Tag Archives: equity markets

The Pension Crisis Is Worse Than You Think, by Lance Roberts

The pension crisis is here, it’s bad, and it will only get worse. From Lance Roberts at realinvestmentadvice.com:

Last year I penned an article discussing the “Unavoidable Pension Crisis.” 

“Currently, many pension funds, like the one in Houston, are scrambling to slightly lower return rates, issue debt, raise taxes or increase contribution limits to fill some of the gaping holes of underfunded liabilities in their plans. The hope is such measures combined with an ongoing bull market, and increased participant contributions, will heal the plans in the future.

This is not likely to be the case.

This problem is not something born of the last ‘financial crisis,’ but rather the culmination of 20-plus years of financial mismanagement.

An April 2016 Moody’s analysis pegged the total 75-year unfunded liability for all state and local pension plans at $3.5 trillion. That’s the amount not covered by current fund assets, future expected contributions, and investment returns at assumed rates ranging from 3.7% to 4.1%. Another calculation from the American Enterprise Institute comes up with $5.2 trillion, presuming that long-term bond yields average 2.6%.

With employee contribution requirements extremely low, averaging about 15% of payroll, the need to stretch for higher rates of return have put pensions in a precarious position and increases the underfunded status of pensions.”

But it is actually worse than we originally thought as Aaron Brown recently penned:

“Today, the hard stop is five to 10 years away, within the career plans of current officials.  In the next decade, and probably within five years, some large states are going to face insolvency due to pensions, absent major changes.

If we extrapolate from the past, rather than use promises in the state budget, current employees plus the state will contribute about $25 billion over those seven years, which could provide another few years before the till is empty. But it will also add around $60 billion of future liabilities to current employees.The system probably breaks down before the pension fund gets to zero, for example if assets were to fall below $30 billion while projected future liabilities exceeded $300 billion. Even the most optimistic people would have to admit the situation is unsustainable. This could happen in three years in a bad stock market, or perhaps 10 with good stock returns.But fund assets are so low relative to payouts that good returns aren’t that helpful.

The next phase of public pension reform will likely be touched off by a stock market decline that creates the real possibility of at least one state fund running out of cash within a couple of years. The math says that tax increases and spending cuts cannot do much.

To continue reading: The Pension Crisis Is Worse Than You Think

No Lifeboats, by Robert Gore


Who has the most to gain from low and negative interest rates? Obviously debtors. The world’s biggest debtors are governments, with the US government number one. Debt today is like a listing ship. The objective of governments is to get themselves to the part of the ship that’s highest out of the water—the bridge—and cram everyone else below decks, submerged. The ship will sink, but governments and their cronies will let the other passengers drown before they breathe their last.

The real purpose—the only one that matters—of governments and central banks’ machinations since the financial crisis has been to finance governments. The world stood on the edge of the debt contraction abyss. Debt had reached an unsustainable level. Economies could no longer bear the load of interest payments and principle repayment. The marginal value of most debt, particularly that which funded consumption, had gone clearly negative. Even the value of debt incurred to fund “investment” was dicey, since much of that investment was actually speculation in disguise: house flipping, leveraged mortgage security arbitrage, share buybacks, and the like. The financial crisis was the iceberg rending the hole in the hull. Since then, the hole has only grown.

The bridge knows the vessel is taking on water and sinking. Sovereign debt has been monetized and interest rates driven to subzero so governments can buy themselves a little more time. Savers and those living off of fixed income investments were steerage, the first to be sacrificed. For them, the future of diminished consumption that everyone says is inevitable—but nobody seems to believe will ever happen—has arrived. They’ve been told to go to the hold and await further instructions while the central bank pumps bail away, but they’re up to their necks in cold, fast-rising water.

Chest deep and next to be sacrificed are aggregate pools of savings—pension funds and insurance companies. They have to generate a return and cannot survive if they receive no interest income on their bond investments. Underfunded pensions have thrown states, municipalities, and Puerto Rico into financial turmoil. The rates of return they had assumed, in most cases 7 percent or greater, are unavailable in any kind of prudent investment. Imprudent investments offer higher returns, but reluctance to embrace them is rational given multiple crashes in junk bond, equity, and real estate prices since the turn of the century. Insurance companies can at least raise their rates, but in many cases pension contributions are fixed by either law or contract, and can’t be changed without political push back from beneficiaries and other interested parties. Taxpayers are balking at calls to increase their support.

Mis-priced interest rates are also submerging the real economy. The artificial rate distortion produced by central banks’ cheap debt policies has led to malinvestment, glutted markets for both goods and services, and deflationary pressures that will be fully uncorked when debt finally contracts. The return on real investment has followed interest rates, it’s close to zero. The long-term trend rate of growth follows the real return on investment, so it too is falling towards zero (even by suspect official government reckonings) as the burden of servicing the mounting debt load rises.

When the economy gives up the ghost, it will be akin to the flooding of the crew’s quarters. There will still be a few high and dry on the bridge, but the ship cannot function without a crew. Washington and Wall Street are mostly high and dry, but it’s only a matter of time before the surge reaches them. Today’s anemic growth rates have been dragged down by debt. When they finally sport a negative sign (honestly accounted for, some—Europe’s, Japan’s, Russia’s and Brazil’s, et al.—already do), more debt will simply hasten the ship’s final plunge.

Expanding debt has allowed developed country sovereign bond and equity markets to reach record highs. Both, ultimately, are dependent on the real economy, so on many measures the divergence between financial asset prices and economic metrics has reached record extremes. By GAAP accounting or even by Wall Street’s preferred “adjusted” earnings, the stock market is trading at historically high multiples. Sovereign bond prices, which are the inverse of yields (higher prices equal lower yields), are at all time highs since negative yields are all time low yields.

Officially measured developed countries’ growth rates are trending to 1 percent, which is a statistical adjustment away from zero or negative growth. Most of that so-called growth is simply the debt-enabled pulling of future demand forward, which leads to less growth in the future. Cheap debt has blown up unsustainable bubbles in autos, student lending, and the housing market. Corporations have embarked on a borrowing spree, but unlike governments and central banks, they can’t manufacture fiat debt to repay their debts. Notwithstanding infinitesimal interest rates, credit quality has deteriorated to the worst level since the third quarter of 2009, and the default rate is climbing.

Cold water laps at the toes of the financial cronies. There will be more QEs, more ZIRP and NIRP, and inevitably helicopter money, but not because of any of the transparently specious reasons given for these quackeries. That includes the “cynical” one that they’re trying to keep stock and sovereign debt markets high and dry. Eventually stock markets will be sacrificed as the gap between stock prices versus earnings and economic performance grows ever wider and markets are asked to capitalize losses, not dwindling profits. Sovereign debt markets will be the last to go, because they can be supported by an endless supply of central bank fiat debt.

The cynical aren’t cynical enough. The quackeries will continue because they are the only way governments carrying unsustainable loads of debt and unfunded liabilities can be financed. It will not stop when economies improve because economies aren’t going to improve, they’re going to get worse. Look at Japan, which has journeyed the farthest down this road. Its central bank finances the government, buying all the government’s fiat debt with its own fiat debt. Just as the rest of the world’s economies are following Japan’s into zero and negative growth, they will follow its lead in finance. Sovereign debt and central bank debt exchange are all the potentates have to keep their heads above water a little longer.

Their cure is the disease. It is telling that nobody is talking about debt during the presidential campaign. Why stir up trouble? The candidates know that debt will sink the economy, and they’ve known so since at least 2008. It’s easier to find other economic scapegoats. Talking about debt would be like the bridge announcing over the public address system that the ship is sinking, the passengers are going to die, and all emergency measures will be directed towards keeping those on the bridge alive longer than everyone else. They can’t even tell the doomed to man the lifeboats. There are none.



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Weekly Commentary: The Precipice, by Doug Noland

From Doug Noland at creditbubblebulletin.blogspot.com:

Global markets have found themselves again at the precipice. My sense is that everyone’s numb – literally dazed and confused from prolonged Monetary Disorder and the resulting perverted market backdrop. Repeatedly, “The Precipice” has signaled easy-money buying and trading opportunities. Again and again, selling, shorting and hedging at “The Precipice” guaranteed you were to soon look (and feel) like an absolute moron – for some, progressively poorer dunces the Bubble was pushing yet another step closer to serious dilemmas (financial, professional, personal and otherwise). A focus on risk became irrational. Fixation on seeking potential market rewards turned all-encompassing.

All of this will prove a challenge to explain to future generations. Keynes: “Worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally.” And paraphrasing the great Charles Kindleberger: Nothing causes as much angst as to see your neighbor (associate or competitor) get rich. In short, Bubbles are all powerful.

Going back to those darks days in late-2008, global policymakers have been determined to not let the markets down. Along the way they made things too easy. “Do whatever it takes!” “Shock and Awe!” “Ready to push back against a market tightening of financial conditions.” “Do what we must to raise inflation as quickly as possible.” Historic market excess and distortions were incentivized and, predictably, things ran amuck. “QE infinity.” Seven years of zero rates, massive monetary inflation and incessant market backstopping have desensitized and anesthetized. Rational thought ultimately succumbed to “perpetual money machine” quackery. And now all of this greatly increases vulnerability to destabilizing market dislocations, as senses are restored and nerves awakened.

It was a week of ominous developments among multiple key flashpoints. Let’s start with commodities and EM, where the accelerating downward spiral is now rapidly reaching the status of “unmitigated disaster.” In a destabilizing crisis of confidence, panic outflows saw the South African rand sink 10% to an all-time low. Local South African bond Yields jumped 140 bps in two sessions to about 9% (from WSJ). The Turkish lira dropped another 3%, as Turkey’s equities were slammed for 5%. The Russian ruble dropped 3.4%. The Brazilian real declined 3.2%. Despite repeated central bank interventions, the Mexican peso sank 4.4% this week to a record low. Also hurt by collapsing crude, the Colombian peso dropped 4% to a new low.

Crude (WTI) sank 12% this week to the lowest level since the 2008 crisis. The Bloomberg Commodities Index sank to fresh 16-year lows. Natural gas dropped 9%, to lows since 2012. Iron ore was down 4% this week to a record low (going back to 2009). Iron ore prices have collapsed almost 50% this year. Crude prices are down about 35%. For highly leveraged operators throughout the commodities arena, the situation has quickly turned desperate. In the financial realm, the yen jumped 1.7% and the euro gained another 1% against the dollar this week, pressuring the leveraged “carry trade” crowd.

It has rather quickly become equally desperate for financial operators holding risky corporate debt in a marketplace that has turned illiquid and increasingly dislocated. For the first time since the 2008 crisis, a public mutual fund (Third Avenue) this week halted redemptions. A Credit hedge fund (Stone Lion Capital) also halted redemptions. The concept of “Moneyness of Risk Assets” has been integral to my “global government finance Bubble” thesis. Monetary policy coupled with aggressive risk intermediation (certainly including fund structures and derivatives) created the market perception that high-yield corporate debt could be held with minimal risk (price and liquidity). With the Credit cycle turning, this misperception is being exposed. Junk bond fund redemptions jumped to $3.5 billion this week. The halcyon notion of turning illiquid securities into perceived liquid instruments is coming home to roost. Credit spreads widened significantly this week. Ominous as well, bank stocks sank 6.2%, and the Broker/Dealers were slammed 7.5%.

To continue reading: The Precipice


Exit Now, from The Burning Platform

From theburningplatform.com:

The facts speak for themselves. Your choice is to believe in the almighty ability of academic bankers to keep their confidence game going, or exit now before the apocalypse hits. I got no dog in this hunt. I ain’t selling newsletters, gold, or investment ideas. I strictly look at the facts. And they tell me to stay as far away from the financial markets as humanly possible. It isn’t a matter of if, only a matter of when. Here are the pertinent snippets from Hussman’s Weekly Letter:

Unless we observe a rather swift improvement in market internals and a further, material easing in credit spreads – neither which would relieve the present overvaluation of the market, but both which would defer our immediate concerns about downside risk – the present moment likely represents the best opportunity to reduce exposure to stock market risk that investors are likely to encounter in the coming 8 years.

Last week, the cyclically-adjusted P/E of the S&P 500 Index surpassed 27, versus a historical norm of just 15 prior to the late-1990’s market bubble. The S&P 500 price/revenue ratio surpassed 1.8, versus a pre-bubble norm of just 0.8. On a wide range of historically reliable measures (having a nearly 90% correlation with actual subsequent S&P 500 total returns), we estimate current valuations to be fully 118% above levels associated with historically normal subsequent returns in stocks. Advisory bullishness (Investors Intelligence) shot to 59.5%, compared with only 14.1% bears – one of the most lopsided sentiment extremes on record. The S&P 500 registered a record high after an advancing half-cycle since 2009 that is historically long-in-the-tooth and already exceeds the valuation peaks set at every cyclical extreme in history but 2000 on the S&P 500 (across all stocks, current median price/earnings, price/revenue and enterprise value/EBITDA multiples already exceed the 2000 extreme). Equally important, our measures of market internals and credit spreads, despite moderate improvement in recent weeks, continue to suggest a shift toward risk-aversion among investors. An environment of compressed risk premiums coupled with increasing risk-aversion is without question the most hostile set of features one can identify in the historical record.

Short term interest rates remain near zero, 10-year bond yields have declined below 2%, and our estimate of 10-year S&P 500 total returns has declined to just 1.4% (see Ockham’s Razor and the Market Cycle for the arithmetic behind these historically-reliable estimates). Recent weeks mark the first time in history that our estimates of prospective 10-year returns on all conventional asset classes have simultaneously declined below 2% annually. We don’t expect a portfolio mix of stocks, bonds and cash to achieve any meaningful return over the coming 8-year period. The fact that the financial markets feel wonderful right now is precisely because yield-seeking speculation and monetary distortions have raised security prices today to levels where they are likely to stand years from today – with steep roller-coaster rides in the interim.
Even so, historical considerations that have been effective in market cycles across history (and that also would have captured the majority of the market advance since 2009) presently suggest considerable risk of what we’ve often called an “air pocket” – similar to what we observed last October – over the coming 10-12 weeks, with much more severe downside risk possible over the course of the next 18-24 months.


To continue reading: Exit Now

Crisis Progress Report (4), by Robert Gore

Today’s debt is tomorrow’s claim on future production, the unbreakable nexus between debt and production. If debt is incurred for a productive purpose and the return is higher than the interest rate charged, it adds to economic growth. If debt funds present consumption or uneconomic investment, then in the future that debt will necessarily mean that economic growth is less than it would have been in the absence of that debt, regardless of whether it or not it is repaid or refinanced. Repayment reduces the debtor’s future consumption or investment. Default reduces the creditor’s future consumption or investment. Either the debtor or the creditor has fewer funds with which to fund future investment, the basis of future production. Refinancing—replacing old debt with new—merely postpones the eventual outcome.

The world now has about $200 trillion in debt, or almost three times the world’s annual production of about $70 trillion (see “A World Overflowing With Debt,” SLL, 2/5/15). Most of that debt has been for consumption, transfer payments, or politically driven “investments,” which, unlike productive private-sector investments, will not generate economic returns sufficient to pay the debt. Mounting debt service costs, despite generational-low interest rates, are retarding or reversing economic growth in virtually all developed-country economies. Global debt continues to grow, which means repayment of interest, not principle, is imposing this burden on current production. While we all await the fateful snowflake that triggers the avalanche, those who want to know down which slope it will roll are advised to look to the link between debt and production.

If production shrinks at all, some debt will not be repaid. The oil market is first illustration of that point: its precipitous price decline made some production uneconomic, reducing producers’ ability to service debt. There have already been defaults and there will be more, in turn reducing consumption, investment, and eventually production, in ever-widening waves that are rippling and will continue to rippled out beyond the oil sector. Oil is in fact the snowflake, as SLL said back in December (“Oil Ushers in the Depression,” SLL, 12/1/14), just as housing was in 2007.

Europe is frantically trying to postpone its rendezvous with welfare-state destiny in Greece, but the debt has already been incurred and somebody will bear the burden of either its repayment or repudiation. For purposes of this analysis the eventual outcome matters not at all, only that it will inevitably arrive and will entail reductions in consumption, investment, and production, leading to economic contraction. Markets are anticipating all this, steadily marking down the prices of Greek debt and equities.

One facet of the current market adjustment process bears close attention: adjustments are sudden, large, and have far-reaching consequences. European governmental institutions and their financial adjuncts have lost control of the value of Greek debt. In less than five months, from last September to late January, the rate on Greece’s 10-year bond doubled, much as the price of oil more than halved over a period of a few months. When the Swiss central bank decided to unpeg the Swiss franc from the euro, the franc appreciated against the euro over 40 percent in a few hours. There was no bid for euros until the market established a much lower exchange rate (less francs per euro).

The oil, Greek debt, and Swiss franc markets, and their associated derivative markets, have one thing in common with virtually every other financial market around the world: they are heavily leveraged. If speculators are 20 times leveraged (not at all unusual), a 5 percent contra move in the underlying asset wipes them out, so they sell first and ask questions later. Bids and market liquidity evaporate, usually only reestablished at dramatically lower levels later on. The gap in price inflicts huge and often solvency-threatening losses, with substantial secondary effects. Yesterday, a capital hole of up to $8.51 billion in an Austrian bank set up to resolve bad loans was reported, in large part because of deteriorating eastern European Swiss franc mortgages. The mortgagees were essentially short the Swiss franc (see “‘Spectacular Developments’ in Austria: Bail-In Arrives after €7.6 Bad Bank Capital Hole “Discovered’,” from Zero Hedge, SLL, 3/2/15).

The world’s central banks have staked their all on monetizing debt to promote rising equity markets. There is much blather about new equity “wealth” promoting economic growth and rising incomes, but even governments’ statistics, manipulated and biased as they are, give the lie to that one. However, unless the link between equity markets and economic growth has been completely severed, two variables the central banks have sought to control are now in direct conflict. Debt monetization and interest rate suppression promote debt expansion as well as rising equity markets, but debt has become economically counterproductive (David Stockman calls it “peak debt). It now demonstrably retards rather than promotes growth, eventually leading to contraction and—barring that complete severance between equity markets and economies—falling equity markets.

Faltering, on-the-verge-of-contracting economies decrease the debt-servicing capabilities of those economies, and debt levels are rising. SLL has long hypothesized that there will come a day when over-indebted governments face the rising interest rates the government of Greece has already faced. That may be happening now, at least in the US and Japan, where rates have been rising, under the radar (it’s the last thing to which Washington, Wall Street, or Tokyo want to draw attention).

It may be just a blip, and as a trading vehicle only the most intrepid should jump aboard, but it bears close attention. Interest rates are a crucial variable that governments and central banks must control. Keep in mind that governments (including their central banking arms) have historically been “dumb money.” (Who can forget the British Treasury’s sale of gold from 1999 to 2002, at the bottom of the gold market?) A general rise in interest rates, and concomitant fall in bond prices, after years in which central banks have been buying huge amounts of bonds, would fit the “dumb money” historical pattern perfectly, and would inflict grievous losses on the central banks.

Remember the phrase from above concerning market adjustments: they are “sudden, large, and have far-reaching consequences.” Equity markets are just as leveraged as most other markets. Central banks are attempting to manipulate them upwards while at the same time promoting economic growth and suppressing interest rates. The Command and Control Futility Principle (governments and central banks can control one or more, but not all variables in a multi-variable system) and its corollary (due to the impossibility of controlling all variables, they will usually lose control of even the variable or variables they have attempted to control) imply that when they lose control of one of these variables, they will lose control of all them. There is virtually no chance that this loss of control will lead to anything but a gargantuan crash that wipes out a significant, by which is meant 50 to 75 percent, chunk of nominal equity wealth in a hurry. There is no chance that such a crash will not lead to a depression.

There are two classes of participants in today’s equity markets: those who know the game is rigged but think they can get out, perhaps even profit, when the music stops, and those who haven’t a clue. There were corresponding classes who were short the Swiss franc—everybody knew the Swiss central bank “had their backs.” Both classes were scorched when it stopped suppressing the franc’s price against the euro. The only investors who won’t get scorched when equity markets collapse are those who aren’t in them, or those who are fortunate enough to short them at the top. SLL recommends its readers join the former, with the latter being reserved for those with substantial trading experience using a fraction of their risk capital. It’s tough trying to time an avalanche.


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