Saturday, January 25, 2014

U.S. Stock Valuation Triggers Memories Of 1929's 90 Percent Decline

Great chart from this week providing an average of four major valuation indexes for the S&P 500. We are now in territory seen in only 1929 and 2000. Can the next market fall top 1929's 90% decline? We'll have to wait to find out.

Remembering history:

As the DOW fell 300 points on Friday, CNBC's Rick Santelli provided three minutes of honesty discussing what happens when the central bank's cannon balls & fairy dust illusion no longer works. For more on this subject see 2014 Outlook: The Greatest Illusion The World Has Ever Seen.

CNBC Interview: Ray Dalio

Ray Dalio, manager of the largest hedge fund in the world, sits down with CNBC this week to discuss his economic machine model.

Ray finishes the interview by asking viewers to take the time to watch the video "How The Economic Machine Works." I posted the video when it was first released, but I will re-post it again below:

Monday, January 20, 2014

Understanding Where The Economy Will Grow Stronger Within U.S. Borders

A student at Georgia State University, Sarah Arnett, put together a paper that reviews the fiscal condition of the 50 states of the United States. As more and more towns, cities and states move closer to bankruptcy due to the real estate collapse (crushing tax receipts) and impossibly large pension commitments, the location where both people and businesses decide to settle will become an important issue.

State's crushing debt burdens will impact both individuals and businesses with taxes, regulations, quality of schools, infrastructure and much more.

The following graphic was put together by PolicyMic to provide a visual of the fiscal rankings. If you plan to make long term living or business plans in one of the dark blue states below, understand that you will be fighting against the current. The opposite will be true for those states within the center and southeast of the country where both businesses and people will continue to migrate.

For more on this $3.7 trillion debt market see: 2014 Outlook: U.S. Municipal Bond Market

Howard Marks On The Role Of Luck In Investing, Business & Life

The following letter comes from Howard Marks who founded Oaktree Capital Management in 1995. Mr. Marks has a personal net worth of $1.5 billion, and his letters are always must read for the investment community. The most recent, released this week, discusses the role of luck in both investing and life. Click the bottom right box to bring the letter full screen.

Treasuries Due For Short Term Rally; Long Term Collapse

After yields rose from around 1.7% in early 2013 to over 3.0% just a few trading days ago, the 10 year treasury bond is incurring an emotion from the market it has not experienced in a long time; dislike.

The chart below shows that sentiment toward treasuries is hovering close to 20 year lows, meaning most investors believe that yields will continue to move higher.

This is due in large part to the much touted "great rotation." Since investors now believe it is an impossibility for stocks to fall more than a few hours before reaching new highs, the market "knows" that money will continue to move out of bonds and into stocks (as it steadily has over the last 8 months). The market also incorrectly believes that the U.S. economy is now entering the next acceleration phase of an economic recovery. This has historically pushed bond yields higher.

An investment becomes attractive when it is disliked by the market, prices are low and the long term fundamentals are strong. Right now treasuries have one of those boxes checked (disliked by the market). How about numbers two and three?

Going back over one hundred years of data shows that even with the most recent rise, treasury yields are still extremely low (meaning priced extremely high). 

The fundamentals are worse. If you were to take five minutes to discuss the debt market in the United States to an eighth grader, they could quickly understand that the market is a ponzi scheme waiting to erupt. 

The government will most likely issue less that $700 billion in new debt this year (an enormous improvement from the $1.4 trillion in 2009). What most forget is that when the existing bonds mature, they must be immediately refinanced. How large is this adjustable rate refinancing bill? It is currently running at over $100 billion per week. This is actually an improvement; in 2013 the government had $7.5 trillion in debt that matured and needed to roll. 

In other words, if the holders of U.S. debt decided that they did not want to "roll" their worthless I.O.U.'s and take just a small fraction of their bond maturities in cash, then the game would be over in just a few hours. The Fed's (already ridiculously large) $480 billion in annual treasury purchases would only be a small down payment on what is needed.

The TIC data this week showed that China increased its holdings of U.S. government debt to over $1.3 trillion. This was another sign of "strength" in the bond market. China is just a hair ahead of Japan in U.S. debt holdings but a mile behind the Federal Reserve. My question is, what if China, Japan or the Federal Reserve were forced to become sellers of U.S. treasuries?

China and Japan both will face an internal funding crisis over the next few years. China's is due to the leverage used to fund domestic investment and Japan's is due to their government debt burden. If they need cash, which they will, they may decide to ask for a payment on some of their U.S. debt that is rolling.

Ultimately there is only one way for this story to end, which is a much larger monetization of the deficit from the Federal Reserve. While the Fed may continue to taper in the short term, over the long term they will continue to increase their share of treasury bond ownership until the system breaks.

I believe this process will occur first in Japan before it arrives in the United States. For more on the coming Japanese debt crisis see:

h/t Zero Hedge