Day: April 13, 2015

The Fed has bet the financial system on academic theories, that upon close inspection defy even basic common sense.

One could easily write a multi-volume set of books on the Fed’s mistakes. However, in its simplest rending, the biggest flaw in the Fed’s models pertains to its total lack of understanding of human behavior.

The Fed believes that if interest rates are low, investors will seek out higher returns by piling into stocks or even real estate. As these asset prices rose, the investors would feel wealthier and so go out and spend more money… which in turn would drive the economy towards growth (70% of US GDP stems from consumer spending).

Of course, the Fed’s model is far more complicated than this, involving all kinds of “clever” math equations… but ultimately the Fed’s recipe for growth is “cut rates and if necessary, buy bonds with newly printed money and growth will appear.”

The only problem with this all of this is that people buy things with income not based on where their stock portfolio is trading (assuming that have a portfolio, but that’s a issue for another time).

When you go to buy groceries or a new suit, you don’t stop to think where stocks are trading. You think about how much money is in your bank account based on your salary… or you use a credit card and project that you’ll have the money to pay off your debt down the road.

After all, the money you “make” from higher asset prices isn’t actually real money unless you sell the asset. You cannot go into a store and offer to pay your bill with part of your stock portfolio. And most investors have the bulk of their portfolio money in 401(k)s, IRAs, and other investment vehicles which they cannot easily convert into cash without facing a penalty.

Who on earth thinks “I will buy this item today because stocks are up and several years from now (possibly decades) I will sell my stocks and have a lot of money”??? No one but Fed officials apparently.

So while the Fed’s policies haven’t generated any significant growth, one thing they have accomplished is a total mispricing of risk in the financial system. Again, the reason for this has to do with the Fed’s complete and total lack of understanding of basic human nature.

When the Fed began announcing QE programs, the single most obvious trade in the whole world became “front-running the Fed.”

In this trade, traders would buy Treasuries at Treasury auctions only to then turn around and sell the bonds to the Fed a few days (or maybe a week or two) to the Fed. After all, if you know that someone else is going to be buying bonds at a certain date and time in the future… and you know they’re not going to be too picky about the price they pay…why not try to game this system to eek out a profit?

By piling into bonds, traders forced prices higher and yields lower: precisely what the Fed wanted. These folks were looking for profits while the Fed was looking for lower yields (meaning higher bond prices). It’s a match made in heaven.

So how screwed up is the risk profile in the world? Today, the yield on the 10-year Treasury (the benchpark for riskless money according to modern financial theory) is yielding less than 2%

If you were to go all the way back to 1790, the yield on the 10-Year Treasury (or its equivalent at the time) has been lower than it currently is only one time before the Fed started its QE programs, and that was in 1945 at the end of WWII.

Treasuries actually yielded MORE than they are now in the depth of the 2008 collapse when everyone thought the world was ending.

These bonds are the benchmarks for “risk” in the financial system. Stocks, corporate bonds, mortgages, auto loans, emerging market stocks… everything you can name are ultimately priced based on their perceived risk relative to the “risk free” rate of lending money to the US for 10 years.

And believe it or not, Treasuries are actually one of the BETTER bonds to own from a yield perspective. Globally over 45% of Government bonds yield less than 1%… and €2.1 TRILLION in EU bonds now have NEGATIVE yields.

Put another way, the financial landscape is now so screwed up by the Central Planners, that investors are actually INCINERATING their money by lending it to Governments.

What’s coming will be the largest Crisis in financial history. Globally the bond bubble is over $100 trillion in size. It literally dwarfs stocks.

And the ENTIRE bond market is mispricing risk.

This mess will burst just as all bubbles do. And when it does it will be ENTIRE COUNTRIES, not just banks that go bust.

If you’ve yet to take action to prepare for the second round of the financial crisis, we offer a FREE investment report Financial Crisis “Round Two” Survival Guide that outlines easy, simple to follow strategies you can use to not only protect your portfolio from a market downturn, but actually produce profits.

You can pick up a FREE copy at:

http://www.phoenixcapitalmarketing.com/roundtwo.html

Best Regards

Phoenix Capital Research

 

 

 

 

 

 

 

 

 

 

In the early 2000s, Alan Greenspan was worried about deflation. So he hired Ben Bernanke, the self-proclaimed expert on the Great Depression from Princeton. The idea was that with Bernanke as his right hand man, Greenspan could put off deflation from hitting the US. Indeed, one of Bernanke’s first speeches was titled “Deflation: Making Sure It Doesn’t Happen Here”

The US did briefly experience a bout of deflation from late 2007 to early 2009. To combat this, Fed Chairman Ben Bernanke unleashed an unprecedented amount of Fed money. Remember, Bernanke claims to be an expert on the Great Depression, and his entire focus was to insure that the US didn’t repeat the era of the ‘30s again.

Current Fed Chair Janet Yellen is cut of the same cloth as Bernanke. And her efforts (along with Bernanke’s) aided and abetted by the most fiscally irresponsible Congress in history, have recreated an environment almost identical to that of the 1920s.

Let’s take a quick walk down history lane.

In the 1920s, most of Europe was bankrupt due to after effects of WWI. Germany in particular was completely insolvent due to the war and due to the war reparations foisted upon it by the Treaty of Versailles. Remember, at this time Germany was the second largest economy in the world (the US was the largest, then Germany, then the UK).

Germany attempted to deal with the economic implosion created by WWI by increasing social spending: social spending per resident grew from 20.5 Deutschmark in 1913 to 65 Deutschmark  in 1929.

Since the country was broke, incomes and taxes remained low, forcing Germany to run massive deficits. As its debt loads swelled, the county cut interest rates and began to print money, hoping to inflate away its debs.

When the country lurched towards default, US and other banks loaned it money, doing anything they could to keep the country from defaulting on its debt. As a result of this and the US’s relative economic strength compared to most of Europe, capital flew from Europe to the US.

This created a MASSIVE stock market bubble, arguably the second largest in history. From its bottom in 1921 to its peak in 1929, stocks rose over 400%. Things were so out of control that the Fed actually raised interest rates hoping to curb speculation.

The bubble burst as all bubbles do and stocks lost 90% of their value in a mere two years.

Today, the environment is almost identical but for different reasons. The ECB first cut interest rates to negative in June 2014. Since that time capital has fled Europe and moved into the US because 1) interest rates here are still positive, albeit marginally, and 2) the US continues to be perceived as a safe-haven due to its allegedly strong economy.

This process has accelerated in 2015.

• Globally, there have been 20 interest rate cuts since the years started a mere two months ago.

• Interest rates are now at record lows in Australia, Canada, Switzerland, Russia and India.

• Many of these rates cuts have resulted in actual negative interest rates, particularly in Europe (Denmark, Sweden, and Switzerland).

• Both the ECB and the Bank of Japan are actively engaging in QE programs forcing rates even lower.

• All told, SEVEN of the 10 largest economies in the world are currently easing.

Because the US is neutral, money has been flowing into the country by the billions. A lot of it is moving into luxury real estate (particularly in LA and York), but a substantial amount has moved into stocks as well as the US Dollar.

As a result of this, the US stock market is trading at 1929-bubblesque valuations, with a CAPE of 27.34 (the 1929 CAPE was only slightly higher at 30. And when that bubble burst, stocks lost over 90% of their value in the span of 24 months.

Another Crash is coming… and smart investors would do well to prepare now before it hits.

If you’ve yet to take action to prepare for the second round of the financial crisis, we offer a FREE investment report Financial Crisis “Round Two” Survival Guide that outlines easy, simple to follow strategies you can use to not only protect your portfolio from a market downturn, but actually produce profits.

You can pick up a FREE copy at:

http://www.phoenixcapitalmarketing.com/roundtwo.html

Best Regards

Phoenix Capital Research