Welcome back to What’s Happening Now, featured each Monday by Critical Signals Report, your weekly guide to what’s going on right now and why it matters to you… and your money.

Last week (the worst week thus far this year’s market) was stressful for investors, to say the least, as the FED announced its first rate cut in over a decade on the same day the White House reignited its trade war with China.

The markets appeared to like neither…

Meanwhile, U.S. GDP slipped from 3.1% in Q1 to 2.1% for Q2 as markets forecast declining growth for Q4, a Q3 of declining CAPEX and, alas, declining (potentially negative) earnings as well, the first such decline since 2013.

In other words, prepare yourselves for a volatile autumn. As earnings fall, so do markets.

True, the GDP print was above the pathetic Q2 estimate of 1.8%, amply cheered by the mainstream pom-pom squad. But not so by us.

Here at Critical Signals Report, we’re focused on the math not the pom-poms, and the numbers tell us GDP fell 35% from Q1 to Q2 of this year. Ouch.

Combine that fact with the slowest global growth data in three years and there’s reasons to be concerned.

And the Fed is obviously concerned. To soften a further slide, they offered up a much-expected 25 basis point interest rate cut. But here’s the rub… nobody saluted, nobody cheered, and that left investors puzzled.

Let’s discuss.

Puzzling Times

These are indeed puzzling times. So, let us unravel the puzzle for you. Merriam-Webster defines puzzles generally, and “to puzzle” specifically, as an attempt to solve by guesswork or experiment.

And that’s where we are, folks – a central bank guessing and experimenting with your financial fates.

Our U.S. Federal Reserve has embarked upon the biggest experiment in modern times, having reduced interest rates to the floor of history for a decade following the Great Recession – a collapse, ironically of its own making.

The ironies do abound, do they not?

Last week offered up evidence that this desperate guesswork, this massive cheap-debt/low-rate experiment (followed by a herd of other central banks), is beginning to unwind – putting the global economy at increased risk and priming the markets for an inevitable drawdown.

The only tool left by the Fed to make the inevitable less imminent is further rate reductions.

Will it work?

Well, the Fed tried such an experiment in January of 2001 (a 50 bps cut); three months later the U.S. went into recession. Not to be deterred, an equally desperate Fed tried another rate reduction in September of 2007 (a 25 bps cut), and three months later we were once again in a recession.

History does rhyme.

We think this time will be no different; in fact, it could be worse, for unlike 2001 and 2007, when the Fed had higher rates (five percentage points or more) from which it could cut, the current Fed has only two percentage points to play with until it hits zero.

In other words, when the next recession arrives, our puzzled Ph.Ds. at the Eccles Building will be out of cards to play or puzzles to confuse.

Pesky Facts and That Pesky Yield Curve

The idea (experiment) last week at the Fed was to pull short rates down to fix (steepen) our inverting yield curve. But guess what? That didn’t go as planned.

Instead, the curve on yields inverted even more, and as we’ve warned elsewhere, such yield curves are painfully accurate precursors to a recession.

Furthermore, and as recently revealed in our July 29 Report, recessions weaken earnings, and weakened earnings kill inflated market bubbles, of which our current bubble is the largest ever known:

Folks: Recessions matter. I’ve consistently maintained that a tanking market won’t cause the next recession, but rather that a recession will cause the next tanking market. I said as much here in April.

Why?

Simple: In rigged to fail markets, the Fed can play with myths (aka: unravelling lies) about surging GDP, earnings growth, low unemployment (which are, in fact, a lagging indicators), and contained inflation, but it can’t forever gloss over a Main Street already on its knees.

And as the real economy falters, nor can the Fed pretend away a market that, despite Fed-speak, is by no means in “mid-cycle” but rather, at 121 months and counting, is in the longest business expansion in our history, and thus is nearing its end rather than “mid-point.”

All of this Fed distortion (dishonesty) merely confirms that the rigged Fed experiment is coming toward its final chapter, one that can only be extended by more desperate (and increasingly less effective) rate cuts and inevitable money printing to come.

Opinions are open to interpretations; facts are not. And as to our U.S. Treasury yield curve, here’s what it looks like now:

That tiny green arrow points to last week’s “good news,” a 25 basis point reduction in short-term interest rates. The much larger red arrow points to the not-so-good news – a very inverted yield curve out five years.

What’s more, lower interest rates were supposed to boost the equity markets. Nope. That didn’t happen either. The S&P Index tumbled 2.69% from Wednesday to Friday (last three red bars on the chart below).

Rates and Trade Wars – A Dangerous Balancing Act

In fact, last week was the worst week in the U.S. stock market for the entire year, as good news turned bad when, in almost the same breath, the White House escalated the trade war with China, threatening to boost tariffs on another $300 billion of Chinese imports come September 1.

Delicate Balance

Going forward, tariffs and interest rates are increasingly linked in a delicate balance that will affect markets and your money.

We’ve shown here and here that no one really wins a tariff war, though the instability it will unleash will more than likely ensure more “accommodative” rate cuts (and higher debt levels) to come.

This combination of 1) a trade war and 2) a world of central bank rate cutting is becoming global and increasingly dangerous.

We know that global interest rates are tumbling in unison as global growth declines, so let’s think of interest rates as one bucket and tariffs as another.

As to the tariff bucket, a trade war is not just about the U.S. vs. China anymore. It’s a weapon that is catching on. Japan and South Korea stepped up their fight over trade last week, threatening more damage to global trade flows.

A hard U.K. Brexit will negatively impact trade as well. And even if we “beat the Chinese,” keep in mind that China is responsible for 40% of global GDP. If it sneezes – we all get sick.

So, think of each bucket as a counterweight to the other. As the global tariff bucket goes up, trade and growth fall, and hence central banks will take the interest rate bucket down as well – pictured below.

As tariffs mount, rates and thus bond yields will tumble to artificially keep stock and bond markets afloat. That’s the hope, and hope can work for a while, but not without volatility, and not without ending badly, as we’ll see below.

For now, however, the Fed’s experimental idea (and myth) is that lower interest rates, no matter how negative, will bail us out.

Last week, while visiting Berlin, I watched Germany’s entire yield curve fall below zero for the first time, making it the largest economy to have the whole of its debt market yielding less than zero.

This, as they say, is Verruckt. Germany’s bond market is supposed to be one of the world’s safest for its liquidity and quality. No longer (nicht langer)…

And as recently mentioned in Critical Signals Report, the total value of bond debt yielding less than 0% grew last week past $13 trillion to $14 trillion! Such a desperate trend/symptom, as we say in English, is fricking crazy.

If this trend continues, and if tariffs keep rising and interest rates keep falling as an offset, that delicate balance between our two buckets could be turned completely upside down and spill all over your portfolio.

That is, the precarious balance can suddenly shift in any number of ways – none of which are good for investors.

For example, if the trade wars cool down, rates would begin to climb. This, well, would end badly.

After all, when rates rise against a backdrop of $250 trillion in global debt, it’s game over.

But what if the trade war doesn’t cool? After all, China, unlike the U.S., is not under election pressures to reach a convenient cessation by November 2020.

In such a scenario, central banks will desperately seek to keep rates stapled to the floor, but sadly, even such emergency measures can’t prevent the converging forces of weakening GDP and broadly forecasted declines in earnings (about to go negative) and stalling economic growth into Q3 and Q4.

In other words, get ready for rougher weather in the later part of 2019.

Storm Tracker

In the meantime, we’ll be telling you what to do and when to do it. As we enter August, Storm Tracker has notched up slightly but remains at gale force winds in the mid-40s.

That means you should have 40-50% of your portfolio in cash. Markets are changing, and as they do, we’ll be changing portfolio allocations accordingly.

Recently, allocations have shifted from risk-on to risk-off, with long fixed income, long precious metals, and short equities now generally favored.

The Ultimate Sell Signal

We mentioned in last Monday’s What’s Happening Now that when markets go down meaningfully on good news, that’s an ultimate sell signal. That’s just what happened, and last week we saw precisely what we expected.

Sure, the dip buying and market spikes will continue, but the longer-term risks now far outweigh the short-term rewards of being “all-in.”

As to last Monday’s trade recommendation, namely shorting the S&P 500 by buying ETFs that short the major indexes, here’s what happened by the week’s end.

ProShares Short S&P 500 (1x) ETF (SH) was up 2.77%. ProShares UltraShort S&P 500 (2x) ETF (SDS) was up 5.63%, and ProShares UltraPro Short S&P 500 (3x) (SPXU) was up 8.51%all in three days.

If you’re a short-term or day trader, you will likely want to take some profits here. If you are in this trade for the long haul, stay tuned but watch your stop-losses.

Next week’s data docket should provide new clues, along with more Fed speak in the form of tedious commentary from voting members of the FOMC.

Governor Lael Brainard will be speaking on Monday, followed by St. Louis chief James Bullard on Tuesday and Chicago’s Charles Evans on Wednesday.

We’ll be here to help translate their boring nonsense into actionable reality.

Q&A: Your Questions Answered

Meanwhile, your questions keep pouring in and we will address as many as we can here.

Mary St. J. asked if returning to the gold standard could solve any of the problems facing the world and the USA. She also wanted clarification as to when we say 45% in cash, what is this 45% of – one’s total net worth, or just the money actually allocated to the markets?

As to the first question, a return to the gold standard would be an obvious solution in theory, as gold-backing acts as a chaperone on government debts, currency controls and spending.

That is, every unit of currency has to be backed by gold, and hence excessive money printing would be checked unless countries had the gold to back each dollar, yuan, etc.

Unfortunately, when a country needs more money to pay its debt (like Nixon in 1971, or just about every time there’s a war or debt ceiling to pay for), there isn’t enough gold to match the desired money.

Hence, governments, like frat boys, simply ignore/do away with the gold-backed chaperone and seduce themselves with fiat currencies backed by nothing but “faith.”

Perhaps some kind of gold standard return is possible (China is experimenting with some modification of this), but it will likely first require a massive financial catastrophe and global reset to return to such a system, which would likely involve a global reserve currency basket backed by some gold ratio to be determined.

For now, however, I wouldn’t hold your breath. It takes a lot for countries to not only do the right thing, but stick with it…

As for cash percentages, yes, we are referring to the percentage of what one has invested in the securities markets, not one’s over-all wealth.

Neil asked about using precious metals as a protection in a downturn of rigged markets. Well, Neil, we totally agree and have given extensive explanations/arguments for doing precisely that here, here, and many other places elsewhere. Recently, we also made a special case for silver.

Mark F. commented that during the 2008-2009 crash, the FED was lowering rates the entire time, so why do we think this will be different (which we don’t)? Mark correctly foresaw the FED rate cut, and now expects the markets will start to crumble, perhaps within one to four months.

He further noted that many money managers think that lowering rates will give a buffer to a crash and actually create a melt-up. That melt-up, he suggested, if it comes to fruition will, likely only be for three to five days, then reverse. He asked our thoughts on this.

Well, Mark, we agree that the Fed will continue to lower rates, and that this will not prevent a recession, just as it had not prevented a recession in 2001 or 2007, as noted above.

As to your point about a one to four month delay period between the rate cuts and a recession, again, recent history (as well as current fundamentals) confirms your observation.

As to the consensus view held by most money managers that lower rates will be both a crash-buffer and a cause for melt-up, we are not of the consensus view.

Desperate rate cuts typically don’t buy much time, as they come when things are already going so badly that it’s like a finger in a breaking dyke.

Nor do we think rate cuts alone will be the cause of a melt-up. That said, a melt-up is still possible for other reasons, which we’ve explained at length here.

The primary catalyst for a melt-up in the near-term is the ironic but real scenario that U.S. markets, however deformed, are still relatively better than negative-yielding Asian and European markets, and thus the U.S. may enjoy temporary status as a “safe haven” – i.e. the best horse in the glue factory.

In some ways, we’ve seen much of this melt-up already transpire in the early half of 2019, when the Fed signaled a rate pause.

As to how much more upwards “melting” we can expect and for how long, this is not easy to predict with anything more than tarot card precision, as markets can rise on faith and stupidity (as well as Fed myth peddling) far longer than rationality.

Markets can also tank abruptly on either fear or a black swan event.

Given such difficulties with predicting, we rely instead on risk management and common sense, using our Storm Tracker to inform us with objective facts and quantifiable indicators rather than media drivel.

The markets will tell us largely what to do, and as of now, they are telling us that risk far outweighs reward – hence our cash and other allocations are defensive and ready to go on the offensive only when markets eventually re-price (i.e. tank) and we can make a generational killing buying at bottoms, not tops – where all the real wealth is made.

Richard C. asked how can one’s cash be safe in a broker’s or bank account? Should one trust gold or U.S. Treasuries. Is anything, he asks, even safe?

Well, bank accounts are federally insured up to certain limits, but if you’re talking large sums of money, there is greater risk. Gold, of course, can be held personally or in market securities like PHYS or GLD, and thus relatively safely.

As for U.S. Treasuries, we see very little risk of default, as the government can simply print and borrow to meet its debt obligations – the only risk in Treasuries is inflation and rates, which can push pricing down.

Darwin T., referring to our recent Rigged to Fail report in which I mentioned 54 recorded examples of countries having a debt crisis, of which none were resolved by issuing more debt, asked that I give some of the most recent examples, in the last 20 or 30 years.

Greece (2015) and Japan (1989), of course, are obvious choices, but there are so many to select from… Mexico (1982); Thailand (1997); Russia (1998); Ireland and Iceland (2007); Ukraine (2016); too many other countries in Africa and Latin America to list, but just consider South Africa (1993), Argentina (2001), Brazil (1990), Venezuela (2017); Turkey, Portugal, Spain, and Italy (presently)…

Frankly, I would add the U.S. and the entire European Union to the list, but their debt “experiment” has yet to officially hit the historical skids. But as von Mises warned: Be patient – every debt crisis resolved by more debt ends worse than it began – once the party ends.

Ron remarked that neither he nor I are going to move the markets with our volume of personal money, but that the huge multi-billion-dollar institutions can move markets.

His question is: Which one do we believe is going to start pushing the sell button and have the others following them real quickly – and thus sending markets down 300, 400, or more points in an extremely short period of time?

Yes, Ron, the big sell-offs will start when the big players (sovereign wealth funds, de-stressed pension funds, endowments, insurance companies, banks, hedge funds, etc.) begin to panic/sell in synch.

In December, we saw a taste of this, as markets swung by even 1,000 points in less than two consecutive trading days as foreign institutional investors (FIIs) sold off big-time at the first hints of a crisis.

It’s hard to say which specific fund or institution will be the first domino, and in fact, many of the big players (Google, Apple…) are already de-risking and heavy in cash, as are many large institutional investors and funds like Blackrock and Guggenheim Partners – they smell trouble ahead.

Many big banks now have wealthy clients at 25% or more in cash.

Tony W., with two years left to retire, asked if it would it be safe to put 70% of deferred comp into bonds and 30% into moderate investments?

Tony, legally and ethically, we cannot provide you with specific, personalized financial advice, and must caveat any response here by recommending you discuss our opinions with your own advisor.

Broadly speaking, however, we have written extensively about the risks of traditional investing in bonds, which are comprised predominantly of high-risk debtors, and thus not your grandfather’s bond market anymore.

A 70% allocation to fixed income could therefore be riskier than you think, especially if the allocation is to corporate, rather than short-term government bonds.

Guy J. commented that if the majority of stocks are clearly expected to fall, would it not be wise to sell all of one’s investments presently, and reinvest after the expected crash has occurred?

This is entirely a matter of individual risk profiles/tolerances, personal wealth, and individual discipline/patience. I’ve written at length about this very issue here.

A full allocation to cash now, of course, will mean risking the loss of potential upside in the near-term, as well as the more aggressive option (for some) of trading a meltdown via strategic shorts (including such currencies as in Australia, the U.K.), inverse ETFs, put options, etc.

That said, if you are in a position to forego such upside and risk, and want to simply leave the markets entirely, we don’t consider that a foolish instinct, if you are willing to wait for a crisis and market bottom – which can be delayed for quite some time depending on more “stimulus” from the media, central banks, and the sell-side.

In short, Guy, leaving the poker table entirely is a solid option today if it mirror’s your own informed risk profile.

Kurt J. asked about holding an institutional bond mutual fund like PTTRX. He reasoned that when the debt meltdown occurs, won’t the companies in the fund that survive (assuming the majority are in the best-rated companies) need to pay higher rates for rolling over their debt providing higher dividends to the holders of the shares?

Kurt, a peak beneath the ticker PTTRX (the Pimco Total Return Fund) unveils a $66 billion institutional fund with assets concentrated in investment-grade fixed-income instruments of varying maturities, mostly allocated 60% to mortgages and 29% to corporate issuances.

The Fund was flat in 2018 (63rd percentile amongst its peers) and is up 7.03% (37th percentile) 2019 YTD, benefiting from a flight to quality, although that’s a bit of a percentile drop YOY. We’d focus on the individual holdings more than rates. You mentioned “the companies in the Fund that survive” and that is where the risk is – heightened leverage among the underlying holdings in a debt-soaked, borrow-to-buyback-shares world.

Janiece P. wrote that she recently bought iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), iShares 20+ Year Treasury Bond ETF (TLT), iShares MBS ETF (Symbol MBB), iShares Intermediate-Term Corporate Bond ETF (IGIB), iShares JP MORGAN USD Emerging Markets Bond ETF (EMB). She asked if these bonds were the right investment with the Fed just announcing an interest rate cut.

Janiece, thanks for sharing these fixed-income ETF selections. The plot below shows an equal-weight allocation to these five ETFs, back to the Great Recession. To your question, with the Fed announcing a rate cut for the obvious reasons, namely a contracting global economy, the likelihood of a recession ahead is mounting.

These were the right investments heading into the Great Recession, from 2008 to as far out as 2013 (the green zone) compared the SP500 Index, the caveat being that when interest rates ultimately turn up, we could see fixed income, as well as stocks, potentially declining together, which would put both asset classes in jeopardy.

So yes, you’ve shared a protective solution for now, with correlations among the picks about as low as would be expected in the fixed income space, where correlations are uniformly pegged to the same benchmark – interest rates.

As always, we appreciate your comments and questions and enjoy every one of them. Keep them coming.

As we close this Monday, right now, today, we are seeing the undeniable consequences (and volatility) of global trade slowdowns and tariff-driven contractions in PMI (negative for three consecutive months now) at the same time GDP in Asia, the U.S., and Europe are falling dramatically as interest rates do the same.

Ouch.

So… prepare for more volatility as the year closes out. In the meantime, be safe and informed, and keep an eye on your inbox for more blunt speak this week…

Sincerely,

Matt Piepenburg


Comments

3 responses to “What’s Happening Now: Week of August 5”

  1. Hi Matt-

    When is the suggested-recommended Storm Tracker Portfolio coming out – or, did I miss it in the last few weeks?

    Sincerely –
    Your Hard Working Commercial Bank Bear waiting for this Debt Fueled Credit Cycle to Finally End Friend,

    Richie Bare

  2. If you expect a market crash, then your two greatest threats are bonds and stocks going to zero, so interest rates are of minimal concern. Government and utility bonds and cash are the place to be.. But, if rates were to spike, then short duration bonds are the best choice. A rate spike would be of short duration, and afterwards, rates may go even lower. A market crash will destroy wealth, many bonds and stocks will go to zero, and cash will be king. That is, if you can keep it. The socialist government will grab all it can through taxes and other gimmicks, and con men will, too. Hard to see a safe place to store wealth anywhere!

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