Tokyo Doubles Down

“When it becomes serious, you have to lie.”

“I’m ready to be insulted as being insufficiently democratic, but I want to be serious… I am for secret, dark debates.”

“Of course there will be transfers of sovereignty. But would I be intelligent to draw the attention of public opinion to this fact?”

“If it’s a Yes, we will say ‘on we go,’ and if it’s a No we will say ‘we continue.’”

“We all know what to do, we just don’t know how to get re-elected after we’ve done it.”

– All quotes from Jean-Claude Juncker, prime minister of Luxembourg and president of the European Commission

I’ve been busily writing a letter on oil and energy, but in the middle of the process I decided yesterday that I really needed to talk to you about the Bank of Japan’s “surprise” interest-rate move to -0.1%. And I don’t so much want to comment on the factual of the policy move as on what it means for the rest of the world, and especially the US.

But before we go there, I also want to note that today is Iowa, and so we’re about to turn a big corner in what is fast becoming one of the wackiest years in American political history. I’m going to sit down tonight after the caucus results come in and write to you again, for a special edition of Thoughts from the Frontline that will hit your inbox tomorrow. Along with Iowa, I want to delve into the issue of what a “brokered convention” would mean for the Republican Party, and what one would look like.

QE Failed, So Why Not Double Down?

I have been steadfastly maintaining that the Bank of Japan was going to augment its quantitative easing stance sometime this spring. Inflation has not come close to their target, and the country’s growth is dismal, to say the least. So the fact that the Bank of Japan “did something” was not a surprise. I will however admit to being surprised – along with the rest of the world – that they chose to do it with negative interest rates. Especially given the fact that Kuroda-san had specifically said in testimony to parliament only a few days earlier that he was not considering negative interest rates.

While this development is significant for Japan, of course, I think it has broader implications for the world; and the more I think about it, the more nervous I get. First let’s look at some facts.

Conspiracy theorists will love this Bank of Japan timeline:

Jan 21 – Kuroda emphatically tells Japanese parliament he is not considering NIRP. Continue reading

China’s Year of the Monkees

“It does not matter how slowly you go as long as you do not stop.”

– Confucius

“Be extremely subtle, even to the point of formlessness. Be extremely mysterious, even to the point of soundlessness. Thereby you can be the director of the opponent’s fate.”

– Sun Tzu

While we in the West get used to writing “2016” on our documents, China is getting ready for its own Lunar New Year. Their calendar kicks off the “Year of the Monkey” next month. At the rate they are going, though, Chinese markets look more like that hapless rock band that can’t quite reach the main stage.

China isn’t the only reason markets got off to a terrible start this month, but it is definitely a big factor (at least psychologically). Between impractical circuit breakers, weaker economic data, stronger capital controls, and renewed currency confusion, China has investors everywhere scratching their heads.

When we focused on China back in August (see “When China Stopped Acting Chinese”), my best sources said the Chinese economy was on a much better footing than its stock market, which was in utter chaos. While the manufacturing sector was clearly in a slump, the services sector was pulling more than its fair share of the GDP load. Those same sources have new data now, which leads them to quite different conclusions. If you have exposure to China – which you do if you own just about any stock listed anywhere – you’ll want to read this issue carefully.

Let me remind you, before we delve into China, that the early-bird pricing for my annualStrategic Investment Conference ends next Sunday at midnight. I will admit to taking no small amount of pride in the fact that almost everyone who talks to me about the conference says it’s the best investment conference they have ever attended. I carefully craft a blend of speakers each year to speak to the particular dynamic environment we find ourselves operating in. Attendees who have been to most of the conferences tell me that the experience gets better every year, and I have worked hard to continue that positive trend. Continue reading

2016: Surprises & Scenarios

“The expected rarely occurs and never in the expected manner.”

– Vernon A. Walters

“The fundamental nature of exploration is that we don’t know what’s there. We can guess and hope and aim to find out certain things, but we have to expect surprises.”

– Charles H. Townes

I see it every December and January: in the flurry of economic and political forecasts, someone says we ought to “expect a surprise.”

Phrases like this drive the writer part of me crazy. A surprise, by definition, is something you don’t expect, so telling us to expect one makes no sense. They might as well say, “Expect the warm water to be cold.” The words don’t go together that way.

The analyst part of me, though, knows what they really mean: not that we should expect a particular unforeseeable event, but that we should recognize the probability that we will be surprised in some way, at some point.

In fact, that prediction is almost always realized. I can guarantee you’ll get surprised this year. I can’t guarantee what specific events will surprise you, but I can make some educated guesses, as I did last week in “Economicus Terra Incognita.” Today we’ll go a step further and look at some of the “surprises” others are seeing in their crystal balls.

We can acknowledge the difficulty of making forecasts while also learning from informed speculation. How to do this? Pay attention to people who know their limitations. The most useful forecasts come from well-informed analysts who understand the very real boundaries that guide speculation about the future. One of my favorite Clint Eastwood lines, which I often quote to my children and friends, is the familiar, “A man has to know his limitations.”

Last week we discussed the limitations of forecasting. Condensed into one paragraph, my forecast said that world GDP will continue to decline, while the US will have slow growth – closer to 1% than 2% – but we shouldn’t plunge into recession without a shot across the bow to the US economic system from overseas. I speculated that such a shock might come from the collapse of Europe, a true crisis in China (beyond falling to 3–4% growth), or an uncharacteristically severe bear market in stocks. In the past, bear markets have not caused recessions – the causality is the other way around. But in the past, the US economy was not sputtering along at stall speed, so I don’t think we can rule out causation running the other way. All my other forecasts follow from those basic thoughts, which you can readif you like.

So today we’ll look at 2016 forecasts from some professionals I trust. I know most of them personally and have been friends with some of them for years. I know they aren’t just “talking their book.” They may turn out to be wrong, but if so, it will be for the right reasons. After we review the forecasts, we’ll look at some common threads among them, as well as important differences. Continue reading

Chinese Sunset

The jet lag from flying back from Hong Kong on Sunday is just about gone, but I’m still deep in thought about what I learned. As I said in last week’s letter, the overall tone on China was bearish for the group of very sophisticated investors I met with. There was particular mention of the quantity of currency flowing out of China and lots discussion about how that was happening. Suffice it to say that the wealthy in China have ways to move money.

I mentioned that fact at lunch today with a close friend of mine (who will allow me to tell the story but not to mention his name in connection with it), and he shared an anecdote that he had run into on a trip to Seattle the day before. It seems that one of his friends bought a rather large, roughly $8 million, new home in a nice part of Seattle and was selling his old home for a mere $4 million. Thirty prospective buyers came through to look at the property, and not one of them spoke English – they were all Chinese.

Think about that for a moment in the context of money leaving China. At the Hong Kong gathering, a Bank of America Merrill Lynch analyst noted that if the top 3% of wealth holders in China moved just 7% of their money out of the country, it would add up to $1.5 trillion. Personally, I think Chinese investors are being smart to diversify their assets and asset bases. That is something we take for granted in the West.

(My friend David Tice, founder and ex-manager of the Prudent Bear Fund, who has a killer apartment in my building – indeed, his apartment was the inspiration for my getting and building mine out – wonders how he can get prospective Chinese buyers to come see his place! The weather is a lot better in Dallas than it is in Seattle. I know from talking to friends in New York City that a lot of Chinese are also buying there, along with Russians and others from that corner of the world.) Continue reading

What Is Really Bugging the Market

My good friend David Rosenberg, Chief Economist at Gluskin Sheff, has long been one of the biggest draws at my annual Strategic Investment Conference. I had always taken him for a “permabear.” Then three years ago, Dave shocked us by announcing in no uncertain terms – in his usual fire-hose delivery of hard data and brilliant analysis – that he had turned decidedly bullish. His call was of course spot on.

Dave will once again kick things off at this year’s SIC, and you’ll want to be there to catch his every valuable, investable word. David is only one of our all-superstar cast. At SIC we have only headliners, people who would keynote any other investment conference. You get to see them all in one place.

I can say with some justification (and a measure of pride) that SIC is the best economic gathering on the planet, and SIC 2016 is going to be our best yet. The dates are May 24-27, 2016, and this year we’ve moved the conference to Dallas, my home turf, with easy access from anywhere in the world. Just as you’ve come to expect, we’re tackling a big theme: “Decade of Disruption: Investing in a Transformed World.”

In the decade ahead, you and I will not be able to successfully invest in the same way we did in past decades. Our world is transforming at an ever-accelerating rate, and we’re going to need a more comprehensive understanding and better tools if we’re going to invest in that world profitably.

To see how SIC16 will help you with those aims and to get all the particulars on registration, click here. And don’t tarry: if you register by January 31 you’ll save $500 off the walkup rate. Continue reading

The Seven Fat Years of ZIRP

“The Fed’s emergency policies since 2008 have in one sense been a huge success, though we will never know the counter-factual. A great depression was averted. Output is 10pc above its previous peak. Employment is up by 4.7m.

“Yet zero rates and QE set off torrid credit bubbles in the emerging world, pushing up the global debt ratio by 30pc of GDP beyond their previous record in 2008. The Bank for International Settlements calls this a “Pareto sub-optimal” for the world as a whole. The chickens have not yet come home to roost.”

– Ambrose Evans-Pritchard, The Telegraph

For seven long years, under two presidents and two chairpersons, the Federal Reserve kept its key policy rate effectively at zero. Now those years are over. We’re entering a new era – but new isn’t necessarily better.

Just for fun, I looked back to Thoughts from the Frontline for December 19, 2008 – right after the Fed first dropped rates to zero. You can read it here: “I Meant to Do That.” The theme with which I opened that issue could have worked just as well today, although we now have a different circumstance: rising rates.

The Fed has taken interest rates to zero. They have clearly started a program of quantitative easing. What exactly does that mean? Are we all now Japanese? Is the Fed pushing on a string, as Japan has done for almost two decades? The quick answer is no, but the quick answer doesn’t tell us much. We may not be in for a two-decades-long Japanese malaise, but we will experience a whole new set of circumstances.

Indeed, we now face that whole new set of circumstances. The Federal Reserve has created a series of debt and credit bubbles all over the world. The Bank for International Settlements terms this a “Pareto sub-optimal” for the global economy.

On the other hand, to say that the Fed “tightened” this week amounts to a very generous use of the word. They still own a multi-trillion-dollar Treasury and mortgage-bond portfolio in which they continue to reinvest anything that matures or pays interest. Last week’s FOMC statement pledged to “maintain accommodative financial conditions.” No one should call this crew hawkish – just marginally less dovish now.

In today’s letter we are going to examine the problematic credit markets, and I want to focus on something that is happening off the radar screen: the continuing rise of credit in private lending. I predicted the rise of private credit back in 2007 and said that it would become a major force in the world, but I got strange looks from audiences when I talked about the arcane subject of private credit. Today the shadow banking system is taking significant market share from traditional banking. Thus the market is gaining greater control over many of the traditional levers that central banks like to push and pull. While I think that trend is generally a good thing, it means that central banks are going to have to lean even harder in their policy directions if they want to affect the markets. And since they do like to interfere, it won’t be long before we embark on a “whole new set of circumstances.”

But before we turn to the ups and downs of credit, in keeping with my pre-Christmas tradition, I want to commend to you a most worthy cause that will pay fabulous dividends in the future and help bring peace to our troubled world.

My friend Niall Ferguson introduced me to a young former hedge fund manager, Jonathan Starr, who in 2009 started a prep school called the Abaarso School of Science and Technology in Somaliland with a sizable personal donation and the investment of his time. When Jonathan first went there, he and the completely volunteer staff of foreigners did not know the local customs, did not speak the language, and were not professional educators. To say their task was challenging is a huge understatement. The local Muslim community looked on them with suspicion, and there were efforts to close them down. But they persevered and have been wildly successful. If you meet Jonathan and his team, you quickly understand why they have prevailed. Jonathan has invested 100% of his time in Abaarso and has had no other job for 6+ years. Continue reading

The Fed Awakens

I got the following from a friend at J.P. Morgan just a few minutes ago. You might have had something like it hit your inbox as well.

WASHINGTON – Federal Reserve officials said Wednesday they expect a more gradual pace of short-term interest rate increases in coming years than they did three months ago.

They also tweaked very modestly their views on the outlook for the economy, according to forecasts released after the conclusion of the Fed’s two-day policy meeting. Officials made small changes in their views of future economic activity, and they still don’t expect to achieve their 2% inflation rise target until 2018.

Clearly not a surprise and in line with what I’ve recently been saying. I think the Fed is going to be raising rates a lot more slowly than even they project. When you look at the “dots,” the median projection for the Fed funds rate is 3.75% in the much longer run.

Side bet? I think we see 0% again before we see 2%. I’ll take the overs on that bet, thank you very much. If you make the number 3%, I’ll even give you odds.

Today’s Outside the Box is from my friend Danielle DiMartino Booth, who used to work at the Dallas Fed for Richard Fisher. She has gone out on her own and has begun to write occasional pieces that seem hit my inbox at least weekly. The cover a wide range of topics, but many of them deal with the Fed. Continue reading

Of Central Bankers, Monkeys, and John Law

Back in April, my good friend Charles Gave, Chairman of Gavekal, penned a short but brilliant piece in which he likened central bankers to a bunch of monkeys in a cage. In the unforgettable “Of Central Bankers, Monkeys and John Law,” he proceeded to run down the parallels between France’s 18th-century “Mississippi Bubble” and the situation in the Eurozone today.

Now Charles has given us a follow-up, titled “The Apex of Market Stupidity,” in which he regales us with a sardonic but spot-on recap of the sundry ways in which market participants and analysts have been witless over the years. And just last week, he says, we scrambled, clawed, and algoed our way to the very summit of market stupidity, when European markets were routed by the failure of ECB Chairman Mario Draghi to be sufficiently dovish.

Thus, Charles concludes, we now find ourselves in a world where “value in the financial markets is no longer a function of the discounted cash flow of future income, but instead is determined by the amount of money the central bank is printing, and especially by how much it intends to print in the coming months.”

This distortion of the basic tenets of investing is leaving otherwise rational market participants feeling like they are living in an alternate universe. Of course, reality will eventually reassert itself; but as Keynes famously said, “The markets can stay irrational longer than you can stay solvent.”

For today’s Outside the Box I bring you both of these pieces, which not only make for fun reading, as Charles is such a great writer, but will also help you understand a bit more about the psychology of the marketplace.

I want to offer a comment on Donald Trump’s latest contretemps – that we should not allow Muslims into this country for a period of time. That may be simply the most boneheaded, ill-conceived idea I have heard from a politician in my life, which is saying a lot, given Bernie Sanders’ recent suggestions for cutting carbon emissions by 80% by 2050, which is merely impossible without creating a multi-decade depression in the United States.

Aside from the Constitutional, ethical, and practical problems, closing the border to arbitrary groups, even temporarily, would cause enormous economic damage. Muslim-majority countries would certainly retaliate by barring Americans and/or Christians. The result could be a trade war at least as bad as that brought on by the old Smoot-Hawley tariffs, with people as the weapons and no resulting benefit to national Continue reading

Dear Media, Stop Freaking Out About Donald Trump’s Polls

I’m going to offer something a little different in this week’s Outside the Box. Nate Silver has consistently been one of the best political analysts of the past 12 years. I wasn’t terribly enamored of his move from the New York Times to ESPN – to go back to covering sports rather than politics – but he still covers politics over at 538.

This past week he wrote an article called “Dear Media, Stop Freaking Out About Donald Trump’s Polls.” It’s not that he’s got an anti-Trump bias, but he points out in this insightful article that polls taken this month aren’t really telling us anything, and at the end of the piece he shows us what the breakdown of people who are firmly decided on their presidential candidate probably is for Iowa and New Hampshire. If nothing else, that will either make you happy because your favorite guy or gal may not actually be that far behind (assuming you’re Republican, that is) or it will demonstrate the dubious value not just of political polls but also of consumer and economic surveys as opposed to hard facts.

Silver’s analysis speaks to the skeptic in me. In his analysis, Donald Trump still comes in at the top of the heap of announced candidates, but “undecided” is a massive winner. That won’t be the case on February 1 when the Iowa caucuses are actually held, and Nate discusses how and when people actually make decisions on such things. If you are like me and find yourself faced with the choices given us today, you may be (1) overwhelmed and (2) not exactly sure who to support. There is a lot to like about a lot of them, but the choice is confusing to say the least. Do you pick the candidate you think can do best in November, or do you pick the candidate you would really like to be president? I think you will find this a fun and interesting read.

Even though I am not traveling, I seem to stay just as busy as ever. I am beginning to whittle my inbox down while trying to keep up on my book research. When you start trying to write a book on what the world will look like in 20 years, there are just so many moving parts. We are also dealing with well over 100 different research assistants, and trying to coordinate all that and hit writing deadlines does make for a full day. An interesting day to be sure, but full.

You have a great week and be sure to check your inbox for my letter this week. It will have a major announcement that I am sure will intrigue you.

Your skeptical about polls in general analyst,

John Mauldin, Editor
Outside the Box

Be Careful Out There

Michael Lewitt, author of The Credit Strategist, likes to get right to the point. Here’s the opening paragraph of this month’s TCS:

Commodity prices are plunging, the dollar is powering higher, the yield curve is flattening, ObamaCare is collapsing, global trade is plummeting and terrorism is spreading across the globe. The high yield credit markets are sending distress signals and 10-year swap spreads are negative. Energy companies are going out of business faster than you can say “frack” and trillions of dollars of European bonds are again trading at negative interest rates. The world is drowning in more than $200 trillion of debt that can never be repaid while European and Japanese central bankers promise to print more money and the Federal Reserve is being dragged kicking-and-screaming into raising interest rates by a paltry 25 basis points. Accurate pricing signals in the markets are distorted by overregulation, monetary policy overreach and group think. Hedge funds are hemorrhaging and investors, desperate to generate any kind of nominal return on their capital, continue to ignore the concept of risk-adjusted returns. Some market strategists believe this is a positive environment for risk assets; I am not among them.

Michael pays particular attention to the credit markets, and he doesn’t like what he sees. He points out that corporate debt is now much higher than it was on the eve of the financial crisis in 2007, driven by Fed-fueled leverage. This leverage problem is really hurting the energy industry but goes far beyond it, as Michael explains:

Companies in the United States have taken advantage of low interest rates to issue record levels of debt over the past few years to fund buybacks and M&A. This has driven the total amount of debt on balance sheets to more than double pre-crisis levels. However, cash flows have not kept pace, resulting in leverage metrics that are the highest in 10 years.

This month’s issue of The Credit Strategist is sobering, and I hereby forward it to you as this week’s Outside the Box – at the risk of putting you off your Thanksgiving dinner! Michael consistently has one of the most well-reasoned perspectives in the Wide Wide World of Finance, and if you’d like to consider subscribing to TCS, visit his website Continue reading

The Economic Impact of Evil

“Political leaders still think things can be done through force, but that cannot solve terrorism. Backwardness is the breeding ground of terror, and that is what we have to fight.”

– Mikhail Gorbachev

“… Europe exemplifies a situation unfavorable to a common currency. It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe.”

– Professor Milton Friedman, The Times, 19 November 1997

“There is no example in history of a lasting monetary union that was not linked to one State.”

– Otmar Issing, chief economist of the German Bundesbank in 1991

The world can change quickly, and last week it did. The most immediate and heartbreaking impacts of the Paris attacks were suffered by the victims themselves and their families, but from there the ripples of terror spread outward around the world.

The Paris events didn’t happen in isolation. Recent bombings in Lebanon, Iraq, Mali, and Nigeria, plus the Russian airline disaster, showed us how far evil can reach. It isn’t just ISIS: al-Qaeda is getting stronger in some places; Boko Haram continues to strengthen in West Africa; there is a resurgent Taliban in Afghanistan; and the list goes on…

In addition to the catastrophic human cost it exacts, terrorism has economic impacts. It misallocates resources, distorts prices, and prompts adverse government policies. We all feel these effects, even if we live far from the terror zones.

Terrorism is global. So is the economy. We can’t separate them. I’m sure you have spent time reading about the reaction to the terrorist attacks in Paris. I have been reading and thinking a great deal about the effects of recent events on the European Union. Much of what I’ve read seems to miss what I think is the larger context and what may be the real longer-term economic and geopolitical implications of these attacks. It should make for an interesting, and somewhat sobering, letter. Continue reading

The Gig Economy Is the New Normal

An already-confusing employment environment grew even more complicated this past week. Many readers responded to my “Crime in the Jobs Report” letter with their own stories. Some confirmed what I wrote, while others disputed it. Some of the stories I read from readers who are stuck far from where they want to be in this job market were very moving. I think everyone agrees the labor outlook is uncertain. I sense a lot of nervousness, even from those who have secure jobs that pay well. In today’s letter, I’m going to respond to some of the observations and data that came in this week on employment.

As we will see, we have a right to be nervous. Big changes in the employment world are happening, and we don’t yet know how they will affect us individually. Analysts like me can say we’ll muddle through, but we must remember that not everyone will muddle at the same pace.

We will also take a look today at a growing new phenomenon: the gig economy. (I should note that today’s letter is a little shorter. I am trying to reduce the word length of Thoughts from the Frontline.)

Employers Want Gray Hair

We talked last week about employers’ reluctance to hire older workers. Reader Steve Lange from Denver pointed me to a ZeroHedge article that questions this premise.

If you look at the BLS age breakdown for new jobs (Table A-9), you’ll see that workers aged 55 and over accounted for virtually all of October’s strong gains. That group added 378,000 jobs last month.

Meanwhile, the number of workers aged 25-54 actually declined by 35,000. That’s supposed to be “prime working age,” so any decline should ring alarm bells. And the numbers are more alarming if you are male: men aged 25-54 lost 119,000 jobs in October.

This pattern isn’t new, either. I’ve written about this ongoing anomaly in previous letters. Since December 2007, workers aged 55 and older have gained over 7.5 million jobs, while those under 55 have lost a cumulative 4.6 million jobs. Older workers are simply taking employment market share from younger workers.

What would cause this trend? Partly it’s demographic. The population is aging as the Baby Boomer bulge grows older and Millennials postpone parenthood. Nevertheless, it does look as though Baby Boomers are not exiting the labor force as fast as we thought. Continue reading