The Monetary Battle of Little Big Horn

by Victor Sperandeo with the Curmudgeon



Market Week in Review:


The markets this week awaited the “Queen of the Fed” comments to see if Janet Yellen would change her mind about continuing quarter point increases in the Fed Funds rate.  Among the many concerns expressed by analysts: unexpected weakness in global economies; worldwide equity market declines (as the CURMUDGEON wrote about last Thursday); one of the worst yearly starts in the history for the US stock markets; and uncertainty from the continuing decline in oil prices (which is perceived as deflationary).


Here are a few examples of US stock indexes off their respective closing highs:


S&P 500 -13.6% (from 5/21/15), Dow Industrials -13.5% (from 5/11/15), Dow Transports -28.1% (from 12/29/14), and Russell 2000 -26.4% (from 6/23/15).  Near historic market action last week included:


·       The US bond market tested the lowest 30 year yields in the last 10 years (recorded on March 24th and April 1st of 2015 at 2.47% and in 2016 2.49% on February 10, 2016;

·       An explosive up move in Gold- from the low on 12/2/15 of $1054.5 to $1247.8 on Friday’s close (a gain of +18.3% in < 2 ˝ months);

·       The decline of the near month US Dollar Index Futures contract from 100.24 on 11/30/15 to 95.62 on 2/11/16 (-4.61%).  I emphasized the dates above, as gold and the dollar are almost always negatively correlated.

Queen of the Fed Speaks:


The bottom line of Yellen’s comments is best summed up by the 2/11/16 headline of Investor’s Business Daily: “Yellen Sees New Risks, But No Fed Mea Culpa.


The Queen started her comments by saying (emphasis added): "As is ALWAYS the case, the economic outlook is uncertain."  Here is the killer: "Yellen expressed confidence that inflation would eventually rise to meet the Fed's target of 2%.  She blames oil prices and a stronger dollar, saying they are -headwinds which will fade."  


Yellen did say the Fed could adjust policy as needed, but did not rule out a March increase.  Also, she didn't acknowledge that the Fed's December 2015 rate hike (25bps) might have been the trigger for the recent US and global market turmoil.  Instead, she said the key reason for the December rate increase was "inflation expectations." 


“What exactly did Yellen and her fellow members of the FOMC roundtable expect after they raised the funds rate in December, or, more exactly, began to drain capital from the markets?” wrote Steve Blitz, chief economist at ITG Investment Research.  Yellen singled out “foreign economic developments,” which “pose risks to U.S. economic growth.”


Blitz noted, “The weakness in oil and commodity prices, China, Europe and Japan did not suddenly begin in January, and these problems were exacerbated by formally tightening U.S. monetary policy at a time when the rest of the world is easing.”

Her comments at the Economic Club of Washington provide yet another excuse the Fed used to raise rates: “Yellen noted that Fed policymakers have said they'll increase its benchmark rate when they've seen ‘some further improvement in the labor market and were reasonably confident that inflation’ would move up to the Fed's annual 2% target over the medium-term."             


"I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market," Yellen said. Those gains, combined with market inflation expectations, "serve to bolster my confidence in the return of inflation to 2%" as the effects of low energy and import prices fade.


Comment, Analysis and Opinions:


Yellen’s stated reason for current policy was "inflation expectations."  I wonder where she gets such ideas?  The market for inflation expectations, which are used universally, are TIPS Notes and Bonds (Treasury Inflation Protected Securities).   The current 5 year Tips yield is 0.0017 or 17bps. The 10-year yield is 49 bps as of 2/12/16. This is the annual compounded rate.  The 30 year TIPS yield is 1.10%?  Also, Dec 2016 Crude Oil Futures are $39.50, which is still below the average cost of production which is ~$41.00.  Where are the “2%” inflation expectations in those numbers?


CURMUDGEON Note:  Other commodities, like corn are selling BELOW the cost of production.  “Unfortunately for farmers, the forecast for 2016 suggests the cost of production will exceed grain prices by about 70 cents a bushel,” according to the Wisconsin State Journal.


This kind of deceptive excuse is made up, taken out of thin air and is nonsense to any analyst with an IQ over room temperature. The clear illogic of her making-up the bogus case for raising rates, and by defending her tactical gambit, by talking about high auto sales, low unemployment, job gains, and rising wages is a total mystery.  Also, Yellen would not take "negative interest rates" off the table.  What next?


We have either stupidity, incompetence, or fabrication (AKA lies).  Take your pick! These kind of ”Dr. Jekyll and Mr. Hyde” comments from Queen Yellen is even more jaw dropping when considering that negative interest rates have not worked to increase economic growth or inflation anywhere the world! 


Let’s look at Japan for a case in point.  The Yen has been devalued 33% from its high to the low, while the BoJ imposed negative interest rates last month.   What were the results?  The Japanese economy contracted -1.4% in the fourth quarter, while Nikkei stock index is down -29.1%.


In the Eurozone, the ECB has had negative interest rates since June 2014.  The strongest European economy is Germany.  Yet its economic growth has been decreasing, but still positive, since January 2015 (see chart below).  Meanwhile, the DAX stock index is off -27.5% from its 2015 high – a serious bear market!


Germany GDP Growth Rate


If something doesn't work, why do you keep it on the table?  This is an enigma wrapped in a prevarication.  Like Hillary Clinton saying she used a private email server in her home for convenience, and thereby expects the world to believe it because of who she is!


This is why the trust in government is at a nadir. It is a great part of why the world is in decline and (in full disclosure) why I am the most bearish person in the world.


Curmudgeon Notes: 


1.    Victor’s bearishness is directed at the US and global governments and their seemingly inept, if not insane monetary and fiscal policies.

2.    Sub-zero interest rates are becoming the "new abnormal" in a shaky world economy. With fresh panic hitting markets, are we finally hitting the limits of what monetary policy can achieve? Please refer to this interactive map of countries for their history of negative interest rates (we suggest starting with Sweden – the first country to take its benchmark repo rate negative)   

The equity markets are clearly in bear markets everywhere.  The made up number from a TV talking head that the definition of a bear market is "-20% from its last high" is truly off the wall and naive.  As stated above, the Dow Transports and Russell 2000 are each down more than -20%, but the Dow Industrials and S&P 500 have not (YET) declined by -20%.


>Does this mean some US stock market indexes are in bear markets, while others are still in bull markets?


US Debt Growing Much Faster than GDP:


Let's get to the essence of the long term catastrophic problem.  


1.    The Gross US government debt on 12/31/08 was $10.7 trillion. (Go here to view the up to the minute national debt and who holds it).  On 12/31/15 the gross US debt was $18.9 trillion. That’s a compounded annual increase of 8.48%.

2.    From 12/31/08 Real GDP of chained 2009 dollars was $14.8 trillion. On 12/31/15 it was $16.3 trillion. That’s a compounded rate of yearly gain of 1.4%.  Leaving out the 2009 recession year, GDP compounded at 2.11%.

3.    The Debt to GDP ratio is now 1.16.

Here’s the punchline: At these rates of increase, the US national debt in 10 years will be $42.7 trillion, while GDP will be $18.8 trillion. That’s a Debt to GDP ratio of 2.24.  That’s over a 93% increase!


Can you now see the issue? Debt can't grow at 8.5% and be offset by GDP growth at only 1.4%!        


It’s actually worse than that as I’ve not counted unfunded liabilities, off balance sheet debt, gimmick accounting, PLUS the fact that an extra 24% of effective debt comes from printed “out of thin air” money ($4.5 trillion) on the Fed’s balance sheet.


More incredulous is that the CBO estimates $29.3 trillion in gross debt, but with no recessions in the next 10 years!  Great assumption, but typical baloney.


Do Economic Expansions/Recoveries Die of Old Age?


The Fed makes the point that recoveries don't die of old age. Statistics and probabilities would disagree with this kind of propaganda. In 161 years we have had 34 recoveries/expansions.  The current “expansion” will be the third longest at the end of March 2016. The longest (March 1991- March 2000), benefited from the commercialization of the Internet, cheap cell phone innovation, and the introduction of the retail Apple lap-top at the end of 1989. That added to the GDP growth immensely, in my opinion.


Let’s refocus on the current economic “recovery.” What have we had since 2008? Obamacare, Dodd- Frank, zero interest rates, QE's and Operation Twist’s.  President Obama has issued more Executive Orders and Executive Memorandums since Jimmy Carter. He also increased taxes and added a major amount of costly regulations. So the only Growth aspect of Obama's tenure has come from the "Independent” Federal Reserve Board. They have now decided to change their mind and raise rates in the face worldwide deflation and US inflation nowhere near 2% (especially in light of declining energy prices). 


The Battle of Little Big Horn/ Custer’s Last Stand:


The battle of deflation relates to a story told by a technical service (subscription only) named Greg Weldon, who presents an analogy of the "Battle of Little Big Horn" aka "Custer's Last Stand." The Oglala Lakota or Sioux Indians represent deflation, while the heads of the ECB, BoE, BoJ and the Fed represent the four Generals each leading a division of the 7th cavalry of four divisions each led by General’s Gibbon, Terry, Crooks, and Lieutenant Colonel George A. Custer.


The Indians inspired by Sitting Bull are led by Crazy Horse - the great Sioux warrior and leader of the battle. The 7th cavalry lost with 268 men killed.  The Sioux lost 31 warriors, 6 women and 4 children.




The world’s central banks are fighting a war similar to Little Big Horn.  Just like Custer in his battle, they are confident in their unlimited and independent power.  Yet the central banks (especially Japan) keep losing battle after battle, and in so doing are compiling a monster amount of debt that can't ever be repaid.


The problem is a huge, erroneous assumption of using monetary policy and Keynesian economics as the cure for ailing economies.  In reality, it is the fiscal policy agenda that is killing growth, while monetary policies are not at all working! Until the world’s leaders learn this, nothing will change the trend of more US and global economic decline.  


Current fiscal policies are anti-business, while reckless monetary policies are causing deflation.  It’s all leading to its ultimate consequence, which may resemble the Battle of Little Big Horn.  Could we then experience "helicopter money" as some pundits have predicted?


This brings us to Crazy Horse's vision of a battle with Lt Col Custer and life.  His famous quote was:  "Today is a good day to die, for all the things of my life are present."  This saying has everything to do with spiritual completion and soulfulness, readiness and acceptance.  It was later converted to: "Today is a good day to die!”  Yet Crazy Horse won the battle and Custer died.  


Good luck and till next time...

The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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