Tuesday, September 13, 2016

The Farmland Bubble Has Burst

It was amazing to watch farmland prices skyrocket as residential real estate was falling from 2008 to 2012. Now that the market has hit a peak, it will be interesting to watch how far prices falls back to earth.


Monday, September 12, 2016

Donald Trump On Interest Rates, Deficits & Infrastructure Spending

An Easier Way For Corporations To Make A Profit: Just Borrow At Negative Yields

By: Peter Schiff Of Euro Pacific Capital

For years I have argued that ultra-low interest rates act more as an economic sedative than a stimulant. This idea has elicited laughter from the economic establishment. But it is becoming clearer that rates set by central banks that are far below the levels that free markets would have otherwise determined have dragged the world into the economic mud. The simple proof is currently arising in Europe where negative interest rates are now transforming companies from agents of growth, production, and employment into financial sloths that exist solely to borrow money.
 
In a September 7 front page article, the Wall Street Journal reported that as of September 5, €706 billion worth of investment-grade European corporate debt, or roughly 30% of the market, according to trading platform Tradeweb, was trading at negative yields, an increase from just 5% in January. These negative yields were the result of intense activism on the part of the European Central Bank (ECB). 
 
For years the ECB had been trying to stimulate growth by buying trillions of euros’ worth of sovereign debt. But as these programs proved ineffective to wake up the EU economy from its long economic slumber, this year they began moving into the corporate market. Most of this buying has occurred on the secondary market, for bonds that had previously been issued at positive rates. The central bank buying raised prices of these bonds sufficiently to push yields into negative territory. It also has drawn in speculators who have bought low yielding bonds not because they are good investments but because they are convinced that the ECB will one day buy them out at a premium.
 
But the real news of that Journal article was that for the first time, major European firms like German manufacturer Henkel AG and French drugmaker Sanofi SA had issued corporate bonds at negative rates in the primary market. This means that if they are held to maturity, the bonds are guaranteed money losers…in essence, the companies are being paid to borrow. This is a stunning development that alters the fundamental principles of corporate strategy.
 
As this process of ECB corporate bond buying continues, more and more companies will follow suit and issue bonds at negative yields. Why wouldn’t they? It’s nice work if you can get it. To seek profits, why go through the laborious and uncertain process of developing new products and seeking new customers when all you have to do instead is simply borrow money from lenders and pay them back less? It’s fool proof, requires no messy union labor contracts, no R&D, and is infinitely scalable…as long as the central bank keeps buying. All indications are that they will. With such an easy path to profits, it should come as no surprise that this August was the busiest on record in terms of European corporate debt issuance, according to Dealogic.
 
But what are the companies doing with the newly raised cash? They aren't using it to hire more workers. Another story in the same Journal edition detailed how European corporate investment spending stalled at 0% growth in the second quarter (Eurostat data). Rather than investing the money, companies are using the brisk bond issuance to retire older debt, pay dividends, or buyback shares on the open market. While these activities are great for shareholders, they provide very little benefit for workers and consumers. Welcome to the new economy.
 
Normally, if a company borrows cash at a positive rate of interest, it must put that money to some productive use in order to repay lenders both principal and interest, plus generate a profit for its efforts. But now that hurdle has been eliminated. Companies don’t need to create any value with the money they borrow. They just need to borrow. The loans themselves produce the profit. It’s not too difficult to see how the corporate sector will evolve if the “ECB buying at negative rates” trend continues, or picks up steam. Corporations will focus less on business operations and more on ways to increase debt issuance. Fewer engineers and more accountants is never a good recipe for economic growth.
 
Japan has been going down this road even longer than the Europeans, and the results are equally poor. Although it hasn’t been buying corporate debt, the Bank of Japan (BoJ) is on pace to buy more than $786 billion worth of Japanese Government bonds this year, more than double what the government will actually issue. Currently the BoJ owns more than a third of outstanding government bonds and, at the current pace, it could own 60% by the end of 2018. (WSJ, R.Rosenthal & S.Bhattacharya, 9/9/16)
 
But it doesn’t stop there. The BoJ has also become the principle buyer of the Japanese stock market and now owns more than 60% of Japanese ETFs. Clearly, those stock purchases are not motivated by the same market-focused rationale that would compel private investors. Such “investments” are not spurring the Japanese companies to make bolder investments into organic growth. Instead, they are more likely to sit back and let the money roll in. It’s corporate welfare at its worst, guaranteed to produce nothing but short-term profits.
 
But despite all of this, the politicians, central bankers, and economists insist that bolder and more creative techniques of money printing and financial stimulus will unlock the economic puzzle and return the global economy to 3% or 4% growth. I think there is little doubt that the Federal Reserve will ultimately follow the ECB and the BoJ into this bizarre world of negative yields and unlimited financial asset purchases.
 
But as we go down this road, no one in power seems to consider the possibility that “stimulus” does more harm than good. If central banks weren’t buying bonds, interest rates would surely rise, and risks for business and governments would return. But the real world can produce real results. It has worked that way for millennia. Without guaranteed government money, companies would need to attract real investors. To do that they would need to create real businesses, a process that takes investment, innovation, and efficiency. These are the essential elements that create productivity growth that is the single biggest factor in raising living standards. It’s no accident that productivity growth has all but disappeared in the current age of central bank activism.
 
So we have a choice, either we continue down the road of negative rates to Fantasy Land, where central banks own all the stocks and bonds and asset prices always rise, but real wages and average living standards always fall, or we take our chances on a different path that leads to reality, however unpleasant the transition may be. I for one would choose the latter, but it looks like I won’t have much company.

Wednesday, August 24, 2016

The Coming Financial Market Meltdown - How To Be Ready When It Arrives

I'm sorry I've been away the past few weeks. My full time job has me working early in the morning through late at night. My free time has been spent putting in the hours trying to keep pace with everything happening in the global financial markets. The additional hours needed to formulate my thoughts into words here on the site have not been available. More free time will be coming, and there is a lot to discuss in the coming weeks.

Fortunately, not that much has changed in terms of my outlook on the world. While my view has changed little, I can feel the collective psychology of almost everyone around me (business associates, the media, friends, etc.) changing rapidly. This is the power of a bull market in financial assets, and the current mania is fascinating to watch unfold.

Almost everyone has forgotten what occurred back in 2008. Much more importantly, if they do remember, they seem to have forgotten what caused the great crash (debt growth and loose monetary policy). Some people still remember snapshots of that period (I sometimes hear people reference the movie "The Big Short"), but people in general are far more confident their financial assets (stocks, bonds and real estate) are much safer today than they were in March 2009.

I feel another event, similar in magnitude to 2008, is approaching. I do not have an algorithm or mathematical series of models to tell me this is the case. I'm just using common sense. We know with a quick study of financial history that excessive debt and loose monetary policy have been the underlying cause of every great financial crisis over the last 100 years. Over the past 8 years we have experienced the largest combination of excessive debt growth and loose monetary policy in history. If it did not lead to a massive crash it would be the first time in history. It would be similar to a meth addict taking an enormous steady dosage over an eight year period and experiencing no long term negative effects on their body. The only question we have to ask is "when will the negative effects of the drugs finally reveal themselves?"

Based on the belief a large scale "risk off" event is approaching, my life has been dedicated toward preparing for its arrival. I'm not talking about buying guns, water and growing food in the basement, I'm talking about learning the skills and making the contacts needed to become a large scale buyer of assets when fear returns to markets.

My field of study has centered around the commercial real estate market for two main reasons:

1. Leverage - Unlike stocks, bonds and commodities, real estate allows buyers to finance 60% to 100% of the purchase with borrowed money. The deeper your understanding of how commercial deals are financed, acquired and managed, the more leverage you can acquire through partnerships and lending relations.

2. Tax Advantages - The government needs to provide housing, particularly lower income and middle class housing, in order to keep up with a growing population. The tax laws in place exist to incentivize investors to use their capital to make this housing available. This will make the apartment sector an attractive asset class after prices plunge back to earth.

The global bond market bubble is the engine fueling asset bubbles almost everywhere. This has become known as "the reach for yield." As yield has disappeared from global bond markets (bond rates continue to move down or below zero as bond prices rise), investors have sought out other asset classes to find a return. Unlike technology, home builders, or financial stocks in previous stock manias, dividend payers (stocks with yield) have been the darling of the most recent ascent. Assets that have no yield (commodities, cars, fine art, land, etc.) become more attractive when alternative assets yield nothing as well.

The same applies to the commercial real estate markets where the rush for yield has felt like a tidal wave. The ability to borrow money increases a buyers "cash on cash return." This return is measured by the annual cash flow you receive relative to the amount of actual cash it took you to purchase the property.

There are two scenarios that could occur which would prick the current global financial asset bubble:

1. A risk off event where deflation takes control. This would likely lead to a final surge lower in bond yields while stocks, real estate and commodities sell off simultaneously.

2. The 35 year bond bull market ends. Yields finally bottom and begin a multi-year rise. Asset prices that have been rising with the tide of lower yields will now be fighting the current as rates rise.

I should note that even if we move through phase one first, bonds will ultimately bottom following that period and we will begin phase two. At some point, yields will reach their mania bottom and it will signal the beginning of a very painful period for all related asset classes.

The goal during this coming period will involve two major steps:

1. Asset preservation. Cash will be king, with the potential for precious metals outperforming everything. The precious metals out-performance is certainly not a certainty, so cash should always be the primary (largest) holding.

2. Asset accumulation. Just as every man woman and child on the planet wants to own as much real estate, bonds and stocks as they possibly can today, the absolute opposite will occur at the bottom. People will be saying how important cash is to a portfolio and how "saving money" and not "speculating" is the key to financial success. People won't believe they were unable to see the "obvious" disaster coming and promise themselves they will only invest a very limited amount of money in the "dangerous" financial markets moving forward.

This will be a once in a lifetime opportunity to purchase assets. Stocks, bonds and real estate will be available at bargain basement pricing.

Some of the people I work with on a day to day basis can see the potential trouble in the commercial real estate sector, but you have to close your eyes and immerse yourself into what that future world will look like in order to understand the full ramifications.

Investors have oceans of capital lining up at their doors to purchase property today. Some of these investors believe if things slow down then their $5 million credit line will fall to $4 million, but that's not the way things work. The money to invest or refinance in new commercial real estate projects will disappear overnight and move from $5 million to zero. Things do not occur in a calm, linear, fashion on the downside. They occur in a panicked hysteria. The bullish irrationality that exists today is just a small taste of the bearish irrationality that will exist during the coming decline in prices.

The human mind works to make things simple to understand so we can move back to more important things as soon as possible (like food, survival or pleasure). For this reason, investors always tend to extrapolate the future forward based on how the markets have performed in recent years. At tops, it feels as if markets will move up forever, and at bottoms it feels like they will never stop falling.

I've spent the last 8 years working in three main fields of commercial real estate (management, finance and acquisition). I've been fortunate to gain a strong understanding, from the inside, of how these three crucial components work toward building a successful portfolio. I have always taken positions that were geared toward preparing myself for the next major reset in financial markets, and I am fortunate to do consulting work today with some of the brightest minds in this field.

Try to close your eyes and imagine how everything will be occurring in your world on the backdrop of financial panic. If you can put yourself in that world mentally today, when it eventually arrives it will provide you with the confidence to take action. Hopefully, it will also keep you from getting swept away in the current mania as we approach the crest of the tidal wave.

Something truly terrible is coming, and we should all be excited for its arrival. I look forward to the day when this site will be focused on accumulation, instead of preservation. Stay tuned.....

Monday, August 1, 2016

How Much Growth Does It Take To Cover Interest On Global Debt?

Great piece this morning in the Financial Times by Satyajit Das, who wrote my favorite book of the year (so far); "The Age Of Stagnation."

Policymakers have chosen to ignore the central issue of debt as they try to resuscitate activity. Since 2008, total public and private debt in major economies has increased by over $60tn to more than $200tn, about 300 per cent of global gross domestic product (“GDP”), an increase of more than 20 percentage points.

Over the past eight years, total debt growth has slowed but remains well above the corresponding rate of economic growth. Higher public borrowing to support demand and the financial system has offset modest debt reductions by businesses and households.

"If the average interest rate is 2 per cent, then a 300 per cent debt-to-GDP ratio means that the economy needs to grow at a nominal rate of 6 per cent to cover interest."

For the full article click here.

The Rise & Fall Of Yahoo