USDCHF: Remains Bearish Despite Marginal Lower Close.

USDCHF – Although closing marginally lower the past week, its broader downside bias remains intact. The risk is for a retake of the 0.9000 level to occur. A violation of here will turn attention to its Oct 2013 low at the 0.8889 level. Further down, support lies at the 0.8750 level followed by the 0.8700 level. Its weekly RSI is bearish and pointing lower supporting this view. On the other hand, to resume its recovery triggered off the 0.8889 level now on hold, the pair will have to take out the 0.9249 level, a tough call at its present price levels. This if seen will aim at the 0.9454 level with a cut through here paving the way for a push towards the 0.9496 level. On the whole, the pair remains biased to the downside in the medium term despite its marginal lower close the past week.

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Trinidad & Tobago holds rate, economy still recovering

    Trinidad and Tobago’s central bank held its benchmark repo rate steady at 2.75 percent, saying partial data on the non-energy sector in the third quarter indicates a mixed performance, suggesting “that the economy still remains on its path of slow but steady recovery.”
    The Central Bank of Trinidad and Tobago, which cut its rate by 25 basis points in 2012, said planned maintenance by two major natural gas products and shutdowns in the downstream industry in September led to a contraction of just over 4 percent, year-on-year, in energy production in the third quarter. However, with most of the maintenance work completed, output will return to more normal levels in 2014.
    Trinidad & Tobago’s Gross Domestic Product contracted by an annual 1.15 percent in the second quarter, down from an expansion of 0.66 percent in the first quarter. In 2012 the country’s economy expanding by 0.2 percent after contracting by 2.6 percent in 2011. The IMF forecasts growth of 1.6 percent this year and 2.3 percent in 2014.

    The central bank said headline inflation in the 12 months to October decelerated to 2.7 percent from 3.0 percent in September, mainly due to a slowdown in core inflation that was 1.9 percent in October, down from 2.9 percent.
    “However, the recent heavy rains and resulting floods in Trinidad may lead to some up-tick in food inflation in the coming months,” the bank said.
     Despite a narrowing of the interest rate differential between longer term Trinidad & Tobago and U.S. Treasury bonds, the central bank said there was not evidence of disruptive portfolio flows. The differential fell to minus 29 basis points in November from minus 20 points in October, the bank said.


23andme and The Witch Hunt over Your DNA


I wrote earlier in the year in The Daily Reckoning about a new territory. It was based around the premise that Google might one day start their own country. They’d just carve off a piece of the world to make their own.

For arguments sake let’s call it Googleece.

Google CEO Larry Page said:

But maybe we should set aside a small part of the world, like going to Burning Man [festival] for example…That’s an environment where people can try out different things, but not everybody has to go. And I think that’s a great thing too. I think as technologists we should have some ‘safe places’ where we can try out some new things and figure out what’s the effect on society what’s the effect on people without having to deploy it kind of into the normal world.

And I think I know of another CEO that might be joining Larry. The world of Googleece might just find themselves willing cohabitants.

That would be Anne Wojcicki and her company

Anne is the also the founder of 23andme. She also just so happens to be married to Google’s other co-founder, Sergey Brin (although reports have it they’re now separated).

Anyway Anne started 23andme to get into personal genomics and biotechnology. She believed genetic testing would have huge benefits for the world. As such she built 23andme to bring cost effective DNA analysis to the masses.

In fact 23andme is the same company that a few of Port Phillip Publishing’s editors used to have our own DNA tested a few months ago.

23andme is one of the most influential companies this decade. 23andme is also a part of a select group of pioneering companies.

These companies are at the pinnacle of an entire medical revolution. This new revolution is bigger and more exciting than any other era in history.

However, when you push the boundaries of science…you’ll meet some opposition. And in the case of 23andme, that’s exactly what they’re now dealing with.

In the last couple of weeks 23andme has copped the full brunt of US lawmakers. In particular the wrath of the FDA. But this isn’t the first time 23andme has been in the firing line.

The US congress has been after 23andme for years. Their hatred even goes back to a congressional hearing from 2010. In this hearing the House Committee on Energy and Commerce Subcommittee on Oversight and Investigations grilled 23andme and others.

This hearing seemed more like a witch-hunt than a congressional hearing.

A blog post from, explained some contrasting facts from this hearing. One in particular was about a misleading statement from the FDA.

During the hearing Rep. Parker Griffith of Alabama said:

I don’t think the companies here, if they disappeared tomorrow, would impact the scientific community…this is all bogus. This is nothing more than the snake-oil salesman revisited again in a high-tech way.

Dr. Jeffrey Shuren and FDA official said about the companies,

From the information we know, they are not doing their own research on the genetic profiles…they are interpreting the studies that have been performed by others.

The FDABlog continues on,

Just two days earlier, Dr. Shuren and other senior FDA officials sat ten feet from the podium as Anne Wojcicki, founder of personal genomics leader 23andMe, boomed into a microphone. "A unique and significant part of 23andMe’s site is the research component," said Wojcicki. "In 2009, we launched our first disease community in Parkinson’s disease. We enrolled over 2,000 individuals in the first three weeks alone. We have over 4,000 participants today… we are running hundreds of genome-wide association studies on a nightly basis. We have been able to replicate many of the major genetic findings and plan to publish more soon."

Note: Shuren still holds a senior position at the FDA.

Furthermore this latest attempt to bring 23andme to its knees seems to be quite coincidental. Coincidental in the fact just a few weeks ago 23and me was granted a new patent. This patent brings the subject of eugenics back into the public eye.

The FDA request of 23andme stinks of political influence. They’ve outright told them to stop selling their DNA kits.

Whether it’s politically driven or driven by motives of self-interest I’m not sure but it’s something I’ll dig further into.

DNA analysis is a part of the bigger picture of improving the public health. It’s valuable information about your own genetic make-up. And with that you can make positive changes to your lifestyle.

The way Congress and the FDA are making 23andme out to be charlatans is irresponsible at best.

 I’m all for safe and effective DNA testing. And from my  experience, and knowledge of the technology 23andme uses, it’s reckless to say they’re ‘Snake Oil Salesmen’.

Watch this space. For now 23andme has been apologetic to the FDA, no doubt through fear of wider reaching consequences. But no doubt behind closed doors they too are seething at the witch-hunt that seems to be on again.

If Page and Google open invitations to their new land of decreased regulation and increased innovation…I’m sure Wojcicki and 23andme will be asking for their golden ticket.

Sam Volkering+
Technology Analyst, Revolutionary Tech Investor

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The Technology Sector: Determine Fad from Fantasy


There’s your average long term investor, and then there’s Alfred Feld.

Mr Feld recently died at 98 after – get this – eighty years with investment bank Goldman Sachs.

The Australian tells us he began as an office boy in 1933. Later he chose stocks and investments for clients, what today we would call ‘wealth management’.

Just off the top of our head, in financial terms that means he lived and invested through the Great Depression, the 1937 stock market decline and the Second World War. Then came the post-war baby and stock market boom and later the collapse of the Bretton Woods agreement.

In the 1970′s was the OPEC oil crisis and economic stagflation. Then came the twenty year gold bear market, the 1987 Wall Street collapse, the technology bubble of the 1990′s, the housing bubble, and the subprime collapse and panic of 2008.

Not to mention the rise and fall of countless companies and industries. That kind of puts the next quarterly update into a bit of perspective.

The only one constant for Feld was the same for all of us… 

The Nasdaq Rises Again

And that’s change. And right now the one thing Feld admitted he never really got – technology – is driving big change.

In case you missed it, the Nasdaq went over 4000 points for the first time in thirteen years this week. The Nasdaq is America’s second biggest stock exchange. It’s largely seen as a proxy for the technology industry and growth. Big technology stocks like Microsoft, Apple, Facebook and Amazon are listed on it.

You’ve no doubt heard of the Nasdaq, famous to this day thanks to one of the biggest, most insane stock market bubbles in history.

That was in the late 90s, when it went from 1000 points in 1995 to over 5000 in the year 2000. Many companies had unbelievably high valuations because it was a ‘new era’. This was despite the fact that some companies didn’t have any revenue, let alone profit. 

A lot of those companies went bust and investors lost millions. Investors have been wary of technology ‘stories’ ever since. Now, there’s no point getting too carried away from what’s happening on the Nasdaq. It’s taken 13 years to get back to where it is now.

But the way events are going, no investor can afford to miss what’s happening in the technology sector. That’s because it impacts on so many different industries.

Take gaming company Aristocrat Leisure [ASX: ALL], for example. The Australian Financial Review reported this week that,

‘For the first time in its history, Aristocrat Leisure will next year release digital versions of its new poker machine titles to personal mobile devices before they hit casino floors…It also comes as Aristocrat’s social casino platform, Product Madness, is growing at such a rate it looks likely to be split out of the company’s fledgling “online” reporting line at next year’s full-year results.’ 

You can only use Product Madness in your Facebook account. According to the AFR, Aristocrat will release the stand alone Android and IOS apps for mobile devices next year, as well as distributing digital poker machines to online casinos in the US.

Aristocrat is defending its position in the industry here in Australia from Ainsworth Game Technology [ASX: AGI]. Ainsworth is up over 100% for the year and taking market share off Aristocrat in the traditional gambling space. No doubt Ainsworth has digital plans on the boil, though we aren’t aware of anything yet.

We know plenty of people object to gambling companies as a matter of principle, but we’re using Aristocrat here simply as an illustrative example of how ‘disruptive tech’ can change entire industries and even influence other sectors.

If people are gambling online, maybe they don’t need to go to the pub, or won’t as often. That affects the hospitality industry, and beverage sales. If it’s easier to gamble, perhaps more people will, and consumer spending will shift. Discretionary retailers might suffer.

Aussie companies who previously couldn’t compete in the hyper competitive markets of the US and Macau might find they can win market share. 

There’s no ‘safe’ business model. Technology means you have to adapt or die. 

How Excited Will Investors Get? 

Gayle Bryant reported on some renewed interest in the technology sector in the Australian Financial Review on Wednesday.

He quoted Bell Direct chief executive Arnie Selvarajah as saying,

While momentum has been created by listings such as those by Twitter and Facebook, there have also been standout performers, which tend to be the companies that are disrupting business models.

He then cites a company called nearmap, which is up 1400% over the past 12 months.

Interestingly, Bryant quotes Platinum Asset Management chief exec Kerr Neilson (one of Australia’s best investors). Neilson comes across as a bit miffed about the lack of excitement from investors toward technology in general. The hard part, says Neilson, is to ‘discern fad and fantasy from long-term winners‘. 

One way is to check out Revolutionary Tech Investor.

You could do worse than focus on one area they do: medical tech, set to grow as the western world ages and the baby boomers go into their later years.

Revolutionary Tech Investor editors Sam Volkering and Kris Sayce have their eyes squarely on the canary in the coalmine: Japan.

Here’s a graphic of Japan’s demographic profile from a recent RTI update: 

Source: United States Census Bureau
Click to enlarge

Japanese society is old and getting older. To really ram the point home, we recall reading some time ago that adult nappies outsell baby ones in Japan. There’s a massive market for healthcare.

The RTI editors say that means tech-savvy investors should look into regenerative medicine. The Japanese government has just moved aggressively on this issue.

Here’s the breakthrough news, as reported by the Japan Times:

‘The Upper House passed a bill Wednesday aimed at ensuring the safety of regenerative medicine and another to revise the pharmaceutical affairs law to promote safe and swift treatment using induced pluripotent stem (iPS) cells and other stem cells…

‘The revised pharmaceutical affairs law defines medical products containing stem cells as regenerative medicine products. It allows the government to approve such products conditionally even when their effects are not verified, if their safety is confirmed in clinical trials.’

According to Kris, this is a big deal. He argues that in effect, the new laws in Japan mean that stem cell companies don’t have to provide proof their treatment works, only that it doesn’t cause harm. The stem cell companies can ‘fast track’ their treatment straight to market.

The good news is there are some Aussie and ASX-listed companies flying the flag in this space. You can check who they are by clicking here. Stay tuned.

Callum Newman+
Editor, Money Weekend

Special Report: The ‘Wonder Weld’ That Could Triple Your Money

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Colombia holds rate, confirms Q3, 2013 growth forecasts

    Colombia’s central bank held its benchmark interest rate steady at 3.25 percent, as widely expected, and confirmed its forecast for economic growth this year of 3.5 percent to 4.5 percent and that inflation should return to the bank’s target range as a shock to food supply is diluted.
    The Central Bank of Colombia, which has held rates steady since April after cutting by a combined 100 basis points in the first three months of the year, also confirmed its estimate for third quarter growth of between 3.8 percent and 5.4 percent.
    In the second quarter, Colombia’s Gross Domestic Product rose by 2.2 percent from the first quarter for annual growth of 4.2 percent, up from 2.8 percent. In 2012 Colombia’s economy expanded by 4.0 percent.
    “Interest rates remain at levels that stimulate aggregate spending in the economy,” the central bank said.
    In its quarterly report from earlier this month, the central bank forecast 2014 growth of between 3 percent and 5 percent and third quarter growth of 3.8-4.5 percent, putting 2013 growth within reach of a forecast 4.0 percent despite a weak start to the year.
     The central bank’s board also agreed on an inflation target of 3.0 percent, plus/minus 1 percentage point, for 2014, unchanged from this year.

    In October Colombia’s inflation rate fell to 1.84 percent from 2.27 percent in both September and August due to lower food prices and the bank said one-year inflation expectations fell and are now below 3 percent.
    “To the extend that supply shocks are diluted and aggregate demand continues to be driven by expansionary monetary policy, expectations are expected to converge to the long-term goal,” the bank said.
    Household confidence recovered in October, the bank said, along with improved sales or durable goods and surveys suggest a rise in shipments and manufacturing production. Although growth in total credit slowed last month, it remains higher than the rise in nominal GDP.

Zambia holds rate, sees December inflation pressures

     Zambia’s central bank held its policy rate steady at 9.75 percent, saying an expected increase in inflationary pressures in December are likely to be moderated by the central bank’s tight policy stance.
    “Hence, after weighing the inflationary risks, the Committee decided to sustain the current relatively right monetary monetary policy stance and maintain the Bank of Zambia policy rate at 9.75%,” the central bank said.
    Zambia’s inflation rate rose slightly to 7.0 percent in November from 6.9 percent in October, above the central bank’s 6.0 percent target for the year, but in line with the bank’s expectations.
   The central bank raised its rate by a total of 50 basis points in June and July.
   Inflationary pressures are expected to emanate from the lagged effects of the recent depreciation of the kwacha’s exchange rate coupled with higher seasonal demand for some consumer products as the holiday season approaches and a seasonal increase in the prices of maize grain and mealie meal, the Bank of Zambia said.
    Like many other emerging market currencies, the kwacha fell in late May through early July but then rebounded and rose until the end of October. It then dropped by 5 percent to 5.58 per U.S. dollar on Nov. 10 from late October. Earlier today it was trading at 5.50 to the dollar.
    Last week an official at the central bank said a drop in the kwacha to near its weakest levels in 4-1/2 years was temporary and it was set to rebound.
   Emmanuel Pamu, financial markets director at the central bank told Bloomberg that the kwacha would be in an equilibrium at a rate of 5.30 to 5.40 to the dollar.

Worst November in 35 Years for Gold as India’s Import Ban Forces Jump in Recycling

London Gold Market Report

from Adrian Ash


Fri 29 Nov 08:45 EST

WHOLESALE London prices for gold pushed higher in quiet trade Friday morning, on course for the largest November drop since 1978 in US Dollar terms.

 Down 5.9% from the last London Fix of October, Dollar gold this morning touched $1249 per ounce.

That would be the lowest monthly finish since June’s 3-year low.

 Global stock markets meantime hit fresh 6-year highs on the MSCI World index, as the Japanese Nikkei closed its strongest November since 2005.

 The Japanese Yen today hit its lowest level in a half-decade to the Euro.

 Gold for Japanese investors rose to 1-week highs Friday morning, cutting November’s drop to 1.9%.

 “Trading has been relatively subdued,” says a European bank dealing desk, pointing to the US Thanksgiving holidays.

 “Some light buying from short-term players,” says a Swiss refiner’s note, again citing “very thin conditions.”

 Tracking Friday’s rally in gold, silver also rose but held $2 per ounce below the end of October, heading for a 9.1% drop in November at $19.93.

 “Physical [gold] demand is solid,” says ANZ Bank’s commodity team in a special report, “but not bullish enough to spark significant short covering [by bearish traders in gold futures].

 “[That’s] reflected in subdued Shanghai Gold Exchange premiums.”

 Trading volumes in Shanghai gold slipped back Friday, pulling the premium above London settlement down to $6 per ounce from the recent peak of $9 hit Thursday.

 ANZ now forecasts 2013 gold imports to China of 1,050 tonnes, topping last year’s record by some 80%.

 “[But] we believe caution is warranted in expecting the growth in Chinese gold demand will be repeated next year,” says the banks’ analysts, stating a “baseline expectation” of a drop in 2014 imports back to 900 tonnes.

 Meantime in former world No.1 gold consumer nation India, where gold prices on the MCX futures market ended the day unchanged near 6-week lows, “People have started coming with recycled gold,” Reuters quotes a gold retailer in the famous Zaveri Bazaar.

 Thanks to the Indian government’s gold import rules effectively shutting legal inflows, “There is no gold available in the market this wedding season,” the retailer, Kumar Jain, goes on.

 So the parents of brides-to-be “have started exchanging their old gold for new, and paying the labor charges,” he adds, forecasting perhaps 400 tonnes of gold recycling this year, compared with more typical levels of 130 tonnes.

 Import duties, the lack of supply and other costs have pushed Indian gold dealers‘ quotes for physical bullion to $130 per ounce above world prices this month.

Adrian Ash


Gold price chart, no delay | Buy gold online


Adrian Ash is head of research at BullionVault, the secure, low-cost gold and silver market for private investors online, where you can fully allocated bullion already vaulted in your choice of London, New York, Singapore, Toronto or Zurich for just 0.5% commission.


(c) BullionVault 2013


Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.



Discretionary vs. Mechanical Trading: Human Brain vs Trading Technologies

Online trading, especially if you are a day trader or high frequency trader, requires trading technologies that are capable of completing mathematics thousands of times per second.

Especially in day trading operations, trading technologies can play a small or pivotal role, depending on whether the trader uses a discretionary or mechanical trading technologies

So trading technologies are awesome, but what about human brain performance?

Well, the brain remains, by far, the most powerful tool available to human beings. Studies have found that our brain is capable of 1016 processes per second, which makes it faster than any high frequency trading technologies out there.

However, it does have major limitations.

Think about it. We do not need to have the best technology available to view a simple ADX indicator or a moving average. Add the fact that our memory is more often than not, useless and that sometimes our thinking is subject to cognitive biases and logical fallacies.

Not surprisingly many traders recognize that their brain is their best tool, especially when it comes to analyzing and processing ‘soft’ information – things that are so important in today’s market analysis and trading decisions. However, they also recognize that it can serve as their enemy as well, when those cognitive biases and logical fallacies kick in.

Before we go further let me quickly clarify the terminology that we are using here and explain the difference between cognitive biases and logical fallacies

A logical fallacy is an error in logical argumentation. Examples of logical fallacies are slippery slopes, homonym attacks and circular arguments. On the other hand, a cognitive bias is a genuine deficiency or limitation in our thinking — a flaw in judgment that arises from errors of memory, social attribution and miscalculations.

Logical fallacies are unquestionably a limitation, but they can be clearly identified and managed or limited. Cognitive biases are more of a gray area when it comes to identifying and recognizing them. Psychologists believe that our cognitive biases help us process information more efficiently.

Use the example of  ’soft’ signals from the financial markets that we were talking about earlier; they can be recognized, elaborated upon and interpreted thanks to our cognitive biases.  Technology still cannot replicate this process, no matter what neural networks and other scientists say.

So what? Well, it turns out that our brain is more powerful than any trading technology available to traders nowadays. It is wired in a way that can surely lead to mistakes, but it can also perform extremely efficiently and read “soft” signals like no trading technology can do.

We have the most powerful machine to date, it is free and still many discretionary traders are scared by it and thus, shift to mechanical systems.

To those traders I ask the following question:  In a competitive  environment such as financial markets, do you really want to do give up learning how to master the best ‘technological’ instrument that you own?

I know, becoming a master your mind is a lifelong project. I hope you will come to find that it is worth the effort. You could become a better trader, a better investor and a better person.


About the Author

This was a guest post by Robert Main of


How to Find Safe Yields in an Interest-Rate-Sensitive World

By Dennis Miller,

While Mr. Bernanke’s policies have taken a toll on seniors and savers, his mere mention of the word “taper” last spring did us all a favor. It sent interest rates rising, bond and stock prices tumbling, and in the days that followed, the Fed went into damage control—quite a lot of hubbub for something the Fed was only pondering. What happens when they announce they actually did something?

To pinpoint the answer, the Money Forever analysts and I looked at the performance of utilities, a longtime favorite of conservative investors. Because of egregiously low yields, investors had moved billions of dollars out of fixed-income investments and poured into bonds and dividend stocks—utilities in particular. That caused utilities to become interest-rate sensitive, meaning they began to behave like bonds: falling when interests rates rise.

We recommend holding at least 30% of your nest egg in cash or cash alternatives. Unfortunately, if 30% of your portfolio is earning a measly 1% or less (the going rate on most cash instruments), the other 70% is up against a Herculean task. That portion would need to earn just under 10% in order for your entire portfolio to yield the old-line goal of 7.2% (the rate at which, compounded, your portfolio doubles every 10 years).

The solution: find cash positions with higher yields that are less sensitive to rising or falling interest rates. That way, the rest of your portfolio won’t have to work so hard, and you won’t be tempted to take risks ill suited for a stable retirement.

You might be thinking, “That’s a nice idea, but where are these ultra-safe cash alternatives offering healthy yields regardless of interest rates?” Rest assured, they exist, but as Doug Casey would say, you have to look where no one else is looking.

With that in mind, I sat down with my friend and colleague Alex Daley to bring you some clear answers.

Dennis Miller: Alex, it’s nice to speak with you again. I would like you to elaborate on one of the ideas we’ve discussed. Many folks are bewildered and frustrated, waiting for juicy Treasuries, bonds, and 6% CDs to come back. In the meantime, they are pouring their money into investments that have become interest-rate sensitive. What advice can you offer these folks?

Alex Daley: Those kind of interest rates are only coming back if one of two things happens: if the economy starts booming, in which case the loose-money policy of today will feed much larger price inflation than we are already seeing, and rates will be raised in reaction; or if there is a loss of faith in the US currency or our government’s ability to pay debts from the outside, and investors start demanding higher rates to compensate for that risk. It’s a fine line the Fed is walking with policy, but it could walk it for a long time.

In other words, low rates are probably going to be with us for a while. There likely won’t be a sudden jump. But if we pull off the monetary stimulus at some point, they’re going to start heading back up, because if you’re China or India, do you want to add to your stockpile of American debt?

Rates are already so incredibly low that even the slightest increase will send a lot of investments reeling. When the 10-year Treasury is yielding anywhere from 1.66% to 2.98% like it has been this year, then a 1% jump in rates is a huge relative increase.

Two things will follow a move like that:

  1. The price of those bonds will fall quickly because investors are willing to pay less for that yield. After all, they could find better returns elsewhere.
  2. The price of things that yield close to the same amount, like traditional blue-chip dividend stocks, will also drop in tandem.

Now, if you own a whole bunch of bond funds, you can easily tell what your real exposure is. You can measure (or read the prospectus of your fund, as they do it for you) the “effective duration” or just duration of your fund. That will tell you, in no uncertain terms, how much you’re likely to lose when rates rise by 1%. A duration of 7—about the average for most bond funds—means that a 1% increase in nominal rates like the 10-year Treasury everyone uses as a benchmark will mean a 7% drop in your portfolio.

Generally with bonds, the shorter the maturity, the better they do when rates are rising.

For instruments other than bonds, the risk is harder to quantify. The XLU fund, which is full of utilities—often called “widows and orphans stocks” in part for their supposedly low volatility—reacted sharply to rising rates earlier this year.

There’s one rule of thumb to apply to both categories: the higher the yield is relative to the 10-year Treasury, the safer it is from rising rates. So, instruments that yield 3% today are more dangerous than those that yield 5% or 6%. That may sound counterintuitive, but when rates are rising, investors should understand this.

With bonds, the best way to measure this sensitivity is to find instruments with high yield-to-duration ratios. Those are the investments that recover most quickly from a dip because of rising rates.

So, to get back to your question, chasing yield in and of itself is not a bad thing. There are categories of yield that are relatively resistant to interest-rate creep. But it’s important to understand what drives that correlation, lest you get caught with your proverbial pants down (say, holding a bag of long-dated muni bonds—bad advice I’ve seen from far too many stock pickers).

There are lots of good choices, in bonds, in stocks, and in alternatives off the market.

Dennis: During a presentation you gave at the most recent Casey Summit, you really emphasized moving out of our comfort zone and investing in different vehicles. You suggested Lending Club to us some time back, and we’re seeing excellent returns. In addition, I’ve been writing covered calls on stocks and had some terrific returns between dividends and the income from the calls.

Some readers may be a tad squeamish about out-of-the-ordinary investments. What do you suggest for these reluctant folks?

Alex: Dennis, I know one of your core beliefs is never investing in anything you don’t understand or are uncomfortable with. You and your team do a great job educating in straightforward terms so your subscribers can easily weigh the risk and rewards for themselves. Ultimately, that’s what investing comes down to: How risky is this? What’s my likely return? If you can answer those two questions, you should be comfortable with an investment.

So, take your example of Lending Club. It’s pretty easy to understand: they make personal loans to people; their rates are a little below what banks can lend at because they sell the loans directly to investors like you and me over a simple website; and they don’t have 3,000 branches to support and big margins to maintain. Essentially, the company is much more efficient as a middleman than any bank can be.

What’s the risk? Well, look at it qualitatively first. People can default. That’s the risk. But most people try their best to pay their debts. So only a portion of people will fail to pay back their loan. With the tools you can buy $25 slices of 1,000 loans instead of lending your brother-in-law $25,000 in one shot. That spreads the default risk out.

Looking at the numbers, it stands up, too. It’s why Lending Club claims that no investor with more than 800 notes (i.e., slices) has ever lost money on their investment. As you research the loans, you can find lots and lots of data on defaults to ensure you know what you’re buying. Each class of loan has historical default information, and you can see how it stacks up to returns, and what your likely net return is.

You can talk to other investors on the many blogs that cover people’s experiences. You’re an investor, Dennis, and you mentioned that you’re currently earning a 9.8% return on your invested capital and have just increased your allocation. I began investing with them just months after the company was founded, and I’ve seen very similar returns year in and year out.

So you can understand the risks, even if you aren’t a banker. You can see the returns. And both are backed up by lots of data.

Like any investment though, start small and get comfortable firsthand. That’s the only way to be sure you’re making the right decision.

Dennis: One final question. We discussed CDs and the thought of interest rates going back to “normal.” You said that today’s low rates are the new normal. If the Fed continues to buy our debt and interest rates rise, things like 6% CDs might become available again. However, we agreed that jumping right back in to them could be risky. Can you elaborate on that?

Alex: Carter-era inflation is a good clue as to what lies ahead. Let me refresh your memory.

1977—6.5% inflation

1978—7.6% inflation

1979—11.3% inflation

1980—13.5% inflation

1981—10.3% inflation

You put a great graphic in a recent article that shows a person buying a $100,000, five-year CD with a rate of 6% on January 1, 1977. That person would have had a net loss of 25.9% in terms of buying power when the CD matured, after factoring in their interest income. Investing like that will have a real negative effect on your retirement lifestyle.

As the Federal Reserve continues to buy more of our country’s debt, it will be increasingly difficult for it to keep interest rates under control. Foreign governments like China and Russia will demand higher rates or they will unload our debt, causing inflation.

Finding investments that will have good yields regardless of the direction of interest rates, that have low effective duration, and that are much more liquid than a CD or long-term bond is a much better approach. This will allow you to be responsive to rates without having to sit in cash, waiting on the sideline as the world changes. If inflation starts to rise, like in our example, you can move more heavily to equities, which will see dividend increases under those circumstances.

Or, if rates start to rise first, you can rotate into investments whose yields are rising in tandem. The artificial bond ladders you build with things like target maturity funds, short-term consumer debt like Lending Club, floating-rate funds, bank loans, etc. are tools to prepare your portfolio for the change that’s coming without having to sit on the sidelines.

You CAN sleep at night AND find yield, if you make sure to measure the right things.

As I mentioned in my Tucson presentation, your team is doing a great job of finding these kinds of investments now in places where most folks aren’t looking. That adds a great dimension of safety.

Dennis: Alex, thank you for your time.

Alex: My pleasure.

Grabbing yield wherever you can find it sure is a good proposition… but the fact is that those high yields and above-average gains aren’t always found in the same place. Trying to catch a bull run in a certain sector can be like firing at a moving target.

However, there are those very rare times when opportunities present themselves in every sector we follow—and this is one of those times. Our team spreads the net wide to find yield in all sectors it makes sense, and lately there have been several good investments added to our portfolio.

We, like you, strive for bulletproof income and we have found several opportunities out there to grow your nest egg while protecting it. And you can get access to these investments today, risk-free, by trying Miller’s Money Forever. With our 90-day trial you get access to the complete portfolio, our special reports dedicated to issues facing investors today, and all of our archives. In them you’ll find several interviews like this one with experts from all sectors.

So, try it today. You risk nothing and you will find stocks poised to make you the returns you want, with the protection you need.


How to Find Safe Yields in an Interest-Rate-Sensitive World


Outside the Box: An Open Letter to the FOMC-Recognizing the Valuation Bubble in Equities

By John Mauldin

In today’s Outside the Box, my friend John Hussman of Hussman Strategic Advisors addresses the members of the Federal Open Market Committee, the Federal Reserve committee that makes decisions about interest rates and national monetary policy. The Fed has been notoriously clueless about bubbles, particularly in the run-up to the Great Recession, and so John would like to help them recognize the currently inflating bubble in equities.

He leads off with the key point that when the Financial Accounting Standards Board abandoned the FAS 157 “mark-to-market” accounting standard on March 16, 2009, in response to Congressional pressure from the House Committee on Financial Services, the FASB removed at a stroke the threat of widespread insolvency by making insolvency opaque. In other words, anyone with anything to hide could now hide it. John goes on:

My impression is that much of the market’s confidence and oversensitivity to quantitative easing stems from misattribution of the initial recovery to QE. This has created a nearly self-fulfilling superstition that links the level of stock prices directly to the size of the Fed’s balance sheet, despite the absence of any reliable or historically demonstrable transmission mechanism that relates the two with any precision at all.

Still, it may ease the burden of power to consider the likelihood that the actions of the Federal Reserve … were not responsible for the recovery.

So he is saying to the FOMC, “Yes, the market hangs on your every word, but don’t get to thinking that you’re the be all and end all.” Ironically, though, when the Fed even hints at tapering its purchases of Treasury bonds, the market falls into paroxysms of despair.

Then he asks, “How does one establish the value of a long-lived asset?” What he’s driving at is that if you just look at the current price of a stock, or at the price-earnings ratio based on just a single year of earnings, you aren’t likely to be able to figure out anything about long-term value. And that’s the fix – well, one of them – that we investors (and the Fed) are in today. It comes right back to that question I’ve been asking you a lot the past few years: Is this time really different?

If you want beef (your prime rib for Thanksgiving on the brain analyst says), this article has got it. So get out your carving knife (and hopefully a few of our Fed friends will have theirs at the ready, too).

These issues are part and parcel of the concerns that we covered in Code Red, which is again on the Wall Street Journal’s list of best-selling books this week. Let me offer a couple sound bites from some of the many reviews:

If you are concerned with protecting the value of your investments, you should read this book – 2 or 3 times…

Code Red is a solid analytical account of just exactly what that inscrutable fraternity of central bankers has done to the world economy and to our individual stores of wealth. It provides an illuminated tour of the mysterious world of public and private financial institutions, and also unveils many of their dubious and outrageous motives. It is well written and requires intelligence to read. It is not for the fainthearted. I found it to be an education. It is also full of wit, hilarious anecdotes, and humor. Mauldin is folksy and clear in his insights. Tepper is brilliant and makes the complicated and technical realm of high finance, banking, and public policy understandable. It is a five-star read.

You can watch a video of Jonathan Tepper and me discussing the book and get your copy here. It is also on Amazon and at your local bookstore. It might make a great holiday gift for your clients and friends.

I grew up learning to tinker with engines and do plumbing, TV repair, a little simple electrical work, framing, roofing, sheet rock, painting, landscaping, and all manner of things when I ran a print shop. Truly a jack of all trades and never a master of anything. Pretty much everything they are doing upstairs as they build my apartment but nowhere close to the true master’s level I see on display every day. My friend (and no stranger to many readers) Bill Bonner at Agora, who can afford to hire any master of anything he likes, prefers to build stone walls and personally renovate old homes himself, creating gardens and such; but I always did such things as a defense against leaky roofs or to pay the bills or because I couldn’t afford to pay someone to do them.

That being said, watching the true craftsmen work on my new apartment, taking pride in the smooth texture of paint or the finish on the granite or the way joints should be made to fit just so is a real pleasure. My perfectionist designer (and niece) decided that the leftover slabs of granite would make a beautiful backdrop over my bed in the new master bedroom, and the pieces of granite looked truly magnificent when bookended; but there were slight gaps at the joints, which I thought were just part of the piece. But today I look in to find a young man (they are all young to me lately) patiently mixing a half dozen colors of grout which he will work into those small gaps, matching the blues and browns and tans and greens and whites, turning the pieces into one seamless masterpiece. He went on mixing his colors, holding them up in the light to get just the right tones, dabbing a little more brown here, a little blue there.

Wiring is now an art form with the new electronic controllers, and anything electrical or that can be made electric has now been connected to my iPad mini, from which any of 8 TVs, multiple sound systems and speakers, lights (LEDs that can change colors and put on light shows – who knew?), curtains, security cameras that are almost spooky in their latest tech capabilities, locks – everything is connected to one device.

The multiple dozens of workers come from all over the country and world. Carol, my general contractor, has collected a team of subcontractor specialists that work together like a precision dance team, selected over the years for their quality and ability to get it done right and on time. This being Texas, there are of course a number of Latinos on the job. The painting crew comprises something like ten brothers and cousins who clearly come from the same tight gene pool. I turn a corner to find the guy who I thought was in the last room working in the next.

This being Texas, and me being me, I asked yesterday if one particularly gifted craftsman was legal, as his accent betrayed his roots. “I think so,” said Carol, “but the owners are and they all have insurance.” This being Texas, most of us really don’t care. Are you a good and honest person and do you get the job done right? If you make your own way, you are welcome in God’s country to help us build and grow and make it all work better.

Many of my fellow Republicans have this immigration thing all backwards. We should be striving to find more young people to come to this country. Yes, college-educated kids with tech skills are needed. But we need the young people who can build and plough and dig and tinker. The country is going to wake up one day and realize that the most important product it can import is young, hard-working people.

Control the borders, absolutely. Know who is coming in, yes. If you come you must contribute and not have access to welfare. But with those caveats, open the doors very wide. That is oddly a big part of the answer to the Code Red crisis that central banks are bringing our way. Someone has to work and pay the bills for a (large!) generation that will want to retire.

And now it is time to start thinking about cooking and enjoying 50-60 people who will invade my new, almost-finished home. You have a great week and enjoy your family and friends.

Your baking cakes and making stuffing analyst,

John Mauldin, Editor

Outside the Box[email protected]

An Open Letter to the FOMC: Recognizing the Valuation Bubble In Equities

November 25, 2013

John P. Hussman, Ph.D.

To the members of the FOMC,

You’ve emphasized the tremendous burden placed on the Fed in recent years, and your dedication to collectively doing right by the country. It’s important to start with that recognition, because as concerned as I’ve been about the impact and economic assumptions behind the Fed’s actions, I don’t question your motives or integrity. What follows is simply information that may be helpful in realistically assessing the outcomes and risks of the present policy course, and perhaps to help prevent a bad situation from becoming worse.

Some brief background

As the head of an investment company, it’s natural to conclude that what follows is simply “talking my book,” but for what it’s worth, the majority of my income is directed to the Hussman Foundation. Academically, I earned my doctorate in economics from Stanford, studying with Tom Sargent, John Taylor, Ron McKinnon, Robert Hall, and Joe Stiglitz, and spent several years as a professor at the University of Michigan and Michigan Business School before focusing on finance.

We’ve done well in prior complete market cycles (combining both bull and bear markets), and were among the few who warned of the market collapses and recessions of 2000-2002 and 2007-2009. In contrast, the half-cycle of the past 5 years has been challenging because of the awkward transition it provoked, following a credit crisis that we fully anticipated. Economic policy failures, departures from Section 13(3) of the Federal Reserve Act (which Congress subsequently spelled out like a children’s book), avoidance of needed debt-restructuring (except in the auto industry), and extortionate cries of “global meltdown” from the financial industry all contributed to a collapse in economic confidence beyond anything witnessed in post-war data. That forced us to stress-test every aspect of our approach against Depression-era outcomes. We missed returns from the market’s low in the interim of that stress-testing, and have foregone the more recent speculative advance because identical features have resulted in spectacular market losses throughout history.

In hindsight, the crisis ended – precisely – on March 16, 2009, when the Financial Accounting Standards Board abandoned FAS 157 “mark-to-market” accounting, in response to Congressional pressure from the House Committee on Financial Services on March 12, 2009. That change immediately removed the threat of widespread insolvency by making insolvency opaque. My impression is that much of the market’s confidence and oversensitivity to quantitative easing stems from misattribution of the initial recovery to QE. This has created a nearly self-fulfilling superstition that links the level of stock prices directly to the size of the Fed’s balance sheet, despite the absence of any reliable or historically demonstrable transmission mechanism that relates the two with any precision at all.

The FOMC certainly had a part in creating a low-interest rate environment that provoked a reach-for-yield and a gush of demand for securities backed by mortgage lending of increasingly poor credit quality (I’ll note in passing that new issuance of “covenant lite” debt has now eclipsed the pre-crisis peak largely due to the same yield-seeking). Still, it may ease the burden of power to consider the likelihood that the actions of the Federal Reserve – though clearly supportive of the mortgage market – were not responsible for the recovery. One can thank the FASB for that, provided we’re all comfortable with the reduced transparency that results from mark-to-model and mark-to-unicorn accounting.

Recognizing the equity bubble

How does one establish the value of a long-lived asset? Hopefully, that question stirs the economist in all of you, and you immediately respond that every security is a claim on some long-term stream of cash payments (including any terminal value) that the holder can expect to receive over time. If price is known, the discount rate that equates price to the present value of expected future payments can be interpreted to be the expected long-term return of that security. This is how one calculates the yield-to-maturity on a long-term bond, for example. Conversely, we can make assumptions about the long-term return that investors will require over time and then calculate an implied price. Discounting the expected long-term stream of cash flows using some required long-term return results in a “fair value” that quietly incorporates those underlying assumptions.

Of course, nobody likes to discount an entire stream of expected payments, so investors create shortcuts. The most common shortcut is to compress all of the relevant cash flows and discount rates into a “sufficient statistic.” So for example, if we have a perpetuity with price $P that throws off cash flow $C every year forever, the ratio C/P is a sufficient statistic for the expected long-term rate of return, and everything knowable about valuation can be neatly summarized by that ratio. Nice economic assumptions about constant growth rates, returns on invested capital, payout ratios, and other factors encourage similar approaches in the equity market. So we look at price/earnings ratios based on a single year of earnings and immediately believe we know something about long-term value.

But valuation shortcuts are only useful if the “fundamental” being used is representative of the entire long-term stream of cash flows that will be delivered into the hands of investors. And it’s precisely here where the FOMC may find a careful review of the evidence to be useful.

The chart below is from one of the best tools that the Fed offers the public, the Federal Reserve Economic Database (FRED). The chart shows the ratio of corporate profits to GDP, which is presently at a record. The fact that profits as a share of GDP are more than 70% above their historical norm should immediately raise a question as to whether current year earnings or next year’s projected “forward earnings” should be used as a sufficient statistic for long-term cash flows and equity market valuation without any further reflection. Then again, more work is required to demonstrate that such an approach would be misleading. We’re just getting warmed up.

A simple way to see the implications of the present elevation of the profit share is to relate the level of profit margins to subsequent growth in profits over a reasonably “cyclical” horizon of several years. Remember, when one values equities, one is valuing a long-term stream, not just next year’s earnings. Investors taking current-year or forward-year profits as a sufficient statistic should be aware that high margins are reliably associated with weak profit growth over subsequent years.

The next relevant question is to ask why profit margins are presently so high. One might argue that the profitability of companies has achieved a permanently high plateau. Despite historical mean-reversion in profit margins (which tend to collapse over the full course of the business cycle), maybe this time is different. As it happens, we can relate the surfeit of corporate profits in recent years rather precisely to the extraordinary combined deficits of the household and government sectors during the same period.

The deficits of one sector emerge as the surplus of another

To see what’s going on, we can exploit the savings-investment identity

Investment = Savings

Investment = Household Savings + Government Savings + Corporate Savings + Foreign Savings (the inverse of the current account)

Corporate Profits = (Investment – Foreign Savings) – Household Savings – Government Savings + Dividends

This basic decomposition, at least to an approximation allowed by national income accounting and modest statistical discrepancies, is shown below (h/t Jesse Livermore, Michal Kalecki).

We can go further. The reason (Investment – Foreign Savings) are in parentheses above is because particularly in U.S. data, they have an inverse relationship, as “improvements” in the current account are generally associated with a deterioration in gross domestic investment. So the term in parentheses adds very little variability over the course of the business cycle. Likewise, dividends are fairly smooth, and add very little variability over the course of the business cycle.

As a result, the above identity reduces – from the standpoint of overall variability – to a statement that corporate profits as a share of GDP are nearly the mirror image of deficits in the household and government sectors. A simple way to think about this is that dissaving in both sectors helps to support corporate revenues and limit the need for competition, even when wages and salaries are depressed. It follows that most of the variability in corporate profits over time is driven by mirror image variations in the household and government sectors. As it happens, this relationship turns out to be strongest with a lag of roughly 4-6 quarters. Given the general improvement in combined government and household savings that began just over a year ago, it follows that current-year or even higher year-ahead earnings estimates may not be particularly useful “sufficient statistics” for the purpose of valuing equities.

A predictable response among investors is to immediately seek alternate explanations that might allow profit margins to remain permanently elevated. First among these is the argument that somehow the production of U.S. companies abroad is not being taken into account. But the difference between Gross National Product (which does exactly that) and Gross Domestic Product – even if it represented pure profit – is only about 1%. The adjustment might make a difference in Ireland, where the gap between GNP and GDP is far larger, but the effect is purely second-order in the United States. Moreover, any additional dynamic that prompts the claim “this time is different” had better be one that emerged in the past few years, because as the charts above demonstrate, the mirror-image relationship between variations in corporate profits and variations in combined government and household savings has hardly missed a beat in the past century.

Valuation measures and prospective equity returns

Even if we overlook the foregoing arguments, a historical comparison of competing valuation methods speaks loudly enough. The most important test of any valuation measure is how closely that measure is related to actual subsequent returns over a period of several years. While valuation measures often have little to do with near-term returns, valuation measures that are also unrelated to subsequent long-term returns are not only useless, but dangerous.

The fact is that valuation measures driven by single-period earnings (whether trailing earnings or forward operating earnings) are poorly correlated with subsequent market returns, mainly because they impose the counterfactual assumption that profit margins can be held constant over time. In contrast, measures that account for the cyclicality of profit margins typically have far greater explanatory power than their raw counterparts.

A few examples will demonstrate these regularities. The first chart presents estimated and actual subsequent 10-year S&P 500 total returns (in excess of the 10-year Treasury bond yield) based on the S&P 500 forward operating earnings, but adjusting for the predictable cyclicality of profit margins (see Valuing the S&P 500 Using Forward Operating Earnings). Presently, this estimate implies that the S&P 500 is likely to underperform even the depressed yield on 10-year Treasury bonds over the coming decade. The same was true at the 1972 peak (before stocks lost half their value), the 1987 peak, not to mention the more severe valuation peaks of 2000 and 2007. Present valuations notably contrast with the quite favorable estimated premium that briefly emerged in 2009.

The raw counterparts to the above graph are what Janet Yellen appeared to reference in her testimony to the Senate two weeks ago. Below are two alternate versions of the “equity risk premium.” The first shows the raw “forward operating earnings yield” of the S&P 500 less the 10-year Treasury yield. The second shows the dividend yield on the S&P 500 plus 6.2% (reflecting long-run nominal economic growth) less the 10-year Treasury yield. Neither measure has a very good empirical record of explaining subsequent S&P 500 total returns in excess of Treasury yields.

As a side-note, the presumed one-to-one relationship between forward equity yields and bond yields is actually an artifact of the 16-year period from 1982 to 1998 when bond yields enjoyed a disinflationary decline while stocks gradually moved from a secular valuation low to the dangerous elevations of the late-1990’s. Though Fed officials including Alan Greenspan and Janet Yellen seem attracted to the seemingly elegant simplicity of these “equity risk premium” models, they seem somehow oblivious to the fact that they don’t actually work.

Why is the historical record of these simple “equity risk premium” estimates such a cacophony of noise? The answer should be immediately apparent. It turns out that the error between these estimates and actual subsequent 10-year S&P 500 total returns (in excess of 10-year Treasury yields) has a correlation of 0.86 with – you guessed it – profit margins. With profit margins at the highest level in history, the record suggests that these models are grossly overestimating prospective equity returns at today’s all-time stock market highs.  Unfortunately, this evidence also suggests that the faith expressed in these “equity risk premium” estimates by Janet Yellen and others is likely to coincide with their most epic failure in history.

My strong disagreement should not be confused with disrespect, and none is intended, but wasn’t it Janet Yellen who in October 2005, at the height of the housing bubble, delivered a speech effectively proposing that monetary policy could mitigate any negative economic consequences of a housing collapse, and arguing that the Fed had no role in preventing further housing distortions? Given the lack of concern with the present elevation of the equity markets, these remarks from 2005 have a rather ominous ring in hindsight:

“First, if the bubble were to deflate on its own, would the effect on the economy be exceedingly large? Second, is it likely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble? My answers to these questions in the shortest possible form are, ‘no,’ ‘no,’ and ‘no.'”

The reason that the Fed does not see an “obvious” stock market bubble (to use a word regularly used by Governor Bullard, as if to imply that misvaluations cannot exist unless they smack their observers with a two-by-four) is because while price/earnings multiples appear only moderately elevated, those multiples themselves reflect earnings that embed record profit margins that stand about 70% above their historical norms.

We can demonstrate in a century of evidence that a) profit margins are mean-reverting and inversely related to subsequent earnings growth, b) margin fluctuations are largely driven by cyclical variations in the combined savings of households and government, and importantly, c) valuation measures that normalize or otherwise dampen cyclical variation in profit margins are dramatically better correlated with actual subsequent outcomes in the equity markets.

A few additional charts will drive this point home. The chart below shows the S&P 500 price/revenue ratio (left scale) versus the actual subsequent 10-year nominal total return of the S&P 500 over the following decade (right scale, inverted). Market valuations on this measure are well above any point prior to the late-1990’s market bubble. Indeed, if one examines the stocks in the S&P 500 individually, the median price/revenue multiple is actually higher today than it was in 2000 (smaller stocks were more reasonably valued in 2000, compared with the present). This is a dangerous situation. In this context, the dismissive view of FOMC officials regarding equity overvaluation appears misplaced, and seems likely to be followed by disruptive financial adjustments.

One obtains a similar view, with equal historical reliability, from the ratio of nonfinancial equity capitalization to nominal GDP, using Federal Reserve Z.1 Flow of Funds data. On this measure, equities are already beyond their 2007 peak valuations, and are approaching the 2000 extreme. The associated 10-year expected nominal total return for the S&P 500 is negative.

The unfortunate situation is that while the required financial adjustment may or may not be as brutal for investors as in 2007-2009, or 2000-2002, or 1972-1974, when the stock market lost half of its value from similar or lesser extremes, the consequences of extremely rich valuation cannot be undone by wise monetary policy. The Fed has done enough, and perhaps dangerously more than enough. The prospect of dismal investment returns in equities is an outcome that is largely baked-in-the-cake. The only question is how much worse the outcomes will be as a result of Fed policy that has few economic mechanisms other than to encourage speculative behavior.

Textbook speculative features

A discussion of bubble risk would be incomplete without defining the term itself. From an economist’s point of view, a bubble is defined in terms of differential equations and a violation of “transversality.” In simpler language, a bubble is a speculative advance where prices rise on the expectation of future advances and become largely detached from properly discounted fundamentals. A bubble reflects a widening gap between the increasingly extrapolative expectations of market participants and the prospective returns that can be estimated through present-value relationships linking prices and likely cash flows.

As economist Didier Sornette observed in Why Markets Crash, numerous bubbles in securities and other asset markets can be shown to follow a “log periodic” pattern where the general advance becomes increasingly steep, while corrections become both increasingly frequent and gradually shallower. I’ve described this dynamic in terms of investor behavior that reflects increasingly immediate impulses to buy the dip.

Along with this pattern, which has emerged with striking fidelity since 2010, we observe a variety of other features typically associated with dangerous extremes: unusually rich valuations on a wide variety of metrics that actually have a reliable correlation with subsequent market returns; margin debt at the highest level in history and beyond 2.2% of GDP (a level that was matched only briefly at the 2000 and 2007 market extremes); a blistering pace of initial public offerings – back to volumes last seen at the 2000 peak and featuring “shooters” that double on the first day of issue; confidence in the narrative that “this time is different” (in this case, the presumption of a fail-safe speculative backstop or “put option” from the Federal Reserve); lopsided bullish sentiment as the number of bearish advisors has plunged to just 15% and bulls have crowded one side of the boat; record issuance of covenant-lite debt in the leveraged loan market (which is now spreading to Europe); and a well-defined syndrome of “overvalued, overbought, overbullish, rising-yield” conditions that has appeared exclusively at speculative market peaks – including (exhaustively) 1929, 1972, 1987, 2000, 2007, 2011 (before a market loss of nearly 20% that was truncated by investor faith in a new round of monetary easing), and at three points in 2013: February, May, and today (see A Textbook Pre-Crash Bubble). Many of us in the financial world know these to be classic features of speculative peaks, but there is career risk in responding to them, so even those who view the situation with revulsion can’t seem to tear themselves away.

While I have no belief that markets follow any mathematical trajectory, the log-periodic pattern is interesting because it coincides with a kind of “signature” of increasing speculative urgency, seen in other market bubbles across history. The chart above spans the period from 2010 to the present. What’s equally unsettling is that this speculative behavior is beginning to appear “fractal” – that is, self-similar at diminishing time-scales. The chart below spans from April 2013 to the present. On this shorter time-scale, Sornette’s “finite time singularity” pulls a bit closer – to December 2013 rather than January 2014, but the fidelity to this pattern is almost creepy. The point of this exercise is emphatically not to lay out an explicit time path for prices, but rather to demonstrate the pattern of increasingly urgent speculation – the willingness to aggressively buy every dip in prices – that the Federal Reserve has provoked.

The way forward

In my view, good public policy acts to both impose and relieve constraints – focusing on relieving obstructive constraints when they actually become binding; imposing constraints where their absence creates excessive risk or the potential for undue harm to others; and avoiding policies where the risk of unintended consequences overwhelms the expected benefit from any demonstrated cause-effect relationship.

From this perspective, the policy of quantitative easing has run its course. It undermines planning, as every economic decision must be made in the context of what the Federal Reserve may or may not do next. It starves risk-averse savers, the elderly, and the disabled from interest income. It lowers the bar for speculative, unproductive, low-covenant lending (as it did during the housing bubble). It relaxes a constraint that is not binding – as there are already trillions of dollars in idle reserves at U.S. banks, on which the Federal Reserve pays interest both to keep them idle and to avoid disruptions in short-term money markets. It undermines price signals and misallocates scarce savings to speculative pursuits. It further skews the distribution of wealth, and while the extent of this skew has a scarce chance of persisting, the benefits of any spending from transiently elevated stock market wealth will accrue to primarily to higher-income individuals who are not as constrained as the millions of lower-income, low-asset families hoping for some “trickle-down” effect. We have seen numerous variants of this movie before, and we should have learned the ending by now.

Importantly, the magnitude of the “wealth effect” on employment is dismally small. Even if the entire relationship between stock market fluctuations and employment fluctuations was causal and one-directional, it would still take a roughly 40% advance in the stock market to draw the unemployment rate down by 1%. Unfortunately, price advances do not create the underlying cash flows to support them, so the strategy of manipulating stock prices higher also involves a piper that must be paid.

As for inflation-unemployment “tradeoffs,” we should all be clear about what the data look like in practice, particularly how weak and unreliable the relationships are between the two. There are numerous ways to plot the data. For example, lagging unemployment strengthens the positive relationship between inflation and unemployment, while lagging inflation flattens the nearly non-existent relationship from unemployment to inflation. One can augment this with expectations, or vary assumptions about NAIRU all one likes. The scatter is simply not amenable to a practical degree of “optimal control.”

This isn’t to say that A.W. Phillips was incorrect. Rather, his “Phillips Curve” was actually a relationship between the unemployment rate and wage inflation, in a century of British data when Britain was on the gold standard and general prices were stable. What Phillips said, in effect, is that unemployment is inversely related to real wage inflation. That proposition holds true in U.S. data as it does internationally. But it is hardly the basis for any strong belief that we can buy a few more jobs by targeting a higher inflation rate in the general price level.

It’s notable that the “dual mandate” of the Fed repeatedly includes the phrase “long run.” The Federal Reserve has not been asked to be “data-dependent” in response to every monthly fluctuation in output, employment and financial markets. Instead, the Fed is asked to consider the long-run effects of its actions. Minimizing the consideration of longer-term risks in the pursuit of outcomes that are largely beyond the reliable effects of the Federal Reserve’s tools cannot be justified by referencing the Federal Reserve’s mandate.

The intent of this letter is not to criticize, but hopefully to increase the mindfulness of the FOMC as to historical evidence, the strength of various financial and economic relationships, and the potentially grave consequences of further relaxing constraints that are not binding in the first place.

To some extent, certain consequences are baked-in-the-cake, as are various adjustments that the Federal Reserve will have to make in order to normalize its policy stance in the years ahead. Gradually rolling assets off the balance sheet as they mature is certainly an option, though the time profile of maturities is not smooth, the strategy may not be robust to material economic acceleration even several years from now, and such a strategy will continue to punish risk-averse savers for years. You already know my views on what a time-consistent path for normalizing the balance sheet would look like.

The immediate objective, I think, is to continue to emphasize that a gradual reduction in the pace of Fed purchases is distinct from a “tightening” – our own estimates are that a contraction of more than $1 trillion in the Fed’s balance sheet would be required simply to bring Treasury yields to 0.25% without raising the interest rate the Fed pays on excess reserves. Having missed the opportunity for a broadly anticipated “taper” in September, and having provoked even greater speculation as a result, the potential disruption of even a small move in this direction is a legitimate concern. At whatever time this occurs, my own view is that even $10 billion may be too large for a speculative market to swallow, while $5 billion is so small that it could make the Fed appear timid. One might suggest $8.5% billion, or 10%, which is so small a taper that the markets would hopefully view an overreaction as ridiculous – which is not to say that the markets would not overreact even then. From the standpoint of a financial market participant, I can’t emphasize enough how broadly the Fed is viewed as the only game in town.

There is certainly more progress that needs to be made on employment and economic activity. The legitimate question is whether continued relaxation of non-binding constraints is likely to produce this outcome without the increasing risk of severe and unintended consequences. This is a question that begs not for verbal arguments, but empirical evidence, realistic estimates of effect sizes, and clear transmission mechanisms. The Federal Reserve has a critical role in easing constraints – particularly shortages of liquidity in the banking system – when they become binding, and in applying constraints and oversight – or at least refraining from further harm – when risks become untethered. The second aspect of that role is far more imperative today than might be obvious.

I hope that some part of this is useful.


John P. Hussman, Ph.D.

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Outside the Box and is not an offering for any investment. It represents only the opinions of John Mauldin and those that he interviews. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest and is not in any way a testimony of, or associated with, Mauldin’s other firms. John Mauldin is the Chairman of Mauldin Economics, LLC. He also is the President of Millennium Wave Advisors, LLC (MWA) which is an investment advisory firm registered with multiple states, President and registered representative of Millennium Wave Securities, LLC, (MWS) member FINRA, SIPC, through which securities may be offered . MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB) and NFA Member. Millennium Wave Investments is a dba of MWA LLC and MWS LLC. This message may contain information that is confidential or privileged and is intended only for the individual or entity named above and does not constitute an offer for or advice about any alternative investment product. Such advice can only be made when accompanied by a prospectus or similar offering document. Past performance is not indicative of future performance. Please make sure to review important disclosures at the end of each article. Mauldin companies may have a marketing relationship with products and services mentioned in this letter for a fee.

Note: Joining The Mauldin Circle is not an offering for any investment. It represents only the opinions of John Mauldin and Millennium Wave Investments. It is intended solely for investors who have registered with Millennium Wave Investments and its partners at (formerly or directly related websites. The Mauldin Circle may send out material that is provided on a confidential basis, and subscribers to the Mauldin Circle are not to send this letter to anyone other than their professional investment counselors. Investors should discuss any investment with their personal investment counsel. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments. John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private and non-private investment offerings with other independent firms such as Altegris Investments; Capital Management Group; Absolute Return Partners, LLP; Fynn Capital; Nicola Wealth Management; and Plexus Asset Management. Investment offerings recommended by Mauldin may pay a portion of their fees to these independent firms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor’s services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Since these firms and Mauldin receive fees from the funds they recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.


Hussman Strategic Advisors