Protect Yourself From the “Crazy Man Theory”

By James Rickards

Nixon and Trump

This post Protect Yourself From the “Crazy Man Theory” appeared first on Daily Reckoning.

One topic that has received a lot of attention lately is what some call the crazy man theory of negotiation.

This theory says that a rational actor trying to optimize the outcome of a negotiation can benefit from making the other party to the negotiation believe he’s mentally unstable. This perceived instability by one side throws the other side off-guard and confuses their analysis. This confusion can then be exploited to optimize the outcome for the presumed crazy man.

A simple illustration is a chess game, the ultimate in rational calculation and decision-making.

The two sides in chess are white and black; white goes first. White might open with queen’s pawn to queen’s pawn 4, a traditional opening. Black sees this traditional opening and immediately eliminates 19 other possible openings and thousands of possible second moves by white from his calculations.

White has chosen a path but ultimately has given up millions of other paths. Black makes his first move accordingly. White assesses black’s gambit and either proceeds with his original plan of attack or adjusts as needed.

The game proceeds from there, rational move followed by rational move until the endgame.

But suppose instead black simply raises his forearm and wipes all the pieces off the board onto the floor, looks up at white and says, “Your move, pal.” That’s the crazy man theory in action.

I’ve encountered many crazy man negotiators in my four-decade career as a lawyer. I don’t negotiate that way myself, but I’ve seen it in action. Goldman Sachs infamously threw spitballs as I was negotiating the rescue of LTCM in 1998.

At one point Goldman lobbed in an offer to buy LTCM, signed by Warren Buffett and Jon Corzine, while Corzine’s people were at the Fed simultaneously pretending to play nice with the Wall Street consortium.

That crazy man tactic almost worked until Buffett’s lawyer failed to get Buffett on the phone to approve my required changes (Buffett was on a fishing trip in Alaska with Bill Gates at the time and out of cellphone range). So I told Buffett’s lawyer, “Nothing done” and went back to the Fed’s plan.

Still, crazy man tactics can be productive. If you have a specific goal in mind and a crazy man is in action, you might say to yourself, “OK, this guy is nuts. What will it take to settle him down, get him back to the table and get a deal done we can both live with?”

The crazy man also burns up time and energy because your calculations and prior progress are often thrown in the trash. The crazy man literally wears you down.

The key attribute for dealing with a crazy man negotiator is patience. Your most powerful weapon is just walking away from the table. That’s how you turn the tables and wear out the crazy man. Still, it’s not easy.

One of the greatest challenges for investors today is that there are several crazy man negotiators on the loose.

First and foremost are U.S. President Trump, North Korea’s Supreme Leader Kim Jong Un, Israel’s Prime Minister Benjamin Netanyahu and Iran’s Ayatollah Ali Khamenei.

I would put other world leaders in the rational camp (more my style) including Russian President Vladimir Putin, China’s President Xi Jinping and German Chancellor Angela Merkel. Of course, the difficulty with this mix of crazy men and rational actors is that you never know when all of the chess pieces will end up on the floor.

President Richard M. Nixon and President Donald J. Trump have both exhibited what some call the crazy man style of negotiation. The idea is to act in unexpected ways to keep opponents off balance and to leave the impression they may resort to extreme measures if they do not get what they want.

Crazy-man negotiating tactics have a long pedigree. President John F. Kennedy took the world to the brink of nuclear annihilation with a credible threat to attack Russia during the 1962 Cuban Missile Crisis.

President Nixon shocked the world with his 1972 visit to China, after decades of U.S. isolation of China and Nixon’s long career as a communist baiter.

President Reagan literally got up and walked out of the room at his 1986 nuclear summit with Russia’s Gorbachev in Reykjavik, Iceland. A shocked world was unsure whether Reagan was on his way back to Washington to order a first strike.

All of these crazy man tactics worked. Russia did remove its missiles from Cuba in 1962. The U.S. did use its new relationship with China after 1972 to isolate Russia and win the Cold War. Gorbachev and Reagan did return to the negotiating table with Russia more willing to sign substantive treaties once they understood U.S. resolve not to be disadvantaged.

Yet there’s one crucial difference between the crazy men of yesterday and those today.

Kennedy, Nixon and Reagan were all highly intelligent and seasoned negotiators (Kennedy less so than the others), advised by the top strategists at the time including Dean Rusk, Henry Kissinger and James Baker among others. They were highly rational on the inside but found the crazy man posture tactically useful on limited occasions. In short, they weren’t too crazy.

Today, it’s hard to tell. Trump and the other new crazy men use irrational posturing almost full time. They are impulsive and don’t seem to listen to expert advice. This makes it harder to see the endgame and harder for the rational players to see through the pose. The chess pieces don’t just end up on the floor occasionally; they more or less stay there.

Trump called Kim Jong Un “little rocket man” and threatened “fire and fury.” Kim called Trump a “dotard” and threatened nuclear annihilation of the United States. The Ayatollah Khamenei shouts, “Death to America,” while Netanyahu threatens to destroy Iran’s uranium enrichment capability the minute one centrifuge is turned on.

The Iran nuclear deal involving the U.S., U.K., France, Russia, China and Germany took two years to negotiate and was ended in two seconds with Trump’s signature on …read more

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Trump Haters Don’t Get the “Art of the Deal”

By James Rickards

This post Trump Haters Don’t Get the “Art of the Deal” appeared first on Daily Reckoning.

I’m continually amazed at the legions of politicos, pundits and so-called “experts” who don’t understand President Trump or how he conducts policy.

These elites have a mental model of how a president is supposed to behave and how the policymaking process is supposed to be carried out. Obviously, Trump does not fit their model.

Instead of trying to grasp the model that Trump does use, they continually berate and disparage Trump for not living up to their expectations. A more thoughtful group would say, “Well, he’s different, so why don’t we try to understand the differences and analyze the new model?”

Really, these people need to get out of Washington, New York and Hollywood more and get away from their screens. If they knew more everyday Americans, they would come a lot closer to understanding how Trump gets things done.

It’s not chaos; it’s just a little different and more down to earth.

This is because of Trump’s “art of the deal” style described in his best-selling book by that name. Bush 43 and Obama were totally process-driven. You could see events coming a mile away as they wound their way through the West Wing and Capitol Hill deliberative processes.

All you had to do was understand the process and you could forecast big developments in a relatively straightforward way.

With Trump, there is a process, but it does not adhere to a timeline or existing template. Trump seems to be the only process participant most of the time.

Here’s the Trump process:

  1. Identify a big goal (tax cuts, balanced trade, the wall, etc.).
  1. Identify your leverage points versus anyone who stands in your way (elections, tariffs, jobs, etc.).
  1. Announce some extreme threat against your opponent that uses your leverage.
  1. If the opponent backs down, mitigate the threat, declare victory and go home with a win.
  1. If the opponent fires back, double down. If Trump declares tariffs on $50 billion of good from China,and China shoots back with tariffs on $50 billion of goods from the U.S., Trump doubles down with tariffs on $100 billion of goods, etc. Trump will keep escalating until he wins.
  1. Eventually, the escalation process can lead to negotiations with at least the perception of a victory for Trump (North Korea) — even if the victory is more visual than real.

No one else in Washington thinks this way. Washington insiders try to avoid confrontation, avoid escalation, compromise from the beginning and finesse their way through any policy process.

Trump is in a league of his own. What amazes me is that the media still do not understand his style and keep taking the bait when he announces something crazy, as in Step 3 above.

Here’s a list of big issues that are now in play from Trump’s perspective and may lead to dramatic results with important implications for investors:

  1. Tariffs and penalties on China for theft of intellectual property.
  1. Trump’s threat to withdraw the U.S. from the World Trade Organization (WTO).
  1. Trump’s threat to quit NATO. Trump will not actually do this, but he could withdraw U.S. troops from Germany. This would drive Germany closer to Russia.
  1. The U.S. and China can find no middle ground in disputes over rights in the South China Sea
  1. North Korea seems to be cheating on its commitment to Trump to denuclearize the Korean Peninsula.

All of these developments and more have the potential to reach crisis proportions. The problem from an investor’s perspective is they are “slow burn” crises and can linger for a long time before producing anything dramatic such as a shooting war or market collapse. They are not date-driven or date-specific in the short run.

One story that’s under the radar and could blow up soon is Chinese currency devaluation.

If Trump puts a 25% tariff on Chinese imports but China then devalues its currency 25%, then the net effect is zero. The impact of the devaluation offsets the impact of the tariff and then you’re back where you started.

This new currency war seems to be happening.

Once Trump focuses on this, he’s likely to be infuriated and retaliate against China in the currency war and take steps to penalize China for currency manipulation over and above the existing tariffs and penalties for theft of intellectual property. This has a hard date of Oct. 15, 2018.

That’s the date of the U.S. Treasury’s semiannual report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States.

That report is the formal mechanism for labeling a trading partner such as China a “currency manipulator” with severe consequences. Oct. 15, 2018, is just three weeks before the midterm elections, so it could be a highly popular political move in addition to being economically important.

All of this and more is on Trump’s policy plate right now. Just don’t expect him to handle it the way politicos usually do. Investors should expect dramatic policy shifts and extreme threats. But don’t overreact like the Washington pundits.

Remember, it’s all the art of the deal.

Regards,

Jim Rickards
for The Daily Reckoning

The post Trump Haters Don’t Get the “Art of the Deal” appeared first on Daily Reckoning.

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Trend Alert: From Band Geek To Prom King

By Zach Scheidt

Zach Scheidt

This post Trend Alert: From Band Geek To Prom King appeared first on Daily Reckoning.

Ever notice how as time passes, things go in and out of style?

My 17-year-old daughter loves wearing jean jackets. Ray-Ban sunglasses are making a comeback. Even the fanny pack is supposedly trendy now!

As dividend investors, we often watch fads in the market come and go.

For a short time, some investors loved “cloud technology” stocks. And then they shifted focus and moved all their capital into cryptocurrency plays. It’s possible that the next hot investment idea could be artificial intelligence or self-driving car platforms.

I don’t have any problem investing in great companies that are in sync with the current popular trends. But I only want to put my hard-earned cash to work if I can be confident that the companies I invest in will give me a healthy return — with plenty of income along the way.

By taking this approach, we’ve been able to collect reliable income payments month after month while avoiding a lot of the drama and uncertainty that comes with investing in the latest fad.

Today, I’m a little bit amused to see that our tried-and-true strategy of investing in quality stocks that pay reliable dividends is becoming more “popular.” In fact, dividend stocks are showing signs of becoming the new “fad” as investors look for ways to protect their capital and grow their income.

That’s all well and good with me. This new fad (or old fad, depending on your perspective) is giving new life to some of my favorite income opportunities…

A Resurgence in Consumer Staples Stocks

After years of being some of the most overlooked stocks on Wall Street, consumer staples stocks are now showing up in headlines and even being discussed on shows like CNBC’s Fast Money. How’s that for ironic?

To refresh your memory, consumer staples companies are the “boring” businesses that provide all of the things that you need for day-to-day living.

We’re talking about things like cleaning supplies, cosmetics, personal products and basic food items.

In other words, these are the things that you buy regardless of whether the economy is doing great or in a slump. And because these companies have very steady businesses, investors haven’t been interested in owning shares.

After all, you’re not going to double your money in a year with one of these stocks. (At least, that’s the prevailing wisdom.)

With so much attention on blockchain technology, self-driving cars and media entertainment, trendy investors have moved money out of consumer staples stocks. There isn’t anything wrong with the businesses (or with the income they pay to investors). But the stocks simply haven’t been “sexy” enough to hold investors’ attention.

That’s one of the main reasons shares of consumer staples companies like one of my favorite income plays, Procter & Gamble (PG), have pulled back.

Fortunately, the steady income payments investors received from PG have more than offset the pullback in the stock price. That’s the beauty of income investing… Even with the market’s back-and-forth, shareholders still get paid real cash, which is theirs to keep regardless of what stock prices do.

Today, the newest investment fad is to buy shares of companies with stable earnings and reliable dividends. Does that sound familiar?

This new fad is helping to drive shares of consumer staples higher, which is great news for many of The Daily Edge’s favorite income positions!

Now, to be clear, I’m not saying you should be in these names because they’re now more popular. Buying and holding quality stocks that pay great dividends is something we do year-round. Whether it’s in fashion or not.

But I am saying that if you’re not yet invested in PG or other consumer staples stocks on your radar, now is a great time to buy these names. After all, the stocks are still very cheap and now we have momentum on our side.

In fact, I’d go as far as to recommend adding to your position since the stock price is very low, the dividend yield is over 3.6% and the momentum is in our favor.

Stalking Utilities for New Opportunities

Another great area for dividend stocks that has been overlooked is the utility sector.

Shares of utilities have historically been considered safe and boring places to park your money. In fact, many people dubbed these investments “widow-and-orphan stocks” because they were only good for protecting the assets of people who couldn’t afford to take much risk.

Today, utility stocks are on the move and headed higher.

The same forces that are helping to push consumer staples stocks higher are also propelling the stocks of stable utility companies. In other words, investors are looking for safe places to earn income, and utility stocks offer the perfect advantages.

If you’re interested in investing in a wide assortment of utility opportunities, the Utilities Select Sector ETF (XLU) is a good place to start. This fund currently pays a 3.4% yield, and it’s a great way to profit from the rebound in this sector.

Here’s to growing and protecting your wealth!

Zach Scheidt
Editor, The Daily Edge
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“I Don’t Know About You, but I’m Worried”

By Brian Maher

This post “I Don’t Know About You, but I’m Worried” appeared first on Daily Reckoning.

“What trade war?” asked an Op-Ed writer in Tuesday’s Washington Post, triumphantly.

“Investors on Monday continued shrugging off fears that President Trump’s escalation of trade hostilities will put a dent in share prices.”

We almost pity the poor fellow — all that egg he had scrape from his face.

The Dow Jones tumbled 219 trade-warring points yesterday — and once again turned negative on the year.

Damage spread far… and wide… like a virus unleashed in a busy airport:

S&P — down.

Nasdaq — down.

Global stock markets — down.

Oil, gold, commodities in general — down.

Copper, which many consider a true barometer of global growth, plunged as much as 4% yesterday.

The one major exception?

The dollar — the dollar was up — which partly explains the commodities shellacking.

But the central reason for yesterday’s far-flung panic is trade…

The president threatened additional tariffs on another $200 billion of imported Chinese goods.

This, coming days after the U.S. and China imposed $34 billion of tariffs on the other’s goods.

This, coming as Trump harrumphs he may seek tariffs on over $450 billion of Chinese wares.

Markets made good many of yesterday’s losses today.

They nonetheless remain, to cadge a hackneyed phrase, “on edge.”

“We view the White House’s announcement of an additional $200 billion round of tariffs as significant in escalating the tensions closer to a full-blown tit-for-tat trade war,” warns Bart Melek of TD Securities.

Commerzbank analysts affirm:

“There is growing concern among market participants that the trade war will affect the real economy and put the brakes on global economic growth.”

The way ahead is a gauntlet… and arrows come zinging from every direction…

To trade wars we must add rate hikes. Quantitative tightening. Inverting yield curves. Overvalued stocks. Sky-shooting deficits. More.

“I don’t know about you, but I’m worried,” confesses Kevin Muir, market strategist at East West Investment Management, listing a parade of horribles:

The economic cycle is long in the tooth. Equity valuations are stretched. The yield curve is flattening. Emerging markets and other liquidity-sensitive markets are sagging. The Federal Reserve is raising rates while also attempting the never-before-accomplished feat of reversing a decade of quantitative easing — seemingly oblivious to the hornet’s nest they are walking into. And President Trump seems determined to antagonize as many trading partners as possible before the summer holidays begin in earnest.

Sell everything is the message — include the sink in the kitchen, the floorboards, the wife, the children.

But is that the message?

“Although every bone in my body wants to sell this market,” Muir anguishes, “I am petrified this trade is so obvious, it can’t be right.”

It can’t be right?

What about the economic cycle you mentioned… equity valuations… the yield curve… emerging markets… the Federal Reserve… Donald Trump’s antagonizings?

I know all the reasons why the stock market should go down. The investor in me agrees 100% with the skeptics who worry we are late-cycle and that risks are rising. But the trader in me is even more concerned that everyone is already positioned for this outcome… I don’t think the Market Gods will allow this many to catch the top. Markets don’t roll over with the vast majority of market participants calling for a correction. No, they top with buyers being absolutely convinced the only way is up.

The consensus-busting conclusion?

“That path is higher — not lower.”

A contrarian we have here.

Many boastful types bellow contrarian gloats and gurgles — “I never follow the crowd. I always do the opposite. I’m my own man.”

In reality… few can summon the courage to stray from the herd’s comforting embrace.

The pull proves irresistible for most.

Do you have the nerve?

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post “I Don’t Know About You, but I’m Worried” appeared first on Daily Reckoning.

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Crisis Alert: The $80,000 Job Nobody Wants Is Costing You Money!

By Jody Chudley

soaring cost of trucking

This post Crisis Alert: The $80,000 Job Nobody Wants Is Costing You Money! appeared first on Daily Reckoning.

It is a problem impacting everyone, including you.

And it is hitting us right where it hurts — in the wallet.

The issue is a massive shortage of truck drivers in the United States. American Trucking Associations believe that we need at least 50,000 additional truck drivers, and we need them today.1

It isn’t hard to fathom how a shortage of truck drivers impacts all of us financially. Just take a look around you right now…

If something is in your home, then it has at some point been on a truck.

To attract new drivers companies have had to pay more. On top of that we also have rising fuel costs.

The cost of shipping a “dry good” (one that doesn’t require refrigeration or special conditions) by truck has risen by almost 80 percent since 2010 and 40 percent in the past year alone.

These increased trucking costs are impacting nearly every company that is in the business of selling goods.

Tyson Foods (TSN: NYSE) for example has indicated that its shipping costs will increase by a whopping $200 million this year. It doesn’t matter what is being shipped, if it is going by truck it will cost more.

You know what happens when corporations see their costs rise. They pass those cost increases on to us, the consumers. Since virtually everything we consume gets shipped to us, that means we are going to be paying more for everything.

Were you wondering why the cost of your Amazon Prime membership jumped from $99 to $119? This truck driver shortage is it.

Worse still, this is not going to be a temporary problem.

With e-commerce growing at a rapid pace, an even greater strain will be placed on our transportation system and the truck driver shortage will grow.

Expectations are that we will need nearly 900,000 new drivers over the next decade to keep up with the growth in demand for freight transportation.2 There is no way that the trucking industry attracts all of those bodies without continuing to offering higher and higher compensation…

We Can Eat These Cost Increases Or We Can Do Something About Them

It is pretty clear that as consumers, we are going to be bearing the brunt of these shipping cost increases over the coming decade.

It therefore makes sense for us as investors to hedge way our exposure to what is coming.

So how do we do that? How do we profit from truck driver wages rising?

Next to becoming truck drivers ourselves, the most obvious way to do that is by owning the railroads which become much more competitive as the cost of trucking goes up.

Interestingly, we wouldn’t be the first smart investors to see opportunity in the railroads. Warren Buffett purchased all of Burlington Northern Santa Fe in 2009 for his company Berkshire Hathaway, and his pal Bill Gates has owned a significant position in the Canadian National Railway since 2002.3

The specific railway that I like best right now is Kansas City Southern (KSU: NYSE). My preference for Kansas City Southern today is based entirely on one thing, the shares of the company are cheap.

At just over 11 times earnings, KSU is trading at a lower multiple than it has for years.

Kansas City Southern

The reason for Kansas City Southern’s depressed valuation is concern over the North American Free Trade Agreement (NAFTA). KSU has built an expansive rail network that connects the U.S. heartland to Mexico, and President Trump’s threats to exit from the existing NAFTA deal have cast a shadow over KSU’s share price.

I believe that any concerns over the U.S. exiting NAFTA are more than priced into this stock. The market has accepted the idea that NAFTA and trade in North America are going to crumble.

In doing so, the market has missed how much Kansas City Southern is going to benefit from a boom in the petrochemical business that is happening on the Gulf Coast. The market has also missed this company has just completed spending on two major capex projects and is going to see a $100 million reduction in spending this year. That means increased free cash flows which means more money for dividends and share repurchases.

Today, shares of Kansas City Southern are priced for the complete death of NAFTA. As they old saying goes, “if it’s in the news, it’s in the stock.

I think there is significant upside here even if NAFTA disintegrates because of the items the market has missed. Should we get a resolution to this NAFTA issue that is any less than disastrous for trade with Mexico, this stock will move higher in a hurry.

That means that these shares don’t have much room to fall, but oodles of room to rise. That is especially true with the demand for railroad shipments increasing as the cost of shipping by truck rises.

This is the kind of risk/reward trade that we should always be looking for.

Here’s to looking through the windshield,

Jody Chudley

Jody Chudley
Financial Analyst, The Daily Edge
EdgeFeedback@AgoraFinancial.com

1America has a massive truck driver shortage. Here’s why few want an $80,000 job., WaPo
2There Aren’t Enough Truckers, and That’s Pinching U.S. Profits, Bloomberg
3BILL & MELINDA GATES FOUNDATION TRUST, Whale Wisdom

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“Remarkably Accurate” Market Indicator Predicts “Devastating Losses”

By Brian Maher

10-Year Treasury Rate Minus Two-Year Rate

This post “Remarkably Accurate” Market Indicator Predicts “Devastating Losses” appeared first on Daily Reckoning.

MarketWatch gives the warning:

“Investors face ‘devastating losses’ if this ‘remarkably accurate’ indicator flashes.”

What “remarkably accurate” indicator is this?

When can you expect it to flash?

And how devastating the losses?

Today we square our shoulders… set our jaw against the wind… and light out for the uncertain horizon.

Since 1955, claims the San Francisco branch of the Federal Reserve, this indicator has accurately forecast all nine U.S. recessions.

All nine.

Only once did it cry wolf — in the mid-1960s.

It has also soothsaid every major stock market calamity for the past 40 years.

This indicator last went off in early 2006.

It had previously flashed in 2000.

On both occasions, mischief and havoc were soon at hand.

And now, in 2018…

This signal of recession is beginning to flicker and spark.

What is this ominous indicator of which we write?

The yield curve.

The yield curve is simply the difference between short-term and long-term interest rates.

Long-term rates are normally higher than short-term rates.

For the reasons, we needn’t look far…

The further out in the future… the greater the uncertainty.

Investors, for example, demand greater compensation to hold a 10-year Treasury than a 2-year Treasury.

And the 10-year Treasury yield rises when markets anticipate higher growth… higher inflation… higher animal spirits.

The 10-year yield should therefore run substantially higher than the 2-year yield.

But when the 2-year yield and the 10-year yield begin to converge… the yield curve flattens.

And a flattening yield curve is a possible omen of lean times.

Bob Johnson, director of economic analysis at Morningstar:

A flatter yield curve is viewed as a sign of upcoming weakness… If long-term and short-term rates are close, markets must be expecting little growth…

The Federal Reserve controls directly neither the 10-year yield nor the 2-year yield.

That business falls to what many still wistfully call the “free market.”

But being shorter term, the Fed exerts greater influence over the 2-year yield.

And its current rate hike cycle has worked upward pressure on this key rate.

Financial analyst Daniel Amerman:

Yield curve inversions generally occur when the Federal Reserve has been boosting interest rates. Because the interest rates that the Federal Reserve raises are short term, this tends to push the short term up relative to the long term, which is exactly what has been happening.

Last September the 2-year yield was 1.25%.

And today… it sits at 2.58%.

Meantime, since topping 3% in late February, the 10-year yield has fallen… to 2.85%.

The yield curve, therefore, is flattening (2.85% – 2.58% = 0.27%).

And the Fed is doing the flattening.

We note — in passing of course — that the yield curve has not been this “flat” since 2007.

As the calendar confirms… 2007 preceded 2008.

The flattening yield curve thus indicates recession may be gathering in the distance.

Research and investment consultant 720 Global:

Currently, the 2s/10s yield curve spread has been flattening at a rapid pace and, at only [0.27%] from inversion, raises concerns that a recession might be on the horizon…

While there are many explanations for why the curve is flattening rapidly, the consensus seems to be that inflation and the long-term economic growth outlook for the future are benign despite a recent spurt in economic activity.

Evidently the market believes the tax cuts will run their course soon enough… and lose their oomph.

And that inflation will stay in its cage.

But is a flattening yield curve an immediate menace, a thundercloud overhead?

Not necessarily, say the experts. Not yet.

The yield curve can stay good and flat for a while — with no ill effects.

Bloomberg’s Tim Duy:

The [yield] curve was extremely flat during the second half of the 1990s, a stretch of high growth. Only late in that period did the yield curve invert, finally foreshadowing the 2000 recession.

Here this fellow points out the true bugaboo — the inverted yield curve — when short-term rates actually overtake long-term rates.

It is only when the yield curve inverts that trouble follows.

The graphic evidence, stretching to 1980:

Right now the yield curve is flattening — but at 0.27%, it has not inverted.

All is peace, therefore.

But when can you expect the lethal inversion?

The Fed currently projects two additional 0.25% rate hikes this year — in September and December.

The first rate hike should further flatten the curve as it pressures the 2-year Treasury.

The second — in December — may just invert the slope.

The aforesaid Daniel Amerman:

So all it potentially takes is the Fed following its publicly stated game plan of increasing rates by another 0.50% before the end of 2018, with that continuing to have a larger impact on short-term than long-term rates, and that could be enough to produce an inverted yield curve by the end of 2018.

Does that mean you can expect recession later this year?

It does not.

History reveals the catastrophic effects of an inverted yield curve do not manifest for an average 18 months after the inversion.

Let us assume the pattern holds.

Let us further assume the yield curve inverts this December.

We conclude the economy may hum and the stock market may purr for the 18 months following.

Then comes trouble… sometime in mid-2020.

Two years from today.

Given the extreme duration of the current recovery and the super-inflated stock market, the thumping could assume historic grandeur.

“The cost of every pleasure,” as Buddha probably never said, “is the pain that succeeds it.”

And the stock market could be severed in half.

But the comeuppance nonetheless remains two years distant — if the foregoing holds together.

Of course… we cannot guarentee it does…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Don’t Bet IN Casinos… Bet ON Them!

By Zach Scheidt

World poker tournament

This post Don’t Bet IN Casinos… Bet ON Them! appeared first on Daily Reckoning.

As you read this Daily Edge alert, a handful of poker players are battling for their share of a $74 million prize pool, with the ultimate goal of grabbing the $8.8 million first place payout and a diamond-studded World Series of Poker bracelet.

This year’s World Series of Poker (or WSOP) main event tournament features the second largest field in history.

A total of 7,874 people were willing to pay $10,000 to enter the tournament. The tournament actually started on July 2nd, and by today there are only a few dozen players left in the running.

As an amateur poker player myself, I’ve had a good time watching a bit of the coverage from this year’s tournament. Today, I wanted to point out a couple of important takeaways that apply to us as investors. So here goes!

The Scariest Three Words in Poker

“I’m all in.”

As a poker player, whenever you hear these words, you know something big is about to happen.

The phrase “I’m all in” simply means that a player is betting all of his chips. And while this type of bet can put a lot of pressure on your opponents, it also carries a lot of risk.

It might surprise you to hear that the game of poker is very similar to our investment markets.

  • Just like the market, a typical poker game has a mix of amateurs and professionals.
  • Poker players and investors try to earn a good return while minimizing risk.
  • Basic math skills (statistics in particular) are important for investors as well as poker players.
  • Human emotions drive many investing and poker decisions. Those who set emotions aside do much better.
  • Risking too much on any one opportunity is foolish.

Over the weekend, I heard one famous player state that he had gone “all in” several times during the tournament so far.

The player was somewhat astonished that he didn’t get knocked out. Because if he had lost on any one of those hands, his chips would have been gone, ending his run in this year’s main event.

Hearing him talk about betting all of his chips reminded me of so many investors who get excited about a new investment opportunity and bet all of their capital on a single stock.

You might get away with this once or twice (as the player I listened to did), but any time you risk all of your capital in one play, you run the risk of getting knocked out of the investment game.

This is why I’m constantly encouraging you to take a balanced approach when it comes to investing.

There are so many great investment opportunities, that you don’t have to put too much of your capital into any one opportunity. Instead, it’s best to spread your investments across many different opportunities so that you have many chances to win, and no one loss will hurt you too bad.

Consumers Have Money to Burn!

Another takeaway from the WSOP event this week is the sheer dollar figures in play this year.

As I mentioned, this was the second largest field for the WSOP main event, and each player forked over a cool $10,000 to play.

Now keep in mind, most of these players are coming in from out of town, they’re staying at a local hotel or resort, they’re spending money on food and entertainment, and most are gambling at the Las Vegas casinos in between tournament sessions.

In other words, these consumers have money to burn, and they’re living it up!

This scenario lines up perfectly with the retail theme that we’ve been talking about here at The Daily Edge.

Thanks to the strong job market — which continues to grow even faster than investors expect — consumers have money to spend. And these consumers are buying merchandise, going to restaurants, and checking “bucket list” experiences off their list (including playing in the WSOP main event).

This trend gives us plenty of opportunities to make money in the market by investing in consumer discretionary stocks.

I’m interested in casino stocks right now, not only because they fit into this consumer discretionary category, but also because many casino stocks have pulled back recently.

Concerns about gaming rules in China have caused some investors to question how fast big casino companies can grow. But the strong global economy should drive profits for these companies not only in the U.S., but also in exciting gaming destinations that international travelers will frequent.

So in addition to restaurant stocks, branded apparel, and home decor stocks, I suggest adding casino stocks to your watch list. Taking advantage of the wealth effect for consumers is a great way to consistently book investment wins.

Here’s to growing and protecting your wealth!

Zach Scheidt

Zach Scheidt
Editor, The Daily Edge
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Trump’s Devastating Trade War Weapons

By James Rickards

Weimar Republic hyperinflation

This post Trump’s Devastating Trade War Weapons appeared first on Daily Reckoning.

The news last week was dominated by breathless headlines about the new trade war between the U.S. and China. But this trade war has been brewing for years and came as no surprise to readers of my newsletter, Project Prophesy. In fact, the new trade war is simply a continuation of the currency wars that began in 2010.

I’ve warned for over a year that President Trump’s threats of tariffs should be taken seriously, while most of Wall Street discounted Trump’s talk as mere bluster. Now the trade wars are here as we expected, and they will get much worse before they are resolved.

The most powerful analytic frame today for understanding political and macroeconomic developments is the sequence from currency wars to trade wars and then ultimately shooting wars.

Currency wars arise in a condition of too much debt and too little growth. Economic powers try to steal growth from their trading partners by devaluing their currencies to promote exports and import inflation.

This can work in the short run, but the benefits are strictly temporary because trading partners retaliate by devaluing their own currencies. The tit-for-tat devaluations leave everyone worse off because of the uncertainty and transaction costs imposed.

Once it becomes clear that currency wars are a failure, nations resort to trade wars. These begin with tariffs imposed by one nation on another to protect domestic industry and reduce trade deficits. As with currency wars, the problem is retaliation. Victims of tariffs impose their own tariffs and the world is worse off.

We’ve seen this pattern before in the 1920s and 1930s. It began with currency wars (1921–-1936), then trade wars (1930–-1939) and finally a shooting war in the Second World War that began in Asia in 1936, spread to Europe in 1939 and subsumed the U.S. in 1941.

The present currency war began in 2010. The new trade war began in 2018. Let’s hope a new shooting war or even a third world war does not follow in sequence.

Trump is like a five-star general in the currency and trade wars. It’s important to understand his weapons and tactics. Trump likes to threaten to get results but often does not follow through on his threats.

Recently he threatened to withdraw the U.S. from the World Trade Organization (WTO), the primary multilateral body for settling trade disputes and a successor to one of the original Bretton Woods institutions (along with the IMF and World Bank) established in 1944.

But Trump’s threat to withdraw from the WTO will not be carried out. It’s in the bluff category, strictly for show.

The fact is Trump is turning trade policy upside down without withdrawing from WTO by using other tools at his disposal.

There has always been an exemption from the application of WTO rules where national security is involved. It’s just that past presidents have never used the authority because they are globalists (Republicans and Democrats).

Trump’s method is to weaponize national security considerations in the context of trade disputes. The U.S. has always had ways to stop trade flows and restrict direct foreign investment based on national security considerations.

Trump’s three main “weapons,” mostly unknown to everyday Americans, are IEEPA, CFIUS and Section 301 of the Trade Act of 1974.

IEEPA stands for the International Emergency Economic Powers Act. Enacted in 1977, it allows the President to regulate commerce after declaring a national emergency. He can declare this emergency “to deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States.”

CFIUS stands for the Committee on Foreign Investment in the United States. It began under President Ford in 1975. CFIUS gives the Executive Branch power to monitor the impact of foreign investment in the United States, and determine if it jeopardizes national security. It can block acquisitions of U.S. firms by Chinese companies, for example.

Section 301 of the Trade Act of 1974 is the “nuclear option” when it comes to trade wars. I don’t want to get too deeply in the weeds here, but Section 301 gives the president broad authority to impose sanctions and penalties. It gives the president a free hand to impose billions of dollars of damages if not more on China.

So Trump has the best of both worlds. He can threaten the WTO, but doesn’t actually have to withdraw because he can get everything he wants anyway using IEEPA, CFIUS and Section 301. The globalists are freaking out but can’t stop him.

Unlike previous globalist presidents, Trump is a nationalist. And he’s using these powers like crazy to push his agenda. The Congress can’t stop him because all of these weapons are statutory; they were already passed by Congress in the 1970s and 1980s. These statutes delegate expansive powers to the president.

What’s new is not the law but the way the law is being used.

During the Weimar Republic hyperinflation in 1922–23, paper money became worthless and was swept down sewers (left, below) or fed into furnaces as fuel (right, below). The currency wars continued with French devaluation (1925), U.K. devaluation (1931) and U.S. devaluation (1933). When the currency wars failed to produce growth, the trade wars erupted with the Smoot-Hawley tariffs (1930) and similar tariffs from U.S. trading partners. After currency wars and trade wars failed came shooting wars in Asia (1936) and Europe (1939). The same pattern is repeating today with a new currency war (2010) and trade war (2018).

There is legislation pending in Congress right now to amend CFIUS. The name of the bill is the Foreign Investment Risk Review Modernization Act, or FIRRMA. This amendment to CFIUS will give CFIUS greatly expanded powers to stop Chinese takeovers of U.S. crown jewels in technology, telecommunications and the defense sector.

This new law shuts the Chinese (and anyone else Trump doesn’t like) out of the market to acquire U.S. tech and defense stocks. Once you remove the biggest buyers from the market, prices will …read more

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Currency War, Then Trade War — Is Shooting War Next?

By James Rickards

This post Currency War, Then Trade War — Is Shooting War Next? appeared first on Daily Reckoning.

My thesis is that currency wars are followed by trade wars and then finally shooting wars among major powers.

This happened in the 1930s and it seems to be happening again.

Currency wars begin in a condition of too much debt and not enough growth. Countries steal growth from their trading partners by cheapening their currencies to promote exports and import inflation.

The present currency war started in January 2010. The problem with currency wars is that all advantage is temporary and is quickly erased by retaliation. Trading partners retaliate with their own devaluations. Currency cross-rates end up back where they started, with costs imposed due to the uncertainties.

Not only is the world not better off but it is worse off because of the costs and uncertainty resulting from the currency manipulations.

Eventually, the world wakes up to this reality and moves to the trade war stage. Once countries realize that currency wars don’t work, they turn quickly to trade wars through tariffs and other trade barriers.

The problem is that trade wars don’t work either, for the same reason currency wars don’t work — retaliation or tit-for-tat tariffs soon puts everyone back where they started.

The new trade war started in January 2018 with the announcement of tariffs, and those tariffs actually began to take effect last week. Just because trade wars have started does not mean the currency wars are over. Not at all. The currency wars and trade wars continue side by side. In fact, they are related.

If the U.S. puts tariffs on China, which we have, then China can fight back two ways. The first is to impose their own tariffs on U.S. exports, which they have.

The second is to cheapen their currency to offset the impact of the tariffs. If the U.S. imposes a 25% tariff on China but China cheapens its currency by 25%, then everyone is back where they started in terms of the costs of Chinese goods to U.S. consumers.

This would be a potentially devastating development for markets.

A shock yuan maxi-devaluation will be the shot heard round the world as it was in August and December 2015 (both times, U.S. stocks fell over 10% in a matter of weeks).

There are individual winners and losers from the currency and trade wars, but the global economy as a whole is definitely a loser. This new trade war will get ugly fast and the world economy will be collateral damage. I believe it will get much worse before it is resolved.

We should look for slower growth and possibly a recession as the trade and currency wars play out. Let’s hope that history does not repeat and that we don’t end up in a Third World War, as the currency/trade wars of the 1930s helped lead to WWII.

Regards,

Jim Rickards
for The Daily Reckoning

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Rickards: Here’s Where the Next Crisis Starts

By James Rickards

This post Rickards: Here’s Where the Next Crisis Starts appeared first on Daily Reckoning.

So many credit crises are brewing, it’s hard to keep track without a scorecard.

The mother of all credit crises is coming to China with over a quarter-trillion dollars owed by insolvent banks and state-owned enterprises, not to mention off-the-books liabilities of provincial governments, wealth management products and developers of white elephant infrastructure projects.

Then there’s the emerging-markets credit crisis, with Turkey and Argentina leading a parade of potentially bankrupt borrowers vulnerable to hot money capital outflows and a slowdown of growth in developing economies.

Close on their heels is the U.S. student loan debacle, with over $1.5 trillion in outstanding debts and default rates approaching 20%.

Now we’re facing a devastating wave of junk bond defaults. The next financial collapse, already on our radar screen, will quite possibly come from junk bonds.

Let’s unpack this…

Since the great financial crisis, extremely low interest rates allowed the total number of highly speculative corporate bonds, or “junk bonds,” to rise 58% — a record high.

Many businesses became highly leveraged as a result. There’s currently a total of about $3.7 trillion of junk bonds outstanding.

And when the next downturn comes, many corporations will be unable to service their debt. Defaults will spread throughout the system like a deadly contagion, and the damage will be enormous.

This is from a report by Mariarosa Verde, Moody’s senior credit officer:

This extended period of benign credit conditions has helped many weak, highly leveraged companies to avoid default… A number of very weak issuers are living on borrowed time while benign conditions last… These companies are poised to default when credit conditions eventually become more difficult… The record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.

Many investors will be caught completely unprepared.

Each credit and liquidity crisis starts out differently and ends up the same. Each crisis begins with distress in a particular overborrowed sector and then spreads from sector to sector until the whole world is screaming, “I want my money back!”

The problem is that regulators are like generals fighting the last war. In 2008, the global financial crisis started in the U.S. mortgage market and spread quickly to the overleveraged banking sector.

Since then, mortgage lending standards have been tightened considerably and bank capital requirements have been raised steeply. Banks and mortgage lenders may be safer today, but the system is not.

Meanwhile the Fed is raising interest. It’s undertaking QE in reverse by reducing its balance sheet and contracting the base money supply. This is called quantitative tightening, or QT.

Credit conditions are already starting to affect the real economy. New cracks are appearing in emerging markets, as I mentioned. I also mentioned that student loan losses are skyrocketing. That stands in the way of household formation and geographic mobility for recent graduates.

Losses are also soaring on subprime auto loans, which has put a lid on new car sales. As these losses ripple through the economy, mortgages and credit cards will be the next to feel the pinch.

It doesn’t matter where the crisis begins. Once the tsunami hits, no one will be spared.

The stock market is going to correct in the face of rising credit losses and tightening credit conditions.

No one knows exactly when it’ll happen, but the time to prepare is now. Once the market corrects, it’ll be too late to act.

That’s why the time to buy gold is now, while it’s cheap. When you need it most, once the crisis hits, it’ll cost a fortune.

Regards,

Jim Rickards
for The Daily Reckoning

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