Category Archives: Strategy & Scenarios

Extreme Crazy

I was going to say Peak Crazy, but we all know things can always get crazier. Some things that spring to mind.

Political craziness: Mob violence on left and right, blatant defiance of federal law by city politicians, attempts to rewrite or at least deny history, demonization of Trump, Putin and anybody associated with them, and so on. Immigration in Europe – it’s that 4.7 kids per woman in Africa that nobody dares to talk about. Not to mention the crazy fat kid.

Fiscal craziness: Federal funding of runaway price increases, notably in university tuition, prescription drugs but also many other subsidized goods and services. Gross under-funding of state and local pension schemes even under ludicrous assumptions about future returns.

Monetary craziness: Central banks threatening to tighten but pumping away, consumer credit at record highs in US and elsewhere (Canada, that’s you I’m talking about with highest household debt in the world), government deficits keep growing. Subprime crdiet still gowing while defaults rise. Most of all, ICOs. People pouring money into blockchain-based tokens. Really?

Market craziness: Housing bubbles in China, Canada, Australia, UK and some US cities. Massive (record) risky speculation in many markets – short vol, long crude for example. Setups (risk parity) similar to portfolio insurance (remember 1987?).

I could go on. But I won’t. I’m just grumbling while I wait.

Portfolio Insurance

A strategy called portfolio insurance, which nowadays we would call a form of dynamic hedging, is widely blamed for the 1987 crash. This strategy, in effect, creates a ‘stop-loss order’ that gets larger in size and closer to the current market price as volatility gets lower.

The combination of shorting volatility, option hedging and risk-parity strategies sets up a very similar situation. Make hay while the sun shines, but thunderstorms are likely.

The Economy In One Chart

Source: WSJ

Fed Folly

Lacy Hunt from Hoisington Management.

Hubris

Janet Yellen today:

“Will I say there will never, ever be another financial crisis? No, probably that would be going too far. But I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will.”

Seriously? If nothing else, the coming pension tsunami virtually guarantees it. It is truly scary that this powerful person seems to live in an alternate universe.

GLWT.

Nothing To See Here

I just saw that Charles Schwab, the brokerage company, in April announced that the number of new accounts increased 44% y/y in 1Q2017 as individuals were opening up stock trading accounts at the fastest pace the company has seen in 17 years.

Actually the company called them individual investors but I can’t stomach calling anyone trading stocks at these prices an investor.

A more recent announcement from the company showed new accounts in May at 115,000, up 42% from the prior-year month and the sixth consecutive month of 100,000+ growth.

Whoopee! Oh, and 17 years ago, that would be…?

Dreaming

FANG is so over. Now it is FANTASIA (Facebook, Amazon, Netflix, Tesla, Alphabet, SalesForce, Intel, and Apple)

The Future Is Now

Debt pulls demand forward in time. Borrowers use debt to pay for consumption today and commit future income to service the debt.

The amount available for consumption today represents the present value of that committed income, discounted by the prevailing interest rates.

The further that borrowers reach into the future, the more that discount lessens the amount available today. The Fed wants consumption today, so it attempts to induce inflation in order that borrowers are more confident of their future nominal incomes, while holding interest rates low so that the discounting of that income is minimized.

This strategy has sustained consumption in the short term, at the expense of reducing future income available for consumption.

The problem is that the future is now.

As consumption slows, so does production and inflationary pressure. Defaults rise – just look at the subprime auto loans. Yes, defaults eliminate debt – but only at the expense of the creditor who takes an immediate hit to income, charged against net worth or equity capital. Lenders are forced to reduce their assets.  Borrowers find that debt service takes more of their income than they had expected. Purchasing power erodes and deflation sets in. Spending capacity falls even more rapidly and the economy slides into recession and depression.

The larger the accumulation of debt, the longer it takes to purge the financial system and restore it to stability. Debt – credit – is a necessary and healthy part of the economic system. But the economy cannot depend on consumption funded by the continuous growth of debt. Debt must revolve, expanding and contracting within limits proportional to the size of the economy.

A Bit Of Math

Simon Mikhailovich of Tocqueville Bullion Reserve reminds us of the deadly numbers with a sobering tweet:

A bit of math. With the global debt / GDP ratio at 320% and the cost of average debt service at 2%, it takes 6.4% growth per annum just to service the debt. Not happening.

Jimmy

JIM ROGERS: The worst crash in our lifetime is coming

Amen.