Since President Trump first discussed firing Jerome Powell, out of a sense of frustration that his Fed Chair pick was not dovish enough, he has regularly expressed his displeasure at Powell’s lack of willingness to do whatever it takes to keep the economy booming beyond its potential. Strong economic growth serves Trump well as it boosts the odds of winning a second term.
This thought of firing the Fed Chair took an interesting turn yesterday when Mario Draghi, Jerome Powell’s counter-part in the ECB, commented that he was open to lowering interest rates and expanding quantitative easing measures if economic growth in the E.U. didn’t start to pick up soon.
This led to the following Trump tweet:

Mario Draghi just announced more stimulus could come, which immediately dropped the Euro

In, The Lowest Common Denominator, we quantified the extent to which growth of consumer, corporate, and government debt has greatly outstripped economic growth and our collective income. This dynamic has made the servicing of the debt and the ultimate pay back increasingly more reliant on more debt issuance.

Fortunately,
taking on more debt for spending/consumption and to service older debt has not
been a problem. Over the past twenty years there have been willing lenders
(savers) to fund this scheme, even as their reward, measured in yield, steadily
declined.

Unfortunately,
two of the largest buyers/holders of U.S. Treasury debt (China and the Federal
Reserve) are no longer pulling their weight. More concerning, this is occurring
as the amount of Treasury debt required to fund

Debt allows a consumer (household, business, or government) to
pull consumption forward or acquire something today for which they otherwise
would have to wait. When the primary objective of fiscal and monetary policy
becomes myopically focused on incentivizing consumers to borrow, spend, and
pull consumption forward, there will eventually be a painful resolution of the
imbalances that such policy creates. The front-loaded benefits of these tactics
are radically outweighed by the long-term damage they ultimately cause.

Due to the overwhelming importance that the durability of economic
growth has on future asset returns, we take a new approach in this article to
drive home a message from our prior article The
Death of the Virtuous Cycle. In this article,
we use two simple examples to

“The biggest problem that most people have is that they read Wall Street research reports and they believe the Wall Street hype… Wall Street analysts are very, very easy to fool, they’re generally parrots for what management tells them.” – Sam Antar, former CFO Crazy Eddie

In 2018, Goldman Sachs underwrote 513 corporate debt issuance deals totaling $94.5 billion. They were paid an average fee of 0.48% or approximately $453.6 million for those efforts.

In a recent
research report entitled, Corporate Debt
Is Not Too High, Goldman Sachs discusses why they are not concerned with the current levels of corporate debt despite
record levels of corporate debt when compared to the nation’s GDP as shown in
the chart below.

Goldman’s
argument cites the following four reasons:

Since the post-financial
crisis era began more than a decade ago, record low-interest rates and the
Fed’s acquisition of $4 trillion of the highest quality fixed-income assets has
led investors to scratch and claw for any asset, regardless of quality,
offering returns above the rate of inflation. 

Financial media
articles and Wall Street research discussing this dynamic are a dime-a-dozen.
What we have not heard a peep about, however, are the inherent risks within the
corporate bond market that have blossomed due to the way many corporate debt
investors are managed and their somewhat unique strategies, objectives, and legal
guidelines. 

This article
offers insight and another justification for moving up in credit within the
corporate bond market. For our prior recommendation to

This article is the first part of a two-part article. Due to its length and importance, we split it to help readers’ better digest the information. The purpose of the article is to define money and currency and discuss their differences and risks. It is with this knowledge that we can better appreciate the path that massive deficits and monetary tomfoolery are putting us on and what we can do to protect ourselves.  

How often do you think about what the dollar bills in your wallet or the pixel dollar signs in your bank account are? The correct definitions of currency and money are crucial to our understanding of an economy, investing and just as importantly, the social fabric of a nation. It’s time we tackle the differences between currency and money and within that conversation break

“Don’t piss down my back and tell me it’s raining” –Clint Eastwood/The Outlaw Josey Wales

On April 30,
2019, one day before the Federal Reserve’s FOMC policy-setting meeting, the
Wall Street Journal published an article by Nick Timiraos and Paul Kiernan
entitled Inflation
Is Likely to Fuel Discussions as Fed Officials Meet. We quickly
recognized this article was not the thoughts of the curious authors but more
than likely indirect Fed messaging.

Similar to a
trial balloon, conveyances like the one linked above allow the Fed to gauge
market response to new ideas and prepare the markets and public for potential
changes in policy.

Based on numerous
articles published over the last two weeks, we are under growing suspicion that
the Fed wants us to believe we need more inflation.

The following article was posted for RIA Pro subscribers on Monday. We share it with you to give you a flavor for the benefits of becoming an RIA Pro subscriber. Sign up today at RIA Pro and use our site for 30 days for FREE.

On Friday, April 26, 2019, the market was stunned with a much stronger than expected 3.2% rate of first-quarter economic growth. Wall Street expectations were clearly off the mark, ranging from 1.3-2.3%. The media took this as a sign the economy is roaring. To wit, a headline from the Washington Post started “US Economy Feels Like the 1990s.”

Upon first
seeing the GDP report, we immediately looked with suspicion at the surprisingly
low GDP price deflator.  The GDP price deflator
is an inflation measure used to normalize GDP so that prior periods are
comparable

Many financial assets, especially those that are the riskiest, are priced well above their respective fundamental values. A thank you primarily belongs to unprecedented monetary policy conducted on a domestic and global scale. The vast financial rewards and temporary economic stability attributed to central bank actions appear to be blinding many investors to the longer-term consequences of these actions and the implications for their investments in an era of monetary policy normalization.

Accordingly, we discuss the proverbial fly in the
ointment, or what might prevent central bankers from being able to successfully
“manage” markets with their extraordinary
policies.

The Fed Put

Many investors assume that, if the equity markets decline in a meaningful way, the Federal Reserve

When one bets on a sporting event the facilitator of the
bet, referred to as a bookie, charges the
winner of the bet the vigorish. The
vigorish, commonly known as the vig, is a fixed percentage of the bet that serves as compensation to the bookie
for providing numerous betting options (liquidity) and the financial surety of
collecting on winning bets.

Financial
institutions, like bookies, are intermediaries. They link borrowers with
lenders and investors and provide financial
security similar to bookies. The fees, or vig, they charge can be thought of as
a tax on capital transactions and thus a tax
on the economy. If the vig is excessive,
individuals, businesses, and the government
are unnecessarily sacrificing capital and wealth to bolster the profits of financial institutions.

“The problem with the war (Vietnam), as it often is, are the metrics. It is a situation where if you can’t count what’s important, you make what you can count important. So, in this particular case what you could count was dead enemy bodies.” – James Willbanks, Army Advisor, General of the Army George C. Marshall Chair of Military History for the Command and General Staff College“If body count is the measure of success, then there’s a tendency to count every enemy body as a soldier. There’s a tendency to want to pile up dead bodies and perhaps to use less discriminate firepower than you otherwise might in order to achieve the result that you’re charged with trying to obtain.” – Lieutenant Colonel Robert Gard, Army and military assistant to Secretary of Defense Robert McNamara

Verbal

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” – Charlie Munger

As described in a recent article, Has This Cycle Reached Its Tail, an appreciation for where the economy is within the cycle of economic expansion and contraction is quite important for investors. It offers a gauge, a guidepost of sorts, to know when to take a lot of risk and when to take a conservative approach.

This task is
most difficult when a cycle changes. As we are in the late innings of the
current cycle, euphoria is rampant, and everyone is bullish. During these
periods, as risks are peaking, it is very
challenging to be conservative and make less than your neighbors. It is equally
difficult taking an

The following article was posted for RIA Pro subscribers last week. We believe this article points to a precarious situation in the market that investors should be aware of. We hope you enjoy this article and get a better flavor for the benefits of becoming a RIA Pro subscriber.
Sign up today at RIA Pro and use our site for 30 days before being charged.

“So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself” – Franklin Roosevelt March 4, 1933

Those infamous words were spoken by President Franklin D. Roosevelt at a time when the nation was mired in the great depression, and the stock market had collapsed 80% from the highs of 1929.
We argue in this article that today, fear is exactly what we should fear as a wave of complacency rules the

We asked a few friends what the picture below looks like, and most told us they saw a badly drawn bird with a wide open beak. Based on the photograph below our colorful bird, they might be on to something. 

As you might suspect, this article is not about our ability to graph a bird using Excel. The graph represents the current bull market and economic cycle as told by the yield curve and investor sentiment.

As the
picture is almost complete, the bird provides a clue to where we are in the
current cycle and when the next cycle may begin.
For investors, one of the most important pieces of information is understanding
where we are in the economic cycle as it offers a critical gauge in
risk-taking.

Cycles

Economic Cycles- Economic cycles are frequently depicted with a

On Sunday, March 11, 2019, Federal Reserve
Chairman Jerome Powell was interviewed by Scott Pelley on 60 Minutes. We
thought it would be helpful to cite a few sections of their conversation and
provide you with prior articles in which we addressed the topics discussed.

We have been
outspoken about the role of the Fed, their mission and policy actions over the
last ten years. We are quick to point out flaws in Fed policy for a couple of
reasons. First, is simply due to the enormous effect that Fed policy actions
and words have on the markets. Second, many in the media seem to regurgitate
the Fed’s actions and words without providing much
context or critique of them. The combination of the Fed’s power over the
market coupled with poor media analysis of their words and actions might

“It’s difficult to make predictions, especially about the future.” – Niels Bohr

On November 28, 2018, Federal Reserve
(Fed) Chairman Jerome Powell gave a speech at the Economics Club of New York
that sent the stock market soaring by over 2%. The reason cited by market
pundits was the reversal of language he used a few weeks earlier suggesting
that the Fed still had several more rate hikes ahead. In other words, he
softened that tone and seemed to imply that the Fed was close to pausing.

By most accounts, Fed policy remains
very accommodative but the “Powell Pivot”, which began in late November and
continues to this day, hinges on an obscure metric called R-Star (r*).  Even though interest rates have been held low
and vast amounts of liquidity force fed into markets through

A scorpion asks a frog to ferry it
across a river. The frog tells the scorpion he
fears being stung. The scorpion promises not to sting the frog saying if I did
so we would both drown. Considering this, the frog agrees, but midway across
the river the scorpion stings the frog, dooming them both. When the frog asks why the scorpion replies that it was in its nature to do so.

On February 20, 2019, the Federal Reserve released the minutes from their January policy (FOMC) meeting. As leaked last week by Fed Governor Loretta Mester, and discussed HERE, it turns out that in January the committee did indeed discuss a process to end the systematic reduction of the Fed’s balance sheet, better known as Quantitative Tightening (QT).

Within the minutes was the following sentence:

“Such an

Recently, Wall Street and the Financial Media have brought much attention to the flattening and possible inversion of the U.S. Treasury yield curve.  Given the fact that an inversion of the 2s/10s Treasury yield curve has predicted every recession over the last forty years, it is no wonder that the topic grows in stature as the difference between the 2-year Treasury yield and the 10-year Treasury yield approaches zero. Unfortunately, much of the discussion on the yield curve seems to over-emphasize whether or not the slope of the curve will invert.  Waiting on this arbitrary event may cause investors to miss a very important recession signal.
The Incentive to Lend
A friend approaches you and asks for a loan. You are presented two options, lend her money for two years at 2% annually or for

“That is some crazy talk” – Bill Gates on the topic of MMT
In our article, MMT Sounds Great in Theory… But, we dove into the latest and greatest of economic thinking, Modern Monetary Theory (MMT). This theory is crucially important for investors and citizens to understand as its popularity is spreading like wildfire. The theory promises to be a strong force in the coming election and a challenge to the popular Keynesian policies that are widely adhered to by most governments and central banks.
Free healthcare and higher education, jobs for everyone, living wages and all sorts of other promises are just a few of the benefits that MMT can provide. At least, that is how the theory is being sold. Regardless of the apparent unreasonableness of such promises, it’s not hard to imagine

Economics on Gilligan’s Island

Famed economist
Henry Hazlitt wrote the economics classic, Economics in One Lesson: The Shortest and Surest Way
to Understand Basic Economics. The book is quite
popular and has sold well over one million copies. While the content is
brilliant, what makes it distinctive is the simple clarity he uses to explain
complex economic concepts.

We try our
best to follow in Hazlitt’s footsteps and explain economics without the
complexity and jargon so often used by trained economists. One of our
techniques is to bring an economic concept to its most basic level so that it’s
easily understood by all readers. While at
720Global, we produced an animated video, The Animated Virtuous Cycle, which allows a ten-year-old to understand the complex economic topic of

There are
countless ways to evaluate equities, and they
all have glaring flaws. Equity valuation is not a science with predictive formulas.
It is subjective, and the formulas
themselves and the interpretation of the results rely on an estimate of what
the future holds.

Some models use
historical data under the assumption that the current trend will be predictive
of the future while others use forecasts
that differ from the past. It is a rare
occasion that the past neatly maps out the future or, for that matter, that anyone
accurately predicts the future. No model represents the holy grail of investing,
but understanding their inputs and outputs can reveal a lot about relative
valuations and the sentiment of a market. As investors,
we need to take into account all types of valuation

“Gradual inflation has a numbing effect. It
impoverishes the lower and middle class, but they
don’t notice.”—Andrew
Bosomworth, PIMCO Germany, as quoted in Der Spiegel

Media reports
and political candidates have been stressing the rising wealth and income
inequality gaps in the United States. They do so to advance their agendas, but
the problem is real and they are justified in raising it. At the same time,
both groups are largely overlooking an important piece of the puzzle in the way
they talk about it. To properly diagnose
this important problem, we need to
understand the role the Federal Reserve plays in managing economic growth and how
it contributes to these rising imbalances. This article examines the Federal
Reserve’s monetary policy objectives and their stated inflation goals

The Kansas City Federal Reserve posted the Twitter comment and graph below highlighting a very important economic theme. Although productivity is a basic building block of economic analysis, it is one that few economists and even fewer investors seem to appreciate.

The Kansas City Fed’s tweet is 100% correct in that wages are stagnating in large part due to low productivity growth. As the second chart shows, it is not only wages. The post financial-crisis economic expansion, despite being within months of a record for duration, is by far the weakest since WWII.
Productivity growth over the last 350+ years is what allowed America to grow from a colonial outpost into the world’s largest and most prosperous economic power. Productivity is the chief long-term driver of corporate

“Ted Williams described in his book, ‘The Science of Hitting,’ that the most important thing – for a hitter – is to wait for the right pitch. And that’s exactly the philosophy I have about investing – wait for the right pitch, and wait for the right deal. And it will come… It’s the key to investing.” – Warren Buffett
Many investment managers tempt investors with historical returns by using them as indicators of future return expectations. Unfortunately, even if they are clairvoyant, a buy and hold strategy based on a “known” long term return is likely not in a client’s best interest. Buy and hold strategies that are solely focused on a long-term total return fail to consider the current state of valuations, the risk reward profile, and therefore the path of returns the market may take

On the day after Christmas when investors were sad with the coal they found in their stockings, Santa provided some Boxing Day cheer. The S&P 500 posted a 5% gain, in a rally that was widely expected. We along, with many market technicians, had been highlighting the extremely oversold conditions and thought a relief rally was inevitable. The question was just a matter of when.
Of note, the most vocal about the potential for a short term rally appeared to be those with longer term bearish outlooks. In particular, John Hussman who over the past few years, has repeatedly made a strong and compelling case for the market dropping 50% or more. On Wednesday morning with the market barely green, he posted the following bullish statement on his Twitter account:
ICYMI: “While we don’t observe

A special thank you to Peter Cook, CFA for co-authoring this article with us.
Imagine an island called Stiltsville, where a person’s value is based solely on their height. In order to increase their value, people living on the island used to wear platform shoes. A person wearing six-inch platform shoes would suddenly be more valuable than a person of similar height who wore normal footwear. Eventually, platform shoes were replaced by stilts, three-foot stilts were be replaced by six-foot stilts, and so on. People eventually rose to be the height of giraffes. The main point is that, on an island where height is valued above all else, people will try to game the situation to their advantage by increasing their height by any means available.
People from other lands would look at the people of

Clues from the Fed II, an RIA Pro article from November 28, 2018, provided important insight into one of Jerome Powell’s most important speeches as the Federal Reserve Chairman. We share the article to provide context to this article as well as to demonstrate the benefits of subscribing to RIA Pro.
Since the latter stages of Chairwoman Janet Yellen’s term and including the beginning of Powell’s term, the Fed has been on monetary policy autopilot. As a result of policy actions taken following the financial crisis, the fed funds rate was so far below the rate of inflation and economic growth that they felt comfortable raising rates on a steady basis without much regard for economic, inflationary and financial market dynamics. In Fed parlance, they were not “data dependent.”
Based on Powell’s

The price depreciation of risky assets in the financial markets continued through most of November but took a breather late in the month. The rebound in the final week provided for month-end to month-end optics that were otherwise better than what one might expect had they been watching markets transpire day-to-day.
Performance across the fixed-income sector was reflective of the recent challenges that extended into November. The list of issues included the sell-off of General Electric stock and bonds, Brexit uncertainty and the devastation and financial uncertainty associated with the California wildfires. The market reaction to these events has been justifiably imposing and leaves investors to consider the anxiety-inducing potential for contagion risk.
Money flowed into the safety of

In 1897, Virginia O’Hanlon asked her father if Santa Claus was real. He said she should ask The Sun, a prominent New York City newspaper of the day. Back then there was no fake news apparently, so if the Sun put it in print that there was a Santa Claus, there must be a Santa Claus.

Francis Church, an editor for The Sun, penned the response which contained the now famous phrase “Yes, Virginia, there is a Santa Claus.”
As the holiday season rolls around, many investors have a similar question; will there be a Santa Claus rally? In this article, we examine historical data to see whether Saint Nick will provide holiday cheer to investors or the Grinch will foil their wishes.
The Santa Claus Rally
The Santa Claus Rally, also known as the December effect, is a term for the occurrence of more

On November 27, 2018, the CFO from United Technologies (UTX) stated that his company will focus on deleveraging and not stock buybacks. This announcement comes as General Electric (GE) is struggling mightily to retain investment grade status and its stock is nearing levels last seen during the depths of the financial crisis. While there is much to attribute to GE’s decline, massive stock buybacks in 2016 and 2017 are largely to blame.
To wit: “The root problem at GE — and why the stock is where it is — is poor capital allocation,” said RBC Capital Markets analyst Deane Dray.
Corporate debt now stands at record levels versus GDP as shown below. While the debt has been used to fund expansion and R&D it has also been used to fund record numbers of share buybacks. The pitfalls of such a