Posts by The Trend Letter

Macron

Is a pro-EU vote a good thing?

France had the first round of its presidential election yesterday, and in order for a candidate to win, they would have had to receive over 50% of the votes.  If no candidates gets more than 50% of the votes, then the top two candidates move on to a run-off election on May 7th.

No candidate received 50% of the votes, and the two top candidates were a centrist candidate, Emmanuel Macron, with 23.7% and right-wing candidate  Marine Le Pen with 21.7% of the vote. It is noteworthy that this was the first time in modern history that no mainstream party made it to the second round run-off.

Prior to the election the markets were worried that France would end up having a run-off election between a far-right and far-left candidate, both anti-EU, which could have meant the effective end of the European Union as we know it.

But centrist candidate Emmanuel Macron made it to the run-off against the anti-EU Le Pen.  Current polls project a Macron victory as he is running at 69% to 31% for Le Pen. The markets tend to like the status quo so a projection of a Macron victory has sent the Euro and global equity markets higher, while gold and other “safe- haven” bets moved lower.

While the markets are ‘relieved’ that Marcron is leading the polls, we must remember that he is very pro-EU which represents the status quo, meaning continuing down the same flawed path. Einstein defined insanity as “doing the same thing over and over again, expecting different results.”

The mainstream media is hailing Macron as a pro business candidate, but we must remember that not only is Macron pro the EU, he wants the EU to have even more power.  Europe has  spent the past four decades living in an ‘age of entitlement’, with governments offering handouts every election, treating its voters like heroin addicts, their motto being “just promise them more stuff, and they will be happy.” It didn’t matter which party, they all did the same thing. The problem was they didn’t have the money to pay for all these freebies, and now we are on the verge of a massive debt crisis.

We are not promoting Le Pen as a better choice,  but we are saying that by electing a pro EU leader the French people will be sending a very dangerous message to the politicians and bureaucrats in the EU. A vote for the status quo will be seen as an endorsement by the political elite. 

As investors it tells us that should Macron get elected the problems in the EU will continue because the pressure to reform will subside. Those in charge have run the European economy into the ground, initiating monetary policies that included forcing negative interest rates onto consumers. They have robbed the seniors of any return on their savings, and have now jeopardized pension funds, which have incurred massive funding gaps thanks to low rates.

And look what all their policies have done for the young people in Europe.  These are the current unemployment rates for young people under 25 in each country. Seven countries have a youth unemployment rate of over 23%, including Spain, Italy, and Portugal.

Eurounemployment

While the mainstream media is applauding a pro- EU president for France, as investors we see it as a vote for the status quo which will delay the required reform to get Europe out of its financial mess.

European countries have deep, rich, and varying cultures, and the concept that 19 countries with vastly different cultures, could co-exist, sharing a single currency, but not a single debt, was doomed from the beginning. It puts countries with under-performing economies at the mercy of those with more robust economic performance.

A pro-EU president for France will simply delay the required positive reforms and prolong the “era of entitlement” driving the economy further into the ground until we hit the “age of consequences.”

The EU needs another smack in the face much like Brexit, forcing major reforms to how it manages its economy. A pro-EU vote will simply delay the much needed  reforms in Europe.

Stay tuned!

Shopper

Malls are dying at record pace as Amazon eats up retailers

According to Bloomberg  the demise of so many retailers has left shopping malls with hundreds of slots to fill, and the pain could be just beginning. More than 10% of US retail space may “need to be closed, converted to other uses or renegotiated for lower rent in coming years”, according to data provided to Bloomberg by CoStar Group.

Urban Outfitters Chief Executive Officer Richard Hayne didn’t mince words when he sized up the situation last month. Malls added way too many stores in recent years — and way too many of them sell the same thing: apparel.

“This created a bubble, and like housing, that bubble has now burst,” he said. “We are seeing the results: Doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.”

Year-to-date store closings are already outpacing those of 2008, when the last U.S. recession was raging, according to Credit Suisse Group AG analyst Christian Buss. About 2,880 have been announced so far this year, compared with 1,153 for this period of 2016, he said in a report.

Extrapolating out to the full year, there could be 8,640 store closings in 2017, Buss said. That would be higher than the 2008 peak of about 6,200.

retailers

Many retailers are trying to re-emerge as e-commerce brands. Kenneth Cole Productions said in November that it would close almost all of its locations. Bebe Stores Inc., a women’s apparel chain, is planning to take a similar step. But these brands who are trying to move aggressively online are having trouble trying to keep up with the growth in market leader Amazon.

The Seattle-based company accounted for a massive 53% of all e-commerce sales growth last year, with the rest of the industry sharing the remaining 47% according to EMarketer Inc.

Amazonrules

This glut of malls is predominately a US issue, as “Retail square feet per capita in the United States is more than six times that of Europe or Japan,” Urban Outfitters’ Hayne said last month. “And this doesn’t count digital commerce.”

Read complete article

 

Fed

What happens when the Fed unwinds its $4.5 trillion in assets?

As we highlighted in Wednesday’s Musings, the US Treasury Department issued copious amounts of debt in the form of US Treasury bonds to cover massive deficits, and to try stimulating the economy. We also showed how the Fed was a major purchaser of those bonds and accumulated a massive $4.5 trillion in assets on its books.

Feddebt032017

That $4.5 trillion includes almost $2.7 trillion in Treasury bonds and about $1.8 trillion in mortgage-backed bonds. Just last year, the Fed made over $92 billion in interest from those bonds. The Fed then gives that money to the government (Treasury Department).

Below is a chart showing how much the Fed has given the government in each of the last sixteen years. As we can see, starting in 2009 (the start of QE) the amount of interest the Fed earned in its bond holdings increased almost 50%, from $32 billion in 2008, to $47 billion in 2009. As the Fed kept buying more and more bonds, their interest gains moved up significantly as well, to the point where in 2014 and 2015, the Fed made almost $100 billion in interest from those bonds.

Fedbondinterest

And each year the Fed gives that money to the government. It sounds crazy that the government received almost $580 billion in interest from bonds that were initially purchased by money created out of thin air.

Now that the Fed is done with QE and its bond buying initiatives, what does the Fed do with the huge $4.5 trillion in bonds? Remember, those payments of almost $100 billion a year to government was earned from just the interest on these bonds, they haven’t actually sold any bonds yet.

When the Fed bought the bonds, they did it to manipulate the bond market and force interest rates (yields) lower. Although the Fed purposely disrupts the markets when buying bonds, they do not want to disrupt the markets selling them. If they were to sell large blocks of bonds it would flood the market with bonds, driving the value of the bonds down, and raising the yields higher.

Their other option is to hold the bonds to maturity and not replace them. This would allow their portfolio to shrink over time, and it would have a much calmer impact on the market, as everyone would know when these bonds are coming due.

Whatever route they choose, sell the bonds, or let them mature, the proceeds go back into government coffers. If they let the bonds mature, over the next five years there is almost $1.5 trillion that will mature, and that money goes back to the government.

You just have to believe that Trump has his eye on this cash windfall, as it would allow him to implement his infrastructure plan without having to increase the deficit or raise taxes.

Stay tuned!

headlines1

Headlines – March 31/17

  • Wall St slips as investors lock in gains of strong quarter. Read story
  • Inflation hits Fed target for first time in nearly five years. Read story
  • Euro-area inflation cools more than predicted on oil, food. Reads story
  • Thanks to US Senate vote, your ISP can now sell your entire browsing history to literally anyone without your permission. Read story
  • Steve Eisman of ‘The Big Short’ says subprime auto loans concern him. Read story
  • Putin takes tough stance on protests, warns of Arab Spring’ chaos. Read story
  • Trump says trade gap will make China meeting ‘a very difficult one.’ Read story
  • Luxury items seized in Dutch tax raids. Read story
  • Elon Musk has officially taken the space race between SpaceX and Blue Origin into orbit. Read story
  • Latest WikiLeaks release shows how CIA uses code to hide its hacking attacks and ‘disguise them as Russian or Chinese activity’. Read story
  • Venezuela muzzles legislature, moving closer to one-man rule. Read story
  • Germany balks at Tillerson call for more European NATO spending. Read story
  • Ford boosts CEO’s pay 19% to $22 million. Read story
  • On the lighter side. Check it out! 
Treasury

Foreign institutions are dumping US bonds

As the 2008 financial crisis hit, the US Treasury Department issued massive amounts of debt in the form of US Treasury bonds to cover massive deficits, and to try to stimulate the economy. As we can see on the following chart, on August 20/08 the US Federal Reserve (Fed) owned just under $900 billion in assets. But as the Treasury department issued more debt, the Fed was a big buyer of that debt, and on December 31/08, just four months later, the Fed owned over $2.24 trillion in assets. By December 2015, the Fed had over $4.5 trillion, and today the Fed still has $4.47 trillion in assets on its books.

Feddebt032017

As we highlighted in our March 23rd Musings the “official” US federal debt has grown dramatically over the past 16 years.  The total “official” US debt today is $19.98 trillion! 

Feddebt

Thanks to the Fed suppressing interest rates, the cost to service the ballooning debt burden has been relatively manageable. But as Newton showed us, for every action, there is an equal and opposite re-action.

As investors we need to understand that while the US Fed has been major buyers of US debt, they have by no means been the only buyers of US debt (bonds). Foreign governments and large foreign investors have been major buyers of US bonds, but that trend is now changing.

As shown on the following chart from Goldman Sachs, foreign official institutional investors have been selling US treasuries at a record pace.  A significant portion of this selling pressure is coming from China. Recently Chinese FX reserves hit five year lows as China has liquidated reserves to keep their currency from depreciating.

USbondtrend

As this massive debt rolls over, the US Treasury must re-issue new debt to cover the maturing debt, (or default on their debt). To attract new buyers, Treasury rates will need to rise dramatically to cover the ever rising budget deficits and maturing existing debt. While rising interest rates will be a welcome reprieve for income starved savers, rising rates will mean a huge rise in debt serving costs for the US government. The real question going forward is who is going to buy the new and maturing US debt, if China and other foreign official institutions are dumping US debt? And who is going to buy the $4.5 trillion that the Federal Reserve has on its books? Just asking!

Stay tuned!

leaking balloon

Is air leaking out of the balloon?

In the November election, once the markets digested a Trump victory it liked what it was hearing, and from that election day till the end of February the S&P 500 has jumped almost 15%. A 15% rise in under four months is impressive.

The market priced in a ‘deal maker’ president, and loved the idea of slashed regulations, lower corporate and personal taxes, along with a massive infrastructure spending program.

Electionday

But since the end of February the markets have started to see some air leaking out of the balloon. Last week’s failure to replace Obamacare is the latest event that has the markets now wondering how soon will it be until we see the positive impact of lower taxes, slashed regulations, and that massive infrastructure spending program? Investors have answered those questions by moving capital out of the stock markets.

Some of that capital has been flowing into bonds.

10ybond

Some of that capital has moved into gold.

gold0327

And some of that capital has moved into Emerging Markets.

Emerging markets

Tax reform was a big ticket item for Trump and in order for him to dramatically lower corporate and personal taxes, he needs to get funding from other sources to keep his budget from going out of control. Repealing Obamacare was to be a major source of that funding, and another was to be the Border Adjustment Tax (BAT) that his administration has been proposing.

According to the Congressional Budget Office (CBO) a nonpartisan analysis of congress, a repeal of Obamacare would remove close to $500 billion off the deficit. The Border Adjustment Tax was supposed to bring in $1 trillion in new revenue, but lately Trump is being challenged by the House Freedom Caucus, who have concerns with this action.

So in the short term, the anticipated $1.5 trillion in extra revenue to offset tax cuts will be a challenge for the Trump administration. The market wants those tax cuts, infrastructure spending, reduced regulations, and economic growth. Right now the market is concerned that these changes are being stalled.

A market correction here is something that we have been calling for. In fact on February 28th we sent subscribers an insurance trade to protect them for this very situation.

Ultimately, Trump may not get tax cuts as deep as he wants, but there will be tax cuts. As Mark Meadows, leader of the House Freedom Caucus stated yesterday…

“[Americans] need lower intrusion from the federal government in their lives, they need lower taxes, so that they can take more of their paycheck home. And I know President Trump and those in the GOP conference are committed to making sure that that happens.”

This correction could shape up as a great buying opportunity.

Stay tuned!

rates

How high can US government allow interest rates to rise?

It doesn’t matter which party is in power in the US, as both Republicans and Democrats overspend their budgets. The pace of overspending has ramped up with Bush and Obama. In fact, Obama racked up more debt than all other presidents combined. With Trump’s promises of massive spending, this trend is not likely to end anytime soon.

Here is a chart showing how the ‘official” US federal debt has grown dramatically over the past 16 years.  The total ‘official’ US debt today is $19.98 trillion! To put that number into perspective, it equates to $61,000 per citizen, or $165,000 per taxpayer.

Feddebt

With the debt doubling over the past 8 years, one would expect that percentage of the Federal budget to service the debt would have risen dramatically over that same period of time. But as we can see on the following chart, the interest expense paid in 2016 was actually less than what was paid in 2008…how can this be?

Interest expense

The answer is interest rates. In the early 1980’s after interest rates hit almost 20%, we started a 35 year bond market rally, and since yields decline when bonds rise, we had a 35 year decline in yields.

So the reason that the amount of interest expense in the US has not increased dramatically, even as the debt has, is solely based on the fact that interest rates have declined from almost 20% down to almost 0%.

But as we can see at the far right on the previous chart, yields (interest rates) have started to rise. What does this mean for the for the interest expense for the US Federal government to service its debt?

Given the sheer size of the US debt, if the interest rate were to rise by even 1%, the annual federal deficit rises by $198 billion. A 2% increase in interest rates would increase the federal deficit by $396 billion. If rates were to ‘normalize’ to 6%, the annual federal deficit rises by $990 billion, just to service its debt.

So the question going forward is how high can the US government allow rates to go, knowing that each percentage point rise will cost them an additional  $198 billion in interest expense?

Stay tuned!

Musings

Market Musings – March 15/17

1. Inflation

 The US Bureau of Labor Statistics reported that Consumer Price Index (CPI) jumped 0.1% in February. Even though this was the smallest month-over-month increase since the summer, prices are now rising at a 2.7% annualized rate.

CPI

2. Bonds

With inflation rising at an annualized rate of 2.7%, the US Federal Reserve did the expected today, raising the Fed Fund Rate 25 basis points. The market was expecting this rate hike and was looking for three more later this year, but the Fed surprised by indicating they were forecasting only two more rate hikes this year.

This less ‘hawkish’ outlook juiced the bond market, pushing bond prices higher, and yields lower. 

10-year_bond

3. Currencies

With the Fed forecasting a slower pace of rate hikes the US dollar sold off.

USdollar0315

A declining US dollar pushed up the Euro, Yen, Canadian dollar, and most other currencies.

Euro0315

4. Equities

With a less hawkish forecast from the Fed, investors poured back into stocks, with the S&P 500 up almost 20 points today.

SPX0315

5. Gold

With a weaker US dollar, gold and silver moved higher, with gold up 17.00 and silver up .48.

GLD

6. Oil

The International Energy Agency reported that US oil stocks declined for the first time in ten weeks, They also said that OPEC compliance with their production cut deal reached 91% in February. Combined with the US dollar weakening on a more ‘dovish’ Fed forecast of two more rate hikes versus three, oil rallied 3.48% today.

Oil0315

Stay tuned!

student debt

More than 1 million borrowers defaulted on their student loans last year

From Market Watch….

Even as the economy continues to improve, student loan borrowers are still struggling to cope with their debts, a new analysis indicates.

Roughly 1.1. million borrowers entered default on their Direct Loans, a type of federal student loan, last year, about the same as the previous year, according to an analysis of publicly available government student loan data by Rohit Chopra, a senior fellow at the Consumer Federal of America, a network of more than 250 nonprofit consumer groups. Overall, there were 4.2 million borrowers in default in 2016, up 17% from 3.6 million the year before, as some borrowers exited default while others remained in the red.

The analysis likely underestimates the number of federal student loan borrowers in default as it doesn’t account for borrowers who are in default on types of federal student loans other than Direct Loans.

Even borrowers who aren’t in default, appear to be struggling, Chopra’s analysis indicates. The total amount owed by federal student loan borrowers has grown 16.5% since 2013 from $26,300 to $30,650. Though it’s hard to say exactly why that’s the case, it may be because even those borrowers who are current on their loans aren’t making payments high enough to cover the interest on their debt, allowing the balances to build.

“Despite a booming stock market and falling unemployment, student loan borrowers in today’s economy are still struggling,” said Chopra, the former student loan ombudsman at the Consumer Financial Protection Bureau, the Washington, D.C.-based government agency. “We should be seeing more improvements given the broader economic environment. This raises the question about whether things will truly get better in the absence of broader reform.”

The findings come as policy makers, higher education officials and student loan borrowers wait to learn how the Trump administration will approach the nation’s $1.3 trillion student loan challenge. The consequences of defaulting on a federal student loan are severe for borrowers: They can have their wages, Social Security checks and tax refunds garnished. The government garnished more than $160 million in wages over unpaid student debt in last quarter alone.

Read complete article at Market Watch

headlines1

Headlines – March 15/17

  • Fed expected to raise rates as US economy flexes muscle. Read story
  • US stocks, oil rise as dollar slips before Fed. Read story
  • Trump paid $38 million in taxes in 2005. Read story
  • Dutch vote in test of anti-immigrant sentiment in Europe. Read story
  • Early voter turnout high in Netherlands elections. Read story
  • Does Saudi King have power over US stock market? Read story
  • GM will re-hire 500 Michigan workers slated for layoff. Read story
  • Why Republican’s support for Trump is ‘sky-high.’ Read story
  • Canadian consumer debt hits $1.72T amid threat of ‘pain’ from rate creep. Read story
  • Hannity: NBC on ‘political jihad’ against Trump. Read story
  • Ireland is surprised by the number of British banks looking to relocate after Brexit. Read story
  • US jobless rate down, but wage growth slows. Read story
  • Poll: Worries about race relations hits record high. Read story
  • On the lighter side. Check it out!