Lord Rothschild: "This Is The Greatest Experiment In Monetary Policy In The History Of The World" (August 2016)....now the experiment apparently failed.

In June 2016, the bond manager of what was once the world's biggest bond fund had a dire prediction about how "all of this" will end (spoiler: not well).

Then was the turn of another financial icon, if from a vastly different legacy -  and pedigree - that of Rothschild Investment Trust Chairman himself, Lord Jacob Rothschild, who appears to be the latest entrant to the bearish billionaire club. 

We were surprised to find his summary of recent events downright gloomy, and certainly non-conforming with a stock "market", manipulated by central banks as it may be, trading at all time highs. Here are the key excerpts:

The six months under review have seen central bankers continuing what is surely the greatest experiment in monetary policy in the history of the world. We are therefore in uncharted waters and it is impossible to predict the unintended consequences of very low interest rates, with some 30% of global government debt at negative yields, combined with quantitative easing on a massive scale.

To date, at least in stock market terms, the policy has been successful with markets near their highs, while volatility on the whole has remained low. Nearly all classes of investment have been boosted by the rising monetary tide. Meanwhile, growth remains anaemic, with weak demand and deflation in many parts of the developed world.  

Many of the risks which I underlined in my 2015 statement remain; indeed the geo-political situation has deteriorated with the UK having voted to leave the European Union, the presidential election in the US  in November is likely to be unusually fraught, while the situation in China remains opaque and the slowing down of economic growth will surely lead to problems. Conflict in the Middle East continues and is unlikely to be resolved for many years. We have already felt the consequences of this in France, Germany and the USA in terrorist attacks.

As a result, Rothschild has put his money where his mouth is: "we have reduced our exposure from 55% to 44%. Our Sterling exposure was significantly reduced over the period to 34%, and currently stands at approximately 25%. We increased gold and precious metals to 8% by the end of June."

* * * 

Not surprising, RIT's investment portfolio continues do quite well, and has now returned roughly 2,000% since inception

Here is the full section from the RIT Capital Partners' latest half-year financial report. 

The six months under review have seen central bankers continuing what is surely the greatest experiment in monetary policy in the history of the world. We are therefore in uncharted waters and it is impossible to predict the unintended consequences of very low interest rates, with some 30% of global government debt at negative yields, combined with quantitative easing on a massive scale. 

To date, at least in stock market terms, the policy has been successful with markets near their highs, while volatility on the whole has remained low. Nearly all classes of investment have been boosted by the rising monetary tide. Meanwhile, growth remains anaemic, with weak demand and deflation in many parts of the developed world. 

Many of the risks which I underlined in my 2015 statement remain; indeed the geo-political situation has deteriorated with the UK having voted to leave the European Union, the presidential election in the US  in November is likely to be unusually fraught, while the situation in China remains opaque and the slowing down of economic growth will surely lead to problems. Conflict in the Middle East continues and is unlikely to be resolved for many years. We have already felt the consequences of this in France, Germany and the USA in terrorist attacks. 

In times like these, preservation of capital in real terms continues to be as important an objective as any in the management of your Company's assets. In respect of your Company's asset allocation, on quoted equities we have reduced our exposure from 55% to 44%. Our Sterling exposure was significantly reduced over the period to 34%, and currently stands at approximately 25%. We increased gold and precious metals to 8% by the end of June. We also increased our allocation to absolute return and credit, which delivered positive returns over the period, benefiting from a number of special situations. Within this category our new association with Eisler Capital had an encouraging start. We expect this part of the portfolio to be an increasingly important contributor to overall returns. 

On currencies, we reduced our exposure to Sterling in anticipation of Brexit and the generally unsettled UK political environment. Our significant US Dollar position has now been somewhat reduced as, following the Dollar's rise, we saw interesting opportunities in other currencies as well as gold, the latter reflecting our concerns about monetary policy and ever declining real yields

Below is a snapshot of where every hedge fund wants to end up: the Rothschild investment portfolio.

Finally, for all those wondering where the Rothschild family fortune is hiding, here is the answer.

“The Leaders Are Crashing" - It's Not Just Junk Bonds That Have Given Up

We have been warning about significant divergences between equity prices and other asset classes for a few weeks (most notably the decoupling from equity risk and credit risk, junk bonds), but as BofA notes its not just these assets that are breaking away from soaring Nasdaq levels, in fact many of the rally's leaders are crashing... in a way we have not seen recently.

High yield risk has suddenly decoupled from equity markets...

And Jeffrey Gundlach has been warning something's got to give. Based on the past two days, looks like we have our answer.

Stocks fell around the world a second day and high-yield bonds headed for a fourth straight loss, resuming a historic correlation that the hedge fund manager on Wednesday had warned was alarmingly out of whack.

"JNK ETF down six days in a row, closing near its seven month low," the DoubleLine Capital LP co-founder wrote on Twitter Wednesday. "SPX up five of last six days, closing at an all time high. Which is right?"

In fact the correlation between these two leaders has crashed...

In the past decade, there were only three other instances where the relationship between JNK and mega-cap tech broke down to this degree. Each time, the two assets began to resume their positive correlation within four to 12 days, data compiled by Bloomberg show.

But given the last few days in equities and credit... High Yield Bond prices (HYG) are at 8 month lows...

On record dollar volumes of trading...

Gundlach is calling a win...

"A material pullback would be something we need to watch for, as a deteriorating credit market has led each of the largest equity pullbacks since 2014," said Frank Cappelleri, a senior equity trader and market technician at Instinet LLC.

"With divergences once again apparent now, the bulls face their latest test."

It's not just credit risk, but equity risk has decoupled from equity prices too...

VIX has started to creep higher but has further to go to fit with credit risk...

But it's not just high yield bonds, price leadership has been stung in recent days: Oct 26th/27th ECB announced "tapering", Brent broke $60/b…concerns of "peak policy" stimulus & "peak profits"caused toppling of credit, bank, tech "leadership"; sell-off sequence past few weeks = 1st EMD, 2nd HYG, 3rd SX7E, 4th BKX, and #5 SOX...

As BofA's Michael Hartnett notes, watch EMD & HYG in particular...needs to stabilize... but the recent pullback also follows insane gains...

FAANG+BAT market cap up $1.5tn YTD, a sum larger than entire market cap of DAX ($1.4tn); and Aug saw all-time low yields in US HY tech bonds (4.3% H0TY) & EU HY corp bond yields hit low in Oct (2.1% HE00, i.e. lower than yield on US Treasuries).

Finally, in case you think this is all much ado about nothing. The last time we saw such a divergence between credit and equities was in Aug 2015...

Just two weeks before the huge ETF  flash crash.

U.S. TAX CUTS WILL BALLOON US DEBT TO 120% OF GDP, BUT BOOST TO ECONOMY WILL BE “SHORT-LIVED”

It's uncertain what if anything in the mix of tax cuts and tax increases being kicked around in Congress will become law.


But Fitch Ratings believes that some combination will make it, and that it will sap US government revenues.


"Under a realistic scenario of tax cuts and macro conditions," the US deficit would rise to 4% of GDP next year,


and balloon the US debt to 120% of GDP by 2027. And that might be the best-case scenario.


That debt-to-GDP ratio just shot up to 105% – based on annualized Q3 GDP of $19.5 trillion and the US gross national debt of $20.5 trillion that had spiked by $640 billion in eight Weeks, following the suspension of the debt ceiling in September. The debt-to-GDP ratio was 103% earlier this year.


Fitch said in the report that it expects some version of the package to pass the US Congress, and that it "will be revenue negative, even under generous assumptions about its growth impact."


The tax package, which includes cutting the corporate tax rate from 35% to 20%, "would deliver a modest and temporary spur to growth," Fitch said. Even with these tax cuts, Fitch expects US economic growth to peak at 2.5% next year and then fall back to 2.2% in 2019 – the same kind of economic growth the US has seen since the Financial Crisis. So any boost to output from the tax cuts would be "short-lived."


These tax cuts would "not pay for themselves or lead to a permanently higher growth rate," Fitch said, adding:


The cost of capital is already low and corporate profits are elevated. In addition, the effective tax rate paid by large corporations is well below the existing statutory rate.


Throwing in these tax cuts to add to demand "at this point in the economic cycle" could boost inflationary pressures and "lead to additional monetary policy tightening."


This is something various Fed governors have also suggested. The Fed has already begun the QE unwind, has hiked its target rate four times so far, and is very likely to hike it again in December. More rate hikes are on the menu next year, but for now they're expected to be few and far between. This could change if inflation, perhaps stimulated by tax cuts or whatever, picks up steam. Higher rates might follow, which would further increase the government's cost of funding, the deficit, and the debt.


So the tax cuts "will lead to wider fiscal deficits and add significantly to US government debt." Fitch added the not very veiled warning concerning the AAA-rating Fitch still maintains on the US:


The US will enter the next downturn with a general government "structural deficit" (subtracting the impact of the economic cycle) larger than any other 'AAA' sovereign, leaving the US more exposed to a downturn than other similarly rated sovereigns.


The US is the most indebted 'AAA' country and it is running the loosest fiscal stance. Long-term debt dynamics are also more negative than those of peers, with health and social security spending commitments set to rise over the next decade.


At this point, Fitch believes that these weaknesses are still "outweighed" by the "flexibility" the US enjoys in financing its debts – the entire world clamors to buy US Treasuries for now – and by "the US dollar's reserve currency status." These two factors combined are still "underpinning" Fitch's AAA/Stable rating.


These are longer-term considerations that could impact the US credit rating after the tax package takes effect and starts having an impact on deficits and the debt.


Short-term, there is another risk to the AAA-rating: Congress's "failure to raise the debt ceiling" by the first quarter next year, when the Treasury Department runs out its "extraordinary measures" that allow it to kick the out-of-money date down the road.


The current suspension of the Debt ceiling expires on December 8. Then the debt ceiling charade will be back, along with the brinkmanship among lawmakers to extract from each other some concessions by holding out the possibility of a self-inflicted US default. This makes bondholders and ratings agencies nervous.


But the debt-ceiling charade has some peculiar effects, beyond its entertainment value: For months on end, it covers up the true extent of US government debt, and its continued surge. Then suddenly, the floodgates open.

Overbought!

"I had to cover my shorts." That's what a friend of mine told me after the company came out with its quarterly earnings and issued upbeat projections. I asked him, "how long are you going to keep shorting these companies. This is like the 10th time you've been forced to cover."

I don't remember anymore how he responded. But I do know he was later proved right to be wary. The company he was shorting in October 2000, Juniper Networks, had just reported earnings that were double year ago levels, and on strong revenue growth. The stock was up briskly on the news – eclipsing the $200 a share level. And he had to cover. But just one year later, when revenue was flat, beating expectations and causing the stock to soar 23%, the stock had already lost more than 90% of its value.

So how do you play this? I mean my friend was 100% right. And ironically, because we were working at an Internet company that seemed to us like total smoke and mirrors, we knew his scepticism made sense. But he was also early. And there was a lot of pain to endure until Juniper and stocks like it gave way.

I'm reminded of this story this morning by my Twitter feed. One story from P. da Costa talks about soaring household debt. And another tweet from B. Klaas talks about putting nuclear-armed bombers on 24-hour alert. Yet H. Tschaepitz notes the 15th consecutive gain for the Japanese Nikkei 225, a record streak. And J. Crombie talks of record junk bond issuance in Europe.

It was when J. Weisenthal tweeted about record highs in the Nasdaq 100 that I thought of my friend's shorting Juniper back in October 2000. Here's Weisenthal's chart:

So how do you play this? Just last week I was telling you that there are zero signs of economic recession coming in the data. The one data series I like the most says the jobs market is stronger today than it was a year ago, 9 years into this expansion. So there's no obvious economic break to stop the market freight train. And let's not forget that it was 196 when Alan Greenspan mused aloud about "irrational exuberance". The markets continued higher for another 4 years.

If you look at a chart of Juniper Networks, the October timing was actually spot on. The stock went from a close of $122.81 on 23 Jun 2000 to a closing peak of $219.08 on 26 Sep 2000, two weeks before Matt was forced to cover. After the earnings, it went to an all-time closing high of $230.96 on 16 Oct 2000. After that, the bottom fell out and it never recovered. The stock trades at about $26 a share today, 17 years later.

There are a lot of metrics showing that markets are on a tear right now – whether you look at stock market cap to GDP, P/E ratios, Shiller P/E ratios, high yield spread to treasuries, Corporate bond spread to treasuries or whatever metric you use. What stops this tear from continuing and asset prices from rising further still? Short of a 1987-style crash, you have to believe that the economic data lead the markets. And by that I mean that there are few times – if any – you get an extended bear market run in the face of positive economic data. As long as the economy holds, even stretched valuations can be substantiated. It's only when the economic data soften that things start to fall apart.

That doesn't mean that some sectors of the market won't get crushed first though. Back during the housing bubble, I started to buy puts on a number of housing related companies like KB Homes and Washington Mutual. WaMu eventually went bust but KB Homes – the former Kaufman & Broad, a major junk bond issuer in the Milken days – is still alive and well. Shares peaked in July of 2005 with home prices and have never recovered. Today's price is only 1/3 of the July 2005 high.

This quote from Wikipedia is noteworthy about the housing bubble period:

In November 2006, KB Home president, CEO, and chairman Bruce Karatz resigned after an internal accounting probe into his alleged backdating of stock options. KB Home also announced the resignation of its head of human resources, Gary A. Ray, and the resignation of its chief legal officer, Richard B. Hirst. The company determined that Karatz and Ray had picked grant dates under the company's stock option plans. According to the Wall Street Journal, Karatz was one of the most highly paid executives in 2005, earning almost $156 million, primarily from options.

My take: it pays to have a grounding in macro because it helps understand economic turns that drive large falls in asset prices. Yet, at the same time, it also pays to do bottoms up research and hone in on sector analysis to shift asset allocation. The housing stocks were telling you in 2005 that something was wrong. It wasn't until 2007 that a broader economic downturn developed. Right now, no sectors are screaming downturn; the economic data remain firm. But the grind higher in these markets cannot go on forever. Risk assets are overbought and we should be attuned to a potential shift in fortunes because some of these high fliers are the Junipers of 2017. And you don't want to own them when the reversal comes.

The Fetid Swamp of Tax Reform

The likelihood that either party will ever drain the fetid swamp of corruption that is our tax code is zero, because it's far too profitable for politicos to operate their auction for tax favors.


To understand the U.S. tax code and the endless charade of tax reform, we have to start with four distasteful realities:


1. Ours is not a representational democracy, it's a political auction in which wealth casts the votes that count. Those seeking political influence over issues such as taxation place their bids in the political auction via campaign contributions and lobbying. The winner of the political auction gets favorable treatment, and everyone else ends up subsidizing the gains of the winner.


2. The wealthy pay the vast majority of federal income taxes (as oposed to payroll taxes, i.e. Social Security and Medicare), so tax cuts end up benefiting the wealthy.


High-income Americans pay most income taxes, but enough to be 'fair'? (Pew Research Center)


In 2014, people with adjusted gross income, or AGI, above $250,000 paid just over half (51.6%) of all individual income taxes, though they accounted for only 2.7% of all returns filed.


By contrast, people with incomes of less than $50,000 accounted for 62.3% of all individual returns filed, but they paid just 5.7% of total taxes.


After all federal taxes are factored in, the U.S. tax system as a whole is progressive. The top 0.1% of families pay the equivalent of 39.2% and the bottom 20% have negative tax rates (that is, they get more money back from the government in the form of refundable tax credits than they pay in taxes).


3. The unseen burden of the tax code is the complexity tax levied on small business, the self-employed and domestic corporations with no access to global tax-avoidance schemes.


4. This complexity is necessary to hide all the special favors won in the political auction. The tax code could be a few pages long: all accounting of income and expenses must conform to accepted accounting rules, and here are the tax rates on net income/earnings.


Any special tax breaks or subsidies would stick out like sore thumbs in a simple tax code, so it's necessary to generate thousands of pages of tax code to create a thicket in which auctioned-off favors can be hidden from public view.


The Tax Foundation explains the three layers of compliance complexity: Title 26 of the U.S. Code, the tax statutes enacted by Congress, run to 2,600 pages. The details are left to the IRS (Internal Revenue Service), which publishes roughly 9,000 pages of regulations.


But wait, there's more—much more. If you end up in tax court, there's around 70,000 pages of case law to pore over to make your case.


Playing around with tax brackets skirts the core problem with the U.S. tax system: the entire tax code is little more than a clearing house of political bribes paid for tax breaks and a complexity thicket that requires the services of legions of accountants, tax attorneys, software coders, and specialists in tax avoidance strategies.


This clearing house and complexity thicket are intrinsically unfair, as insiders and the super-wealthy can avoid taxes via political influence and offshore tax havens. This systemic unfairness erodes the social contract's key compact: that the playing field will be kept more or less level for all participants.


But the U.S. tax system is anything but level. The Institute on Taxation and Economic Policy (ITEP) recently published an analysis of the corporate taxes paid by Fortune 500 companies over the past eight years. Consistently profitable companies paid a federal tax rate of around 21%, considerably lower than the nominal corporate tax rate of 35%. But 18 profitable companies paid no federal taxes over the eight years, and about 50 corporations paid rates of 10% or less.


Immensely profitable corporations such as Apple have mastered the offshore tax avoidance game. Others persuade members of Congress (impolite term: bribe) to include obscure tax breaks tailored to their company in legislation.


So the most successful at gaming the system pay near-zero (saving tens of billions of dollars) while the chumps pay the top rate.


There's another systemic source of unfairness in the tax code: the gap between the high rates on earned income (wages and salaries) and the much lower rates on unearned income-- what we might characterize as income generated by capital rather than labor: rents, capital gains, speculative gains and so on.


If you manage to earn $500,000 in wages, most of that income is taxed at 33%, and the income above $415,000 is taxed at 39.6%. Meanwhile, the top rate for long-term capital gains is 20%. Over time, that 15% adds up.


In effect, the rich get richer because most of the lower-tax-rate unearned income flows to them.


If we really want to reform federal taxation, we'd do three things:


1. Radically simplify the tax code from thousands of pages to dozens of pages


2. Lower the corporate tax but eliminate all the overseas schemes and scams


3. Increase the tax rate on unearned income above (say) $100,000 annually.


Needless to say, the number of taxpayers with more than $100,000 in unearned income annually is tiny, so the vast majority of taxpayers with capital gains earned from selling a second home, exercising stock options, speculative trading, etc. would still pay the existing low rate.


But those reporting substantial unearned income would pay the same tax rates imposed on labor: up to 39.6% above $415,000 annually.


These charts help us understand that despite its crushing flaws, federal taxation is highly progressive. The bottom 75% pay little to no federal income tax and receive more federal benefits, while the wealthy pay the vast majority of federal income taxes:





These two charts break out who pays most of the taxes:








The likelihood that either party will ever drain the fetid swamp of corruption that is our tax code is zero, because it's far too profitable for politicos to operate their auction for tax favors. This reality unites the Democrats and Republicans in an unholy marriage of corrupting wealth and power.

SHILLER WARNS U.S. STOCKS LOOK LIKE THEY DID BEFORE 13 PREVIOUS COLLAPSES

Robert Shiller, the Nobel Prize-winning economist that teaches at Yale University, has a warning for investors: stocks today look a lot like they did at the peak before the last 13 previous price collapses. This doesn't mean stocks are going to crash next week, but it does mean investors shouldn't be complacent.

According to Shiller, the U.S. stock market is "characterized by a seemingly unusual combination of very high valuations, following a period of strong earnings growth, and very low volatility."

In a recent post, Shiller said his cyclically adjusted price-to-earnings ratio (CAPE), which helped him win the Nobel Prize for Economics in 2013, helps predict returns by comparing current prices to average earnings over the last 10 years.

Historically, in the peak months before a bear market, which Shiller defines as a drop of 20% or more, the CAPE ratio was above its average of 22.1 (the long-term average is 16). On Friday, September 22, 2017 the CAPE was at 30.57. The CAPE ratio has only been higher than 30 twice before: in September 1929, when it was at 32.56, and from 1997 to 2002 (in December 1999, it hit a peak of 44.20).

More broadly, the peak months before the last 13 bear markets occurred in 1892, 1895, 1902, 1906, 1916, 1929, 1934, 1937, 1946, 1961, 1987, 2000, and 2007. Two big stock market collapses in 1968-70 and in 1973-74 are not included because they were more drawn out and gradual.

Even though stocks are currently overvalued, Shiller does not suggest a bear market is imminent. "Such episodes are difficult to anticipate, and the next one may still be a long way off," he said.

Still, it's important to remember that the last two times valuations were above 30, it didn't end well.

Regardless, investors shouldn't get complacent just because U.S. stocks are reporting decent earnings.

Shiller notes that peak months before past bear markets also showed strong earnings growth–on average, 13.3% for the last 13 bear markets. Interestingly, at the market peak, just before the biggest stock market crash (1929), 12-month real earnings growth was 18.3%.

Shiller ends by saying that U.S. stocks look a lot like they did at the peaks before the last 13 bear markets. Of course, the CAPE ratio is not perfect in predicting a correction, because they are difficult to anticipate.

"But my analysis should serve as a warning against complacency," Shiller concludes. "Investors who allow faulty impressions of history to lead them to assume too much stock-market risk today may be inviting considerable losses."

Are The Rich Panicking?

European elites are hoarding cash, the Japanese are stuffing safes full of high-denomination bills, the saudis are scrambling, and judging from the following chart, the richest Americans are getting increasingly concerned about the safety of their wealth...

For a decade, Security & Armored Car Services workers in the US have earned around $14 to $15 per hour.

But all that changed as President Trump was elected...

Demand for security services has soared driving wages up a stunning 24% YoY!

What are America's 1%-ers worried about? (the answer is simple... the rest of us)

Sudden contagious & hazardous' China bank warns Beijing is on BRINK of economic collapse CHINA have been warned that they are on the brink of financial collapse in a shock warning from central bank governor Zhou Xiaochuan.

CHINA have been warned that they are on the brink of financial collapse in a shock warning from central bank governor Zhou Xiaochuan.

Chinese bank chief warns country is risking financial collapse

China's financial system is becoming more vulnerable due to high levels of leverage, or borrowing, the central bank governor Zhou Xiaochuan has claimed. 

Writing in an article published on the People's Bank of China's website late Saturday, Mr Zhou warned about the prospect of potential financial problems in the world's second-biggest economy.

Mr Zhou claimed that the country needed to tighten regulation as the governor warned about looming risks. 

The central bank governor released his strategy to avoid a financial crisis by calling for equity funding and to eliminate "zombie" companies.

GETTY•YOUTUBE

China news: Zhou Xiaochuan said China's financial system is becoming more vulnerable

Risks of damage to the financial markets in China are "hidden, complex, sudden, contagious and hazardous," according to Mr Zhou.  

He wrote: "High leverage is the ultimate origin of macro financial vulnerability. 

"In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly."

Mr Zhou, who is expected to retire after a record 15 years, referred to a fear of sudden collapse in asset prices after large periods of growth. 

When answering questions at the 19th Communist Party Congress report, Mr Zhou explained how to strength China's financial system. 

He said: "Financial risks include basic risks associated with financial markets and financial institutions. 

"For example, some unhealthy financial institutions fail to meet relevant standards, and as a result may have to be closed or go bankrupt. 

"By comparison, systemic financial risks can lead to financial crisis, set off dramatic chain reactions in the market, and cause great shocks to the economy and employment." 

The Governor did explain that the overall health of the financial system in China remained good, despite warnings. 

In the article Mr Zhou also said China should: "actively develop equity financing, and steadily increase the proportion of direct finance."

In a bid to fight off risks, China should handle "both cause and symptoms", and be active in "both pre-emptive measures and reactive solutions", Mr Zhou wrote.