Our stay in Argentina was cut short. One of our two daughters had a baby. We hasten thither to see her, our fourth grandchild.
In the meantime…
What we were getting at on Friday was that there is a lot more ruin in the country than we thought.
In 2009 — with the Dow sinking to half its peak, Wall Street so deep under water that almost every major bank was on the brink of insolvency, and millions of people getting thrown out of their homes because they couldn’t pay their mortgages — we thought the jig was up.
No serious person could believe that you could solve a debt crisis with more debt…or so we thought.
But the manipulators kept at it. The people demanded action; the feds gave it to them.
The Fed went back to its usual errors…repeating Mistake #3 (cutting rates in a panic) so forcefully that it raised stock prices by 200% over the next nine years.
But that achievement came at a cost. With rates near 5,000-year lows, and a central bank buying up government treasuries, the feds could afford to borrow — and spend — like never before.
Instead of owing $10 trillion — as it did in 2009 — now, the government owes $21 trillion. And instead of having about $110 trillion of debt worldwide, the total today is about $230 trillion. (We’re talking round numbers…What’s a trillion or two, one way or the other?).
And instead of half the economy being dependent on a 5% interest rate (the yield on a 10-year Treasury in 2007), today, practically the entire world lives or dies on a rate of less than 3%.
Of course, we can never know what will happen — the future comes to us like a dream; we never know what crazy and bizarre thing will happen next.
But that’s the advantage of theory over pure guesswork. You don’t necessarily have any better idea of what is coming, but at least you know what OUGHT to happen.
So let’s try to connect the dots and understand the theory.
Let’s see…stocks have been going up for the last nine years. Prices are now at the top of their range. By some measures, they are more expensive than ever — even after the modest correction this year.
Yes, they could go up. But they ought to go down. At least, that is the way it ought to work.
Stocks go up, drawing in the gamblers, speculators, and easy-money chasers.
Then, they go down…shifting wealth to the ‘stronger hands’ of people who kept their heads when everyone else was acting like Peter Navarro and Larry Kudlow.
Meanwhile, the bulls — such as the aforementioned Kudlow and Navarro — tell us that stock prices are not high at all.
‘Compared to bond yields,’ they say, ‘stocks are very reasonable.’ Some go further, saying that it makes no sense to buy anything but stocks, since you get little yield at all from bonds.
The current real yield on a 10-year Treasury for example, is only about 0.5%. Why accept so little interest — almost nothing — when the stock market could go up 5%…10%…or more?
There are two things wrong with this line of thinking. First, it ignores risk. Stocks could be sawed in half…and — as Japan has proven — not come back.
Second, if stocks now depend on interest rates, they’re in trouble anyway. Central banks flooded the world with fake money (money nobody ever earned or saved)…and then drove down lending rates, intentionally distorting price signals all up and down the capital structure.
What the Fed giveth it now taketh away. Slowly. Hesitantly.
Interest rates are going up. Already, in three baby steps, the Fed has approximately doubled its key rate. It is still absurdly low — below the rate of inflation — but clearly rising.
So the Dow that made sense in 2017 — at the peak of the money-pumping frenzy — will not make sense in 2018…or beyond.
Just like stocks, interest rates follow ‘ought’ patterns, too. The whole cycle usually lasts two generations. That is, one generation remembers; the next forgets.
The previous bottom in bond yields (the top of bond prices) came after the Second World War.
The country was awash in wartime savings. And with military spending coming to an abrupt end (back then, we won real wars…we didn’t just fight phony ones), many economists expected another Depression.
Rates sank…and sank…until finally, the soldiers started families, houses started going up, and the Eisenhower boom years began.
Then, investors forgot about the Depression. Instead of worrying about losing money, they began worrying about missing the bull market.
Note that, during the boom period, real rates ran about 3%. And so did real GDP growth, with higher salaries, real savings, and real investment. By comparison, the ‘stimulus’ of a real rate that is still negative…by about 50 basis points…now produces wage stagnation for most people, the lowest savings rate in half a century, falling real investment, and barely 2% GDP growth.
Interest rates reached a peak in 1980, when Paul Volcker drove up the prime rate to 18% to try to get ahead of inflation.
He succeeded. And then, the next long move began as investors gradually forgot about inflation. Rates fell for the next 36 years — when the 10-year Treasury yield dropped to 1.37 on the 4 July 2016.
Now, yields are rising again.
Logically, if falling interest rates sent stocks up…interest rate increases should send them back down. And already, they have. The Nasdaq is negative for 2018. The Dow has moved about 8% below its peak.
And if we’re right about the general direction of things, theory tells us that interest rates ought to continue going up…and stocks ought to continue going down.
Not that we have any way of knowing that that is what will happen. But that’s probably the best bet.
Then, when higher rates set off a real crash on Wall Street, in another panic, the feds can get back to work…ruining the economy even more.
For, Markets & Money