Springer said. "It looks like there's been a terrible breakdown of checks and balances at Wells Fargo."
In response to CNNMoney's report, a Wells Fargo spokeswoman said: "We do not tolerate retaliation against team members who report their concerns in good faith." She emphasized that employees are encouraged to immediately report unethical behavior to their manager, HR representative or 24-hour ethics line.
'Excessive tardiness' eight days after HR email
Wells Fargo confirmed to CNNMoney that Bado had worked there. However, the bank declined to comment on why Bado left and and on the ethics complaint with corresponding report number he cited in emails. "Everything submitted to the EthicsLine is investigated," a Wells Fargo spokeswoman said.
While ethics complaints are supposed to be confidential, documents show that Bado did speak out before he was fired. On September 19, 2013, Bado wrote an email to a Wells Fargo HR rep and copied his regional manager, where he detailed improper sales tactics.
Documents show Bado was fired -- for "excessive tardiness" -- just eight days later.
"I have been asked on several occasions to do things that I know are not ethical and would be grounds for discharge," Bado said in the email to HR.
He said a branch manager on "many occasions" asked him to send out a debit card, "pin it," and enroll customers in online banking -- "all without the customers (sic) request or knowledge." Those are precisely the same practices that regulators fined Wells Fargo for three years later and that senators grilled the bank over this week.
Lose, lose situation for Heather Brock
Brock, the business banker from Texas, told CNNMoney she experienced a similar situation. The 26-year-old single parent of two young boys was fired soon after she contacted the company's ethics line about illegal sales practices she witnessed.
Wells Fargo also confirmed Brock used to work at the company but declined to comment further.
Brock was fired earlier this month, with Wells Fargo accusing her of falsifying documents -- a charge Brock emphatically denies. Brock said the company bullied her into admitting she did something wrong.
A current Wells Fargo employee who works in Brock's branch vouched for her version of events.
"That's really scary when you're with a big corporation like this and HR doesn't have your back," said the current employee, who wished to remain anonymous so as not to get fired as well.
Brock is hoping her story forces meaningful change at Wells Fargo.
"You lose if you do complain and you lose if you don't. What does a powerless employee do?" Brock said.
-- To reach the author of this article email Matt.Egan@cnn.com
Friday, September 16, 2016
88% Probability We Just Entered Recession
by Tyler Durden
Sep 16, 2016 12:30 PM
My last piece “The Matrix Exposed” generated a bit of a stir. And as per usual the PhD’s had some fairly colourful things to say to me regarding the notion that more money and more credit may actually stall an economy. But look I’m not trying to be offensive to anyone. I’m simply making a case that when consumer credit becomes the basis of growth, well you have a real problem. And that is a pretty reasonable argument even without the hoards of data backing it up.
But so allow me an attempt to mend some bridges. Let’s start by looking at the various existing frameworks that drive economic policy. We have Monetary policy (the banks), Fiscal policy (Congress), Microeconomic policy (Corporations). So let’s look at each.
Let’s begin with Fiscal policy.
The very first issue that should jump out to everyone is that Congress has been utterly ineffective for almost 2 decades now. That is because the partisanship has become so intense that there simply seems no room for compromise in an effort to get any reasonable piece of legislation done. What we are left with is a slew of outdated fiscal policies. Perhaps most detrimental is a corporate tax rate nearly twice that of many other developed nations.
The problem with relatively (to other nations) high corporate tax rates is it means that any domestic investment, everything else equal, has a significantly longer breakeven point. Said another way, the return on domestic investment is much lower than the return on foreign capital investment (ceteris paribus). This is a very intuitive concept, easily digestible by all. The implication is that the relative level of corporate tax rates here in the US incentivize corporations to invest elsewhere.
And corporate tax is now a catch 22 because government transfers have become such a robust part of the societal fabric. We need the high corporate tax level for the transfers but the transfers are in part a result of the high corporate tax level. This quickly becomes a highly sensitive political point of dispute. And again with Congress completely locked down by partisanship there is essentially zero probability of any significant legislation (either tax cuts or spending initiatives) being passed anytime soon. And so Fiscal policy is off the table.
Now let’s look at Monetary policy and the Fed.
If you follow my research and writing you’ll know that I’m not the Fed’s biggest fan. That said, if we are going to have a Fed it should do what it can to be beneficial to the economy. But so how does the Fed affect the economy? Well it does so through interest rates and money supply. Now the major problem with monetary policy is that it attempts to stimulate economies by incentivizing capital allocators (corporations) to be productive. It does so by essentially dictating the cost to borrow, which flows through to breakeven point and thus return on investment. It also increases the effective money supply in the economy (through credit i.e. fractional reserve) in an effort to kickstart a demand side that then incentivizes capital allocators (corporations) to be productive.
By being productive I mean initiating domestic capital investment, which should lead to jobs and thus demand via improved incomes; and the boom cycle begins. And the Fed had some success historically. But Fed/Monetary policy has been ineffective during its latest recovery program post financial crisis. Why? Well when we look at things like corporate debt levels we see that Fed easing did incentivize corporations to borrow but what they did with that capital countered the Fed’s objective and this is the main problem with monetary policy. It is indirect and requires allocators to play along and this time they didn’t.
And so when we look at what corporations did with that money we find the broken mechanism of monetary policy.
Rather than initiating productive domestic investments a significant amount of those funds went to dividends, buyback and foreign capital investment. None of which hit on the Fed’s objective for easing monetary policy. And so while the Fed may have been genuine in its attempt to stimulate the domestic economy, it was reliant on corporate microeconomic policy to follow suit. And that simply didn’t happen. Let’s visualize this story with real data.
Here’s the Fed’s implemented monetary easing post financial crisis.
Next chart shows that Fed policy did incentivize capital allocators (corporations) to borrow.
Next chart shows that corporations have been increasing dividends as their borrowing increased.
Next chart shows that corporations have taken buybacks to record levels as borrowing increased. If you summate divs and buybacks you’ll note it is more than 100% of net income.
Next chart shows the increased debt is used almost exclusively to buy back shares (cash distribution – the most inefficient use of capital).
Next chart shows that real private domestic business investment peaked in Q1 ’15 at a much lower level than where it was in the late 1990s and has again been contracting for the past year despite the most extreme monetary easing in the history of the Fed.
This means that the significant increase to borrowing that was incentivized by Fed policy in order to stimulate productive domestic investment actually went to the most inefficient use of capital, i.e. cash distributions. And that means the Fed’s monetary policy objectives failed to be realized.
Notice in the above chart that a recession (grey verticals) immediately followed every sharp drop in real net domestic business investment (recession was delayed in the 80’s but we ultimately succumbed to recession before increasing). However, today we are asked to believe record equity valuations are warranted based on near/medium term expectations despite an 88% probability that we have just entered a recession? Well that’s a topic for another day. Now what happens at the microeconomic level when capital is misallocated?
Next chart tells us exactly what happens. Return on investment and balance sheets deteriorate. So we add risk while reducing return. An investing 101 No – No.
The result of perpetually misallocating capital is that everyone dies in the end. And look I have sympathy for CEOs. In fact, I’ve given CEOs a pass on criticism. It is because CEOs are simply pawns in the system. They are beholden to what investors demand. And investors want returns.
Investors today, with median holding periods now less than 60 days, don’t care if a CEO can provide return through expansion of operations or contraction (raiding the balance sheet). For the past 8 years CEO’s have only been able to provide investors a return through contraction (as a result of a damaged demand function) and so they have done so. The problem is that while this is generally ok on a short term basis as an individual firm awaits its demand universe to correct, things are different this time. Demand isn’t coming back because all firms have implemented the same survival policies, which become destructive to both demand and productivity on the macro level.
The result is that these corporate microeconomic policies of capital misallocation (implemented in an attempt to appease investors) are negating all of the intended benefits of Fed policy. This means we are fully reliant then on fiscal policy which, as we already discussed, is off the table for as far as the eye can see.
And so even if we accept that all existing economic policy frameworks (fiscal, monetary, microeconomic) really do have the very best of intentions we are still effectively dead in the water.
Thursday, September 15, 2016
The Smartest Market in the World Isn’t Buying the Bounce
Sep 14, 2016 9:11 AM
One of the most critical ideas you need to understand as an investor is that while the media focuses on stocks, they are the usually the last asset class to “get” major changes to the financial system.
This is simply due to liquidity and size of markets.
1. Globally, the stock market is about $69 trillion in size, trading about $191 billion in shares per day.
2. The bond markets are well north of $140 trillion, and trade about $700 billion in volume per day,
3. The currency markets are unmeasured as every currency trade is ultimately a pairs trade (meaning to buy one currency you have to sell another). However, we do know that the currency markets trade $5.3 trillion in volume per day.
Put another way, the currency markets trade over 26 times more volume than the global stock market every single day. As such they are the most liquid, sensitive markets in the world.
So major changes in the markets first hit in the currency markets. And the key item to watch is the $USD.
The US Dollar is coiling tighter and tighter into a triangle pattern. If we get a breakout to the upside, the next target is 97.
Historically, spikes to this level have resulted in a stock market meltdown soon after.
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In it, we outline the coming crash will unfold…which investments will perform best… and how to take out “crash” insurance trades that will pay out huge returns during a market collapse.
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Sunday, September 11, 2016
Gary Shilling: Get Defensive
Sep. 10, 2016 11:14 AM ET
By FS Staff
Markets are hanging on every pronouncement from the Fed, and rate hike expectations have repeatedly been pushed back. While many still expect the next move to be up, Gary Shilling, financial analyst and author of The Age of Deleveraging, recently told Financial Sense that he thinks the Fed won't be able to raise rates. Instead, he expects to see rates fall.
Here is an abbreviated version of his interview, which aired last weekend on our podcast (see An In-Depth Discussion With Dr. Gary Shilling for the full audio).
When people don't believe a bubble exists, that's exactly when the possibility for one is greatest, Shilling explained. For example, in the case of the housing market early last decade, he said, people were convinced the market would never correct.
"Of course, that is when bubbles break," he said. "It's what's going on now. It's a potential bubble."
With interest rates at historic lows in the US, and with negative rates in Europe and Japan, we're seeing people assuming all kinds of risk, he added. Individual investors to pension funds have been encouraged to move out on the risk curve because the alternative is poor returns.
It seems that people are abandoning hedge funds and moving into real estate, Shilling noted. Of course, this creates the risk that anything investors chase will be overdone, leading to still more bubbles forming.
"Not Going to Be Pretty"
Instead of focusing on nominal rates, we need to look at real interest rates, adjusted for inflation, Shilling argued. Under that rubric, we see that rates have been negative several times in history.
"When we get enough perspective-we're going to find that this whole situation with negative nominal interest rates and with very aggressive monetary policy-has not done much for economic growth, (along with) all the confusion this has created," Shilling said.
We have a situation where most people in Europe and North America have seen declines in their purchasing power for over a decade, Shilling said, and he thinks voters are furious at this point, which partially explains the populism sweeping the Western world.
"I wish we could pull out the crystal ball and see what is going to come out of this," he said. "I rather suspect that it's not going to be pretty to go through."
Because of the low inflation and deflation that we're seeing, Shilling still expects that his call for still-lower rates in certain US Treasuries to come to fruition. Inflation expectations and safe-haven buying are the driving forces here, Shilling stated, and he is looking for 1 percent on the 10-year and the 2 percent on the 30-year Treasury note.
This won't deter investors, Shilling noted, as interest rates can go lower or even negative, and he added that he owns Treasuries for capital appreciation, rather than yield.
What's the Fed Going to Do?
In a recent letter, Shilling said the Fed's next move will be to lower interest rates.
"The Fed has had a very poor record in forecasting through this expansion," he noted. "They have consistently over-estimated economic growth and underestimated inflation."
Though the Fed did raise rates slightly last year, he thinks this has more to do with their need to retain credibility. With ongoing global economic weakness and signs growth is slowing yet again, he thinks the overall atmosphere is more conducive to reducing rates rather than raising them.
Ultimately, central bankers are too mired in an academic mindset, Shilling said and are out of touch with what's going on. Fundamentally, he thinks the Fed's use of forward guidance is creating more distortions than it's helping to resolve.
Additionally, Shilling argues that the published unemployment figures are distorted, and real unemployment is probably closer to 11 percent, because of the declines in the number of people looking for work.
Ultimately, he expects to see "helicopter money" in the form of both monetary and fiscal stimulus taking hold. With the overhang of debt globally and the chance for more fiscal stimulus, Shilling thinks we'll see more slow growth as a result. If we see the cost of debt increase, he added, we might be facing serious issues, which further constrains the Fed's course of action.
"(A huge increase in interest rates) in itself can upset the apple cart," he noted. "If that happened, I think we would have a lot more important things that we would need to worry about."
Shilling advocates holding Treasuries and cash right now in a defensive stance. Ultimately, he expects the next move on the Fed's part is to lower, and not raise, interest rates.
This Is The Reason Gold Dropped On Friday And Here's What Investors Should Do About It
Sep. 11, 2016 12:20 AM ET
Speculative traders increase their positions to close to record highs on anticipated Fed dovishness.
Recent Fed speak has been pretty hawkish and we believe that the Fed will raise rates in September.
This is further supported by a surprise Fed speech on Monday that seemed to cause markets to drop.
While the picture is bearish short term for gold, we think fiscal stimulus and much higher gold prices are on the way.
The Latest COT Report Shows Traders…
The latest COT report showed a massive build in speculative long positions as traders seemed to think that the weak data is not going to be strong enough to allow the Fed to hike rates when they meet in a few weeks. Much of this speculative build may have been reversed by Friday as traders started to once again change positions on a possible Fed hike based on the recent "Fed speak" and a previously unannounced speech by the central bank's most dovish official, Governor Lael Brainard.
Regardless, as of the Tuesday COT report close, we are again approaching all-time record levels of net long speculators in gold. We will give our view and will get a little more into some of these details but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
About the COT Report
The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.
The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.
There are many different ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the exports on it. What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
This Week's Gold COT Report
This week's report showed a massive increase in speculative gold longs and a good-sized decrease in speculative shorts with longs increasing by 31,805 contracts and shorts closing out 9,037 contracts on the week. Investors should note that the COT report's close is Tuesday, so this data doesn't include the late week swoon in gold which caused the metal to drop slightly on the week despite the strong Monday open.
One thing that is interesting is despite the 40,000 contract increase in the net speculative position, gold was only able to muster a 1.45% gain for the week. We would have expected a bit more of a gain in gold based on that sort of build in net longs - which tells us that other gold players (think physical gold holders and Eastern retail buyers) aren't as bullish.
Moving on, the net position of all gold traders can be seen below:
Source: Sharelynx Gold Charts
The red-line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, speculative traders whom have pulled back over the past few weeks significantly increased their positions back close to all-time high levels. Currently, those positions sit at a net long position of around 279,000 contracts - only a stone-throw's away from the all-time high seen in early July.
As for silver, the action week's action looked like the following:
Source: Sharelynx Gold Charts
The red line which represents the net speculative positions of money managers, saw a slight increase similar to gold but it was clearly not as large of a rise. Speculative silver traders simply weren't as bullish on silver for the week as they were gold. This may explain silver's underperformance towards the end of the week and we're very cautious on silver right now as we do see the potential for much more downside if speculative traders cannot pick up the slack for retail investors.
Friday's Market Plunge and Our Take
It seems every week there is some Federal Reserve related event that is affecting markets. Last week it was Yellen's Jackson Hole speech, this week we got some late fireworks as evidently a simple press release announcing that a Fed governor will be delivering a speech the following week is enough to spark a selloff in Treasuries, which spread to the rest of capital markets.
The unorthodox thing was that this speech was rather hastily announced the day before the Fed's pre-meeting blackout period, which seems to us a bit unusual. Additionally, since she is a noted Fed dove, the rumors were building that it was going to be more hawkish to increase market expectations of a rate hike (remember the Fed doesn't want to hike rates to an unprepared market).
Peter Hooper, chief economist at Deutsche Bank Securities, wrote a note to clients on Thursday with the following:
As a dovish member, Brainard would carry a lot of credibility delivering a more hawkish message. It could be a coincidence, but it could also be an important opportunity for the Fed to raise market expectations and give the FOMC more room to maneuver at the September meeting. After San Francisco Fed President John Williams failed to budge the market with a fairly hawkish speech Monday evening, we assumed it would likely take an interview with Yellen to turn market expectations about the September meeting around, should they seriously be considering a rate hike. Certainly a good case can be made for moving "soon" (in September) given: (1) payroll growth in recent months now averaging in excess of where the Fed wants to see it, (2) generally improving signs for consumer spending and overall GDP growth (the latest ISM notwithstanding), and (3) relatively favorable financial conditions. I had moved my odds on a September hike to the mid-40s in the wake of recent Fedspeak, but not higher because there is still some room for improvement in the inflation picture. But this development re. Brainard has to place the probability very close to 50%.
We think he's probably dead-on, and as we stated last week, we believe the Fed does want to raise interest rates in September. This part of what we believe is a significant narrative change in the way governments are going to battle this seemingly endless economic malaise around the world - less monetary stimulus (i.e. zero interest rates) and more fiscal stimulus (government spending).
The Narrative Shift
We believe the narrative is changing here as we start to see the signs of a switch in strategy by governments and central banks from monetary stimulus to fiscal stimulus. We don't think it was a surprise that the ECB let down bond markets by not announcing the need for further stimulus - it's clearly central bankers working in unison as the realization that ZIRP and NIRP are not working.
What that means for investors is that we believe rates are going to begin to rise - slightly but move up nevertheless and the Fed will probably begin the process when it meets in September. Monday's speech by Ms. Brainard will be a key thing for investors to monitor as if she's hawkish then it's a clear signal from the Fed to markets that September is a "live" meeting and rates will probably be moving up.
Here's where it's important to note the narrative shift and see keep the big picture in mind. For the past few years markets have intensely monitored the Fed's interest rate policy as low/negative rates meant loose money, while rate tightening meant the Fed was going to be ever so slightly less accommodative. So if you've been tuned into this show over the past few years then that would be bad for gold. But here's where we believe the narrative is shifting.
While the Fed wants to raise rates, they don't believe the economy isn't very strong at all and thus if they're going to tighten money on the interest rate side there has to be a commensurate loosening somewhere else to balance or even outdo the rate increase. That "somewhere else" is fiscal policy.
As we've stated before, both presidential candidates are promising to significantly increase infrastructure spending to the tune of hundreds of billions of dollars to fight this global economic weakness. It is not just them though as economists, politicians, and governments are all signaling the need for greater fiscal stimulus and spending - the calls are getting louder and louder.
What That Means for Gold Investors
Fiscal spending is actually good for gold investors as it's a key ingredient for classic monetary inflation. While we believe we're already seeing inflation in paper asset prices, replacing monetary stimulus with fiscal stimulus will move inflation from Wall Street to Main Street as it tends to be much more widespread.
But we are not there yet - first we have to see the narrative fully change.
Right now, we believe markets (including the gold market) are fully focused on the old narrative and tightening of money via rising interest rates. Pair that with the large speculative net long position in gold and we have the potential for significant short-term weakness. But we don't believe that will last for long as markets begin to realize fiscal spending is on the way and is much more of an inflationary multiplier than a 0.25% rise in interest rates.
Based on that theory, we believe investors should expect more short-term gold weakness until the Fed makes it move in September, which we think is a likely increase in rates. But they shouldn't be completely out of gold (or worse shorting it) because we have no idea when the market will realize that fiscal stimulus is on the way - don't get stuck picking up those pennies in front the fiscal bulldozer.
So in summary, investors should keep their core positions in the gold ETF's such as the SPDR Gold Trust ETF (NYSEARCA:GLD), ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), iShares Silver Trust (NYSEARCA:SLV), and miners such as Randgold (GOLD) and Barrick Gold (NYSE:ABX). Also, those investors who followed our advice and sold out of some of their gold trading positions, now would be the time to start nibbling away and buy some of the old positions back. Keep in mind we don't believe the real buying should be done until AFTER the September Fed meeting until we become more certain the Fed is going to start raising interest rates and some of the speculative traders have sold out of their record-high positions.
Disclosure: I am/we are long SGOL, SIVR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
The Gold Miner Rally Is On Borrowed Time
Sep. 11, 2016 5:49 AM ET
Gold prices are largely a function of real interest rates.
The idea that the Federal Reserve is on hold is the main driver of this appreciation in gold prices and mining stocks.
There will likely be one interest rate increase this year and at least two in 2017 as the economy improves. Markets are not discounting this.
Negative rates in Japan and Europe are bearish for gold as it creates a tailwind for the U.S. dollar which trades inversely with gold.
I expect gold prices to fall back to the $1,000 an oz level or below. Inflation adjusted gold prices are very elevated still.
Gold prices are largely a function of expected real interest rates. This is the difference between interest rates and inflation. Rising real rates are negative for gold, while declining real rates are gold price positive. As one can see in the charts below the 10 year inflation indexed treasury bond depicts real interest rates. When real rates are rising gold has fallen and when real rates decline, gold prices appreciate. There is an inverse correlation. I believe the upward adjustment in interest rates will be quicker and more substantial than any upward movement in inflation pushing gold prices lower in the near term.
The driver behind the gold price rally and decline in real rates since the Federal Reserve lifted off the zero lower Federal Fund Rate bound is the idea that the Fed is on hold. During the end of 2015 markets and the FOMC were anticipating three or four rate hikes over the course of 2016. Market turmoil and economic data deterioration caused the Fed to pull back from raising rates. Gold responded appropriately and prices rose on that fact, as treasury yields tumbled. I think it is overdone though. Markets have become excessive and overly dovish pricing out rate hikes through 2017. According to CME Group and the Fed Funds futures market there is only a 43% probability of one rate hike by June 2017 and a 46% probability of a December increase. This would require major deterioration in the U.S. economic data or a recession. I find this unlikely. My baseline scenario is near term moderate improvement in the U.S. economy, which will allow the normalization of monetary policy. I expect one rate hike this year, potentially in September and two or three over the course of 2017.
Many people attribute the gold price rally to negative interest rate policy globally. I disagree with this. Negative interest rates from the ECB and Bank Of Japan are in fact bearish for gold. One of the transmission mechanisms of negative rates is depreciating a currency making exports more competitive. If Japan or the ECB were to push rates further into negative territory, this would be bearish for gold (NYSEARCA:GDX) (NYSEARCA:GLD) (NYSEARCA:GDXJ) (NYSEARCA:NUGT) (NYSEARCA:JNUG) (NYSEARCA:DUST). Gold typically trades inversely with the U.S. dollar. A rising U.S. dollar index is a likely scenario as Japan and Europe take further measures to stimulate their economies.
I cannot argue with the reality that gold should have rallied through H1 of this year as real rates declined and the Fed continued to stay on hold. Though, I may question the sustainability of it. How long can we assume the Fed is simply on hold? This is especially true given recent comments from FOMC officials. They have made it very clear that they intend to raise rates preemptively before inflation accelerates, as a later and steeper rise in rates could create a recession. The longevity of the economic expansion would be extended from raising rates earlier rather than later. This is the Fed's thinking. Rising interest rates with inflation staying stable creates rising real rates and therefore declining gold prices.
The only scenarios that can save gold at this point would be a recession leading to QE4/negative rates in the U.S. or a sudden surge in inflation. I find both unlikely in the near term. I am quite optimistic on the U.S. economy. We have debt to income ratios at 30 year lows along with repaired household balance sheets. This is a good signal for credit growth and lending/borrowing. Remember the Federal Reserve which is of extreme importance is a central bank. They set interest rates or the price of credit. The amount of credit growth is arguably the most important driver in an economy. It is very strong in the United States, unlike Japan. Is it a coincidence that Japan's economic stagnation since 1990 coincided with stagnant credit growth? The U.S. financial crisis, deleveraging and recovery also happened with a decline and subsequent recovery in credit growth as shown in the charts below. Consumer credit came in hot yesterday for the month of July and the previous month was revised higher. It has recovered strongly since 2010 and is at an all time high. This will tempt the Fed to raise rates here soon.
In conclusion, the interest rate expectation pendulum has swung too far. While gold bulls have been correct this year, I think it is unsustainable to expect the Fed to be on hold indefinitely which is essentially what the markets are pricing in. If you look at how gold is trading any piece of good economic data or hint of a rate hike is bearish for gold prices. Inflation adjusted gold prices are historically at a high level and there is plenty of downside price potential.
Disclosure: I am/we are long DUST.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Is Deutsche Bank The Next Lehman Brothers?
Sep. 10, 2016 12:12 PM ET
By Valentin Schmid
During the financial crisis of 2008, Deutsche Bank AG (NYSE:DB) was one of the few banks that proudly refused to take bailout money from the government. Eight years later, its stock price is down almost 90 percent from the peak, one of Europe's biggest banks is staring into the abyss.
Similar to Lehman Brothers in 2008, very few, if any, analysts think Deutsche Bank could go bankrupt. Although investment bank Citigroup rates the stock "high risk," it thinks the company is worth 13 euros ($14.3) per share, or 18 billion euros in total ($19.8 billion).
Reggie Middleton, CEO of the fintech (financial technology) company Veritaseum, was one of the few people who saw the risk and warned about the collapse of Lehman Brothers and Bear Stearns on his research website BoomBustBlog.
Today, he thinks Deutsche Bank poses a similar risk to the world financial system, which was almost brought to its knees by the failure of Lehman, although he says central banks and governments won't let the situation spiral out of control this time.
"Deutsche Bank is the equivalent of an American B-rated horror movie. Not A-rated with the fancy stars like Robert De Niro," he said in an interview with Epoch Times. "I read the Deutsche Bank balance sheet, and I say Deutsche Bank has an excess amount of balance sheet liabilities, and their derivative exposure is extremely dangerous."
Derivatives are private contracts among banks or other participants in financial markets. Derivatives help institutions make bets on currencies and stocks, for example, without using a lot of cash.
The Citigroup analysts do mention several risk factors, such as litigation - Deutsche Bank was involved in several banking scandals, including collusion to rig the interest rate benchmark LIBOR - but do not mention the bank's derivative exposure in their latest report from Aug. 9.
According to the bank's April 2016 earnings report, the gross notional derivative exposure was $72.8 trillion, or 35 times the bank's balance sheet.
Analyst or Sales?
Middleton said analysts from big investment banks are limited in their ability to express negative views because they make money through their trading business. Saying that one of the biggest banks in the world will go bankrupt is not conducive to that business.
"Most of the sell-side and the broker community, I allege, is really marketing and sales for the transaction business behind them. If that's the case, then they can't go against their bosses and their largest clients because then they lose the business. But if that is also true, they're not analysts; they're salespeople," he said.
Citigroup analyst Matt King featured this chart in his 2008 report, "Are the Brokers Broken", to show that other companies stopped doing business with Lehman Brothers. (Citigroup)
Middleton has detected another flaw in Deutsche Bank that few people talk about. According to him, the bank is overstating the value of collateral behind the loans it is making.
"These obligations have counterparties, but they don't rate the risk of these counterparties because these transactions are backed by collateral, that's absolutely ridiculous," he said.
If for example, Deutsche Bank gives a loan to a shipping company and the company pledges ships as collateral, then the risk of the loan increases if shipping prices fall. The process is similar to what happened with mortgages and house prices during the last crisis, and Deutsche Bank should account for it in its annual report.
"You get a house, and we put a mortgage on a house. If mortgages drop in value because they're not being paid, chances are the house prices are going to drop as well," he said.
Why does Middleton see the things other people don't? As an independent analyst, he doesn't benefit from rising or falling securities.
"We don't have an ax to grind. I could care less whether these institutions shoot to the moon or fall to zero," Middleton said. "So, we're very objective, very analytical, and we do deep-dive forensic research - the old-school fashion where we go through and read through every footnote. We build our own models from scratch, and we don't rely on any outside interpretation whatsoever."
He said it took his small team of analysts days to go through Deutsche's 500-page annual report.
Ironically, the last time investment bank Citigroup did something similar, Lehman Brothers went bankrupt a few weeks later, hurting not only Citigroup but also the rest of the global financial system. In a note called, "Are the Brokers Broken", Citi analyst Matt King went through the footnotes of Lehman Brothers' financial statements to conclude that it was too reliant on short-term institutional funding through repurchase agreements.
Furthermore, he found that companies trading with Lehman had started to withdraw collateral from the company at an alarming rate. After his report was published on Sept. 5, 2008, other counterparties started to pull that funding, and Lehman Brothers was bankrupt. Neither the Treasury nor the Federal Reserve intervened to save the company.
Chances are that Citigroup would like to avoid repeating the same exercise with Deutsche Bank this year.
Because of the fallout after Lehman, Middleton and other analysts think Deutsche Bank will not be allowed to go bankrupt. "If Deutsche Bank goes, this would break many other banks in the European Union, and not just the banks but insurance companies as well."
Bailout or Bust
Jeffrey Gundlach, CEO of DoubleLine Capital, told RealVisionTV: "It's pretty clear investors will be on edge with the next down move in Deutsche Bank … I said when Deutsche Bank goes to single digits, that's when the panic will really be palpable."
"When Bank of America went to single digits back at the end of 2008 and early 2009 … then they said, we really do have to do something. There's something about single-digit stocks that sound like the pink sheets. You're not really an investment-quality entity anymore if you're trading for pennies on the dollar."
The pink sheets are lists of stocks traded over the counter that often do not meet minimum requirements or file with the Securities and Exchange Commission.
Middleton thinks a stealth bailout through the European Central Bank (ECB) has already begun, but not without some unpleasant consequences.
"Think of trying to save somebody from drowning by picking them up from the water by their throat, so you get them out of the water so they don't drown immediately. But you suffocate them over time because they can't breathe, and that's what's happening with European banks," he said.
He said the negative interest rate policy of the ECB and its continuous intervention in asset markets saves the bank's balance sheet but hurts its income. The higher the interest rate, the higher the margins banks can charge for lending money to companies. The reverse is true for zero or negative interest rates.
"Their lending business has minimal margin; they are shrinking. Their transaction business has minimal margin, and it's shrinking. Their fee business, such as asset management, has minimal margin, and they're shrinking," Middleton said.
Even the Citigroup of today picked up on this point. The analysts reduced their earnings-per-share estimate for 2016 by 34 percent, mainly because of a weaker outlook for the transaction-driven markets division.
So if Deutsche "doesn't have a large amount of equity left", according to Middleton, but the ECB doesn't want it to go bankrupt, what is going to happen?
"As long as you have insolvent players in the system, you have a value trap where you cannot create economic value in the short or medium term. I suggest short-term pain, so let some players collapse. To prevent a fall, they should simply ring-fence the necessary banking functions. What you would consider utilities, the things that are necessary, just like water, electricity, and heat: savings, checking, basic banking functions."
Deutsche Bank: The US May Now Be In A Recession
by Tyler Durden
Sep 10, 2016 10:52 AM
Three months ago, we presented an analysis which showed something disturbing: according to Deutsche, the "current business cycle is already the fourth longest in the post- WWII period, and the corporate debt-to-GDP ratio suggests that imbalances are building", and that worse, as a result of soaring corporate debt and rolling-over profit margins, "a recession could hit as soon as the second half."
Overnight, and three months since its last such analysis, Deutsche Bank has published an update. It shows that, as illustrated in the chart below, profits per worker have generally trended higher over time. This is a function of productivity gains and inflation. However, this has changed in recent years. "In the current business cycle, margins peaked at $18,752 per worker in Q4 2014. This compares to a ratio of $16,487 per worker as of Q2 2016. Margins have fallen because corporate profits have declined -6.3% annualized over the past six quarters, while private sector job growth over this period has been very steady at around 2.1%."
And before we get the usual "but... but... you must exclude energy" complaints (we wonder why: it is becoming increasingly obvious that oil is not going back to $100 so the new normoil may well be crude at $50 or lower, which means including all energy-related data), here it the punchline: it's excluded.
As of the latest sector-level data available through Q1 of this year, domestic profits excluding petroleum and coal products and Federal Reserve Banks were down -5.2% compared to a year ago. In fact, this series has been declining in year-over-year terms since Q2 2015. This means that recent overall margin compression has had less to do with the strengthening dollar and depressed energy prices, and more to do with weak domestic demand coupled with near-zero growth in nonfarm business productivity. From Q4 2014, when profit margins peaked, to Q2 2016, domestic profits have declined by a little less than $200 billion. As we can see in the charts below, this compares to a negligible $10 billion decline in profits from outside the US over the same period. Not surprisingly, the decline in profit growth has occurred alongside a deceleration in domestic demand. The year-over-year growth rate of real final sales to private domestic purchasers peaked at 3.9% in Q1 2015 and has since slowed to 2.3% as of last quarter.
So why are margins important? Because as we noted in our June note, margins always lead en economic contraction and always peak in advance of a recession: there has not been one business cycle in the post-WWII era where this has not been the case.
The reason margins are a leading indicator is simple: When corporate profitability declines, a pullback in spending and hiring eventually ensues. Thus far, firms have reacted to declining profit growth by cutting back on capital spending and inventory accumulation and have kept layoffs to a minimum. For example, real non-residential fixed investment has declined -0.2% annualized over the last six quarters. However, this has done little to stem the tide of margin compression because unfortunately productivity growth has been just 0.1% annualized over the same period, while unit labor costs are up 2.4%. This highlights a major risk that we see to the labor market at present: Nominal income growth continues to outpace nominal GDP, a terrible situation for corporate profitability.
In light of collapsing productivity, declining domestic demand, and sliding growth of real final sales, how has the US corporate sector avoided a full-blown recession so far? Simple: it has been loading up on debt to mask the income statement effects of declining demand. As DB calculates, the corporate sector has taken on a substantial amount of debt in the current business cycle. Nonfinancial corporate debt has increased by $4.5 trillion from its trough in Q4 2009 (the latest corporate debt data correspond to Q1 2016). As illustrated in the chart below, the ratio of nonfinancial corporate debt to nominal GDP is at its highest level since Q1 2009, when the economy was still in recession and nominal output was substantially depressed. Alongside tepid demand, the weakness in corporate balance sheets means that the Fed needs to be alert to any possible tightening in financial conditions, for one reason: based on nominal corporate balance sheets, the US is already effectively in a recession - the only thing preventing the hammer from falling are record low interest rates, keeping interest coverage ratios at all time lows.
So if the corporate balance sheet screams recession, what does the corporate income statement say?
Well, the average and median lead times between the peak in margins and the onset of recession are nine and eight quarters, respectively. This would imply... the second half of 2016. To be sure, as shown in the table below, the time period between the peak in profit margins and the beginning of recession varies substantially across business cycles. Margins can sometimes peak well in advance of the onset of recession, as they did in the 1960s and 1990s business cycles. In the former period, the peak in margins occurred 16 quarters before recession. In the latter episode, the peak occurred 15 quarters ahead of the economy’s entering recession. Conceivably, such a scenario could unfold now. However, the current business cycle is already the fourth longest in the post-WWII period, and as we mentioned before, productivity growth has been abysmal. Hence, there is little cushion for the economy to absorb any negative endogenous shock. And, worse, as the chart above shows, with corporate debt-to-GDP ratio at recession highs, it suggests that imbalances have built up to the point where there is absolutely no capacity for tighter financial conditions.
Summarizing all of the above: based on corporate balance sheets and income statements, the US economy may be in a recession as of this moment... and if it isn't, even just one rate hike by the Fed, either in the September 21 meeting or in December, will assure that the backbone of corporate America, already straining under record debt and tumbling profits, will finally snap.
Friday, September 9, 2016
EU’s ZOMBIE banks: ECB is destroying Europe’s finance hubs, warns leading investment bank
EUROPEAN banks are slipping into a terrifying zombie state of decline thanks to the European Central Bank (ECB), a leading investment bank has warned.
Financial firms on the continent are falling victim to a scourge already seen in Japan where firms are considered to be the undead of the world, according to JP Morgan.
Ultra low interest rates inflicted by the ECB have lowered business lending.
And the central bank’s money-printing programme is also hurting earnings.
In fact, firms will face a worrying shortfall of €15billion (£12.7bn) by 2018, JP Morgan found.
Kian Abouhossein, chief analyst at JP Morgan, said: “Our conclusion is that European banks are moving more towards a Japanese standard than a US one.”
Financial institutions in Japan have survived decades of economic stagnation on life support from political and monetary intervention.
Mr Abouhossein said: “Europe has been experiencing a meltdown of bank balance sheets since 2008.”
He also warned that if the banking sector in Europe doesn’t pull itself together soon, then the so-called Japanification could be unstoppable.
Full article: EU’s ZOMBIE banks: ECB is destroying Europe’s finance hubs, warns leading investment bank (Express)
Major Problems Announced At One Of The Largest Too Big To Fail Banks In The United States
By Michael Snyder, on September 8th, 2016
Do you remember when our politicians promised to do something about the “too big to fail” banks? Well, they didn’t, and now the chickens are coming home to roost. On Thursday, it was announced that one of those “too big to fail” banks, Wells Fargo, has been slapped with 185 million dollars in penalties. It turns out that for years their employees had been opening millions of bank and credit card accounts for customers without even telling them. The goal was to meet sales goals, and customers were hit by surprise fees that they never intended to pay. Some employees actually created false email addresses and false PIN numbers to sign customers up for accounts. It was fraud on a scale that is hard to imagine, and now Wells Fargo finds itself embroiled in a major crisis.
There are six banks in America that basically dwarf all of the other banks – JPMorgan Chase, Citibank, Bank of America, Wells Fargo, Morgan Stanley and Goldman Sachs. If a single one of those banks were to fail, it would be a catastrophe of unprecedented proportions for our financial system. So we need these banks to be healthy and running well. That is why what we just learned about Wells Fargo is so concerning…
Employees of Wells Fargo (WFC) boosted sales figures by covertly opening the accounts and funding them by transferring money from customers’ authorized accounts without permission, the Consumer Financial Protection Bureau, Office of the Comptroller of the Currency and Los Angeles city officials said.
An analysis by the San Francisco-headquartered bank found that its employees opened more than two million deposit and credit card accounts that may not have been authorized by consumers, the officials said. Many of the transfers ran up fees or other charges for the customers, even as they helped employees make incentive goals.
Wells Fargo says that 5,300 employees have been fired as a result of this conduct, and they are promising to clean things up.
Hopefully they will keep their word.
It is interesting to note that the largest shareholder in Wells Fargo is Berkshire Hathaway, and Berkshire Hathaway is run by Warren Buffett. There has been a lot of debate about whether or not this penalty on Wells Fargo was severe enough, and it will be very interesting to hear what he has to say about this in the coming days…
Wells Fargo is the most valuable bank in America, worth just north of $250 billion. Berkshire Hathaway (BRKA), the investment firm run legendary investor Warren Buffett, is the company’s biggest shareholder.
“One wonders whether a penalty of $100 million is enough,” said David Vladeck, a Georgetown University law professor and former director of the Federal Trade Commission’s Bureau of Consumer Protection. “It sounds like a big number, but for a bank the size of Wells Fargo, it isn’t really.”
After the last crisis, we were told that we would never be put in a position again where the health of a single “too big to fail” institution could threaten to bring down our entire financial system.
But our politicians didn’t fix the “too big to fail” problem.
Instead it has gotten much, much worse.
Back in 2007, the five largest banks held 35 percent of all bank assets. Today, that number is up to 44 percent…
Since 1992, the total assets held by the five largest U.S. banks has increased by nearly fifteen times! Back then, the five largest banks held just 10 percent of the banking industry total. Today, JP Morgan alone holds over 12 percent of the industry total, a greater share than the five biggest banks put together in 1992.
Even in the midst of the global financial crisis, the largest U.S. banks managed to increase their hold on total bank industry assets. The assets held by the five largest banks in 2007 – $4.6 trillion – increased by more than 150 percent over the past 8 years. These five banks went from holding 35 percent of industry assets in 2007 to 44 percent today.
Meanwhile, nearly 2,000 smaller institutions have disappeared from our financial system since the beginning of the last crisis.
So the problem of “too big to fail” is now larger than ever.
Considering how reckless these big banks have been, it is inevitable that one or more of them will fail at some point. When that takes place, it will make the collapse of Lehman Brothers look like a Sunday picnic.
And with each passing day, the rumblings of a new financial crisis grow louder. For example, this week we learned that commercial bankruptcy filings in the United States in August were up a whopping 29 percent compared to the same period a year ago…
In August, US commercial bankruptcy filings jumped 29% from a year ago to 3,199, the 10th month in a row of year-over-year increases, the American Bankruptcy Institute, in partnership with Epiq Systems, reported today.
There’s money to be made. While stockholders and some creditors get raked over the coals, lawyers make a killing on fees. And some folks on the inside track, hedge funds, and private equity firms can make a killing picking up assets for cents on the dollar.
Companies are going bankrupt at a rate that we haven’t seen since the last financial crisis, but nobody seems concerned.
Back in 2007 and early 2008, Federal Reserve Chair Ben Bernanke, President Bush and a whole host of “experts” assured us that everything was going to be just fine and that a recession was not coming.
Today, Federal Reserve Chair Janet Yellen, Barack Obama and a whole host of “experts” are assuring us that everything is going to be just fine and that a recession is not coming.
I hope that they are right.
I really do.
But there is a reason why so many firms are filing for bankruptcy, and there is a reason why so many Americans are getting behind on their auto loans.
Our giant debt bubble is beginning to burst, and this is going to cause a tremendous amount of financial chaos.
Let us just hope that the “too big to fail” banks can handle the stress this time around.
Your grocery bill is cheaper. Here's why
If you've noticed that your grocery bills are a little lower these days, you're not alone. The price of food has fallen sharply in the past few months. And while that's great for consumers, it's terrible news for big supermarket chains.
Grocery giant Kroger (KR), which also owns regional supermarket chains Ralphs, Harris Teeter and Roundy's, reported quarterly sales on Friday that missed forecasts. The chain also cut its earnings and same store sales outlooks for the year.
The main reason? Food deflation. Weak global demand (particularly in China) as well as excess supply thanks to advances in agricultural technology have helped push the prices of key food commodities sharply lower lately.
The price of corn, cocoa and lean hogs futures trading on commodities exchanges are down more than 10% in the past year. Wheat has tumbled 20%. Cattle futures have plunged 30%.
That's a problem not just for Kroger, whose stock has fallen 25% this year. Falling food prices have also hurt higher-end organic rivals like Sprouts (SFM) and Whole Foods (WFM) as well as grocery chain Supervalu (SVU).
To that end, Supervalu slashed its earnings forecast on Thursday. The company cited "deeper levels of deflation" and a "greater than anticipated degree of competitive openings" from rivals.
Increased competition from the likes of Walmart (WMT), Target (TGT) and Costco (COST) -- as well as new efforts by Amazon (AMZN, Tech30) to boost its home delivery grocery business -- are all weighing on prices as well.
This is welcome news if you have a family to feed. (The stomachs of my two young boys are essentially bottomless pits. More mac & cheese? Seriously?) But grocery store stocks may be stuck in Wall Street's bargain bin until food prices start to stabilize.
Thursday, September 8, 2016
Zero Hedge by Tyler Durden
It ain't working. Eight years after the outbreak of the financial crisis, central bank chiefs suggest they have saved the world, but have they? We argue central banks have become part of the problem, not the solution. At its core, their indoctrinated focus on inflation may well do more harm than good, with potentially perilous implications for investors.
Justification of Monetary Policy
Most central banks have a mandate to promote price stability; the Fed is said to have a dual mandate to also maximize employment. Over the decades, we believe most economists have come to believe pursuing an inflation target is the holy grail of modern central banking. As such, it's not a surprise that by arguing inflation is too low, central bankers have justified the pursuit of their various policies since the onset of the financial crisis. Some prominent central bankers, including European Central Bank (ECB) head Draghi, have argued the law requires them to pursue an inflation target, thus pursue potentially ever greater monetary easing; and that if there are unintended consequences, 'macro-prudential' measures ought to be employed by policy makers to address those (as an example, the argument is central to this speech by Draghi last February). Our interpretation: Draghi sees his role as doing whatever it takes, and don't blame him if there are unintended consequences. While Draghi may be more radical in some of the tools he employs, we consider his "leadership" as a symptom of the environment we are in.
Inflation Targeting Ain't Working
Inflation targeting isn't working. Below is a chart of market-based long-term inflation expectations for the U.S. and Eurozone (EZ). If we are not mistaken, Draghi shutters when he sees long term inflation expectations sagging; we believe former Fed Chair Bernanke would have long been tempted to resume quantitative easing (QE) looking at this chart. Fed Chair Yellen is a labor economist, so she may not be quite as glued on this particular chart. The Fed, in general, also likes to point out that there are other (survey based) measures of inflation that don't paint that bleak a picture.
Why is it bad that inflation expectations are ticking downward? Isn’t your purchasing power improving when inflation is low, even negative? You might say that as a saver, but if you have debt, you might prefer inflation. Economists have figured out that workers have a greater incentive to work if inflation chips away at the purchasing power of your hard earned cash ever so slightly every year. A credit (read: debt) driven economy might go into reverse (a deflationary spiral) if inflation is too low. It’s why we sometimes state that incentives of a government in debt may be very different from those of investors.
The Fed’s Mandate Ain’t Inflation Targeting
The biggest bully tends to grab everyone’s attention. Be that Mr. Bernanke, under whose leadership a formal inflation target was established at the Fed; or be that Mr. Draghi, who has suggested he’ll pursue the ECB’s inflation target no matter what. In their defense, they firmly believe that a big part of achieving an inflation target is to shape expectations that such a target may be achieved, and putting up a good show (it’s called communication) may well be part of it. As such, we don’t mean to personally offend them in implying they may be bullies; it’s part of their institutional role that they tend to bully the market.
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. [emphasis added]
Unlike the U.S., other major central banks around the world do not have an explicit employment target; the argument against an employment target is that the best way to achieve maximum employment is indeed by providing price stability. If, however, employment were the focus, the central bank might be at risk of becoming politicized (which would be bad for the effectiveness of the central bank and ultimately inflation).
The short of it is, central bankers the world all over have learned to love the inflation target; so much so, that is has become a formal target in many countries; while it isn’t the law in the U.S., the Fed adopted a formal target under Bernanke’s leadership.
So why am I arguing the Fed's mandate isn't inflation targeting? Because the law clearly puts a litmus test on monetary policy, namely that they must be "commensurate with the economy's long run potential to increase production"
Economy’s Long Run Potential
We believe many economists would agree that an economy’s long run potential is reflected in its long-term interest rates; more specifically, it is reflected in long-term interest rates net of inflation (long-term real interest rates). The rarely mentioned third mandate, namely, “moderate long-term interest rates” refers to just that: higher longer-term rates are desirable if they reflect a potential to increase production rather than inflation.
And that’s another sign that the stubborn focus on inflation targeting has failed, as long-term nominal interest rates are at 1.5%, as measured by the yield on 10-year Treasury Note. If policies being pursued were working, these rates would be higher.
If you ask central bankers, you will hear lots of reasons (or head-scratching) why rates are so low, with some blaming factors beyond the control of the Fed. We may be the first to agree that the Fed shouldn’t try to solve all the problems of the world, but allege that the Fed is part of the problem rather than solution.
Fed Mandate: Do No Harm
While a focus on inflation may have served the Fed (and other central banks) well, we believe we have ushered in an era that’s become myopically focused on inflation while forgetting what the task at hand really is. With regard to the Fed, it’s been hiding in plain sight; our direct conclusion from reading the law is
The Fed’s focus must be on the economy’s long run potential.
The Fed’s tools in achieving the goal must be credit and monetary aggregates
The litmus test are the Fed’s mandates, notably also the third mandate
Our take is that just as maximum employment has long been understood to be the result of pursuing a policy of low inflation, we argue that low inflation itself is the result, not the cause of a policy focused on an economy’s long run potential.
If inflation targeting were the solution, we should not see inflation expectations sag. Something is wrong. Central bankers appear to argue that they simply haven’t doubled down enough. Maybe they should pause and take a step back.
When we take a step back, we interpret the Fed’s mandate to focus on the economy’s long run potential to suggest a rule that we believe should take priority: do no harm.
If the Fed, and other central banks, gave a higher priority to the harm their policies might be doing, they might be more humble in their pursuit of policies in uncharted waters. Economists will counter that there will always be winners and loser, and that it would simply not be workable.
In our humble opinion, though, that’s not the right way to look at it.
Harmful Fed Policy?
We believe central banks should consider whether the policies they pursue might be harmful to its mandated goals. One can argue, and we would agree, that for an economy to reach its optimal long run potential, much of it is in the realm of fiscal policy. The Fed’s mandate is on “monetary and credit aggregates”; as such, it appears all too obvious to us for the Fed to cross check whether they deviate from a focus on ‘monetary and credit aggregates’ and, in turn, are harming an economy’s long run potential.
A focus on ‘monetary and credit aggregates’, at least in theory, should allow the Fed to focus on monetary policy. In practice, though, the Fed, and other central banks, have increasingly veered into fiscal policy. Fiscal policy, in contrast to monetary policy, doesn’t deal with aggregates, but with favoring sectors of an economy, i.e. making what may easily amount to political calls as to who the winners and losers should be.
We allege central bankers have created distortions in the credit allocation process. How can one expect to reach an economy's long run potential if policy makers interfere in the credit allocation process? It should not be a surprise the economy is running below its potential when policy makers become central planners. If policy makers then double down, all they might do, is to exacerbate the distortions.
Specifically, we have long argued that central banks have compressed risk premia, i.e. made so-called risk assets (really anything other than Treasuries, but risk assets tends to refer to stocks and junk bonds) appear less risky. In plain English, we believe risky borrowers have been getting a subsidy; that in turn, has distorted the capital allocation process of investors, investing in assets that have a higher risk profile than they otherwise would. A common reference is that investors are chasing yield.
What’s bad about this? What’s bad about this is that these assets are still risky, and we now depend on central banks to ‘come to the rescue’ whenever risk sentiment flares up. That is, central banks now ‘own the problem.’
Instead, the stakeholders of risk assets ought to own the problem. In our humble opinion, the way one gets those stakeholders to own the problem is to allow a market based pricing of risk, one where a risky borrowers pays a reasonable premium. What is reasonable? The Fed should allow the market to determine this; and while the market may not always be right, the opposite is, in our humble opinion, certainly wrong: the Fed cannot possibly know what the appropriate risk premium is.
Our central bankers have avoided allowing the market to price risk premia because it might render some issuers, including potentially some sovereign governments, insolvent. And to those who think this is only a problem for the Eurozone (think peripheral Eurozone countries) or Japan, we believe it’s also a problem for the U.S., where we have, amongst others, seen seismic shifts in the capital structure of corporate America. Shifts, such as a raising debt to finance share buybacks, but without an investment in future productivity.
The Game is Rigged
We have seen financial assets skyrocket with a major populist backlash because the man (and woman) on the street feels the game is rigged. The Fed disputes this because, all they do, so they might say, is to pursue their inflation target. Our analysis, though, agrees with the complaining public: the game is rigged, as the Fed meddles with efficient capital allocation to the detriment of the economy’s long run potential, as evidenced by low long term rates, in direct violation of the Fed’s mandate.
Implications for Investors
So what does it mean for investors? For many investors, it has meant that they stay on the sidelines, as they don’t like to invest in a game that may be rigged. For others, it has meant to join the ride and enjoy a rise in both equity and bond prices. To us, it means that we might have created a bubble; more specifically, we have created an environment where the traditional way to diversify a portfolio might not be effective should we ever experience a downturn again. The time to truly diversify a portfolio is when times are good.
The Great Debt Unwind Beneath the Surface: US Commercial Bankruptcies Soar
by Wolf Richter • September 7, 2016
They’d believed in six years of Wall Street hogwash.
Not that you would have guessed from the stock market, hovering at all-time highs, or from soaring junk bonds, even the riskiest paper: CCC-and-below rated junk bonds skyrocketed since their February 12 low as their average yield plunged from 21.6% to 13.5%. Even the S&P US Distressed High Yield Corporate Bond index has soared 57% since February 12.
Those are miracles to behold.
At the slightest squiggles of the market, the Fed goes into bouts of by now embarrassing flip-flopping on rate increases that demonstrate to the world that they have absolutely nothing else in mind than keeping the stock market inflated and keeping the biggest credit bubble in US history from unceremoniously imploding.
And the ECB is out there with its scorched-earth monetary policies, with negative interest rates and bond purchases, including asset backed securities and corporate bonds, that it has been caught buying directly from issuers. It’s driving even corporate bond yields into the negative. Just now, French drugmaker Sanofi and German household products maker Henkel issued bonds with negative yields, thus getting paid by these hapless investors to borrow.
The idea for bondholders being that you have practically no income throughout and get “most” of your money back at maturity. An idea that is sending NIRP refugees into US assets, driving up their values and pushing down their yields. It all works wonderfully.
But beneath this magic is the real US economy, and there, despite this flood of money and the low interest rates and the soaring stocks, and all the shenanigans to keep the credit bubble from imploding, business bankruptcies are soaring.
In August, US commercial bankruptcy filings jumped 29% from a year ago to 3,199, the 10th month in a row of year-over-year increases, the American Bankruptcy Institute, in partnership with Epiq Systems, reported today.
There’s money to be made. While stockholders and some creditors get raked over the coals, lawyers make a killing on fees. And some folks on the inside track, hedge funds, and private equity firms can make a killing picking up assets for cents on the dollar.
Bankruptcy is one of the few booming sectors in the US at the moment. But it’s seasonal. Commercial bankruptcy filings reach their annual peak in March and April. Then in June and July, filings typically decline, and they did so this year too. And in August, filings jumped. But the moves are far beyond seasonal.
In August, the worst August since 2013, bankruptcy filings were up 44% from September last year, the low point in this multi-year cycle, and up 29% from August last year:
During the financial crisis, commercial bankruptcy filings soared, peaking in March 2010 at 9,004. Then they fell sharply on a year-over-year basis. In March 2013, the year-over-year decline in filings reached 1,577. Filings continued to fall, but at a shrinking pace, until November 2015, when for the first time since March 2010, they rose year-over-year. That was the turning point:
Bankruptcies – and defaults, which precede them – are indicators of the “credit cycle.” The Fed’s policy of easy credit with record low interest rates has encouraged businesses to borrow. And borrow they did.
In October 2008, as the prior credit bubble was beginning to implode, there were $1.59 trillion commercial and industrial loans outstanding at all US banks. Then the Financial Crisis hit, and loans outstanding plunged, many of them wiped out or restructured in bankruptcies. But then the Fed solved a credit problem with even more credit, and as of July 2016, there were $2.064 trillion of C&I loans outstanding, a 30% jump from the peak of the prior credit bubble that blew up so spectacularly:
The end of the credit cycle arrives when businesses can no longer carry the debt they incurred in good times, or when they believed that good times were about to arrive. They’d believed in six years of Wall Street hogwash about “escape velocity” They’d borrowed to be ready for it, and now that debt is sinking them – hence the surge in bankruptcies.
Now the hangover is setting in from the Fed’s efforts to solve a debt problem with even more debt, to gain very little economic growth. And there is a leading indicator of big trouble already fermenting in the banks. Read… Business Loan Delinquencies Rock Past Lehman Moment Level