Wednesday, May 25, 2016


Just Stop It!

by David Stockman • May 24, 2016

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The posse of fools in the Eccles Building is so petrified of a stock market hissy fit that it has more or less created a Wall Street doomsday machine.

After trolling on the zero bound for 89 straight months now, the FOMC falsely believes that it has levitated the U.S. economy to the cusp of full-employment via massive liquidity and wealth effects pumping.

As a consequence, it refuses to let the market have breathing room for even a modest correction, insisting that just a few more months of this monetary lunacy will permit a return to some semblance of normalcy.

But it never gets there. The truth is, this so-called recovery cycle is now visibly dying of old age and being crushed by the headwinds of global deflation. Rather than acknowledge that the jig is up, our feckless monetary politburo just equivocates, procrastinates and prevaricates about the monumental policy failure it has superintended.

So the casino punters just won’t go home. They hang around against all odds, failing to liquidate and thereby enabling the robo machines to engage in endless and pointless cycling between chart points. As shown in the graph below, this has been going on for nearly 600 days now.

But of late the churning has been occurring in an increasingly narrow channel. Accordingly, the spring is being coiled ever more tightly.

When this 83-month long simulacrum of a economic recovery finally rolls over into recession someday soon, therefore, the implosion will be thunderous. The robo-machines will chase the punters out the casino exits in an epic stampede of selling.
^SPX Chart

^SPX data by YCharts

Indeed, given the headwinds emanating from all corners of the global economy and financial system it is hard to believe that any sentient carbon units actually participated in today’s 19th nervous short squeeze in as many weeks. Among other things, first quarter results have been fully posted and it turns out that the S&P 500 companies earned $87 per share during the last 12 months (LTM).

That’s down from the $99 per share LTM figure posted in Q1 last year and the peak of $106 per share recorded in the year ended in September 2014.

In short, reported GAAP earnings—–the honest kind companies report to the SEC on penalty of jail—— are now down 18% from their recent bubble cycle peak. But since the S&P 500 has remained within 3% of its May 2015 all-time high (2130), it  means that the PE ratio has been rapidly inflating right into the teeth of falling profits and a rapidly cooling domestic and global economy.

In fact, the market closed today at 23.9X, which is a truly ludicrous valuation level. We are in the waning days of the third bubble cycle of the 21st century, yet the casino is pricing current earnings as if recessions have been outlawed and that the long-term growth trend of earnings is in double digits..

So here’s a spoiler alert.  When S&P 500 earnings peaked prior to the financial crisis in the June 2007 LTM period, they clocked in at $85 per share.

The arithmetic of the matter, therefore, is that corporate earnings have grown at a miniscule 0.2% annual rate during the last nine years. Take the inflation out of that and adjust for nearly $3 trillion of stock buybacks and shrinkage of the share count in the interim, and you have less than no growth at all.

The worse thing is that we have been here before—–at this same juncture exactly eight years ago in May 2008. The just completed earnings season had generated S&P profits of about $61 per share. That was down more than 25% from the prior year peak of $85, but the casino punters ignored the warning signs. The S&P 500 index remained within 3% of its November 2007 high (1570) for a few more months.

Then the sky fell. Nine months later the market was down by 57% and the U.S. economy was in the worst recession since the 1930s.

More crucially, the sell-side assurance that the severe earnings decline then underway was just the “pause that refreshes” and that profits would rebound to $100 per share in no time, proved to be dead wrong.

By the following spring, LTM profits for the S&P 500 companies posted at just $7 per share!

Now, we have no idea how far earnings will fall this time, but we do note that on the eve of the cyclical contraction in May 2008, the S&P 500 was trading at the same drastically inflated multiple as today——- 24X LTM earnings.

We also note that recessions are precipitated not by lagging indicators such as the dubious BLS monthly jobs surveys, but by the accumulation of excess inventories in the face of weakening sales. Here is what happened last time the punters insisted on staying in the nosebleed section of the casino when earnings were already falling rapidly.

Nor is this time any different. As of March, total business sales in the U.S. economy—manufacturing, wholesale and retail——were down 5.5% from their July 2014 peak, while the inventory ratio has soared back up into the recession zone.

That’s right. The scarlet “X” is back.

It means not merely that recession is just around the corner. That eventuality is guaranteed by the fact that this tepid recovery is already very long in the tooth by historical standards and by the reality that global trade, industrial production and PMI’s are slipping into recession mode virtually everywhere.

What is also proves is that the Fed and other central banks have absolutely destroyed the last semblance of honest price discovery. How is any other conclusion possible?

That is, with headwinds ranging from the tottering Red Ponzi of China, to the collapse in Brazil, the depression in the Baaken and Texas shale patch, the plunge in Japan’s trade accounts, the swirling liquidity crisis in the petro-states, the slump in German exports, the double digit decline of US freight volumes, the flat-lining of temp agency employment levels and much more, why would any rational investor pay 23.9X for the S&P 500 at this juncture—–and especially after nine years of no earnings growth?

Alas, they wouldn’t.

Wall Street has indeed become a doomsday machine and the Fed has zero chance of stopping its eventual implosion.

So in the interim the posse of monetary cranks in the Eccles Building ought to just stop their dangerous charade; it’s only feeding the robo-machines and putting everyone else deeper into harms’ way.

Tuesday, May 24, 2016

What’s going on in the Richmond FED?

Richmond Fed Crashes Into Contraction From 6 Year Highs, Biggest Drop In History

By Tyler Durden

Created 05/24/2016 - 10:04

Tyler Durden's picture [1]

Submitted by Tyler Durden [1] on 05/24/2016 10:04 -0400

Having spiked mysteriously to 6 year highs in March (from 4 year lows in Feb), Richmond Fed's manufacturing survey crashed back into contraction in May (printing -1 against =14 prior and +8 expectations).


Weakness was broad-based across the entire set of subcomponents with New Orders plunging, shipments crashing, employees and workweek tumbling, and worse still future employment and capex expectations dropped precipitously.

The drop in the last 2 months is the largest in the 23 year history of the survey.


So WTF was that spike in March?

Charts: Bloomberg

Delinquencies Spike

Business Loan Delinquencies Spike to Lehman Moment Level

by Wolf Richter • May 19, 2016

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A leading indicator of big trouble.

This could not have come at a more perfect time, with the Fed once again flip-flopping about raising rates. After appearing to wipe rate hikes off the table earlier this year, the Fed put them back on the table, perhaps as soon as June, according to the Fed minutes. A coterie of Fed heads was paraded in front of the media today and yesterday to make sure everyone got that point, pending further flip-flopping.

Drowned out by this hullabaloo, the Board of Governors of the Federal Reserve released its delinquency and charge-off data for all commercial banks in the first quarter – very sobering data.

So here a few nuggets.

Consumer loans and credit card loans have been hanging in there so far. Credit card delinquencies rose in the second half of 2015, but in Q1 2016, they ticked down a little. And mortgage delinquencies are low and falling. When home prices are soaring, no one defaults for long; you can sell the home and pay off your mortgage. Mortgage delinquencies rise after home prices have been falling for a while. They’re a lagging indicator.

But on the business side, delinquencies are spiking!

Delinquencies of commercial and industrial loans at all banks, after hitting a low point in Q4 2014 of $11.7 billion, have begun to balloon (they’re delinquent when they’re 30 days or more past due). Initially, this was due to the oil & gas fiasco, but increasingly it’s due to trouble in many other sectors, including retail.

Between Q4 2014 and Q1 2016, delinquencies spiked 137% to $27.8 billion. They’re halfway toward to the all-time peak during the Financial Crisis in Q3 2009 of $53.7 billion. And they’re higher than they’d been in Q3 2008, just as Lehman Brothers had its moment.

Note how, in this chart by the Board of Governors of the Fed, delinquencies of C&I loans start rising before recessions (shaded areas). I added the red marks to point out where we stand in relationship to the Lehman moment:


Business loan delinquencies are a leading indicator of big economic trouble. They begin to rise at the end of the credit cycle, on loans that were made in good times by over-eager loan officers with the encouragement of the Fed. But suddenly, the weight of this debt poses a major problem for borrowers whose sales, instead of soaring as projected during good times, may be shrinking, and whose expenses may be rising, and there’s no money left to service the loan.


The loan officer, feeling the hot breath of regulators on his neck, and seeing the Fed fiddle with the rate button, refuses to “extend and pretend,” as the time-honored banking practice is called of kicking the can down the road in good times.

If delinquencies are not cured within a specified time, they’re removed from the delinquency basket and dropped into the default basket. When defaults are not cured within a specified time, the bank deems a portion or all of the loan balance uncollectible and writes it off, therefore moving it out of the default basket into the write-off basket. That’s why the delinquency basket doesn’t get very large – loans don’t stay in it very long.

And farmers are having trouble.

Slumping prices of agricultural commodities have done a job on farmers, many of whom are good-sized enterprises. Farmland is also owned by investors, including hedge funds, who’ve piled into it during the boom, powered by the meme that land prices would soar for all times because humans will always need food. Then they leased the land to growers.

Now there are reports that farmland, in Illinois for example, goes through auctions at prices that are 20% or even 30% below where they’d been a year ago. Land prices are adjusting to lower farm incomes, which are lower because commodity prices have plunged. (However, top farmland still fetches a good price.)

Now delinquencies of farmland loans and agricultural loans are sending serious warning signals. These delinquencies don’t hit the megabanks. They hit smaller specialized farm lenders.

Delinquencies of farmland loans jumped 37% from $1.19 billion in Q3 2015 to $1.64 billion in Q1 this year, the vast majority of it in the last quarter (chart by the Board of Governors of the Fed):


Delinquencies of agricultural loans spiked 108% in just two quarters to $1.05 billion in Q1. On the way up during the financial crisis, they’d shot past that level during Q1 2009:


Bad loans are made in good times — the oldest banking rule. “Good times” may not be a good economy, but one when rates are low and commercial loan officers are desperate to bring in some interest income. With a wink and a nod, they extend loans to businesses that look good for the moment. That has been the case ever since the Fed repressed interest rates during the Financial Crisis. A lot of bad loans were made during those “good times,” precisely as the Fed had encouraged them to do. And these loans are now coming home to roost.

One of the big indicators of the end of the “credit cycle” is the number of bankruptcies. During good times, so earlier in the credit cycle, companies borrow money. Lured by low interest rates and rosy-scenario rhetoric, they borrow even more. Then reality sets in. Read… US Commercial Bankruptcies Skyrocket

Why was consensus so far off?

Massive Jump in New Home Sales, 17-Sigma Event

By: Mike Shedlock | Tue, May 24, 2016

New home sales surprised in a massive way this morning, blowing out all estimates to the high side.

New home sales came in at 619,000 compared to a Bloomberg Econoday consensus estimate of 523,000 at a seasonally adjusted annualized


The new home sales report has sealed its reputation as the wildest set of data around. April's annualized rate came in at 619,000 which is not a misprint. This is the highest rate since January 2008 and dwarfs all readings of the recovery. February 2015's rate, way behind at 545,000, is the next highest rate this cycle. The data even include a very large 39,000 net upward revision to the two prior months, a gain that reflects annual revisions which are included in the data. The monthly 16.6 percent surge is not only far beyond expectations but is the biggest monthly gain since way back in January 1992.

The data also include a big jump in prices, up 7.8 percent in the month to a record median $321,100 while the year-on-year rate, which was negative in the March report, is at plus 9.7 percent year-on-year.

But the surge in sales is a negative for supply as supply relative to sales fell very sharply to 4.7 months from 5.5 months. The total number of new homes for sale was little changed, down 1,000 at 243,000.

Regional data show a more than 50 percent jump in the Northeast where however the number of sales relative to other regions is very low. The same is true of the Midwest where sales fell 4.8 percent in the month. The two main regions for new home sales both show outsized gains with the South up 15.8 percent and the West up 23.6 percent.

Year-on-year, total sales are suddenly up 23.8 percent, this at the same time that the median price is now well past the 6 percent rate where housing appreciation had been trending. Even though new home sales are volatile, which reflects the report's small sample sizes, the outlook for housing just got a big boost. Talk will build for a greater contribution from housing to overall growth. Watch for FHFA house price data on tomorrow's calendar where another month of solid appreciation is expected.

New Home Sales

New Home Sales

Sales Up Everywhere But Midwest

Sales Up Everywhere But Midwest

17-Sigma Event

ZeroHedge is a bit skeptical, noting the report is a 17 sigma event.

17-Sigma Event

This data is indicative of a hike, so much that one might wonder if the Fed had a leak to the commerce department report.

This is quite amazing to say the least.

For Chart Lovers

Bullish Hopes Negated By Five Bearish Signals

by Lance Roberts • May 24, 2016

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Over the last several weeks, I have discussed the markets entrance into the “Seasonally Weak” period of the year and the breakout of the market above the downtrend line that began last year.

The rally from the February lows, driven by a tremendous amount of short covering, once again ignited “bullish optimism.”

“Canaccord Genuity’s Tony Dwyer estimates the equity benchmark will end 2017 at 2,340, an increase of 15 percent from Wednesday’s closing level of 2,047.63, with half of the gains coming this year.”

But it is not just Tony that is buying into the “optimistic” story, but investors also as the number of stocks on “bullish buy signals” has exploded since the February lows.


While the “bulls” are quick to point out the current rebound much resembles that of 2011, I have made notes of the differences between 2011 and 2008. The reality is the current market set up is more closely aligned with the early stages of a bear market reversal.

It is the last point that I want to follow up with this week.

There is little argument that the bulls are clearly in charge of the market currently as the rally from the recent lows has been quite astonishing. However, as I noted recently, the current rally looks extremely similar to that seen following last summer’s swoon.


Well, here we are once again entering into the “seasonally weak” period of the year. Will the bullish hopes prevail? Maybe. But.

Warning Signs Everywhere

Many have pointed to the recent correction as a repeat of the 2011 “debt ceiling default” crisis. Of course, the real issue in 2011 was the economic impact of the Japanese tsunami/earthquake/meltdown trifecta, combined with the absence of liquidity support following the end of QE-2, which led to a sharp drop in economic activity. While many might suggest that the current environment is similar, there is a marked difference.

The fall/winter of 2011 was fueled by comments, and actions, of accommodative policies by the Federal Reserve as they instituted “operation twist” and a continuation of the “zero interest rate policy” (ZIRP). Furthermore, the economy was boosted in the third and fourth quarters of 2011 as oil prices fell, Japan manufacturing came back on-line to fill the void of pent-up demand for inventory restocking and the warmest winter in 65-years which gave a boost to consumers wallets and allowed for higher rates of production.

2015-16 is a much different picture.

First, while the Federal Reserve is still reinvesting proceeds from the bloated $4 Trillion balance sheet, which provides for intermittent pops of liquidity into the financial market, they have begun to “tighten” monetary policy by ending QE3 and increasing the overnight lending rate. As shown below, the changes to the Fed’s balance sheet is highly correlated to the movements of the S&P 500 index as liquidity is induced and extracted from the financial system.


Secondly, despite hopes of stronger rates of economic growth, it appears that the domestic economy is weakening considerably as the effects of a global deflationary slowdown wash back onto the U.S. economy.


Third, while “services” seems to be holding up despite a slowdown in “manufacturing,” the service sector is being obfuscated by sharp increases in “healthcare” spending due to sharply rising costs of healthcare premiums. While the diversion of spending is inflating the services related part of the economy, it is not a representation of a stronger “real” economy that creates jobs and increased wages.


Fourth, the US dollar, as I addressed in this past weekend’s missive, is back on the rise.

“Well, with the revelation of the recent FOMC minutes the worries about a June rate hike, as suspected, have indeed surfaced sending the US dollar spiking above resistance.”


If the Fed hikes rates in June, as is currently expected, higher rates will attract foreign money into US Treasuries in search of a higher yield. The dollar will subsequently strengthen further impacting commodity and oil prices, as well as increase the drag on companies with international exposure. Exports, which make up more than 40% of corporate profits, are sharply impacting results in more than just “energy-related” areas. This is not just a “profits recession,” it is a “revenue recession” which are two different things.


Lastly, it is important to remember that US markets are not an “island.” What happens in global financial markets will ultimately impact the U.S. The chart below shows the S&P 500 as compared on a performance basis to the MSCI Emerging Markets and Developed International indices. Notice the previous correlation in the overall indices as compared to today. Currently, the weakness in the international markets is being dismissed by investors, but it most likely should not be considering the ECB’s recent “bazooka” of QE which has clearly failed.


Lack Of Low Hanging Fruit

As I suggested previously, the “seasonally weak” period of the year may be a good opportunity to reduce risk as we head into the “dog days of summer.”

“Does this absolutely mean that markets will break to the downside and retest February lows? Of course, not. However, throw into the mix ongoing high-valuations, uncertainty about what actions the Federal Reserve may take, ongoing geopolitical risks, concerns over China, potential for a stronger dollar or further weakness in oil – well, you get the idea. There are plenty of catalysts to push stocks lower during what is typically an already weak period.

Should you ‘sell in May and go away?’  That decision is entirely up to you. There is never certainty in the market, but the deck this summer seems much more stacked than usual against investors who are taking on excessive equity based risk. The question you really need to answer is whether the ‘reward’ is really worth the ‘risk?’”

While the recent rally has certainly been encouraging, it has failed to materially change the underlying momentum and relative strength indicators substantially enough to suggest a return to a more structurally sound bull market. (valuations not withstanding)


With price action still confirming relative weakness, and the recent rally primarily focused in the largest capitalization based companies, the action remains more reminiscent of a market topping process than the beginning of a new leg of the bull market. As shown in the last chart below, the current “topping process,” when combined with underlying “sell signals,” is very different than the action witnessed in 2011.


While I am not suggesting that the market is on the precipice of the next “financial crisis,” I am suggesting that the current market dynamics are not as stable as they were following the correction in 2011. This is particularly the case given the threat of a “tightening” of monetary policy combined with significantly weaker economic underpinnings.

The challenge for investors over the next several months will be the navigation of the “seasonally weak” period of the year against a backdrop of warning signals. Importantly, while the “always bullish” media tends to dismiss warning signs as “just being bearish,” historically such unheeded warnings have ended badly for individuals. It is my suspicion that this time will likely not be much different, the challenge will just be knowing when to leave the “party.”

“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.” Peter Lynch

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

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More from Hussman

The Coming Fed-Induced Pension Bust

May 23, 2016 9:00 AM ET

John Hussman

John Hussman

Last week, I observed that based on the most reliable measures we identify (those having the strongest correlation with actual subsequent 10-12 year investment returns across history as well as in recent cycles), “the expected return on a traditional portfolio mix is actually lower at present than at any point in history except the 1929 and 1937 market peaks. QE has effectively front-loaded realized past returns, while destroying the future return prospects of conventional portfolios, at least as measured from current valuations. As a result, the coming years are likely to see a major pension crisis across both corporations and municipalities because the illusory front-loading of returns has encouraged profound underfunding.”

On Thursday, Chicago’s Municipal Employees Annuity and Benefit Fund reported that its net pension liability soared to $18.6 billion, from $7.1 billion a year earlier, as a result of new accounting rules that prevent governments from using aggressive investment return assumptions (thanks to my friend Mike Shedlock for his post on this news). But here’s the kicker - the rules only apply after pension funds go broke. In Chicago’s case, pension return assumptions had been optimistically set at 7.5%, and the city had vastly underfunded its obligations. Still, this isn’t a Chicago problem. It’s a national, even global problem, and it’s going to get much worse. See, Chicago’s assumptions were actually below the national 7.62% average. The following chart is from the National Association of State Retirement Administrators (NASRA). Chicago is essentially the rule, not the exception.

These return assumptions effectively guarantee a widespread crisis in already underfunded state, corporate, and municipal pensions in the coming decade. This underfunding has resulted from a failure to appreciate the links between reliable valuation measures, realized past returns, and prospective future returns.

To understand this problem, let’s begin by considering the following chart. It’s a graphic version of the thought-experiment in last week’s market comment. Imagine paying some amount today in return for a $100 bill 12 years from now. The chart shows the 12-year annual return you will earn, based on how much you pay today. The higher the price you pay for a given set of future cash flows, the lower the long-term return you can expect. Notice that the horizontal axis is on log scale, which is what makes the relationship linear. Each point is labeled: paying $13.70 gets you an 18% 12-year return, paying $25.60 gets you a 12% return, paying $39.60 gets you an 8% return, and so forth.

As one gradually raises today's price from $13.70 to $100, the prospective 12-year return drops from 18% annually to zero. The central lesson here isn’t only that rich valuations imply poor long-term returns. It’s also that every increase in valuation converts expected future returns into realized past returns:

“The exercise you just did is the single most important thing to understand about long-term investing. I’ve often called it the Iron Law of Valuation: the higher the price you pay today for a given stream of future cash flows, the lower your rate of return over the life of the investment. As the price goes up, what investors considered “expected future return” only a moment before is suddenly converted into “realized past return.” The higher the current price rises, the more expected future returns are converted into realized past returns, and the less expected future return is left on the table. Notice that the point where a security seems most enticing on the basis of realized past returns is also the point where the security is least promising on the basis of expected future returns.”

Blowing Bubbles: QE and the Iron Laws, Hussman Weekly Market Comment, 5/16/16

Next, let’s generalize this example to real financial markets. In market cycles across history, the valuation measures most reliably correlated with actual subsequent stock market returns are those that mute the impact of cyclical fluctuations in profit margins (see Margins, Multiples, and the Iron Law of Valuation). These measures are linked to subsequent returns in very much the same way as in our simple thought-experiment. The chart below presents the ratio of nonfinancial market capitalization / nominal GDP on log-scale, versus actual subsequent S&P 500 12-year nominal annual total returns in data since 1926.

Note that although low interest rates may encourage yield-seeking speculators to drive stock market valuations to extremes, those rich valuations, in turn, are associated with low subsequent market returns. This is precisely what one should expect when investors respond to zero interest rates by driving valuations on risky assets to obscene levels: realized past returns are amplified for a period of time, but expected future returns are driven toward zero.

The chart below presents estimated 10-year returns on a conventional asset mix (60% stocks, 30% bonds, 10% Treasury bills) versus actual historical returns on that mix. We would obtain the tightest historical relationship by using a 12-year horizon (the period over which the autocorrelation of valuations decays to zero) and by estimating S&P 500 total returns using MarketCap/GVA, but the version below offers a more standard rule-of-thumb and a longer data set.

We currently estimate that the total return on a conventional portfolio mix of stocks, bonds and Treasury-bills is likely to average scarcely 1.5% annually over the coming decade. Ironically, however, the advance to extreme valuations (and correspondingly poor long-term return prospects) has encouraged pension administrators to underfund future liabilities, on the belief that high realized past returns are representative of future outcomes.

I should point out that there are a few “outliers” in the S&P 500 return estimates. For example, S&P 500 total returns in the 10-year period following 1988-1990 significantly exceeded estimated returns, due to a bubble that brought equity valuations at the end of that 10-year period (1998-2000) to the highest levels in history. There’s a smaller outlier in 2005 corresponding to the valuation extreme a decade later in 2015. Conversely, S&P 500 total returns in the 10-year period following 1964 and 1972 were much weaker than one would have estimated, owing to a market collapse that brought valuations to deep secular lows in 1974 and 1982. That said, to rely on portfolio returns much different than these estimates is essentially to rely on an obscene bubble or deep secular low a decade from now.

Notice that between 1980 and 1991, the financial markets were priced to deliver significantly above-average long-term returns for a conventional portfolio mix. As the late-1990’s tech bubble unfolded, much of this expected future return was converted to realized past return, leaving little on the table for long-term investors. Indeed, at the 2000 market peak, I estimated that the S&P 500 was priced for negative expected 10-year total returns, even on the basis of optimistic assumptions. Still, because 10-year bond yields were near 6.5%, investors at least had other conventional investment options available. The 2002 and 2009 bear market lows restored long-term return prospects to some extent, but the stronger prospective equity market returns were joined by rather meager bond yields, so prospective returns on the overall mix were restrained.

At present, years of relentless quantitative easing by the Federal Reserve have driven equity valuations to the point where prospective 10-12 year S&P 500 total returns are just 0-2% by our estimates, while Treasury yields are also below 2% and Treasury bill yields are only a fraction of a percent. The combination brings the expected return on this portfolio mix to the lowest level in history outside of the valuation extremes of 1929, 1937, and 2000. Yet, because investors and policy-makers seem incapable of distinguishing realized past returns from expected future returns, they fail to see the danger in this situation.

Recall, as I detailed last week, that real "wealth" is not inherent in the price of a security, but in the stream of cash flows it delivers over time, and the value-added production that generates those cash flows. The only way for you to spend out of the paper "wealth" of an overvalued security is by selling it to someone else and letting them hold the bag. By encouraging a sense of illusory, paper wealth, all the Fed has done is to discourage saving, and by extension, real investment (which in equilibrium must be identical to saving). Because of the Fed's singular focus on punishing saving and encouraging debt-financed consumption, growth in real gross private domestic investment in the U.S. has collapsed in the past 16 years, growing at less than 1.0% annually since 2000, compared with 4.6% annually in the preceding half-century. Put another way, the Fed has encouraged the illusion of paper wealth while simultaneously destroying the capacity of the U.S. to produce real wealth.

All of this is tied together: zero interest rate policy, speculative yield-seeking, pension underfunding, financial bubbles, malinvestment, crisis, and economic stagnation. The intentional distortions created by wholly experimental monetary policy carry a great deal of responsibility for these outcomes. The global financial economy has been pushed to such reckless speculative extremes that the ability of this house of cards to survive even a quarter point increase in short-term interest rates is a subject of serious and uninterrupted debate.

The Fed has done enormous violence to the public, and to the underlying stability of the financial markets, not only by encouraging a reckless yield-seeking financial bubble as the response to a global financial crisis that resulted from the previous Fed-induced yield-seeking bubble; not only by driving the financial markets to the point where poor long-term returns and wicked interim losses are inevitable (the same dangers investors faced at the 2000 and 2007 peaks); but also by creating an environment where scarce savings have been increasingly diverted to speculative activities, and where pensions have been encouraged to underfund their liabilities in the belief that past realized returns are indicative of future outcomes.

Savings and umbrellas

Despite the dismal 10-12 year prospects for conventional portfolios, we strongly encourage investors to continue to save in a disciplined way, but nothing forces investors to allocate these funds to speculative asset classes. I expect the S&P 500 to lose about 40-55% over the completion of this cycle, which would be only a run-of-the-mill outcome from a historical perspective, given current valuation extremes. It’s unfortunate that prospective returns on traditionally rewarding asset classes have been driven to zero, and it may be uncomfortable to park savings in safe but low-return investments, hedged equity, and the like. Still, I strongly encourage investors to continue a disciplined saving program, even if the funds have to stay under an umbrella for a while. Market conditions will change, but the opportunity to save is always much harder to recover once it is abandoned.

I never hesitate to acknowledge that my insistence on stress-testing our methods of classifying market return/risk profiles against Depression era data, following a financial crisis we fully anticipated, led to a difficult and awkward transition from 2009 until mid-2014 when those challenges were fully addressed (see the Box in The Next Big Short for the detailed narrative). But to point to our experience in this speculative period as the basis for ignoring a century of objective historical evidence is terribly misplaced, in my view. One can do what one wishes, but having addressed the challenges we faced in the half-cycle since 2009, I believe that our experience in complete market cycles prior to 2009 warrants consideration - particularly as the stock market continues to trace out an arc that appears likely to represent the top-formation of the third speculative financial bubble in 16 years.

There’s very little that individual investors or pension funds - in aggregate - can do about dismal 10-12 year investment prospects, because every security that is outstanding must be held by someone until it is retired. Injuries are inevitable. Those who are sensitive to deep losses or have relatively short horizons might want to pass their risk exposure off to speculators and passive investors, and allow them to take one for the team (even if they don’t fully realize they’ve done so until it’s too late).

Fortunately, as equity valuations fall, the effective duration of equities also shortens, making stocks more appropriate for investors with more moderate horizons. At a 2% dividend yield on the S&P 500, the effective duration of equities works out to about 50 years. At a more normal 4% dividend yield, the duration works out to be about 25 years. That means that an investor with a 25-year spending horizon could be comfortable being 100% in stocks at a 4% yield, but might best limit exposure to about 50% invested at a 2% index yield. That’s not market timing - that’s just duration matching. Presently, investors with short horizons or low tolerance for steep losses should reach for the available umbrellas. The Iron Law of Equilibrium here is that somebody will have to stand in the rain between now and the point where reasonable long-term return prospects are restored by a surrender of realized past returns.

What’s quite unfortunate, in my view, is that the strong realized past returns of the past 25 years are now actually being taken as a justification of current, unrealistically high pension return assumptions. This, in turn, encourages continued underfunding. This inclination appears to be wholly encouraged by Federal Reserve policies, and threatens to amplify an inevitable pension crisis in the coming years. To get a full sense of the level of denial here, the following argument appeared in a February brief from the National Association of State Retirement Administrators:

“Some critics of the current public pension investment return assumption levels say that current low interest rates and volatile investment markets require public pension funds to take on excessive investment risk to achieve their assumption... Although public pension funds, like other investors, experienced sub-par returns in the 2008-2009 decline in global equity markets, median public pension fund returns over a longer period exceed the assumed rates used by most plans. Specifically, the median annualized investment return for the 25-year period ended December 31, 2015 exceeds the average assumption of 7.62 percent... Over the last 25 years, a period that has included three economic recessions and four years when median public pension fund investment returns were negative, public pension funds have exceeded their assumed rates of investment return.”

National Association of State Retirement Administrators, NASRA Issue Brief, February 2016 To draw an inference about future returns using investment returns over the past 25 years is to draw a line from the depressed valuations of 1990 to the obscene valuations of today, and then extrapolate it indefinitely. The realized past returns of this period have been strong precisely because they have robbed from future expected returns. The tide will turn, as it always has in complete market cycles across history, and as investors discovered during the market collapses of 2000-2002 and 2007-2009. The erasure of realized past returns will restore reasonable prospects for future investment, as other retreats have done. Meanwhile, keep saving, reach for umbrellas, fasten your seat belt, and brace for the consequences and eventual opportunities that the current recklessness will bring.

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Please see periodic remarks on the Fund Notes and Commentary page for discussion relating specifically to the Hussman Funds and the investment positions of the Funds.

Will DB play Lehman?

May 2016: Will Deutsche Bank Survive This Wave Of Trouble Or Will It Be The Next Lehman Brothers?

By Michael Snyder, on May 23rd, 2016

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Euro Question - Public DomainIf you have been waiting for “the next Lehman Brothers moment” which will cause the global financial system to descend into a state of mass panic, you might want to keep a close eye on German banking giant Deutsche Bank.  It is approximately three times larger than Lehman Brothers was, and if the most important bank in the strongest economy in Europe were to implode, it would instantly send shockwaves rippling across the entire planet.  Those that follow my work regularly know that I started sounding the alarm about Deutsche Bank beginning last September.  Since that time, the bad news from Deutsche Bank has not stopped pouring in.  They announced a loss of 6.8 billion euros for 2015, Moody’s just downgraded their debt to two levels above junk status, and they have been plagued by scandal after scandal.  In recent months they have gotten into trouble for trying to rig precious metal prices, for committing “equity trading fraud” and for their dealings in mortgage-backed securities.  The following comes from Zero Hedge

A month after admitting to rigging precious metals markets, Deutsche Bank has been hit with a double-whammy of more alleged fraudulent behavior today and the stock is sliding. First, Reuters reports that the bank took a charge of 450 million euros for “equity trading fraud,” and then Bloomberg reports that The SEC is looking into Deutsche’s post-crisis mortgage positions.

This is a bank that is steadily bleeding money, and so the last thing that it needs is for government agencies to be putting immense pressure on it.  Unfortunately for Deutsche Bank, the SEC seems determined to kick it while it is down

Troubled Wall Street giant Deutsche Bank is under another investigation, this time by the Securities and Exchange Commission regarding the pricing and reporting of certain mortgage-backed securities.

The SEC wants to know whether the Frankfurt, Germany-based bank artificially raised the value of mortgage-backed securities in 2013 and later hid those losses for an extended period of time, Bloomberg first reported, citing people familiar with the matter.

But even if there were no scandals and no government investigations, the truth is that Deutsche Bank would be a deeply troubled bank anyway.

At one point, it was estimated that Deutsche Bank had 64 trillion dollars worth of exposure to derivatives contracts.  That is an amount of money that is approximately16 times the size of the GDP of the entire nation of Germany.

So nobody wants to see Deutsche Bank fail.  It would be a financial disaster unlike anything the world has ever experienced before.

But right now things are not looking good.  As you can see from this chart, the steady decline of Deutsche Bank’s stock price is eerily similar to what happened to Lehman Brothers during the months leading up to the time when it finally completely collapsed…

Deutsche Bank Lehman Brothers - Zero Hedge

Earlier this year, Deutsche Bank’s stock price set a new record low, and since that time it has been hovering just above that record low.

Clearly it is no secret that Deutsche Bank is having big problems, and the outlook for the immediate future is not good.  I included the following quote from Berenberg analyst James Chappell in a previous article, but I think that it bears repeating…

Too many problems still: The biggest problem is that DBK has too much leverage. On our measures, we believe DBK is still over 40x levered. DBK can either reduce assets or increase capital to rectify this. On the first path, the markets do not exist in the size nor pricing to enable it to follow this route. Going down the second path also seems impossible at the moment, as the profitability of the core business is under pressure. Seeking outside capital is also likely to be difficult as management would likely find it hard to offer any type of return on new capital invested.

In the end, I believe that Deutsche Bank will ultimately implode, but it won’t be the only one.

Meanwhile, we just got some more very disturbing news out of Asia.  According to Bloomberg, Japanese exports have now fallen for seven months in a row…

Japan’s exports fell for a seventh consecutive month in April as the yen strengthened, underscoring the growing challenges to Prime Minister Shinzo Abe’s efforts to revive economic growth.

Overseas shipments declined 10.1 percent in April from a year earlier, the Ministry of Finance said on Monday. The median estimate of economists surveyed by Bloomberg was for a 9.9 percent drop. Imports fell 23.3 percent, leaving a trade surplus of 823.5 billion yen ($7.5 billion), the highest since March 2010.

When your imports are 23 percent lower than they were a year earlier, that is a clear sign that consumer demand is way, way down and that your economy is in the process of imploding.

So I will repeat what I have said a number of times before…

Watch Germany and watch Japan.

I believe that they are going to be two of the biggest stories as this new global financial crisis begins to play out.

*About the author: Michael Snyder is the founder and publisher of The Economic Collapse Blog. Michael’s controversial new book about Bible prophecy entitled “The Rapture Verdict” is available in paperback and for the Kindle on*