A Bold Prediction Comes True

By Brian Maher


This post A Bold Prediction Comes True appeared first on Daily Reckoning.

Two weeks ago yesterday we dared the wrathful gods… and tempted fate with a rare prediction.

From The Daily Reckoning, dated 17 May:

May 31 is the date of the next drop… We do not forecast a cataclysm — but a substantially negative May 31. So you can go ahead and put us down for it. The S&P will sink May 31.

If wrong, we boasted, we would eat every word we wrote that day — without salt.

May 31 has come… May 31 has gone.

And our prediction?

We are pleased beyond description today — we’ve been spared a dreadful dish of unseasoned prose.

The S&P sank 19 points yesterday, precisely as predicted… at least to an inch or two.

Three at most.

The Dow Jones fared even worse percentagewise — down 252 crimson points on the day.

Nor was the wreckage limited to the abovementioned.

The Nasdaq and the Russell both ended deeply in red territory.

Incidentally, all three indexes roared back today… and made good most of yesterday’s losses.

Why were we so confident the market would fall yesterday?

The answer arrives in three words:

The Federal Reserve.

It is now hard at the job of quantitative tightening — the reverse of quantitative easing.

Year to date, the Fed had unloaded $117 billion worth of assets before yesterday.

And the S&P lost a combined 4.7% on the specific days these jettisonings occurred.

The reproduced evidence, coming by way of Martingale_Macro:

And yesterday witnessed the largest single balance sheet reduction since the business began last October.

Nearly $29 billion worth of maturing bonds were scheduled to roll off the Fed’s balance sheet yesterday.

Did you hear about it in the financial media?

You did not of course — it went entirely unreported.

It was, nonetheless, the specific basis of our May 17 crystal gazing.

And with the pleasure of repeating ourselves… we were correct.

But do we accept an undeserved laurel?

Did markets sink yesterday for another reason, entirely unrelated to the Fed’s balance sheet?

The Trump administration announced tariffs on steel and aluminum imports from the European Union, Canada and Mexico.

These tariffs were met by immediate threats of retaliation.

Recall, prospects of a global trade war kindled February’s market “correction” — at least in part.

And yesterday those fears bubbled again to the surface.

But we will permit no rain to fall on our triumphant parade today.

No, no, the Fed and its balance sheet alone account for yesterday — and we consider the case jolly well closed.

If you disagree… drive on!

We jest of course.

The tariff announcement may well have been sufficient — or perhaps it was a combination of both.

Or something else entirely.

Every time we think we have the market by the tail… we soon discover otherwise.

But let us now face the horizon…

The Fed is on pace to reduce its balance sheet $420 billion by year’s end… and plans to trim another $600 billion next year.

And another $600 billion the year following.

It does not believe its trimmings will affect markets.

We have our evidence to the contrary — albeit circumstantial — as argued above.

Nor will Jim Rickards guzzle the moonshine:

The Fed wants you to think that QT will not have any impact. Fed leadership speaks in code and has a word for this, which you’ll hear called “background.” The Fed wants this to run on background…

This is complete nonsense.

Contradictions coming from the Fed’s happy talk want us to believe that QT is not a contractionary policy, but it is.

They’ve spent eight years saying that quantitative easing was stimulative. Now they want the public to believe that a change to quantitative tightening is not going to slow the economy.

And so the Fed maintains its thumbless grasp of economic cause and effect.

We’ll be keeping a sharp eye on the Fed’s next substantial rollover date.

Will we crowd our luck with another bold market prediction that day?

No, we had better not — the gods are vengeful.


Brian Maher
Managing editor, The Daily Reckoning

The post A Bold Prediction Comes True appeared first on Daily Reckoning.

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From:: Daily Reckoning

What History Teaches About Interest Rates

By Jacob Johnson


This post What History Teaches About Interest Rates appeared first on Daily Reckoning.

“At no point in the history of the world has the interest on money been so low as it is now.”

Who can dispute the good Sen. Henry M. Teller of Colorado?

For lo eight years, the Federal Reserve has waged a ceaseless warfare upon interest rates.

Economic law, history, logic itself, stagger under the onslaughts.

We suspect that economic reality will one day prevail.

This fear haunts our days… and poisons our nights. But let us check the date on the senator’s declaration…

Kind heaven, can it be?

We are reliably informed that Sen. Teller’s comment entered the congressional minutes on Jan. 12… 1895.

1895 — some 19 years before the Federal Reserve drew its first ghastly breath!

Were interest rates 122 years ago the lowest in world history? And are low interest rates the historical norm… rather than the exception?

The chart below — giving 5,000 years of interest rate history — shows the justice in Teller’s argument.

Please direct your attention to anno Domini 1895:

Rates had never been lower in all of history.

They would only sink lower on two subsequent occasions — the dark, depressed days of the early 1930s — and the present day, dark and depressed in its own right.

A closer inspection of the chart reveals another capital fact…

Absent one instance at the beginning of the 20th century and a roaring exception during the mid-to-late 20th century, long-term interest rates have trended lower for the better part of 500 years.

Could the sharply steepening interest rates that began in the late 1940s be a historical one-off… a Mt. Everest set among the level plains?

Analyst Lance Roberts argues that periods of sharply rising interest rates like that period are history’s exceptions — lovely exceptions.

Why lovely?


Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time.

In this view, rates rose steeply at the dawn of the 20th century because rapid industrialization and dizzying technological advances had entered the scenery.

Likewise, Roberts argues the massive post-World War II economic expansion resulted in the second great spike in interest rates:

There have been two previous periods in history that have had the necessary ingredients to support rising interest rates. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.

The second period occurred post-World War II as America became the “last man standing”… It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed.

Let the record show that rates peaked in 1981… and have declined steadily ever since. If rising interest rates indicate a rising economy, does that mean our best days are in back of us?

And was this post-World War II period of dramatic and exceptional growth… itself the exception?

“Investors have often talked about the global economy since the crisis as reflecting a ‘new normal’ of slow growth and low inflation,” begins New York Times senior economic correspondent Neil Irwin.

“But just maybe,” he concludes, “we have really returned to the old normal.”


Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now… The real aberration looks like the 7.3% average experienced in the United States from 1970–2007.

“We’re returning to normal, and it’s just taken time for people to realize that,” adds Bryan Taylor, chief economist of Global Financial Data.

Today’s 10-year Treasury note yields a relatively slender 2.84%, for example.

But British consols — the world’s low-risk bonds of the day — yielded an even slimmer 2.48% in 1898.

This was, of course, shortly before the steep interest rate rise of the following three decades.

Granted, drawing meaningful comparisons between historical eras can be a snare, a chimera, the errand of a fool if done carelessly.

But maybe today’s low rates aren’t as outrageous as originally strikes the eye.

Paul Schmelzing professes economics at Harvard. He’s also a visiting scholar at the Bank of England, for whom he conducted a study of interest rates throughout history.

Over seven centuries, Schmelzing identifies nine “real rate depression cycles.”

These cycles feature a secular decline of real interest rates, followed by reversals. The first eight cycles tell fantastic tales…

These cycles often pivoted around such events as the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… World War II.


The world is currently immersed in history’s ninth rate depression cycle, which began in the mid-’80s.

It is here where our tale gathers pace…

Schmelzing’s research reveals that the present cycle is the second longest of the entire 700-year record… and the second most intense.

The only longer-lasting cycle came in the 15th century.

Only one previous cycle — also from the same epoch — exceeded the current cycle in intensity.

By almost any measure, today’s rate depression cycle is a thing of historic grandeur. The steep downward slope on the extreme right of the chart gives the flavor of its severity:


Schmelzing’s researches show that the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

And so “relative to both historical benchmarks,” says Schmelzing, “the current market environment thus remains severely depressed.”

That is, real rates are well below historical norms.

And if the term “reversion to the mean” has any currency… rates could accelerate… quickly.

History shows that when rates do regain their bounce, they do so with malice.

We note that 10-year Treasury yields have gained roughly one full percentage point over the past year.

Could the cycle be ending?

It is premature to say.

But if the world is near the end of the current 34-year rate depression cycle, it could be in for a harsh lesson in mean reversion.


The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most …read more

From:: Daily Reckoning

Just How Low Are Today’s Interest Rates?

By Brian Maher

This post Just How Low Are Today’s Interest Rates? appeared first on Daily Reckoning.

“How is your wife?” someone supposedly asked Winston Churchill.

The reply, oozing Churchillian wit from every pore:

Compared to what?

Today’s interest rates are low.

But today we consider the “real” question:

Interest rates are low… compared to what?

The Federal Reserve has been lifting the nominal fed funds target rate since December 2015.

It currently rests between 1.50% and 1.75%.

That is, nominal rates remain low.

Now crane your neck… and glance rearward to the disco-filled days of 1979…

Nominal interest rates averaged a Himalayan 12.5% or thereabouts.

That is, the nominal interest rate was some 8.5 times higher in 1979.

But could it be that today’s puny 1.50–1.75% rate… is “really” higher than 1979’s 12.5%?

A preposterous question, you thunder.

But come sit down before the facts…

The real interest rate is the nominal interest rate minus the inflation rate.

Assume the nominal interest rate is 3%, for example.

Further assume that inflation runs at 1%.

In this instance, the real rate is 2% (3 – 1 = 2).

There is a reason why it is called the real interest rate.

It penetrates numerical mists. It scatters statistical fogs.

It clarifies.

Nominal interest rates averaged 12.5% in 1979.

Inflation ran to 13.3%.

So let us apply some English major math to arrive at the real interest rate in 1979…

We take 1979’s average nominal interest rate (12.5%) and subtract the inflation rate (13.3%).

We then come to the arresting conclusion that the real interest rate was not 12.5%… but negative 0.8% (12.5 – 13.3 = -0.8).

Once again:

The average nominal interest rate was 12.5%.

But the real interest rate was -0.8%.

We can only conclude that real interest rates can be negative despite a high nominal rate.

As Jim Rickards explains:

Negative real rates exist when the rate of inflation is higher than the nominal interest rate. This condition can exist at any level of nominal rates. For example, inflation of 3% with nominal rates of 2.5% produces a negative real rate of 0.5%.

Likewise, inflation of 4% with nominal rates of 3.5% produces the same negative real rate of 0.5%.

Now roll the film forward to today…

Today’s nominal rate is between 1.50% and 1.75%.

Meantime, (official) consumer price inflation goes at about 2%.

Again, if we want the real rate, we must subtract inflation from the nominal rate.

What do we find upon doing so?

We find that today’s real interest rate lies somewhere between -0.5% and -0.25%.

That is, despite today’s vastly lower nominal rate (12.5% versus 1.75%)… today’s real interest rate is actually higher than 1979’s -0.8%.

Shocking — but the facts are the facts.

We must once again conclude that the nominal interest rate lacks all meaning absent the inflation rate.

Yet the difference between nominal rates and real rates scarcely rates a mention in the financial media.

But as Jim Rickards notes, “Real rates are what determine investment decisions.”

A 10-year Treasury bond yielding 6% may draw your interest, for example.

But what if inflation averaged 7% over the same period?

Inflation would devour your 6% yield — and then some.

You would require an 8% yield to keep ahead of inflation.

But let us take a leap forward…

It now appears the Fed has cracked its blessed 2% inflation target.

And it is planning a steady calendar of rate hikes until it reaches 3% by late next year.

We have our doubts it will arrive at the destination.

Another market “correction” could easily knock it off course.

And the economy is long past due for a recession.

Can the current “expansion” peg along for another year and one half?

We are far from certain.

Mr. Powell and his merry band would certainly return to lowering rates in case of recession.

But go ahead and assume a nominal 3% rate at the end of 2019.

Assume further — as the Fed currently does — that inflation will average 2% in 2019.

The math reveals a real rate of only 1%.

Meantime, the nation’s average long-term real interest rate is about 3%.

Even if nominal interest rates rise, real interest rates would therefore remain substantially below normal.

And it could be a long time before they return to normal.

That is, if they ever return to normal…


Brian Maher
Managing editor, The Daily Reckoning

The post Just How Low Are Today’s Interest Rates? appeared first on Daily Reckoning.

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From:: Daily Reckoning

How to Claim Social Security Earlier, without Harm, and Combined with Unemployment Pay

By Nilus Mattive

Nilus Mattive

This post How to Claim Social Security Earlier, without Harm, and Combined with Unemployment Pay appeared first on Daily Reckoning.

I’ve spent a lot of time and effort outlining the actual condition of our nation’s Social Security system… along with some of the changes that could be coming down the pike.

Yet I’m continually amazed at how many misunderstandings everyday Americans have about the program!

For example, a survey of people in my age bracket revealed that 29% expected to claim Social Security benefits at age 65.

The problem? Under current law, people in my generation can’t even start collecting until 67!

Of course, misunderstandings like this are the least worrisome to me. After all, the laws will probably change again before my peers even come close to making serious decisions related to Social Security.

I’m far more concerned about myths and misunderstandings among older Americans – including millions of Baby Boomers who are now facing critical choices related to their retirement benefits.

Heck, many Americans don’t even understand what happens when they delay taking benefits.

Yes, most people do know that they get bigger checks if they wait to start collecting… but they often don’t have a handle on the details.

I’ll give you a real-world case study:

When I first started discussing the topic with my mom, she continually referred to waiting until her “full retirement age” of 66.

In her mind this magical number was the one to focus on. Taking benefits a few months before that age was a big mistake and waiting past it was probably a mistake, too.

That’s not really true at all.

While there are some benefits to waiting until your full retirement age – including the ability to earn as much as you like without affecting your benefit payments – I think you’re much better off viewing the entire process as a gently sloping curve.

Reason: For every month you delay taking benefits, your future check amounts increase. And this happens from the very first month you become eligible to collect Social Security all the way up until age 70.

Please note I said “every month,” which is another finer point that most people do not understand!

In other words, while your future Social Security benefits do increase about 8% for every year you delay taking them, you accrue a portion of that increase for every month you delay.

Also, since you do not continue receiving increases for delaying beyond age 70, there is absolutely no reason to avoid collecting when you hit that age.

Therefore, if anything, I believe it is far more accurate to call age 70 the real “full retirement age.”

And the practical effects of taking payments a few months earlier or a few months later are not going to move the needle all that much one way or another.

Unfortunately, I don’t expect the Social Security Administration or the mainstream financial media to adopt my way of thinking anytime soon.

Meanwhile, another common myth is that Social Security is a good deal for most workers.

This one used to be true, when our country’s demographics worked in the system’s favor.

But today, it’s a different story.

As this article from a few years ago explains:

“A couple who each earned the average wage during their careers and retired in 1990 would have paid $316,000 in Social Security taxes, but collected $436,000 in benefits, according to data crunched by Eugene Steuerle, an economist at the Urban Institute.

“Had that couple turned 65 in 2010, however, they would have paid $600,000 in taxes, but could expect to collect just $579,000. This is the first time in the program’s history that taxes outweighed benefits for this group, a couple with average earnings.

“The imbalance will get more pronounced for future generations of retirees. Couples now in their early 40s will have forked over $808,000 in Social Security taxes by the time they retire, but get back only $703,000 in benefits.”

This is another one of the vagaries of Social Security’s “pay as you go” design.

Yes, certain groups continue to do well under the arrangement – especially single-earner households.

But there’s no such thing as a free lunch. So for every cohort that benefits from the system’s construction, another will inevitably suffer.

And I’ve still just scratched the surface…

Very few Americans realize that select groups of people have been able to opt out of Social Security – including certain religious groups and governmental workers.

They might also be shocked to discover that it’s possible to collect unemployment and Social Security at the same time.

And they probably don’t even realize that today’s Social Security tax rates are six times higher than they were when the program was created 75 years ago.

Obviously, it’s impossible to inform everyone about all of these issues.

But I can at least continue giving YOU the simple facts about Social Security and other retirement matters so you can make the best investment decisions possible.

To a richer life,

Nilus Mattive
Editor, The Rich Life Roadmap

The post How to Claim Social Security Earlier, without Harm, and Combined with Unemployment Pay appeared first on Daily Reckoning.

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From:: Daily Reckoning

A Tale Of Two Citigroups

By Jody Chudley

Global Presence

This post A Tale Of Two Citigroups appeared first on Daily Reckoning.

The time to buy bank stocks is now.

More specifically, the time to buy shares of Citigroup (C) is now.

That is the word from the legendary activist hedge fund ValueAct Capital. ValueAct isn’t just talking, they are acting. ValueAct has invested a whopping $1.2 billion into shares of this banking giant.1

Luckily for us, ValueAct also explains exactly why the market thumping investment firm is pounding the table on Citigroup today…

What Is ValueAct’s Track Record?

Before we take a look at what ValueAct thinks of Citigroup, we need to consider whether ValueAct has a track record worth paying attention to.

The answer to that in my opinion is a resounding yes.

ValueAct was founded by Jeffrey Ubben in 2000. In the 17 years that followed, ValueAct has generated an annualized return of 15% which is far in excess of the performance of the S&P 500.

I should point out that those 15% annualized returns are after ValueAct takes its management and performance fees. Excluding those fees, ValueAct has since inception generated annualized returns close to 20%.

In a world where most active managers can’t even match the performance of the S&P 500, these guys have proven that they can seriously pick some stocks!

I must also point out that ValueAct manages a very concentrated portfolio. As of ValueAct’s last SEC filing, the firm held only 12 different positions.2 That means that each investment has a big impact on performance and must be carefully researched, which means that their $1.2 billion Citigroup investment shows some major conviction…

Why Banks Now?

ValueAct has historically built its excellent investment performance on a value investment philosophy that leads the firm to sectors in the market that are temporarily out of favor.

In the past, ValueAct invested successfully in bargain priced software firms after the Dot-Com crash. The firm had a similar experience with several big pharma companies that offered unfairly discounted share prices in advance of patent expirations.

Today, ValueAct thinks a similar exciting opportunity exists in the banking sector. Here is exactly what ValueAct wrote in the firm’s most recent letter to investors:

“The U.S. banking system now has a structurally lower risk profile than any time in our investing lifetimes’ thanks to lower leverage and higher-quality assets held by the industry after the financial crisis.”

In other words, today is the perfect time to be investing in the banking sector. The balance sheets of the big banks have never been cleaner and the financial reporting never more transparent.

Investors now know exactly what they are buying which allows them to clearly see how cheap these stocks have become.

Why Citigroup Specifically?

The Citigroup banking business has been around for quite a while. Citigroup’s history dates back to the founding of the City Bank of New York in 1812.

So the company has roots that are set a little deeper than those of Facebook or Amazon.

Over the 200 years of operations, this company has been turned into a powerful global business. The numbers are mind-boggling.

Citigroup’s core consumer bank has branches in 700 cities around the world with more than 200 million customer accounts which sees more than $3 trillion worth of transactions on a daily basis.

Click to enlarge

The power of this global business has never really been in doubt. But what is different now is how solid Citigroup’s balance sheet has become.

Further, Citigroup is about to see a massive increase in both earnings per share and the amount of cash that it returns to shareholders.

In the years following the financial crisis, Citigroup has been forced by the Federal Reserve to retain most of the earnings that it generates in order to continue to build balance sheet strength.

That earnings retention has limited the size of the dividend that Citigroup can pay and the amount of shares the company can repurchase.

With each passing year, those restrictions are being eased.

As a result, Citigroup has increased its return of capital to shareholders (combination of dividends and share repurchases) as follows:

  • 2014 — $1.3 billion worth of capital returned
  • 2015 — $6.8 billion worth of capital returned
  • 2016 — $10.4 billion worth of capital returned
  • 2017 — $18.2 billion worth of capital returned

Those rising dividends and share repurchases will continue to be a catalyst for the share price.

In ValueAct’s recent letter to investors, the firm noted that it believes that Citigroup can return $50 billion to shareholders in the form of dividends and share repurchases in just the next two years. That is an incredible amount of money.

ValueAct also believes that Citigroup can double its earnings per share by 2020. An earnings per share double is some pretty incredible growth for a 200 plus year old bank!

I have to think that a $50 billion return of capital and a doubling of earnings per share in two years will do good things for Citigroup’s share price. ValueAct Capital clearly does too, which is why I think now is a great time to buy your shares.

Here’s to looking through the windshield,

Jody Chudley
Financial Analyst, The Daily Edge


The post A Tale Of Two Citigroups appeared first on Daily Reckoning.

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From:: Daily Reckoning

The Threat of Contagion

By James Rickards

This post The Threat of Contagion appeared first on Daily Reckoning.

Each crisis is bigger than the one before. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses.

This means that the larger size of the system implies a future global liquidity crisis and market panic far larger than the Panic of 2008.

Today, systemic risk is more dangerous than ever. Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.

To understand the risk of contagion, you can think of the marlin in Hemingway’s Old Man and the Sea. The marlin started out as a prize catch lashed to the side of the fisherman Santiago’s boat.

But, once there was blood in the water, every shark within miles descended on the marlin and devoured it. By the time Santiago got to shore, there was nothing left of the marlin but the bill, the tail and some bones.

An even greater danger for markets is when these two kinds of contagion converge. This happens when market losses spillover into broader markets, then those losses give rise to systematic trading against a particular instrument or hedge fund.

When the targeted instrument or fund is driven under, credit losses spread to a wider group of fund counterparts who then fall under suspicion themselves. Soon a market-wide liquidity panic emerges in which, “everybody wants his money back.”

This is exactly what happened during the Russia-Long Term Capital Management (LTCM) crisis in 1998. The month of August 1998 was a liquidity crisis involving broad classes of instruments. But, the month of September was systematically aimed at LTCM.

I was right in the middle of that crash. It was an international monetary crisis that started in Thailand in June of 1997, spread to Indonesia and Korea, and then finally Russia by August of ’98. It was exactly like dominoes falling.

LTCM wasn’t a country, although it was a hedge fund big as a country in terms of its financial footings.

I was the general counsel of that firm. I negotiated that bailout. The importance of that role is that I had a front-row seat.

I’m in the conference room, in the deal room, at a big New York law firm. There were hundreds of lawyers. There were 14 banks in the LTCM bailout fund. There were 19 other banks in a one billion dollar unsecured credit facility. Included were Treasury officials, Federal Reserve officials, other government officials, Long-Term Capital, our partners.

It was a thundering herd of lawyers, but I was on point for one side of the deal and had to coordinate all that.

It was a 4 billion dollar all-cash deal, which we put together in 72 hours with no due diligence. Anyone who’s raised money for his or her company, or done deals can think about that and imagine how difficult it would be to get a group of banks to write you a check for 4 billion dollars in 3 days.

Systematic pressure on LTCM persisted until the fund was almost broke. As Wall Street attacked the fund, they missed the fact that they were the creditors of the fund. By breaking LTCM, they were breaking themselves. That’s when the Fed intervened and forced Wall Street to bail out the fund.

Those involved can say they bailed out Long-Term capital. But if Long-Term Capital had failed, and it was on the way to failure, 1.3 trillion dollars of derivatives would’ve been flipped back to Wall Street.

In reality, Wall Street bailed out itself.

The panic of 2008 was an even more extreme version of 1998. We were days, if not hours, from the sequential collapse of every major bank in the world. Of course, the 2008 panic had its roots in sub-prime mortgages, but quickly spread to debt obligations of all kinds especially money market funds and European bank commercial paper.

Think of the dominoes again. What had happened there? You had a banking crisis.

Except in 2008, Wall Street did not bail out a hedge fund; instead the central banks bailed out Wall Street.

And as I mentioned earlier, today systemic risk is more dangerous than ever. Each crisis is bigger than the one before.Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system, and have much larger derivatives books.

The next crisis could well begin in the private bank debt market. The specific culprit is a kind of debt called “contingent convertible” debt or CoCos.

These bonds start out like ordinary debt, but a bank in distress could convert them to equity to improve its capital ratios. The problem is that bondholders know this and start dumping the bonds before the bank can pull the trigger on the conversion clause. This can cause a run on the bank and trigger cross default clauses in other bonds. Far from adding safety to bank capital structures, CoCos can make banks more unstable by igniting panics.

This is just one more example of capital market complexity and it signals the fact that the next crisis will be worse than the last.

Also. new automated trading algorithms like high-frequency trading techniques used in stock markets could add to liquidity in normal times, but the liquidity could disappear instantly in times of market stress. And when the catalyst is triggered and panic commences, impersonal dynamics take on a life of their own.

These kinds of sudden, unexpected crashes that seems to emerge from nowhere are entirely consistent with the predictions of complexity theory.

In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses. This means that the larger size of the system implies a future global liquidity crisis and market panic far larger than the Panic of 2008.

The ability of central banks to deal with a new crisis is highly constrained by low interest rates and bloated balance sheets, which despite some movement …read more

From:: Daily Reckoning

“The Mother of All Systemic Threats”

By Brian Maher

This post “The Mother of All Systemic Threats” appeared first on Daily Reckoning.

Another crack forms in the globalist edifice…

The Dow Jones plunged nearly 400 points yesterday.

The S&P dropped 31… the Nasdaq, 37

Bank stocks took the mightiest wallops — J.P. Morgan, Goldman Sachs, Morgan Stanley, Citigroup and Bank of America all fell over 3%.

Why bank stocks?

And why is it so potentially serious?

Answers shortly.

The proximate cause of yesterday’s panic was the ongoing warfare between localism and globalism.

This time in Italy.

Mercy forbids us from inflicting the grisly details of parliamentary politics upon you.

But in brief:

Inconclusive elections in March have stalemated the Italian government.

And this Sunday, Italian President Sergio Mattarella vetoed the nomination of an anti-EU economic minister.

This anti-EU fellow was proposed by the populist Five Star Movement — Italy’s largest party — and the right-wing League party.

Both parties hold the European Union in what can charitably be termed… low regard.

President Mattarella proposed his own economic minister, an EU drummer.

The Five Star Movement and League party in turn blocked this eurocrat’s nomination.

Hence the impasse.

New elections are scheduled for July.

We are loathe to exaggerate… or exaggerate much, anyway.

But many believe the election could throw the European Union’s future into doubt.

“This could be the straw that breaks the camel’s back in the case of prospects for Europe,” warns Chris Rupkey, chief financial economist at MUFG Union Bank.

Markets are concerned the anti-EU parties will form a winning coalition that could hold a referendum on leaving the EU — “Ital-exit” essentially.

And an Italian defection could spread to Spain. Then Portugal.

From there… who knows?

Anti-EU rumblings have been heard in France, for instance.

Despite its problems, Italy is no small fry like Greece.

Italy boasts the eurozone’s fourth-largest economy.

And what happens in Italy… might not confine itself to Italy.

“Political uncertainty in Italy has unhinged world markets,” confirms CNBC, “raising the specter of a euro crisis that could ripple across the global economy.”

Meantime, Italian government bonds have now fallen to a four-year low.

Government bonds from other eurozone nations also fell yesterday — which does not indicate investor confidence.

But why did U.S. bank stocks stagger so badly yesterday?

We reduce the answer to one word, hinted at above:


European banks hold Italian sovereign bonds as capital reserves.

And Italy’s bond market — which reflects its crippling debt levels — is the world’s third largest.

Many banks have borrowed against that debt… or have indirect exposure.

For these reasons an Italian banking crisis has been called “the mother of all systemic threats.”

If these banks sink, they could send out rippling waves of failure… like a boulder plunged into a shallow pond.

Financial columnist Anthony Mirhaydari of Moneywatch:

As the 2011–12 eurozone crisis demonstrated, the nightmare is a self-reinforcing downward spiral. Lower sovereign bond prices (and thus higher yields) weaken bank stocks and bonds, which results in a pullback in lending and capital market losses. That in turn undermines economic growth, which lowers tax revenues, further drops government bond prices and raises borrowing costs as politicians are forced to consider bailing out banks. U.S.-based banks risk getting caught in the crossfire because of their European asset holdings.

Jim Rickards is no stranger to banking crisis.

Jim was lead counsel for Long Term Capital Management when the hedge fund found itself at the center of a global banking crisis in 1997.

Jim helped negotiate the deal that essentially bailed out the Wall Street banks.

That experience led him on a multiyear pursuit to determine the origins of financial crises… and how they spread.

What does Jim see today?

“Today,” says Jim, “systemic risk is more dangerous than ever. Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.”

(See below for more.)

But will Italian voters tolerate additional bank bailouts while their stagnant economy limps on one leg?

And will another bailout drive Italian voters into the waiting arms of the anti-EU parties?

We thus find the forces of globalism and populism in renewed collision.

Brexit didn’t sink the euro because Britain was never on it.

Italy is an equine of a different shade and hue.

It is the fourth-largest economy in Europe.

If Italy drops the euro it goes into history’s paper basket, where it joins the failed currencies of the past.

Then the curtain falls on the entire European project.

We don’t suspect it will happen — we believe Italy will remain on the euro.

And the crisis will pass.

This crisis will pass, we should clarify.

The ongoing war between globalism and populism will not…


Brian Maher
Managing editor, The Daily Reckoning

The post “The Mother of All Systemic Threats” appeared first on Daily Reckoning.

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Investment Secrets from the 2018 Monaco Grand Prix

By Nilus Mattive

Nilus' Race

This post Investment Secrets from the 2018 Monaco Grand Prix appeared first on Daily Reckoning.

The whole experience was pretty much sensory overload…

For a car nut like me.

The screaming engines… the screeching tires… famous names like Ferrari, McLaren, and Lotus whizzing by at breakneck speeds.

There’s also the glamorous setting – replete with ultra-wealthy fans watching from their yachts, sipping champagne on private balconies overlooking the streets, and pulling up in their own exotic cars.

The 2018 Monaco Grand Prix – one of the most prestigious auto races in the world – was held this past weekend on the streets of Monte Carlo.

Three years ago, I had the good fortune of watching this world-famous race with my wife and daughter in person, from a prime seating area right in front of the Monte Carlo casino.

From my seat at the 2015 race.

Of course, given the extreme limits of modern-day F1 cars, most knowledgeable folks say the only reason this race is still held here is because of its deep history and global cachet.

Remember, unlike most other major automobile races, the Monaco GP is essentially being held on the public streets of a very old town!

This kind of an event feeds into the idea that race car drivers are either reckless, stupid, or both.

The truth, however, is much different.

Indeed, I’ve also attended a high-performance driving school where I learned the ropes driving an open-wheeled formula race car.

One of the first things I learned was that the fastest drivers typically look slow.

They don’t move their hands all that much. Nor do they swerve their cars all over the track. They may seem downright bored behind the wheel…

Even when they’re travelling 200 miles an hour!

It’s the same thing with some of the world’s most successful investors and investment approaches.

Take Warren Buffett.

He’s not changing his strategy every single day or thinking about what other investors are doing. Rather, he continually looks beyond the apex of the turn for an exit point much farther down the track.

That idea of seeing where you want to go, rather than worrying about where you are, is crucial… but it takes a lot of practice when you’re used to looking five feet in front of your face.

In my class, we were encouraged to start out slow and build technique rather than trying to go flat out right away. As our instructor explained, the speed would come naturally over time.

That’s very similar to the approach I recommend in my Rich Life Letter.

All you have to do is pick the right line, run it consistently, and you’ll end up crossing the finish with time to spare — whether you’re talking about the Monaco Grand Prix or the endurance race called retirement planning.

Obviously, there will also be slides along the way… so how you handle them is equally critical!

Whether it was caused by a puddle, a patch of ice, or a sudden jerk of the wheel, it’s almost certain that you’ve experienced the uneasy feeling of having your car’s rear end slide out.

But against all common sense, the absolute worst thing you can do when you slide out is slam on the brakes.

In fact, sometimes you should even step on the gas!

Easier said than done though, right?

The first time I drove the open-wheeled race car, I missed a gear change coming into a sharp left-hand turn. And as I felt the back of the car start to slide, I instinctively pushed in the clutch and braked.

As you can imagine, the whole car spun off the track in a cloud of smoke and dust.

Fortunately, I later had the opportunity to practice driving special cars that automatically start sliding the wrong way whenever you turn them.

At first, I kept making that same instinctive mistake of braking.

But over time I got very comfortable letting the car drift one way and then the next as I blipped the throttle and kept my eyes focused on where I wanted the car to go.

Amazingly, my hands did all the correcting without any input from my conscious mind!

And even more amazingly, the next two times I found myself sliding out in an actual race car, I quickly corrected my mistake and continued zipping along down the track!

The point here is that it takes practice, commitment, and confidence to ride out those shaky moments — in a car or your investment portfolio.

As with anything, you simply have to know when to stay the course or when it’s better to look for a safe exit.

So in the end, I think investors can learn a lot from racecar drivers — whether they like fast cars or not.

To a richer life,

Nilus Mattive

Nilus Mattive
Editor, The Rich Life Roadmap

The post Investment Secrets from the 2018 Monaco Grand Prix appeared first on Daily Reckoning.

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Today’s Vote

By Zach Scheidt

Zach Scheidt

This post Today’s Vote appeared first on Daily Reckoning.

Today is an important day for big U.S. banks!

We’re about to see some big changes to the way the mega-banks in the United States are regulated. And today, the Fed is set to vote on a new set of rules that govern how these banks do business.

If you’re following along with this vote by watching the news or reading mainstream newspapers, you’re probably in a state of disgust or even horror about the upcoming vote.

That’s because big banks are a favorite target of the media.

Ever since the financial crisis of 2008, reporters have hated the idea of banks making money. And the liberal media has done everything possible to sway opinion towards heavier regulatory burdens for these banks.

But today, the Fed is set to take some a big step towards deregulating the banking industry.

And contrary to common wisdom, this step will actually put more cash in your pocket, and should make the markets easier for investors to navigate.

Let’s take a look at what’s happening!

Revising the Volker Rule

Today’s Fed vote covers a set of rules tied to the Dodd-Frank financial law which was passed in the wake of the financial crisis of 2008.

In particular, these rules prevent big banks from speculating in the market by buying and selling shares or other instruments for their own account. (Banks are allowed to buy and sell to fill orders for clients. But it has been difficult for banks to prove that they are acting on behalf of clients instead of for their own interests.)

These new rules the Fed is voting on should help make it easier for banks to stay in compliance with the financial law, while still making trades that help their customers get in and out of positions.

So why do we care about this new law?

For two reasons.

First, relaxed standards for bank trading should lead to higher profits for banks. While trading desks for the biggest financial institutions still cannot go crazy investing their capital, they will still be able to book huge profits.

Imagine if a mutual fund client came to a bank and wanted to sell one million shares of an illiquid stock.

The big bank could more easily buy the shares to help out its client. (Of course the shares would be bought at a discount to the market in exchange for helping the fund quickly get out of its position).

Then, over the next several weeks, the bank could steadily sell its shares at the market, locking in a profit on the trade.

This scenario would fit well under the new proposed rules. And it would allow banks to lock in much larger profits throughout 2018.

The second reason we care about this change is that banks should help the market become more liquid. Which means we can more easily buy and sell investments. A liquid market is good news for all investors.

Capital Requirements Also On the Table

Another piece of the banking regulations on the table right now is the capital requirements that currently restrict what banks can do with their cash.

Initially, these rules were set to protect the public from big banks taking too much risk with their money and triggering another financial crisis.

But now, those rules have led the big banks to keep way too much cash on their balance sheets — cash that could be put to better use if capital requirements were more relaxed.

This year, as banks are given more flexibility with what they do with their capital, we’ll see some big shifts. And these shifts will help you and me as investors.

For one, the banks will be able to more effectively lend money to individuals and businesses. And as this money is lent for new growth opportunities (and for things like cars, houses and educations), our economy will become more robust.

Also, much of this capital will be sent to investors through higher dividends this year. We’re already seeing banks increase the quarterly dividends paid to investors and those payments are only going to get bigger throughout the year.

That gives us another opportunity to put the cash just sitting on bank balance sheets to work. Because once that cash is paid to investors, it can be used to both cover life expenses and to reinvest in companies with better growth opportunities.

In short, looser regulations — starting with the Fed’s vote today — will lay the foundation for more healthy growth for years to come. Which is why I’m still very bullish on America and on the big U.S. banks as investments.

Here’s to growing and protecting your wealth!

Zach Scheidt
Editor, The Daily Edge

The post Today’s Vote appeared first on Daily Reckoning.

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A Trained Monkey Can Predict Markets Better

By James Rickards


This post A Trained Monkey Can Predict Markets Better appeared first on Daily Reckoning.

The first time I appeared on live financial television was August 15, 2007. It was a guest appearance on CNBC’s Squawk Box program at the early stages of the 2007-2008 financial crisis.

Of course, none of us knew at that time exactly how and when things would play out, but it was clear to me that a meltdown was coming; the same meltdown I had been warning the government and academics about since 2003.

I’ve done 1,000 live TV interviews since then, but that first one remains memorable. Carl Quintanilla conducted the interview with some participation from Becky Quick, both of whom could not have been more welcoming.

They and the studio crew made me feel right at home even though it was my first time in studio and my first time meeting them. Joe Kernan remained off-camera during my interview with his back turned reading the New York Post sports page, but that’s Joe. We had plenty of interaction in my many interviews over the years that followed.

When I was done, I was curious about how many guests CNBC interviewed over the course of a day. Being on live TV made me feel a bit special, but I wanted to know how special it was to be a guest. The answer was deflating and brought me right down to earth.

CNBC has about 120 guests on in a single day, day after day, year after year. Many of those guests are repeat performers, just as I became a repeat guest on CNBC during the course of the crisis. But, I was just one face in the midst of a thundering herd.

What were all of those guests doing with all of that airtime? Well, for the most part they were forecasting. They predicted stock prices, interest rates, economic growth, unemployment, commodity prices, exchange rates, you name it.

Financial TV is one big prediction engine and the audience seems to have an insatiable appetite for it. That’s natural. Humans and markets dislike uncertainty, and anyone who can shed some light on the future is bound to find an audience.

Which begs a question: How accurate are those predictions?

No one expects perfection or anything close to it. A forecaster who turns out to be accurate 70% of the time is way ahead of the crowd. In fact, if you can be accurate just 55% of the time, you’re in a position to make money since you’ll be right more than you’re wrong. If you size your bets properly and cut losses, a 55% batting average will produce above average returns.

Even monkeys can join in the game. If you’re forecasting random binary outcomes (stocks up or down, rates high or low, etc.), a trained monkey will have a 50% batting average. The reason is that the monkey knows nothing and just points to a random result.

Random pointing with random outcomes over a sustained period will be “right” half the time and “wrong” half the time, for a 50% forecasting record. You won’t make any money with that, but you won’t lose any either. It’s a push.

So, if 70% accuracy is uncanny, 55% accuracy is OK, and 50% accuracy is achieved by trained monkeys, how do actual professional forecasters do? The answer is less than 50%.

In short, professional forecasters are worse than trained monkeys at predicting markets.

Need proof? Every year, the Federal Reserve forecasts economic growth on a one-year forward basis. In 2010, they forecast 2011; in 2011 they forecast 2012, and so on. From 2009 to 2016, the Fed was wrong eight years in a row. When I say “wrong” I mean by orders of magnitude.

If the Fed forecast 3.5% growth and actual growth was 3.3%, I would consider that to be awesome.

But, the Fed would forecast 3.5% growth and it would come in at 2.2%. That’s not even close considering that growth is confined to plus or minus 4% in the vast majority of years. Let’s not be too hard on the Fed. The IMF forecasts were just as bad.

For further evidence, have a look at Chart 1 below. It shows the implied path of Fed interest rate hikes from 2008 to 2021 based on Fed Funds futures contracts traded on the Chicago Mercantile Exchange.

This forecast is not from a specific institution. Instead, it represents the “wisdom of crowds” or the distilled views of all market participants as aggregated by market prices.

The red line shows the actual path of interest rates over time. The black dotted lines show the expected path of interest rates based on Fed Funds futures contracts traded on the CME at various points in time.

As you can see, from 2009 – 2015, the market consistently expected higher rates than the Fed delivered. Those are the black dotted lines above the red line.

From 2016-2018, the market consistently expected lower rates than the Fed delivered. Those are the black dotted lines below the red line.

Right now, the market seems to have it about right, (the black dotted lines starting in 2018 and predicting higher rates), but we’ll see what happens. My expectation is that the Fed is overtightening and will have to back off from rate hikes later this year. That means the red line will trend below the black dotted lines and the market will miss the mark again.

The Fed Funds futures contract is one of the most liquid and heavily traded contracts in the world. If any futures contract reflects “the wisdom of crowds,” this is it.

What the results show is that “the wisdom of crowds” does not have very high predictive value. It’s just as faulty as the professional forecasts from the Fed and IMF.

There are reasons for this. The wisdom of crowds is a highly misunderstood concept. It works well when the problem is simple and the answer is static, but unknown.

The classic case is guessing how many jellybeans are in a large jar. In that situation, the average of 1,000 guesses actually will be …read more

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