The government is playing a dangerous game. In our society, power rests on belief. In the most basic sense, you vote for the people you want representing you in government. The ones who make laws and rule on your behalf. You vote for them presumably because they represent an alignment with your interests; you "believe" that they will move the country in a direction you think is beneficial and important.
What happens when that belief starts to crumble? What happens when government of, by, and for the people slides into...something else? When the people see institutions of authority as a system rigged against them? The BLM protests last summer (and ongoing) come from that place. So, too, do the election protests. And the lockdown protests that are spreading across Europe and Australia (and coming to the US?).
People, understandably, feel a need to take action. To regain some semblance of control. Our largest collective identity - as a nation, under the same institutions of authority - breaks down and identity becomes more fractured; an "us" vs "them" mentality that fractures across any number of ideological fault lines. The more the belief that those in power have the collective good in mind breaks down, the more fractured those identity groups become until, at the extreme, you end up with anarchy.
Now, governments everywhere and always tend to play fast and loose with credibility. In our own country, you can easily point to entry into the Vietnam War, Weapons of Mass Destruction in Iraq, or domestic surveillance as examples of blatant government lies. But it feels somehow different when you see it play out in front of you. Day in, day out in realtime.
The last newsletter of 2020 is brought to you by the less-than-sign. We are, of course, referring to the shape of the economic recovery post-COVID. Earlier in the year, it was posited that the letter V would be the winner, but it turns out V was already spoken for. Ditto L.
W was popular for a hot second amongst the non-V-believers, but at that point you're getting dangerously close to tautology and Elliott Waves, unless you want to get into semantics about whether the middle peak of the W comes up even with the start and end peaks (as with typeface), or gets short-changed a bit (as with handwriting).
As far as letters go, K is now far and away the dominant narrative for economic recovery, despite itself already being spoken for as well.
And really, K is a bit of a misnomer, since you can't graph a vertical line (valid functions, people!). But we suppose that "less-than-sign" doesn't have the same easy memefication potential (or strong lobby presence in DC perhaps?) despite being more descriptively accurate, so K wins. For the sake of truth and trying to avoid the memefication curse that is currently plaguing our society, we will make a valiant Alamo-like stand and refer to it as the "less-than-sign" recovery. Which, while a mouthful, is still less burdensome than the also accurate "the-right-side-of-the-letter-K" recovery.
In any case, the point is that the economic COVID recovery is completely bifurcated. There's one group of people doing fantastically well, and there's one that is suffering massively. By and large, the upper arm of the less-than-sign was already the "upper" part of society. And the lower arm was already the lower arm. The COVID response has mainly served to exacerbate the already-growing wealth disparity in this country. And for that, you can and should rightly blame the Fed, Congress, and many state governors. Let's recap:
We're going to open this note with a slight adaptation to the musical stylings of Salt-N-Pepa:
Let's talk about symmetry
Let's talk about you and me
Let's talk about all the made up
Things the Fed has caused to be
We are, of course, referring to the Fed's recent "policy decision" from Jackson Hole. (According to Strunk and White's classic Elements of Style (updated and annotated by Robertson), when referring to the Fed, "policy decision" should always be in quotes, to denote its made-up nature).
The "policy decision" essentially codified a symmetrical inflation goal. To translate with some background for anyone not fluent in Fed-speak:
One of the explicit reasons for being of the Fed is to "maintain price stability" (direct quote quotes, not made-up quotes this time). They used to take that literally and target actual price stability. Then in 2012, there was a new "policy decision" (back to make-believe) that said price stability meant 2% increases in price every year. That doesn't sound particularly stable to us, but the Fed hath spoken and so shall it be.
Does Halloween lose a bit of magic because people have been wearing masks for 6 months already? Resoundingly, no. Sure, it may be more trick than treat this year, but Halloween itself is about the atmosphere - shorter days, cooler evenings, foggy mornings, zombies...yes, the zombies. We are in the middle of a zombie apocalypse - you see them every day and probably have no idea until they collapse and die right in front of you. One of the more recent ones to be decapitated and burned (take your pick of favored zombie disposal methods) is...Hertz.
That’s right, we’re talking about zombie companies! Zombie companies are those that should have gone out of business a long time ago, but have been reanimated through the Fed’s zero interest rate policies. Without going on another rant about how the Fed has destroyed the notion of productive capital allocation, here’s how zombie companies form:
The upshot of last month's webinar, for those of you that missed it, was that the Fed is turning the stock market into a house of cards, but you might as well make yourself comfortable in it. Recently, we've been having a number of conversations that suggest we need to elucidate that point a little further than can be accomplished in a 40-minute Zoom. So here we go:
What is investing?
Are you "investing in companies" when you buy into the stock market?
99% of the time you are not investing in a company. The only ways you can actually invest in a company are: public stock offerings (usually IPOs); public debt offerings; private equity or debt deals. Last year, there were a low-200's number of IPOs that raised around $62B total. Through the first half of 2020, there have been 64 IPOs that raised $22.3B. The total value of the US stock market is right around $30T with a "T". So in any given year, about 0.2% of the stock market is actual "I want to invest in your company" money.
You've seen a record $1.2T in new bond issuance (more on this in a bit) year-to-date in a $40T bond market. Private markets are up to about $6.5T total and have added $370B or so a year (including performance). So recently, in any given year, you could reasonably expect about $1.6T in real "give this company my money" investment. In a combined stock/bond/private marketplace in the US of $77T or so. That's 2%.
Okay, sorry, we were wrong: 98% of the time you are not investing in a company (though really, most of that 2% is limited to a very select few, so in our defense it is likely closer to 99%).
So what are you investing in? When you buy your shares of Apple or Tesla or Aurora Cannabis, you aren't giving your money to the company for them to do amazing world-changing things with. You're not giving your money to the company at all. That's why the stock market is a "secondary" market - you're giving it to the person you bought the shares from.
"Capitalism is the worst economic system ever invented...except for all the other ones."
- Winston Churchill (paraphrased) et al.
One of the main effects of this virus - and our response to it - has been to shine a light directly on all the broken parts of our societal system. A really harsh, fluorescent light. In some cases even a seizure-inducing strobe light. Whether your particular flavor of failure du jour is institutional, political, economic, macro, or micro, there is something there for everyone.
Remember all the outrage over "faithless electors" a few years ago? That was people waking up to the fact that their vote doesn't matter. In point of fact, you don't actually vote for President at all. You are really voting for which party you want to appoint a donor fundraiser elector to vote for you. This is like that, but with everything. In the interest of page limits, we'll stick to our broken economic system for now: Covid killed capitalism.
Part 2. There is so much to unpack economically here, it might take us the rest of the year. So we’ll just start for the time being with a real-time post-mortem of the stock market and economy. A peri-mortem, perhaps.
Things in the land of fiat money and made up valuations are...bad. Like, Stewie destroying Mr. Rogers’s Land of Make Believe bad.
The S&P 500 had a closing high on February 19 of 3,386. As we write this on March 19, exactly one short month later, the S&P 500 is sitting at 2,323 about 15 minutes into the trading day. That is a loss of 31% in a month, which is the fastest drop into a bear market from an all-time high on record (the red line).
Three weeks into 2020 and things continue apace. The world has been to the brink of war and back (remember that?), the impeachment trial is finally underway, and now there’s fears of a new global pandemic. Meanwhile, markets are up over 2% on the month, which annualizes to another 30% year. Which is absurd, so don’t get your hopes up.
As for the “why”, well it’s certainly not due to fundamentals. Global trade (as measured by the Baltic Dry Index) is at a 9-month low and falling, and the IMF has cut their global growth forecast to 2.9%, which is the lowest since the financial crisis...and those forecasts tend to be optimistic. But thankfully the Fed shows no signs of slowing their repo operations, so the market has the green light to keep going higher. The Fed even - get this - floated the idea of lending directly to hedge funds during the next liquidity crisis.
Happy Holidays, dear readers! Believe it or not, the vast majority of the newsletters we write are not, in fact, for our own entertainment. A couple of them definitely are - notably the April Tin Foil Hat series and the October Halloween series - but apart from those semiannual gems, most of the time we are trying to educate, inform, amuse, explain, entertain, and/or deobfuscate.
This one, however, will likely turn out to be none of that. If you’ve been paying attention to those trade confirmations that hit your inbox at the stroke of midnight, you’ll have noticed that we’ve been busy headed into year-end. The following is a glimpse into what we’re thinking, and why. Fair warning, it may feel a bit like climbing up an Escher staircase. But like we said, this one’s for us.
It’s the most wonderful time of the year. To only slightly paraphrase Andy Williams:
There’ll be parties for hosting
Marshmallows for toasting
And frightening kids don’t you know
There’ll be scary ghost stories
And tales of the gories of
Halloweens long, long ago
It’s the most wonderful time
Yes the most wonderful time
Oh the most wonderful time
Of the year
There’s nothing quite like the combination of that crisp chill of fall in the air, the sight of millions of leaves dying a fiery death (because of the colors, not because they’re in California), and the earthy scent as they start to decay and crunch underfoot for raising the spirits. Figuratively. But also perhaps literally.
Do you ever find yourself pulled back through history and imagining what life was like for a particular group back in the day? Like the Mayans, or the Romans, or the French aristocracy? Or maybe you looked at the Super Blood Wolf Moon eclipse this January and wondered how many past regimes had been overthrown and leaders axed (literally) because such things were perceived as having lost the favor of the gods? Or maybe not and we’re just weird like that.
In any case, this is an April newsletter, so dust off that aluminum foil and let’s pull back the curtain on the collective solipsism behind the not-so-invisible hand that guides our markets. Also, put 1984 back on top of your summer reading list. Ready? Let’s go.
Happy Spring! The clocks have all been changed, the equinox is behind us, and summer fast approaches. The Fed apparently decided to get a head start on flip-flop season, however, by going full Left Shark this week.
As a reminder, this is what the Fed said just three short months ago, back in December (italicized parentheses our own):
Well, that certainly escalated quickly. The third quarter ended with the US market at pretty much all time highs (again) and the early February gyrations long forgotten by most. But then the calendar rolled over to October, the witching month, and much hell has broken loose. Not all hell, but much. As of last Friday, markets were down about 10% overall - and we mean all markets. Large Cap, Small Cap, International, Emerging...even bonds fell this month. In point of fact, in the last sixty years, this is just the 13th time US markets have sold off by 10% or more within a month after reaching all-time highs. (And yes, that stat is completely cherry-picked because it let us use “Friday” and “13th” in making the same point, and how else would we work a Jason Voorhees reference into this note?) Pretty much the only things that haven’t gone down this month are gold and cash. There has been a little bit of a recovery these last two days, but we are still well on track for all major asset classes to close the month below their average price level for the last year.
So. What was it that solved the puzzle box and unleashed the Cenobites on the market? According to anyone who gets paid to make up explanations for the daily movements of the stock market (and don’t kid yourself, they are made up), the proximate cause was rates going up.
From CNN: “simply put, stocks are sinking as Treasury rates rise...the 10-year hit 3.24% on Wednesday for the first time in seven years. That’s an about-face from 2.85% at the end of August.”
From USA Today: “the catalyst was the recent spike in the yield on a closely watched government bond to a seven-year high.”
There are some tangential things thrown into the mix as modifiers, usually about trade tariffs or geopolitical uncertainty or tech stocks falling, but the main culprit is this nasty “about-face” “spike” that happened in Treasuries. Let’s look at that for a second, shall we?
Check out a graph of the yield on that “closely-watched” 10-year government bond for the last 50 years. Hoo-boy! Take a look at that spike. No, not that first one, that’s the 70s. No, not the big one either, that’s the 80s. Yeah, it does kind of look a bit like a seismograph for the duration of the 80s. That spike? Nope, that’s 1995. Can’t you see it? On the far right-hand side of the graph? Okay, zoom in on just the last two years, since the most recent bottom.
Huh. Well, we’re not sure what that looks like to you, but to us there is neither a spike nor an about-face in that. An actual “about, face” is a two-step, 180-degree change of direction. This is more like “gradual sweeping arc around the entire parade ground, face”. The Fed has raised rates 7 times, or 1.75%, over the last two years. So yeah, yields are higher than they have been since 2011 because rates are higher than they have been since the Bear Stearns bailout in 2008! And what was the yield on the 10-year the last time the Fed Funds rate was at this level you ask? Between 3.5% and 4%. Versus the 3.25% that supposedly precipitated this market correction. If Freddy ever came after us, that would be our nightmare - stuck listening to market commentators whose entire world resets every weekend until our head explodes.
Okay, gratuitous sarcastic rant over. Let’s get to the rotting meat of this Halloween note - Zombies!
First off, an apology. We hear that there were some formatting issues which prevented the Venn diagram in last month’s newsletter from showing up for anybody. That’s a shame, because it was pretty hilarious. But, lesson learned. No more Venn diagram jokes. We'll stick to .jpg based humor.
The Fed met again this month, in a quarterly show that has become increasingly Rocky Horror-esque. No rate hike at the moment, though they expect to hike again in December and 3-4 times next year as well (I’ll take the under on that one if anybody’s interested…). The bigger news out of the meeting was that they are (finally!) starting to reduce the size of their balance sheet.
In response to the Financial Crisis, in 2009 the Fed launched their Quantitative Easing “QE” program, whereby they bought US bonds with money they created out of thin air. About $3.5 trillion (that’s trillion with a “t”), to be exact. The thought was that you could avoid a repeat of the 1929 depression by expanding the amount of money in circulation. And, yay, no depression as of yet, but also no sign of the inflation the Fed has been trying to ignite. Why? Because most signals point to QE not working at all, and in actuality perhaps even hampering the recovery of the last 8 years. All that $3.5 trillion ended up...where exactly? Not circulating in the general economy you say? Ah yes, that’s right, it’s pretty much all held as “excess reserves” at the banks. Fun fact - the Fed pays banks interest on these excess reserves. So, to recap, the Fed creates $3.5 trillion dollars and gives it to the banks. The banks don’t lend it out, they hold on to it. And by “hold on to it”, they say, “Oh hey Fed, we have more cash than we need to at the moment, why don’t you keep some of it safe for us and pay us interest on it”. Brilliant.
All that to say the biggest news of the Fed meeting was probably Janet Yellen herself saying it was a “mystery” why inflation hadn’t been picking up. Yes, that was her exact word. That means that either 1) nobody at the Fed has any clue how the experimental monetary policies they’ve been engaging in actually transmit through the economy, or 2) they know it doesn’t work but can’t actually come out and admit that, so it gets explained away as a “mystery”. Dammit Janet indeed.
Sigh. Now, after that inordinately long introduction (we can be a little prone to ranting about Fed policies), here is what we actually wanted to talk about this month: what to do when you’re on your own. Fitting, perhaps, for the back-to-school season, but this really came about through conversations with multiple clients and prospects in the last couple months. If your employer doesn’t offer a 401(k) plan of any type or you are perfectly at home in the “gig economy”, what should you be doing for yourself and your future?
So much for the summer doldrums! Three big things happened this month that probably went unnoticed by most of you reading this. And please note, when we say “big things that went unnoticed”, we mean “big” in that super geeky personal finance way and not “unnoticed” because we think you are all ostriches.
Those three things are, in no particular order of importance: our one-year anniversary, passage of the DOL fiduciary rule, and a Fed announcement of quantitative tightening. If you caught all three of those things this month, give yourself a gold star! And if not, well that’s what we’re here for...just keep reading.
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