China Beats The Dead Australian Horse

Oh look, Australia’s economy is slowing down.

From Zero Hedge:

Australian unemployment spiked to 6.4% – its highest since 2002, missing the 6.0% expectation by the greatest margin on record. No “qualified’ economists believed the print would be above 6.1%.

Most likely driven by China’s slow down which can also be seen in the fall of iron ore prices below. China imports a massive amount of iron ore which unfortunately ends up sitting in ports as shown in this REUTERS article:

Iron ore stockpiles at main Chinese ports have hit a record high of 112.63 million tonnes by the end of April, aggravating the level of oversupply and curbing buying interest from Chinese steelmakers.

iron ore

So china is slowing down, and the effects are starting to take their toll on the Australian economy with a housing bubble that didn’t collapse with ours back in 2008. The Chinese contraction is already a powerful enough weapon to burst our global debt bubble but there is another weapon that when thrown has a nasty way of coming back when you least expect it… the Boomerang.

Unfortunately I couldn’t find any photos of Putin throwing a boomerang so this will have to do. The Russian strongman continues to out play his western counterparts as he unleashes a horde of sanctions on the EU and the US. The West may have things Russia wants but Russia has things The West needs, oil. Until that balance changes this will be bad for both sides but worse for the Europeans whose economies are far more fragile. Countries that still are still in recession! Countries like Italy which has dipped back into it’s 3rd recession since the financial crisis of 2008. The West’s trade war with Russia will only exacerbate the underlying problems in these fragile economies.

Once again, I will reiterate and make it very clear here and now, the next crisis will be here sooner than people think. We are very close to the top. We may get one more rally but that’s it. And when I say we I don’t just mean the US, I mean the world. The world has pushed its problems into Keynesian Nirvana, but now they are starting to return one by one, faster and faster, until one day we will have too many problems and not enough cow bell…


To Hell With US Equities

I think it’s time to heed Arnold’s famous words. EVERYONE QUICK! TO THE CHOPPAS!

No not that one! That’s the Fed’s helicopter! The other one!

OH the burning choppa, that’s much better (sarcasm).

So there you have it. You can either get in a burning helicopter or one that runs on hopes and dreams. Those are the choices you are left with. That is, if you follow the Fed’s logic.

Of course there is an alternative. I’m talking about the secret, hidden helicopter that your semi-romantic interest has found and remains patiently waiting for you, the hero, to make a daring escape to.

Now that’s the helicopter I will be taking.

Investors are like Arnold Schwarzenager’s character, Dutch, at the end of the movie Predator. Having defeated the coolest alien ever (sorry aliens but laser cannon + invisibility + heat vision beats acid blood any day), they stand over the creature triumphantly as it utters its last words.

It appears to be some alien language that contradicts itself at every turn. Nothing it is says makes sense.
“Short term bonds are too low.” Before finishing its next breath, it let’s out a painful scream, “Corporate debt and small caps stocks are overvalued and banks are still too big to fail!”
“But why”, the US investor asks. “Where do I put my money if not bonds, stocks and banks? Why do you say these things!? ANSWER ME!”

The answer is simple.

Unbeknownst to the US investors, the alien has secretly set off a ticking time bomb that will obliterate them all, The Taper.

The predator continues to talk, as it buys time for the inevitable explosion. When it will occur, who knows? I mean can you read those numbers? I sure as hell can’t, but I can sure as hell see the countdown has accelerated.

Enough predator metaphors, let’s get sort of serious. The Fed is on the verge of bursting the biggest bubbles in modern history.  It has  no idea what it’s doing, and it is doing an amazing job conveying that. First they tell people rates are going up (US 10 year yield just hit a 13 month low), which means it’s time to get out of bonds and into stocks, but just recently Yellen Capital has recently announced it is holding a myriad of short positions on small caps and corporate debt. So I guess it’s time to get out of stocks and back into bonds?

Yeah, I’m confused too.

Rewind nine months, it’s the December before the most bitter economic winter we’ve had in years and yet the Fed, feeling all powerful by the US stock market’s meteoric rise, higher inflation and rising interest rates, decides to wean the market off its “something for nothing” policy. Since then the stock market has barely moved, yields have fallen and the Fed has made the ultimate mistake…

They looked down and saw the vast open canyon that lies below. No, not literally. But it’s clear with their recent announcements that they are panicking like a five year old boy who has just got caught with his hand in the cookie jar, trying to blame everyone including the jar itself for jumping onto his hand. The newest target of Fed Finger pointing are the banks who are apparently still Too Big To Fail.

Let’s try and follow the Fed’s “logic”. They are trying to raise short term interest rates next year after tapering by the end of this year. At the very least, this will cause the bond market to contract considerably, but the Fed at least wants to do it gradually (the feasibility of this is a topic of debate). Currently, they are indicating that the rate hike may happen “sooner than expected”. The idea being, if they scare enough people away from treasuries, they can get the rates to rise before ever having to raise the federal funds target rate and fuel the stock bubble at the same.

Now that makes sense. It does. Well except for the fact that they are tapering into weakness rather than strength which is exactly what happened in 2007 and I think everyone knows how that ended… Well except for the Fed because they seem to have a rather short and selective memory.

But say I’m wrong, and the market isn’t weakening but strengthening. The Fed has saved us all! All will now bow before our might masters, the lords of all things, the guardians of gallantry, the stewards of responsibility, the mother of dragons.

So the Fed is tapering into strength.  That’s what we just assumed. So if that’s true then why does Fed think that biotech and social media stocks as well as corporate debt are overvalued? Social media and biotech are growth stocks! If they are overvalued that means the growth isn’t there, and if the growth isn’t there then the economy isn’t strengthening so then why the hell is the Fed tapering?

Even more ridiculous, the Fed calls out the corporate debt market, which is the very mechanism that’s been propping up our ludicrous stock bubble. Just look at corporate buybacks which are approaching all pre-recession highs as indicated in the chart below.

Let me make this clear, our market is weaker than it was pre-recession. So whenever something approaches pre-recession highs, I get teenage girl in a horror movie scared because it simply is not sustainable.

As of right now, we have near unlimited demand for corporate debt. This is a HUGE problem. Bad companies CANNOT default on their debt even if they tried because there is always a bigger fool around the corner lined up to buy it. But, it gets worse. Much much worse. When you look at the charts below it’s no wonder the Fed thinks corporate debt is overvalued.

The corporate debt market has never been higher and less liquid. Dealer inventories as a percentage of the total market have fallen from a peak of 15% in 2007 to a mere 1.5% today. It doesn’t get much uglier than this, and yet this is exactly what is propping up the stock market, and yet the Fed is trying to force investors out of bonds and into stocks.

DO NOT! I repeat DO NOT buy into this. The Fed won’t be able to save you once the market does turn, which will be sooner rather than later. At best, a few investors may flee bonds into stocks to allow the market to retrace its most recent fall, but it won’t create lasting stock market growth.

So let’s recap: Banks, bad. Small caps, bad. Corporate debt, bad. Bonds, bad. Nothing, good. The Fed has now publicly painted itself into a corner by pointing out that all US markets are overvalued, the Dow Jones is negative for the year, corporate debt is starting to crack, volatility is rising and…


This is not a joke. Well it kind of is, because if you take this to it’s logical end point you find nothing remotely good. It’s more depressing than an episode of HBO’s The Leftovers. I can’t tell if that show is trying to make me depressed or not. Nothing good happens, ever! The purpose of the show it seems is to beat its characters into submission and that is exactly where our world is headed.

If you find my argument compelling, I’d like to point out that I did not once mention ANY of the geopolitical crises taking place around the world. War in Ukraine, Russian sanctions, Isis in Iraq, Syrian Conflict, Gaza Shit Sandwich, South China Seas Pissing Contest, The Euro Debt Contest, Japan’s Screwed, Italian Recession, Ebola Epidemic, I’m not even trying anymore I’m literally just putting random words together and naming a world crisis. That’s how many of these things there are right now!

Anyone of these crises is enough to send our fragile economy into a free fall and yet I didn’t even mention any of the demographic or political problems in the our society, but those are for another equally bleak post.

If you as an investor can look into your crystal ball, past all of this and see growth then c flip the damn thing over, read the bottom label and find out who made it because my guess is Charles Ponzi.

Hell, forget your crystal ball and look the hell around. The only people buying this market are machines, corporations and bigger fools.

Source: Deutsche Bank (July 2014)

And I leave you with that.

Penal Colony Debt = The Best Around?

The most epic shell game in the history of man kind, otherwise known as the next financial crisis, is coming.  At the end of which everyone will flip over their cups and discover that they’re empty… Well not everyone. That good ole’ penal colony south of the equator may be one of the safest places to hold money.

We have acquired the most amount of debt during peace time in history but don’t tell that to central bankers. They’ve been fighting the greatest war in the 21st century, World War: Deflation. Five years in and the central bankers are returning home from the front like they have dealt the final blow to the monster once and for all. Of course, the Bank of Japan who has been fighting the monster for decades, knows the war is not yet won and continues to fight the beast to the bitter end. Unfortunately the bitter end would be a significant improvement on the more likely outcomes of war and hyperinflation.

Unlike what most sociopaths will tell you, war has costs. The cost of the Central Banker’s war is confidence in fiat currencies. Via money printing, central bankers have kept interests rates artificially low which has allowed government debts to sky rocket to record highs. Since the debt is so much higher than revenues, governments can only pay off the debt at a low interest.  The bursting of the global private debt bubble will cause a sharp contraction in GDP which in turn lowers government revenues. With lower revenues the governments will be faced with two choices either lower interest rates to ludicrous lows or default. Only a few countries will have the first option. Most will be forced to do the latter.

This brings me to Australia.

For the following reasons I like Australia’s public debt above all other.

  • The government cuts spending.
  • Commodities Export Country.
  • Low public debt to GDP (20%).
  • High House Hold Debt to GDP (140%).

The Australian government is cutting spending. This is good for two reasons.
1) It reduces the supply of government debt.
2) It slows down the economy which slows inflation.

Secondly, Australia is a heavy export country whose biggest trade partner is China. This can be seen as a good thing and a bad thing. If we just look at the fact that Australia is a heavy export country we see that in the next debt crisis, commodity prices will plummet as global trade slows. This will cause Australia’s economy to contract and possibly crash leading to an rotation of private debt to public debt. Unfortunately Australia and commodities prices are sort of tied to China at the moment. Early in the year China tried to let some businesses and loans fail but quickly realized how bad things would go if they allowed defaults to continue. So now the Chinese are doing more QE, which could push up commodity prices and push up inflation short term in Australia. It is a concern, but losing a few percentage points to inflation and rising yields short term pales in comparison to flipping ones cup over only to find nothing. In short, if you buy Australian bonds now, you may eat some inflation due to China’s last ditch effort to forestall an economic collapse.

Moving on to public sector debt we find that when compared to revenues it comes in at a paltry 54%. Japan and the US on the other hand have public sector debt to GDP ratios of 750% and 400% respectively. For most EU member nations the number is around 100% but those numbers are skewed due to size of government relative to their economies. The point being, in a debt crisis, Australia will be able to absorb more debt without defaulting. Therefore we can think of Australian government debt as safe and of this safe debt, Australia happens to have very little, sitting at 20% of GDP. This number shrinks when comparing it to Australian household debt which sits at a whopping 140% of GDP.

During the next financial crisis, there will be a flight to safety. From the risky private sector to the “safe” public sector. This initial panic will greatly benefit Australian public debt, since there is so little of it to begin with. Once governments around the world start defaulting on their debt, there will be a greater panic as people seek to put their money in the safest place possible, Australian public debt… and gold.

In reality, buying Australian public debt is a kin to buying gold. Both are safe assets which will see enormous inflows when the panic starts. I think gold is safer in some regards and may see more appreciation but Australian public debt is more liquid and pays interest. In the end it’s a trade off and another way to diversify.

In case you are looking for something with a little more risk but with a lot more reward I suggest looking at Russia, Brazil and India. All three countries are major export countries with relatively low debt to GDP and high inflation rates. Russia in particular could be a great buy because sanctions and high commodity prices are pushing rates higher. Long term it is unlikely that both persist. That’s it for now.

Winter is coming sooner than you think.