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Posts Tagged ‘Mauldin’

Capitalism Without Competition

Posted by hkarner - 12. Februar 2019

By John Mauldin

February 8, 2019

Monopoly Rents
Not Free to Choose
Data Oligopoly

The Soviet Union’s collapse and spread of semi-free markets through Eastern Europe seemingly ended the socialism vs. capitalism argument. Capitalism had won. Collectivist economies everywhere began turning free. Even communist China adopted a form of free market capitalism although, as they say, with “Chinese characteristics.”

The fruits of capitalism: millions of people freed from abject poverty and a few who got rich indeed. Nor is this a recent phenomenon. Capitalism in the last three centuries, with all its faults and problems, with all its contradictions, generated the greatest accumulation of wealth in human history. From a few hundred years ago when the vast majority of the people of the world lived below the poverty line, barely above subsistence levels, today we have less than 10% doing so and that number is shrinking every year.

Yet now, perhaps because this prosperity is so easily taken for granted, some on the left are again embracing socialist ideas and irrationally high tax rates. What drives this thinking? One problem is “capitalism,” in practice, does indeed provide many points for justifiable criticism. It is, to paraphrase Winston Churchill, the worst of all systems, except for everything else. Den Rest des Beitrags lesen »

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How Should We Then Invest?

Posted by hkarner - 27. Januar 2019

January 25, 2019

To be absolutely certain about something, one must know everything or nothing about it.“

—Henry Kissinger, former US Secretary of State

This month I’ve discussed some possible pathways for 2019. But beyond that, for the past year or so, I have been talking about what I think may unfold over the next decade. The term I often use is The Great Reset, but in my mind it’s more than just resetting global debt.

I think a number of equally important trends, all extraordinarily eventful, some amazingly positive and some frustratingly negative, when taken all together (which we’ll have to, like it or not) will produce an era unlike anything previously seen in human history. I call it the Age of Transformation. Den Rest des Beitrags lesen »

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Bull in the China Shop

Posted by hkarner - 20. Januar 2019

By John Mauldin

January 18, 2019

Demand Pulled Forward
Job Jitters
Credit Intensity
Rushing the Process

The production of souls is more important than the production of tanks…. And therefore I raise my glass to you, writers, the engineers of the human soul.

Joseph Stalin, 1932

[Our purpose is] to ensure that literature and art fit well into the whole revolutionary machine as a component part, that they operate as powerful weapons for uniting and educating the people and for attacking and destroying the enemy, and that they help the people fight the enemy with one heart and one mind.

Mao Zedong, 1942

Art and literature is the engineering that molds the human soul; art and literary workers are the engineers of the human soul.

Xi Jinping, 2014

This week’s letter focuses on China’s economy. We’ll look at some numbers showing the challenges China faces, but they don’t explain something important. The way China will meet those challenges is going to be substantially different than we would see in the West. So I want to start with a little context.

When European Central Bank President Mario Draghi promised to solve the financial crisis with “whatever it takes,” central bank policy was his only tool. Xi Jinping has a vastly larger toolbox. It is hard for us in the Western world to understand that. Xi not only has every tool a top-down government can have, he has experts to wield them, all of whom are 100% aligned with his goals. Den Rest des Beitrags lesen »

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The Misunderstood Flattening Yield Curve

Posted by hkarner - 17. Dezember 2018

By John Mauldin

December 14, 2018

What we see now is really more of a flattened yield curve, with a smaller but still positive spread between short-term and long-term interest rates. That’s not normal, but it’s also not a recession guarantee. However, when we combine this with assorted other events, it adds to the concerns.

I’ve been writing in this letter about negative yield curve since 2000, when the inverted yield curve said there was a recession in our future and I called a bear market in equities. Ditto for 2006, though that time the yield curve inverted long before the stock market turned. Today, we’ll look at what the yield curve is really telling us.

Now let’s dive into the Great Flattening Yield Curve and what it really means.

Breathless Reporting

In July 2017 I wrote a letter called Happiness Is a Normal Yield Curve and now it seems like about 10 years ago. The Fed was still in tightening mode at that point and short-term rates were rising faster than long-term rates, producing a flatter but not inverted yield curve.

(Quick explanation for the uninitiated: The yield curve is simply a graph showing current interest rates for various maturity periods, with rates on the vertical axis and time on the horizontal. Normally it slopes upward from left to right. All the discussion and drama are about the angle of that line.)

Here is the latest view, via GuruFocus.

The light gray line is the yield curve two years ago, the medium gray is one year ago, and the blue is now. You can see the curve went from very steep to much less so in this period. That is what we mean by “flattening.” It isn’t fully flat yet, but is moving in that direction.

Notice also in the blue line, the area between 3Y and 5Y actually angles slightly downward. That is the “inversion” the media is reporting so breathlessly. It is really more of a bump, if that. As I write, the 3Y is actually 2.84% and the 5Y is 2.83%. So the mainstream media, business media, and writers are getting all breathless about 0.01% on just one part of the curve. Which is kind of, sort of important to watch but it doesn’t really mean anything in terms of the economy, at least yet.

That said, it is still remarkable that 1-year Treasury and 5-year Treasury securities, and everything in between, all have almost exactly the same yields. You don’t see any such plateau in the 2016 or 2017 curves.

For the record, here’s a chart of interest rates for the last two weeks directly from the US Treasury. What you can notice is the fact that short-term rates are rising and long-term rates are falling. This is what you would see ahead of a full inversion but the process can go on for a long time.


Source: US Treasury

Yields are supposed to reflect risk, and risk grows with time. The chance something bad will happen in the next five years is higher than the chance something equally bad will happen in the next year. Lenders, i.e. bond investors, should demand a higher yield as compensation for that higher risk. Presently they aren’t.

I show all this to clarify a point the media is obscuring: The full yield curve is not inverted. Only a small part of it is inverted, which is unusual but no reason to panic. It is nowhere near the kind of inversion that might signal recession. And even if it were, it wouldn’t mean recession is right around the corner.

An Inverted Yield Curve Is Just a Fever

I’ve been using an analogy in my speeches recently that has received excellent feedback, so I want to share it with you. Many media sources and writers seem to indicate that an inverted yield curve causes recession. That is simply not true.

Think of an inverted yield curve as a fever. When your body gets a fever, the fever is not the cause of the sickness. It just says something’s wrong with your body. You have the flu, appendicitis, or some other ailment. The fever indicates you are sick but not necessarily what the sickness is. And typically, the higher the fever the more serious the condition.

It is the same with the yield curve. The more inverted the yield curve is and the longer it stays that way, the more confident we are that something is economically wrong that may show up as a recession sometime in the future. More on that timing below.

Early Predictor

In a true inversion we would see the entire curve angled down from left to right. That last happened in 2005. Were we in recession then? No, not at all. The economy was booming. In fact, the yield curve stayed inverted until mid-2007. Some of us saw cracks forming in the economy, and said so at the time. But the actual recession would not begin until December 2007.

That’s a longstanding pattern. The inverted yield curve has been a pretty reliable recession indicator but it shows up far in advance—months or even more than a year. We might better think of it as signaling the cycle’s “blowout” stage. People see the inversion, observe nothing bad happening, then throw caution to the wind.

Another way to illustrate this is with a yield spread, i.e., a long-term yield minus a short-term yield. You can graph the difference and it goes below zero when the short-term yield is higher, meaning an inversion exists between those two points on the yield curve. This chart shows the spread between 10-year and one-year Treasury yields.


Source: GuruFocus

The gray vertical bars are recessions. You can see how the spread dropped below the 0% line right before each one, and is now close to that point again. But notice also how long it stayed inverted before the last recession, and how far in advance. The 10Y-1Y spread dropped below zero in January 2006, came back above for a little bit, stayed there and was moving higher when the recession finally began. The same happened in 2000. In fact, by the time actual recession arrives the yield curve can resume a normal pattern.

Here’s a slightly different chart from FRED (the St. Louis Federal Reserve all things economic database), using the 10Y-2Y yields. This is the “tens and twos” spread traders usually watch.


Source: FRED

We again see the same pattern. You can vary the parameters but the broad principle holds pretty well. Yield curve inversions precede recessions by anywhere from a few months up to two years.

Recession Probability

This awareness that an inverted yield curve signals recession isn’t new, nor did it appear from thin air. My first economic mentor, Dr. Gary North, was teaching me about inverted yield curves in the early 1980s. To my knowledge, there was no real research, just anecdotal observational analysis, but it still held. Then my friend and economist Campbell Harvey, now at Duke University, first proved its forecasting accuracy in his 1986 University of Chicago doctoral dissertation. Others quickly confirmed and expanded on his conclusions.

In 1996, New York Fed economists Arturo Estrella and Frederic S. Mishkin authored a paper comparing the yield curve to 19 other indicators and, importantly, finding a connection between the yield spread and recession probability.

To summarize, Estrella and Mishkin found the yield curve is most predictive of recession a year or so ahead of time. In fact, they concluded an inverted yield curve was the only useful predictor of recessions. Examining all the data from 1960-1995, they calculated the probability a recession would occur four quarters ahead, based on the spread between three-month and 10-year Treasury securities. They summarized it in this table.


Source: New York Federal Reserve Bank

Again, the yield curve is inverted when the spread is negative. Estrella and Mishkin found recession probability begins rising as the spread drops toward and then below zero. But notice how long it takes. Even when the curve mildly inverts with the spread at -0.17%, the odds of a recession in the next year are still only 30%.

But from a practical standpoint, by the time their model shows a 30 or 40% probability of recession, there has always been a recession following that point.

Your next question, of course, is where are we now. The 3M/10Y spread is about 0.48%. The table suggests this is consistent with about a 15% recession probability four quarters from now. Not so bad, if you are a bull. It means odds are good we’ll get through 2019 without recession. Maybe longer, if the Fed pauses tightening next year and long-term yields stay where they are.

We are not out of the woods, though. We may just be entering them. Here is the 3M/10Y spread, the one Estrella and Mishkin used in their study, since the last recession ended.


Source: FRED

The spread peaked almost coincident with the last recession’s end (the gray area at left) and has been dropping ever since. The ride down was smoother since mid-2017. Another two years like the last two will put the spread around -1.0%, meaning a recession is likely in 2020. The decline could also steepen and bring recession sooner.

After they wrote this paper, Mishkin went on to be a Fed Governor from 2006-2008 and is now at Columbia University. Estrella is still at the New York Fed and has been keeping these numbers updated. Here’s his latest chart showing recession probability.


Source: New York Fed

As you see in the lower right of the chart, recession probability has been rising and is now around 15%, consistent with their earlier work. It is not rising as quickly as it did ahead of the last recession.

A little history: In September 2000 the yield curve was seriously inverting. I called Estrella to talk about the importance of the curve. I wrote then:

First, he told me he had done another study in 1998 comparing even more predictors. The latest study involved 30 potential predictors of a recession. The conclusion of that study was that the 90-day average of the yield curve was still the most reliable predictor of the 30 they studied, so score one for taking this current situation more seriously.

But he would not go so far as to say that he personally saw a recession coming. I would like to consign that reluctance to the fact that he was still at the Fed.

In 2006, I called another Fed researcher and asked about recession probability. Again, there was great reluctance to actually predict a recession. This Federal Reserve economist actually went so far as to say (I swear, the person really said this): “There are reasons to believe it may be different this time.”

Later in 2006, I was on my friend Larry Kudlow’s CNBC show with Nouriel Roubini and John Rutledge. Larry and John were both adamant the bull market was in no way over and no recession was on the horizon. Nouriel and I saw it different. Oddly, we were all correct.

How can that be, you ask? A bear market began about six months after the show and recession six months later. But the stock market rose almost 20% after that show as well, so if you had exited the stock market, you would’ve missed a 20% rise (but still avoided a 50% bear market).

Sidebar: That has now happened to me twice. I’ve called recessions early and missed some opportunities. That is one of the reasons that I now use money managers with quantitative timing models. At the beginning of 2017, the four managers I use were heavily invested in equities. This year they have slowly moved into cash and are now as a group holding a significant portion (over 70%) of cash and cash equivalents. But then again, their models could become bullish. I have come to the point that I simply trust their models. For me, it feels a lot better than trying to make a prediction based upon my own analysis.

I haven’t found a way to predict the future accurately, and certainly not with anything close to precision timing. And so while I can watch the yield curve and begin to get an idea of when there might be a recession in our future, applying that in a portfolio is difficult at best.

A Little Time

So pulling all this together, the flattening yield curve is a fair bit away from signaling a recession in the next year. That could change but it’s where we are now. But it is certainly something to watch.

On the other hand, history never repeats itself quite so perfectly. Other things are different—all the European Threats I described last week, or the prospect of wider trade war as President Trump tries to make China change its ways.

I would not conclude from the yield curve that recession is either imminent or impossible. It says what I already knew: A recession will strike at some point, but we probably have a little time. I suggest using that time to prepare. As I’ve been saying for the last few months, you should prepare to exit positions that may become illiquid, think of ways to hedge, and generally get ready for a volatile 2019. Think of cash as an option on the future.

The high-yield bond market is also illustrative. Here is a chart from a webinar I just did with Steve Blumenthal.


Source: CMG Capital Management (Click to enlarge chart)

Steve has been timing high-yield bond markets since 1992. I was actually timing high-yield bond markets for clients in the early 2000s when Steve and I met and I realized his system was better than mine. He’s had three incredible runs since then in which he exited high-yield bonds and then his quantitative system said to get back in. He will tell you that he was extremely nervous every time but he did what the model told him to do.

Extraordinary gains followed because as rates fell the bonds delivered both high yields and capital gains. Steve feels a similar opportunity is coming. But you’ll need some cash to participate when that time arrives.

I think we’ll see a host of opportunities at the bottom of the next recession. Seizing them will take an iron stomach, but it’s at the bottom of the markets, when everybody else is panicking, that you find real life-changing opportunities. While cash may seem unattractive today, it is really an option on future opportunities

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European Threats

Posted by hkarner - 10. Dezember 2018

December 7, 2018

Someone asked recently how many times I had “crossed the pond” to Europe. I really don’t know. Certainly dozens of times. It’s been several times a year for as long as I remember.

That makes me an extremely unusual American. Most of us never visit Europe, except maybe for a rare dream vacation. And that’s okay because our own country is wonderful and has a lifetime of sights to see. But it does affect our perspective on the world. Many of us don’t fully grasp how important Europe is to the US and global economy.

We may soon get a lesson on that. I’ve talked about Italy’s ongoing debt crisis, which is not improving, but Europe has other problems, too. Worse, events are coalescing such that several potential crises—all major on their own—could strike at the same time, and not too long from now. As I’ve been saying for about three years, there is no reason for the US to have a recession on its own. I think events elsewhere will push us into it, and Europe is a really big current risk. I know from my visits to Europe and discussions with friends there, they see all sorts of problems with Trump and particularly his tariffs.

However, another concern is that the various actors in Europe are not playing nice with each other. I tell my European friends the same forces that yielded Trump are coming to a European country near them. In some places, they already have. Den Rest des Beitrags lesen »

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Posted by hkarner - 3. Dezember 2018

Pyramids of Crisis

November 30, 2018

In fact, we have been doing something about it for many thousands of years. An inverted pyramid of geniuses and giants, modern medicine, nutrition, sanitation, and assorted other innovations has extended our lifespans and helped more of us live to ripe old ages. That’s wonderful… but it’s also a problem many of us still don’t fully understand.

I have mixed feelings myself. At 69, I truly believe I’ll live well past 100 and stay as healthy and independent as I am now. But sometimes I wonder. For instance, in the past few weeks I had a growing adverse reaction to a new (to me) medicine. It made me tired and slowly lowered my blood pressure to a dangerous level. I didn’t recognize it and just thought the years and miles were finally beginning to take their toll. Finally, in consultation with my doctor, we figured out what was going wrong, changed course and the major symptoms improved quickly. But for about a month, I felt much older, almost invalid at times. It was kind of like the Hemingway line, “How do you go bankrupt?” The answer: “Slowly, and then all at once.” Den Rest des Beitrags lesen »

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Double Debt Problem

Posted by hkarner - 24. November 2018

November 23, 2018

The selloff in GE is not an isolated event. More investment grade credits to follow. The slide and collapse in investment grade debt has begun… (and later) Don’t be fooled by bond prices holding up, because trading volumes are down. There are fewer bids in the market, and the dispersion of bids is wider. It is time to jog—not walk—to the exits of credit and liquidity risk.

– Scott Minerd, Guggenheim Partners Chief Investment Officer

From a 50,000-feet viewpoint, we’re probably in a global debt bubble…Global debt to GDP is at an all-time high…This is going to be a very challenging time for policymakers moving forward.

– Paul Tudor Jones at the Greenwich Economic Forum in Connecticut, November 15, 2018

Last week, I talked about Ray Dalio’s new book on debt cycles. He describes how debt is inherently cyclical, because it enables more spending now that must be offset by less spending later.

Ray’s book helped me refine my description of The Great Reset. It’s a critical refinement, too. After reading the book I realized it is entirely possible we will have another debt crisis before what I think of as The Great Reset.,  I firmly believe the latter is still coming, but there may be another “mere” credit crisis beforehand. Den Rest des Beitrags lesen »

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Seventh-Inning Debt Stretch

Posted by hkarner - 19. November 2018

November 16, 2018

Within the closed system called Earth, we are much better at creating debt than eliminating it. But when we have too much, we eventually eliminate it in painful and unpleasant ways via some kind of debt crisis. This has happened over and over again throughout history.

Today we’ll look at a new book by Ray Dalio called Principles for Navigating Big Debt Crises in which he examines those debt cycles and what we can do about them. I read it on my recent trip to Frankfurt and I highly recommend you do the same. That link is for Amazon but you can also get a free PDF copy here. I read it on my Kindle so I could highlight and save notes in the cloud for later reference. Worth every penny of the $14.99 I spent.

At a minimum, you should read the first 60 pages, which explain his principles and thoughts. The rest of the book dives deep in the weeds of 48 modern debt crises, sorting them into different types and then analyzing each type. Data wonks will love that part. Ray gives us a brilliant tour de force examination of how debt crises arise and what you can do when one strikes.

At first blush, you will think that Ray is more optimistic than I am about the next debt crisis and an eventual event which I called The Great Reset, which I’ve written about extensively this year. I see The Great Reset as a generation-scarring economic cataclysm. Debt crises, while painful, have a fundamentally different character.

Ray’s book has helped me refine what I mean by The Great Reset. We’ll explore this more in future letters but here is one very important, critical, point:

 It is possible we will have another debt crisis separate from The Great Reset I envision. Indeed, it may be quite likely. Den Rest des Beitrags lesen »

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Economic Brake Lights

Posted by hkarner - 3. November 2018

By John Mauldin

November 2, 2018

Zombies and Unicorns
Missing Investment
The Deficit and Debt Drag on the Economy
Swimming in Liquidity

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

Warren Buffett (b. 1930), 1987 Berkshire Hathaway Annual Report

Those who do not learn from history are doomed to repeat its mistakes.

—George Santayana (1863–1952), Spanish-American philosopher

Those who don’t study history are doomed to repeat it. Yet those who do study history are doomed to stand by helplessly while everyone else repeats it.

—Tom Toro (b. 1982), American cartoonist for The New Yorker Den Rest des Beitrags lesen »

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Debt Alarm Ringing

Posted by hkarner - 27. Oktober 2018

October 26, 2018

Debt is future spending pulled forward in time. It lets you buy something now for which you otherwise don’t have cash available yet. Whether it’s wise or not depends on what you buy. Debt to educate yourself so you can get a better job may be a good idea. Borrowing money to finance your vacation? Probably not.

Unfortunately, many people, businesses, and governments borrow because they can, which for many is possible only because central banks made it so cheap in the last decade. It was rational in that respect but is growing less so as the central banks tighten their policies.

Earlier this year, I wrote a series of articles (synopsis and links here) predicting a debt “train wreck” and eventual liquidation—an event I dubbed The Great Reset. I estimated we have another year or two before the crisis becomes evident.

That’s still my expectation… but I’m beginning to wonder again. Several recent events tell me the reckoning could be closer than I thought just a few months ago. Today, we’ll review those and end with a few suggestions on how to prepare.

Addicted to Debt

As noted, debt can be appropriate—even government debt, in some (rare) circumstances. I am glad FDR issued war bonds to help defeat the Nazis, for instance. Now, however, governments go into debt not because they face existential threats, but simply to keep their citizens and benefactors comfortable.

Similarly, central banks enable debt because they think it will generate economic growth. Sometimes it does, too. The problem is they create debt with little regard for how it will be used. That’s how we get artificial booms and subsequent busts.

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