We’re getting into an agreeable and relaxed routine here at the ranch.
We go for a hike up the little hill behind the house in the morning. A trail zig-zags up, with the stations of the cross at each zig. We stop and say a little prayer at each one. We’re not really a religious person. But it gives us a chance to catch our breath.
Then, before breakfast, we meet with the ranch foreman who lets us know what the cowboys are up to. We would like to give him more direction; but we hardly know what is going on ourselves, let alone know enough to give advice.
We have breakfast out on the veranda. At about 9 a.m., we get to work… writing this message to you, responding to emails, planning, and working on various projects.
The work goes on until 4 p.m., when we saddle the horses and go for a 2-hour ride, exploring the riverbeds, checking the cows, and making sure the irrigation ditches are working properly.
Yesterday, we discovered an abandoned house that we hadn’t seen before. There are at least a half dozen on the ranch, remnants of an era when there was more water. Often, we find ancient mortars or large grinding pans made of stone, evidence of lives lived there.
After our ride, we return to work and put in a couple more hours before dinner.
The weekends, of course, are a different story.
It was a slow day on Wall Street yesterday. So let us take advantage of this quiet time to get everyone into the same corral.
We began writing a daily e-letter about 20 years ago. At that time, the dot-coms were running wild. We saw trouble ahead.
Why should a company with no real business plan, no revenues, and no assets suddenly be worth so much money?
But we didn’t really understand what was behind it. Besides, readers didn’t want to hear about the downside. Many had staked their financial futures on these fast-moving tech companies.
Many believed that these companies represented something so new that the old investment rules no longer applied.
It was obvious then, as it is now, that there was something going on beyond traditional finance. Markets always go up and down. But this was extraordinary. From 1990 to 2000, the Nasdaq had gone up by a factor of 12.
Fake money had already been around since 1971. Alan “Bubbles” Greenspan had shown in 1987 that he would use the Fed to lower interest rates and backstop stock prices.
The “Greenspan Put,” it was called.
The Nasdaq cracked in January 2000. It lost about 80% of its value in the months following. Recovery took about a decade. But it took another crisis… a bigger one… to fully appreciate what was going on.
Hell to Pay
In the run-up to the crisis of ’08–’09, real estate had gotten way out of whack.
Here again, we guessed that there would be hell to pay. We were right. But we still didn’t understand the full implications of the fake-money system.
Those only became apparent in the aftermath, when the Fed took never-before-seen measures to try to keep the system afloat.
It had taken America’s central bank nearly 100 years to accumulate about $800 billion of assets. But over the following 5 years, it added nearly $4 trillion.
And whatever magic mushroom the Fed was ingesting, the federal government was soon high off of, too. It had taken 230 years to run up a national debt of $10 trillion. But in the next 8 years, it added $10 trillion more.
In a way, the dot-com investors were right. The old rules, the old standards, and the old truths seemed to have been suspended.
Prior to the 21st century, no Federal Reserve chairman would have dreamed of adding so much debt to the bank’s holdings. Nor would any have imagined he could bring the Fed’s key lending rate down to effectively zero… and keep it there for nine years.
Nor would any old-school Republican have thought it possible – and certainly not advisable – to cut taxes at the tail end of a recovery.
There’s always a ready market for a tax cut. But Republicans were supposed to be the party of sensible business people.
They scarcely believed in Keynesian counter-cyclical policies, let alone “pro-cyclical” policies that would amplify the trends rather than offset them.
But heck. Now, at least, we see where we’re going.
And so does the Fed.
Booms and Busts
Despite the remarkable new developments, markets still work in cycles. Booms are followed by busts, bull markets by bear markets, upswings by downswings, summer by fall, and a drinking binge by a hangover.
The Fed, at least, has recognized the problem. It’s gone on the wagon. This expansion is already in record territory (in terms of length).
It will end soon. And when it does, the Fed will want to stimulate the economy by cutting interest rates. So it needs interest rates to cut.
The trouble is, there are limits to everything. And it appears that the economy has reached the point where more fake money lent at fake rates won’t have the desired effect.
The economy already has plenty of debt, far more than it had in the ’70s. When Ronald Reagan entered the White House at the start of the ’80s, the federal government had only $1 trillion in debt.
Now, it has $20 trillion. And auto loans, mortgages, federal deficits, and corporate borrowing all depend on being able to roll over debt at the low rates. Should rates rise, whether driven by market forces or by the Fed, the whole kit and caboodle will come apart.
And now, both the market… and the Fed… are pushing rates up.
The Fed has announced a program of QT – quantitative tightening – in which it sells (or simply allows to expire) the bonds in its portfolio at a rate of $600 billion a year.
Meanwhile, the federal government itself has cut taxes, forcing it to cover its shortfall by borrowing nearly $1 trillion in 2018. The combination will add nearly $2 trillion a year to the supply of bonds available for purchase.
Who will buy them? At what price?
Most likely, no one will buy… unless rates rise to make it worth their while. Most likely, rates will rise. Most likely, asset prices will fall.
And some of Wall Street’s most seasoned pros are bailing out.
Bloomberg says famous analyst Dennis Gartman is selling:
In Wednesday’s edition of his eponymous newsletter, the economist said he is “calling for a major, multiyear top on the equity markets following the recent volatility and following the reversals to the downside that took place yesterday in the Dow Industrials; the Nasdaq; the S&P and the Russell 2000.” He said the forecast represented a “watershed” moment.
And founder of the DoubleLine Capital investment firm, Jeffrey Gundlach says so, too:
We are late in the economic cycle… and it is unusual that the deficit is expanding… [adding stimulus this late in the cycle] has never happened before.
Gundlach sees the deficit getting worse, with “a lot of bonds supplied to the market.” He predicts a negative rate of return for the S&P 500 this year.
My conviction is high, higher than that the 10-year yield will break to the upside.
And most likely, the feds will respond with even more EZ money policies. The Fed will cut rates to zero… and beyond. And the federal government will both cut taxes… and expand spending.
But… will that be a bad thing? Will investors double… or triple… their money by buying the dip as they did the last time the Fed went on a spree? Will the economy recover, however weakly, as it did in 2009?
As always, there’s more to the story. Stay tuned.