Tuesday/Thursday Market Commentary

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12/31/14 3:00 PM


We write to reiterate that the United States and other major stock markets are in what we have termed the “Central Bank Bubble”.   In December, the U.S. stock market staged a furious comeback rally following a rapid and substantial decline.   Just prior to the latest upturn, the market seemed ready and poised for further and even more substantial declines.  The rally appears to have been precipitated by the Fed substituting the word “patience” for “considerable time” in their latest policy statement.  While we were disappointed that the markets rallied based on the simple parsing of words, we remain convinced that deflation, overvaluation, and Fed policy in response have intertwined to cause one of the largest stock market bubbles in history.   

We see nothing that would cause us to change our opinion.  Let us once again point out the near zero interest rate policy and three quantitative easings (along with operation twist) that have not only expanded the Fed balance sheet to unprecedented levels but have thoroughly distorted our capital markets.  With returns to investors in money market funds at zero, investors have had to chase yield in both the stock and bond markets.   A glaring example of capital market distortion is at the sovereign level where the US 10 year Treasury yields 2.16%; while Portugal's 10 year trades at 2.76%,  Italy trades at 1.92%, Spain at 1.63% and Germany at .54%.  A further example of distortion caused by zero rate policy is near record low yields in US Corporate Bonds combined with record high issuance; now over $2tn. for three years running.   Much of the debt sale proceeds have been used to fund share repurchases, which in our view has artificially propped up earnings, while leaving corporate balance sheets more leveraged and revenues lagging.

Importantly, the velocity (turnover of money) of the M2 money supply has remained near the lows of the past 60 years.  That statistic serves as proof that the Fed’s efforts are getting very little “bang for the buck”.  We also observe that the several different commodity price indexes declined to their lowest point in the past 5 years and shows no sign of bottoming.  And as you all know energy prices have been collapsing, as supply is overwhelming demand--many think that energy prices are holding back the U.S. bull market by hurting other countries abroad. Soon they will realize that the commodity price decline (see attachment) is caused by the global distress--not the other way around. For example, Europe will be attempting to do whatever it takes to prevent more deflation with a vote to start a new QE policy at the January 22nd ECB meeting.  Japan is lowering corporate taxes to try to exit 25 years of deflation, and China is trying to prevent a credit bubble crises now that they are no longer the growth engine of the world.  And while they are attempting to move from an exporting led economy to a consumer led economy, in the face of a property overhang.  There are many more examples of stress in the global economy. 

The Fed is about to raise interest rates sometime in 2015 (for the first time in 6 years), and that could be trouble for stocks just as it was after the ending QE-1, and QE 2.  On the other hand, if they don’t raise rates it would only be based on failed QE policies that were supposed to revive the economy.  This is the incredible dilemma that the Fed faces in the coming year.

All of the aforementioned factors are screaming "deflation". Thus far the market has not heard the message.   But we are convinced that it will be heard, and when it does, we believe the U.S. stock market will decline precipitously (see Cycle of Deflation attachment).  

With that being said, we still wish all of you a Happy and Prosperous New Year!

The Central Bank Bubble
As Bad as the Dot Com and Housing Bubble?
12/03/14 2:30 PM

As the long term shareholders of Comstock Capital Value Fund are aware, we warned about the dot com bubble during the late 1990s, and the housing bubble of 2004 to 2008.  We admit to being very early in both bubble predictions.  Presently, we strongly believe that we are in the process of building yet another bubble.  It may well be called “The Central Bank Bubble”.   


It was very painful for Comstock to warn about these bubbles so early, but we must call the markets as we see them.  Recall that Alan Greenspan recognized the dot com bubble as early as December 1996 when he warned investors about “irrational exuberance”.  The warning roiled the stock markets both here and abroad before reaching a trough in early 1997, but the bubble resumed and continued for the next 3 years.  In fact, the NASDAQ Index doubled from 1998 to early 2000.  Dr. Greenspan subsequently reversed his feelings of “irrational exuberance” and instead proclaimed “no one is able to recognize a bubble until it bursts”.


The reason we bring up these two bubbles is because we warned our investors about them years in advance of their bursting.  We now have been warning our investors about the Central Bank (CB) bubble for the past 3 years.  While we did go neutral on the market in 2009, it was after the market rose by about 50% that we began shorting stocks again.  We will continue warning our investors about the CB bubble until it bursts no matter how painful it is during the last stages of the bubble.  We fully expect another crisis to come down on stock investors for the third time in the past 14 years.


Most investors were pleased with the announcement of another 200,000+ employment report, and a 5.8% unemployment rate for October.  The 200,000 barrier was reached for the 9th time in a row.  However, please consider what the Federal Reserve did to get the employment number over the 200,000 barrier.  Consider that in 2008 the Fed’s started with QE 1; in 2010 came QE 2, and in 2012 came QE 3, or some would call it QE to infinity.  QE 2 and QE 3 were separated by “Operation Twist” (the purchase of long Treasury bonds while selling short term Treasury bills).  The Fed’s balance sheet ran up from $800 bn in 2008 to close to $4.4 tn presently.    


It is a statistically significant fact that with this entire monetary stimulus, along with $800 bn of fiscal stimulus, this economic recovery is less than half as strong as the average recovery from recessions over the past 60 years.  Each average GDP recovery since 1983 has been progressively weaker; with the last 3 being 3.6 % following the 1991 recession, 2.8% following the 2002 recession, and 2.2% following the 2008 recession.  This decline in recession recoveries was directly attributable to the continuous build-up of debt.  All this in the face of potential insolvencies in Medicare, Social Security, and the Pension Benefit Guarantee Corporation’s high probability of going under within 15 years.   It stands to reason that an economy that is weak in the face of unprecedented easy money and zero interest rates will be even weaker when the Fed unwinds its balance sheet.


Please also consider that the other major central banks in the world are attempting to stimulate their economies in much the same manner as the Fed in the face of extremely large debt loads.  While US Debt to GDP stands at 330%, the EU and Japan stand at over 460% and over 655% respectively.  It is also significant that these large debt loads are also present in the emerging economies.  We therefore, continue to believe that until the large debt overhang in the world economies is substantially reduced that growth will be limited or potentially negative.



It is the facts stated above, combined with extremely expensive stock market valuations across all major markets of the world that compels us to warn our investors about the potential for a third bubble busting in the short span of about 14 years.

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

We, at 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. 


Remember, 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.  


We continue 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 years. 


The global 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.


The current 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.”


This bull 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 measure it. 


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 countries.

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 attachment). 

Finally, we have some support from the "main stream" for our “cycle of deflation” coming from the well-respected St. Louis Federal Reserve.    


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