People Are In Danger Of Suffering Catastrophic Losses

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2014/5/18_People_Are_In_Danger_Of_Suffering_Catastrophic_Losses.html

Bond markets under stress

I've been warning of this for since late 2008. The fixed-income markets dwarf the equities markets. If the bond market breaks, run for the hills.

http://www.ft.com/cms/s/0/c51fbbce-3908-11df-8970-00144feabdc0.html

The bond vigilantes are finally flexing their muscles. A long period of stability for the US government bond market showed signs of cracking this week as a lack of investor appetite for new debt sent the benchmark 10-year yield to its highest level since last June.

The term “bond vigilantes” was coined in the 1980s when bond investors pushed up long-term yields to force central banks into taking action to curb inflation. This time, bond investors are less worried about inflation: they are fretting about huge fiscal deficits and the looming bond supply needed to finance them.

“Everyone thought we would see rising rates due to higher inflation, but it appears the bond vigilantes are demanding a higher real rate due to concerns about Treasury issuance,” says George Goncalves, head of fixed income strategy at Nomura Securities.

Worries about the debt loads of developed economies have come into focus this year amid the crisis threatening Greece and other members of the eurozone periphery.

“The spotlight on Greece only helped to reveal that the US’s kitchen – with Federal and state budget balances – was itself full of cockroaches,” says William O’Donnell, strategist at RBS Securities.

Treasury Bonds tanking

Today was a watershed event in my eyes. Despite the feel-good moment the media and powers-that-be are trying to portray with today's presidential lunch, the markets reacted very unfavorably to Paulson's semi-admission that we are not out of the woods yet. For those that follow fixed-income markets (which is much bigger than the equities market, and hence, much more foretelling), the Treasuries bubble has burst, and the Fed and Treasury will no longer be able to influence the long end (30-year bonds). They have dropped short-term interest rates as low as they could, but the long-end is mostly market-driven. Buyers of bonds believe inflation will be muted going forward (either 10, 20, or 30 years). Sellers of bonds believe inflation will erode their returns. Mistakenly, bond buyers also believe they are safe havens. The future will prove this assumption false, as bond prices are subject to the soundness of the currency, inflation expectations, and supply/demand of said Treasuries.

Once the market figures out (and it eventually will) that the USDollar is about to be a toilet paper currency, they will demand higher rates of return, driving up interest rates--and basically undoing what the Fed and Treasury have worked so hard to do--lower long rates to reduce mortgage rates, and stabilize the housing market (hopefully). In other words, the gov't can only do so much--and artifically keep long rates down for only so long. The dam will eventually break, rates will soar, as will inflation eventually. The bottom line is that the Chinese and Japanese will no longer support the US deficit (our funding needs are in the trillions) and stop buying our Treasury bonds, as they retrench and try to stimulate their own economies. In other words, buyers at our huge debt financing auctions will be scarce. This is the final bubble bursting, and this time, no one will be able to step in to prop it up.

Anybody who lived thru the 70's knows how ravaging high interest rates are. To be honest, I've been shorting T bonds for a couple weeks, and with Barron's article over the weekend proclaiming the same, I actually have more conviction, as Barron's is one of the few prescient mediums. Gold is still in a secular bull market, but it is taking a necessary pause due to deflationary concerns. But even the Fed and Paulson are acknowledging the long-term risks of what they are doing--they just can't help themselves as they fear the mother of Depressions. Problem is, they are only delaying it, and exacerbating it with their monetary and quantitative easing (providing credit and injecting capital).

Despite periodic snapback rallies, we are in for a different era--and it's not going to be pretty. We are in for several years of deleveraging, with markets moving sideways with a downward bias. Gold and silver will continue their secular bull market.

I have incorporated a wave investment thesis, and firmly believe big asset moves occur approximately every 20 years. It's uncanny, and there is a reason for it: investing is generational. We have lost a whole generation of investors who will never touch stocks again, due to scandals, crises, TWO stock market bubbles, fraud, and most of all, LOST money and lost confidence that buy and hold works. They've seen their grandparents' retirement savings dissipate overnite, their parents lose their jobs, and their own job prospects bleaker than ever. THIS OCCURRED IN THE LATE60'S/EARLY 70'S, USHERING IN A DECADE OF DOLDRUMS! The former Nifty Fifty stocks collapsed, and I recall my dad's friends declaring they will never invest in stocks again. They were justified--until the 1982 bottom, when smart investors eased back into stocks, while the general public was shunning them. Previous false rallies were met with shunted resistance, causing the last bulls to throw in the towel.

A bottom was only formed because Volker said enough is enough, and raised interest rates into double digits (money market accounts were earning 12-13%!). Mortgage interest rates were 15%, because Volker shook out the excesses, and then ushered in lowered rates.

So given that this bear market began in 2000 with the tech bust, we've got another 8-10 years of crappy returns, with sawtooth volatility and sucker rallies. Warren Buffett himself warned of this 8 years ago, as he said investors needed to lower their expectations of equities going forward. Remember: between 1982-2000, stocks had their best run EVER! (Unfortunately, the average investor only earned 2.3% per annum during that span, as they are horrible market timers).

In fact, the only asset that gained in the 70's was our friend gold. I have no idea of the timing, but it is coming. Shorter-term, I'm already up 40% on my short T-bond trade (it's a double-short ETF) in a week. Despite further attempts to prop up bond prices, eventually the avalanche of sellers, and lack of buyers will usurp any attempts to prop up the US bond market.

Why "quantitative easing" will work, but at what cost?

The tandem of the Federal Reserve and the Treasury have taken extraordinary measures to solve the credit crisis. They've lowered interest rates as low as they can go (Treasury bills temporarily dipped below 0% yield recently), providing the markets with plenty of credit. The problem was no lenders were lending, and no borrowers were borrowing. Lenders used the swaps to shore up their balance sheets, dumping bad assets for Treasuries, but they weren't lending.

The Treasury stepped up by pumping the system with trillions of dollars, injecting capital in hopes of stimulating spending. It worked, so we can expect them to step up their efforts. It's one thing to extend credit; now the government is literally printing money out of thin air.

This is, by definition, inflationary. It's necessary to avert a category 5 Great Depression, but it will prove to be problematic down the road when hyperinflation rears its ugly head. Printing money also debases the local currency, as the US Dollar continues to plummet. This flight to quality and perceived safety (short-term T-Bills and long-term T-Bonds) is bumping interest rates down to historical lows, due to the high demand for Treasuries. The operative word is "perceived" as I will soon explain.

My investment thesis is that this low-interest environment will eventually reverse course, as investors demand higher rates of return once they realize how flimsy the US Dollar is. Parking money in Treasuries at such low rates will prove to be disastrous, as inflation asserts itself, accompanied by higher interest rates. Finance 101: when interest rates rise, bond prices decrease.

With borrowing costs so low, we are to the point where any asset other than cash seems too irresistible to pass up. Having said that, with fears of deflation and blood in the streets, temporary irrational pessimism could cause markets to undershoot more than they have. Therefore, despite snapback rallies, further lows could be tested in equities and real estate in this secular bear market.

It is impossible to time market bottoms or tops, but there is value for the patient. My contention is that inflationary monetary policy will eventually lead to inflation, and that precious metals will resume their secular bull market. Equities and other commodities will follow suit within the new couple years, and real estate will recover within 3 - 5 years. I am unsure of the timing, but the direction will reverse course eventually. In other words, I can't call the bottom, but we are closer to the bottom than a top, as many have already taken a 50% haircut on their portfolios and 30% on their home values.

Hence, my current positions are long gold, long the Japanese yen (short the US Dollar), short Treasury Bonds (10 - 30-year maturities). With inflation and rising interest rates, bond prices will plummet going forward.

For those favoring income and dividends, I believe high-quality corporate bonds are extremely attractive relative to Treasuries. A handful of shares are attractive, including companies with leading market share, high cash reserves, strong cash flow, and no debt. For the non-faint of heart, some high-yielding (junk) bonds may also be profitable due to their extreme spreads (20 points above Treasury yields). But be prepared for high default rates.

Please consult your investment and tax professional before investing.

What happened?

The stock market, and pretty much every other assets are plummeting due to hedge fund, mutual fund, and private equity firm redemptions. Investors are bailing out, so these funds have to sell assets--any good assets to raise cash. They can't sell the bad assets because no one wants them. So they are unloading good assets at low prices--that's why value players are salivating, but they keep getting burned because assets at cheap prices are getting hammered and getting even cheaper. This tug of war between bottom fishers and forced asset sellers is what's causing the high volatility. Overall, tho, the sellers are winning, as they are panic selling in droves, swamping any brave buyers. Eventually, these buyers lose out (at least in the short term), as even the savviest value buyers are seeing their entry points as being too early and too high, despite metrics that suggest they are good buys. Ultimately, over the long-term, these value buyers will be proven correct, but for now, guys like Buffett and Soros have seen their positions drop by more than 10-20%, despite buying assets that have already dropped more than 50% already.

For example, if a solid company's share price has already dropped 80%, it may seem cheap. It may be, but that doesn't preclude it from dropping another 50%. Let's say a stock is at $100 last year during its peak. It is now at $20. A Buffett buys at that price, thinking he's getting it at a bargain. He may be right (based on projected earnings growth, or more correctly, discounted cash flow), but that doesn't mean the stock won't drop to 10 before bottoming out, say next year. Ultimately, if the stock is worth $50 a share, Buffett may ultimately win out (he usually does), but only if he has a long-term view. While he may be annoyed, and since he's got plenty of cash, he can wait it out.

Realize that the fixed-income market dwarfs the equities (stock market)--that's why the subprime mortgage debt bomb obligerated everything around its wake. I wrote a quick email to some folks recently:

"That's not entirely correct. Derivatives allowed investment banks to transfer that risk to shareholders and get it off their books. When default rates on sub prime mortgages reached inevitably high rates, the credit default swaps (CDS) blew up, as they insured the sketchy collaterized debt obligations (CDO).

These CDS's are basically contracts which insured these mortgages against default--in this case, highly-risky subprime mortgages to marginal borrowers. The problem was that insurers like AIG didn't charge enough premium to insure these mortgages, as everybody assumed California real estate prices would always go up, and that few borrowers would actually default. With home prices/income ratios above 10, this assumption was unsustainable. And because these derivatives were highly-leveraged ($1 could control $40 or $100 due to Wall Steet's repackaging of said debt), if those assumptions turned sour just a little bit, whatever little equity put up as collateral disappeared. And once the selling of assets to unwind from those positions began, the vicious spiral just fed upon itself, as everybody had to de-leverage from their overly leveraged positions. It became a Category 5 game of hot potato, and the investors (hedge funds, pensions, institutional money) got burned, while chasing the high yields during good times.

Wall St. did a great job of selling this "AAA" paper as non-risky, when they were extremely speculative. The ratings agencies were unknowing perpetrators of this shell game. Wall St. repackaged these @#@% loans, and the ratings agencies gave it their blessing as low-risk, investment-grade securities. What compounded the problem is that some of this paper was created without even any mortgages to back them.

Derivatives by definition use leverage. It can be useful for hedging strategies, but hedge funds didn't use them as hedges--they used them as levers to squeeze out more returns. When the bets turned against them, they had to sell assets to raise cash as investors headed for the exits. This de-levering is causing markets to tumble.

I could go on ad nauseum, but I think you get the picture. I don't worry about what happened--I was able to avoid most of the roadkill, as I was out of the market in June. I am concerned about what's going to happen next, and I'm afraid the worst is ahead of us. We are going to see a carnage unseen since the Great Depression, as the unwinding of positions is not over yet--not even close. Thankfully, I've got a strategy in place for me and my clients which will enable us to not only survive this crisis, but also profit handsomely from it.

Without going into details, it does involve certain currency plays, financial institutions here and abroad, and various asset plays, including equities (surprisingly). More shoes will drop, and there will be bigger shocks and bank failures, some unfathomable only a few months ago. I predicted GM would be insolvent as far back as two years ago when people thought I was crazy (all documented in my blog). Last month, CNBC splashed it on their headlines, and now CNN has it on theirs.

I can send you a link to my blog, as well as what to Google. I will not do the research for you, but I will point you in the right direction. I will tell you the strategies will not be mainstream or conventional, but then again, conventional hasn't worked, has it?

I will give you this thought in case you think I am ringing alarm bells unnecessarily. Everybody is bitching and moaning about a $700 billion bail out (which is less than $1 trillion). Recall I mentioned CDS's as basically insurance--only they were labeled by Wall St. as "swaps" in order to avoid regulation (insurance contracts are heavily regulated, and you can't pile leverage on them). They were creating these insurance contracts with no regulation, and hence, no reserves to cover them. Guess how many swaps were written, and how big the derivatives market is? Some are predicting over $500 trillion! (A definitive number is difficult to calculate since these products were so complex, were sold so many times, and generally not transparent). In other words, there's no bailout that will mitigate this deleveraging. The current band aid will only prolong the process, but the perfect storm will come down upon us--soon."

As an edit: we've lost $10 trillion in equities market capitalization (net worth) in the last two months. That figure will seem minuscule when these derivatives blow up in our faces, and when Paulson et. al will no longer be able to hide it from the public. Read his past comments over the past year and a half. You will see he has hoodwinked us all along.