Did the Fed Save us from a "Liquidity Trap"?
Is this a Global Central Bank Bubble? How will the Markets React?
11/04/14 4:00 PM
There have been a number of very sophisticated economists who recently made some presentations on the financial networks discussing just how effective the Federal Reserve was in being able to avoid a “liquidity trap”. One economist in particular used the avoidance of a “liquidity trap” a number of times as he praised the Fed.
We, at Comstock, were shocked at the praise given to the Fed when we don’t believe the Fed rescued the U.S. from the ravages of a “liquidity trap” at all, but even more shocking to us was the response of the interviewers. We are sure that there were not many people watching on TV that understood the definition of a “liquidity trap”. Yet the economist was never asked to explain it. Hopefully, in this comment we will explain what a “liquidity trap” is, and why we don’t think the Fed avoided the “trap”. We will also explain why we think the Fed painted themselves into a corner and will have to keep rates very low, continue increasing their balance sheet, and maybe even resort to QE 4. We are skeptical that going back to the same old fashioned government subsidies used by the Fed over the past six years will work any better than they did for the past six years.
A “liquidity trap” as defined by BusinessDirectory.com, is a situation when bank cash holdings are rising and banks cannot find a sufficient number of qualified borrowers even at incredibly low rates of interest. It usually arises where people are not buying and firms are not borrowing (for inventory or plant and equipment) because economic prospects look dim, investors are not investing because expected returns from investments are low. People and businesses hold on to their cash and thus get trapped in a self-fulfilling prophecy. Wikipedia agrees that a liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Thus, if an economy enters a “liquidity trap”, further increases in the money stock will fail to lower interest rates and, therefore, fail to stimulate.
We believe that this country and many other countries across the globe are intertwined in this “liquidity trap” presently. It is clear that the Fed has tried to pump as much money as possible into the U.S., but for the past 50 years M1, M2, and M3 have grown at around 7.5% and this past year the Ms grew at 1.5%. According to the Federal Reserve figures and Moebs Service the average checking account balances have averaged about $2,000 for most of the post WW II period, but now they have grown to $3,700 in 2011, $4,400 in 2012, $5,000 in 2013, and $5,800 now.
We are clearly in the same “liquidity trap” that Japan has suffered from for the past 24 years. This is the main reason that this economic recovery from the “great recession” is so weak. We understand that the 3rd quarter GDP came in at 3.5%, but the U. S. has been growing at around 2.2% over the past 6 years. The average recovery from recessions since WWII has been closer to 5%. That is just about double the recovery rate we are experiencing today following the worst recession since the “great depression”.
There was a lot of trepidation in the U.S. stock market as investors were concerned about QE 3 ending. Many investors were worried about the ending being similar to the 12% and 14% declines that followed QE 1 and QE 2. Instead, the markets handled that fairly well, which surprised us.
Then the news came out of Japan! The Bank of Japan (BOJ), the Ministry of Finance (MOF), and the Government Pension & Insurance Fund (GPIF) decided to do even more than our Fed. The BOJ raised its goal for the monetary base to 80 tn. yen from 65 tn. yen. The central bank’s governor, Haruhiko Kuroda, stated that this was aimed at “ending Japan’s deflationary mind-set.”
This past September, the GPIF was supposed to invest in more Japanese equities (going from 12.5% to 25%), but postponed the move until year end. They surprised most global investors last Thursday by not waiting until December. They announced that they would double their positions in Japanese equities to 25%. But, they were so concerned about deflation they also raised their positions in international equities exposure from 12.5% to 25%. They raised the cash to make these investments by trimming their domestic bonds from 60% to 35%. This announcement drove up all international markets significantly this past Friday (including a 7% upward move in the Nikkei).
We suspect strongly that this outrageous surprise move will not help the Japanese market over the long term and be just as ineffective as all the other moves the Japanese made over the past 24 years. Remember, they tried our form of QE about 20 months ago with no apparent inflationary results. Their latest quarterly GDP was down about 7%. They will keep trying to offset the deflation in Japan by exporting it to their trading partners by driving down their yen in relation to their trading partners’ currencies. This is called “competitive devaluation” and we have been stuck for years on this part of our “Cycle of Deflation”(which is attached). Soon, many countries that are caught in the “Cycle” will be forced to move down the “Cycle” to “protectionism and tariffs” and then next to “beggar-thy-neighbor” (an example of this is Saudi Arabia lowering the price of oil today in an attempt to gain market share from the U.S.). They are doing this in an attempt to export their deflation.
This global deflationary environment has resulted in a Central Bank “bubble” that we believe will end badly both here and abroad! The reason for this difficult deflationary environment all over the world is explained very well in The Geneva report titled "Deleveraging, What Deleveraging?" It explains that, most believed that the 2008 crash (caused by the debt explosion) would result in deleveraging. But, instead, due mostly by government spending, worldwide debt grew rapidly. According to the report, global debt as a percentage of GDP has risen 36 percentage points since 2008, to a record 212%.
A Global Deflation
As the Fed Tightens Monetary Policy
10/01/14 3:00 PM
Comstock, believe as the Fed tightens by ending Quantitative Easing 3 (QE-3)
this month, and plans on raising rates next year, that the stock market will
not do well and may wind up crashing.
Logic tells us that the Fed’s reduction in interest rates, and three QE
programs of buying Treasury Bonds and Mortgage Backed Securities has put all
other QE programs to shame. Clearly, the
programs we used to stimulate the U.S. economy was what drove the stock market
up approximately 200% from 2009. Now,
that they are in the process of ending this stimulus, isn’t it logical that the
stock market will decline substantially as these policies are reversed.
this shouldn’t be difficult to understand since when the 1st QE
program ended in 2010 the stock market declined 13.2% in 3 months. When the 2nd QE program ended in
2011 the stock market declined 18% over the next 3 months. Now, you may think that if the Fed decides to
come up with another QE-4, if stocks
decline, they can get bailed out again, but we don’t think they can pull
another rabbit out of the hat a 4th time.
to believe that we are in the midst of a global deflation that will end in
stocks following the same path as Japan after the Nikkei traded at close to
40,000 at the end of 1989. The reason for the Nikkei collapsing at the end of
1989 was because it became obvious that Japan was in the midst of a serious
deflation. It subsequently dropped to
about 7,000 and has been trading between 7,000 and 20,000 for the past 14
deflation we have discussed with our regular viewers over the past decade was
confirmed by other economic data released this week. For example the news of a weakening Eurozone
economic data with an unexpected rise in unemployment in Germany. The German PMI came in at 49.9 (the first
contraction in the past 15 months). The
German 10 year Bund is trading at .91% which is sharply lower than the U.S. 10
year Treasury at 2.38%. Also, the economic sentiment surprised on the
downside as factories slashed prices and inflation slowed to the lowest reading
since the height of the financial crisis.
The European Central Bank (ECB) is meeting today and they probably will
be announcing some form of QE and rate reduction tomorrow. It looks like the Eurozone will be entering
another recession, as well as most South American countries, and Japan which
just reported the second quarter GDP at negative 6.8% as they raise consumption
taxes. China’s debt continues to grow as
their credit cycle peaked, and their attempt to build empty buildings and homes
has backfired while their debt to GDP ratio has grown to over 217%. All this, and commodities continue to collapse.
Geneva report stated that “global debt levels are still rising mostly in
developing countries. Contrary to widely
held beliefs, the world has not yet begun to deleverage and the global debt to
GDP is still growing, breaking new highs.
At the same time, in a poisonous combination, world growth and inflation
are also lower than previously expected.
Debt levels are also rising in the fragile eight countries of India and
Indonesia in Asia, Brazil, Argentina and Chile in South America, plus Turkey
and South Africa. These are all major
emerging markets that suffered credit bubbles and escalating current account
deficits following quantitative easing by the Fed.”
market, measured by the S&P 500, has gone to extremes from the low in March
of 2009 (5 ½ years) without a bear market (down 20% or larger), or from the
high level mark since October of 2011 (1100 days) has not had a correction
(down 10% or larger). This bull market
is what you would consider to be “long in the tooth” anyway you want to
Different Positions about the Federal Reserve's Policies
9/04/14 7:00 AM
Many sophisticated institutional investors are in a camp
that believes the Fed is behind the curve and if they don’t raise rates soon we
will have a high probability of entering a period of either bad inflation, or
possibly even hyper-inflation. Other
camps are supportive of the Fed’s policies in varying degrees.
The example used by the first camp shows that if an
economist was on Mars over the past 5 years and landed in this country, he would
see that we had a decent recovery with the unemployment rate down to 6.2% (almost
full- employment). The rate declined from 10% in October 2009 to 6.2% presently,
and inflation, based on the CPI, of over 2%.
He would not believe that the interest rates controlled by the Fed (or
Fed Funds Rate) would still be at 0 to 0.25%.
He would have thought that the Fed is so far behind the curve that, by
the time they started raising rates, inflation would be “out of control”.
Another camp believes that the Fed is using the correct
policy of not raising rates because half of the countries in the world are
either in a recession or about to enter into a recession. Witness Japan with negative GDP of 6.8%,
Italy that just entered their third recession, Germany and France about to
enter a recession, almost all of South America already in recessions, and
China’s recent debt contraction and real estate over building will drive them
into a major slowdown or crash. Even
though the U.S. was in the best shape of the developed countries we would not
be able to “go it alone”. And if the Fed
raised rates we would be in even more trouble than the other developed
We, at Comstock, believe that the excess debt, not only in
the U.S. but globally will drive developed countries into a deflationary
scenario that could be worse than the “great recession” we experienced in 2007,
2008, and 2009. We see the decline in
commodities (corn, soybeans, hogs, sugar, copper, energy, and even precious
metals), and the decline in interest rates throughout the globe to signal
deflationary forces at work. We have
been worried about this for some time using the “cycle of deflation” (attached)
to make our point. The cycle is still
stuck in the competitive devaluation of currencies segment.
We have used this chart many times in these comments that show the
effect of over indebtedness just like the U.S. in 1929 and Japan in 1989. We wrote the “special report” called
“Inflation vs. Deflation” in June of this year.
We sincerely wish to be wrong about this, but that is our position!
A piece written just this week by the St. Louis Fed confirms
our opinion and goes into the same reasoning we used in the June report. Their report is called “What Does Money
Velocity Tell Us about Low Inflation in the U.S.”? It shows why the U.S.
consumer is hoarding money instead of spending it and generating the inflation
that is normally caused by the typical money printing by the Fed. They explain that the reason for hoarding
instead of spending lies in a combination of two issues: 1. A looming economy
after the financial crisis. 2. The
dramatic decrease in interest rates that has forced investors to readjust their portfolios toward
liquid money and away from interest-bearing assets such as government
bonds. In this regard, the
unconventional monetary policy has reinforced the recession by stimulating the
private sector’s money demand through pursuing an excessively low interest rate
policy. (i.e., the zero-interest rate policy). In this same piece, just published, they show
why increasing the monetary base is not increasing inflation because “money
velocity” is declining dramatically. They
state, as we did in “Inflation vs. Deflation”, “if the money velocity declines
rapidly during an expansionary monetary policy period, it can offset the increase
in money supply and even lead to deflation instead of inflation” (see
Finally, we have some support from the "main stream" for our “cycle of deflation”
coming from the well-respected St. Louis Federal Reserve.
This is What Happens When the Fed Tightens!
When Rates Rise, After Enormous Easing, It Ends Ugly!
7/31/14 9:30 PM
We know we
just changed our comments to the first Thursday of every month rather than each
Thursday. However, we thought it might
make sense to write this comment since we have been discussing what would
happen when the Fed’s monetary ease comes to a halt.
financial press and media were at first concerned about the Portugal,
Argentina, and Ukraine problems as well as the Russian sanctions, but the
overriding problem was the potential for reversing the monetary easing. We had a taste of the Fed possibly raising
rates a little earlier than expected when the Employment Cost Index rose 0.7% for the second quarter.
This was the largest increase for the past 6 years. After this was released the Dow Jones Industrials erased all the gains for the year by dropping over 300 points. We have consistently warned our readers about
the ramifications of the unwinding of the Fed’s loose monetary policies of the
past few years.
In fact, we
just wrote on June 19th, “What Happens When the Fed Unwinds Their
Balance Sheet?” In it we stated, “The
Fed has tried to stop QE strategies before but were unsuccessful. During the first two QE programs, they set a
date when the programs would end. Once
those dates were announced, the markets began to unravel which resulted in the Fed
starting another QE. They essentially
had to start a new QE in order to keep the “wealth effect” alive. Apparently, they noticed that stopping their
programs at a specific date was not working, so they came up with the idea of
getting out gradually (tapering) as if no one will notice and everything will
go back to normal.” We also stated, “However,
we believe the market will correct significantly before the Fed ends the
tapering of the bond purchases.” We also
stated that if and when the market corrects, the Fed may change course and
start another QE.
For all the
people that believe the Fed is omnipotent, you have to keep in mind that the
Fed did not see the bubble that they were causing in housing all through 2003,
2004, 2005, 2006, and 2007 when they lowered Fed Funds to 1% in June of 2003
and kept it there for a year. They also
watched as banks and mortgage companies enticed every American with a heartbeat
to buy homes they couldn’t afford. The
Fed had to use loose monetary policy after the housing bubble burst, but they
still never believed that they caused the bubble in the first place. Greenspan proclaimed that it is
impossible to recognize a bubble until it bursts—and remember Greenspan had the
control of the Fed throughout 2003, 2004, and 2005.
with what the Fed is doing now, is that they have taken the policies that were
needed in 2009 with QE-1, 2010 with QE-2, and started the latest QE-3 that was
driven by bond purchases, and no ending time limit (this is why it was called “QE
to Infinity”). The problem with what the
Fed has done is that they have taken the policies needed with “QE to infinity”
is that it got out of control by expanding the Fed’s balance sheet from $800
billion to $4.4 trillion while keeping the Fed Funds rate at close to
zero. The negative
stock market’s reactions to the unwinding of their balance sheet, or even just
any indication of rising interest rates will be a problem for the stock market.
Now, every time there is any indication of the Fed raising interest rates
or the unwinding of their balance sheet, we believe the ending of this
excessive monetary policy will be ugly!
Why Cyclically-Smoothed Earnings Make Sense
7/10/14 7:30 PM
Almost all professional investors look at the P/E ratio
of the stock market, but rather than smoothing the earnings as we do, they look
at either the past 12 months of earnings or the estimates of earnings over the
next year. We can’t believe how many
sophisticated investors use the P/E ratio based on the past year or following year. The reason we attempt to smooth the earnings is
to dampen the volatility that one year of earnings has had over the past
decades. This will make it easier to
make longer term decisions.
An example of the volatility of one year of earnings over
the past 14 years would be that “reported earnings” (or GAAP—Generally Accepted
Accounting Principles) were $50.00 in 2000, $24.69 in 2001 and came back to
$48.74 in 2004. The earnings “estimates”
over that period of time also had tremendous volatility and it boiled down to
almost a guess. So how could you
possibly base an intelligent investment decision during that time? Also earnings were $66.18 in 2007, $14.88 in
2008, and $50.97 in 2009. Earnings are among
the most mean-reverting statistics in investing, and therefore there has to be a
better way of determining the “true” earnings.
Earnings always return to the trend and the long term trend of earnings growth
over time has consistently averaged about 6% despite the year-to-year volatility.
The idea of smoothing earnings over a period of more than
a single year was first proposed by Graham and Dodd in their classic book “Security
Analysis” published in the early 1930’s.
Cyclically—smoothed earnings have proven to be a much more accurate
predictor of long-term market returns than any method that uses earnings over
the past year or following year. In
fact, we used this method in late 1999 when we published a report forecasting
that the normalized S&P 500 would be about 1260 ten years from then. That was significantly below the then
prevailing price. It was a projection we
made near the peak of the dot-com bubble.
Almost everybody thought the forecast was crazy although it eventually
proved to be highly accurate.
What we do to smooth reported S&P 500 earnings over a
longer period of time is to calculate an average of the past 9 years (which
usually includes at least one and often two business cycles) . We then take that average of the 9 years and place
it in the 5th year, the exact mid-point of the 9 years. We then increase that number by 6% per year
to the last of the nine-year period and use that number as our normalized
earnings for the most current period.
Using that method our normalized earnings for the 12 months ended March
2014 is $90. Then we divide the S&P 500 level of 1970 by the normalized
earnings of $89 and come up with a PE of about 22.. This represents a very expensive level for
the stock market, and was exceeded only in 1929, 2000 and 2007.
There are others in the investment community that also
normalizes earnings such as Robert Shiller, John Hussman, and Ned Davis. They each actually use a longer time frame
than we do, but each of them comes to the same conclusion that the stock market
with normalized earnings is expensive and overvalued.
Note: From this point, we will issue our comments on the
first Thursday of every month, rather than every Thursday, although we may
sometimes do additional commentary when it is appropriate.
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