It Takes a Great Disruptor to Fix a Great Distortion

By David Stockman  |  September 5, 2019

We closed yesterday’s issue with what may be fairly read as an appeal to the Donald’s better guise.

The long-term viability of America as an economic engine strong enough to support the thriving middle class upon which representative democracy depends rests itself on his ability to bring an end to Bubble Finance.

That can only come with great disruption.

It should have happened – could have happened – 11 years ago. The Duopoly didn’t let it. Imperial Washington rescued Wall Street. And, more than a decade later, Main Street still languishes.

In his first Thursday dispatch for Deep State Declassified, Michael Coolbaugh, like a prosecutor, establishes that a “too big to fail” mentality just might do for the U.S. economy what it’s done for Japan and Europe.

That’s decades of stagnation.

What you see today on Bubblevision – the Dow’s up nearly 500 points on Trade War Optimism© – is pure illusion. There is no foundation for compromise between the U.S. and China, as Chris Scott reminded us on Tuesday.

Just as there’s no basis for new highs for the major equity indexes – except, of course, the false hope of more easy money…

About That Inverted Yield Curve…

By Michael Coolbaugh

Considered by many one of the greatest investors of all time, Sir John Templeton is famously quoted as saying, “The four most dangerous words in investing are: ‘this time it’s different.’”

As an ardent student of history and the timeless lessons espoused by investing legends like Sir John Templeton, you can understand why I can instantly feel chills run down my spine whenever I read headlines like these:

  • Yield-curve inversion? Junk bonds still see smooth sailing for economy – MarketWatch (September 4, 2019)
  • Art Cashin says relying on the yield curve inversion as a recession signal is ‘suspect’ this time – CNBC (August 29, 2019)
  • Jim Cramer breaks down recession fears – ‘I think the yield curve linkage is wrong’ – CNBC (August 27, 2019)
  • Mohamed El-Erian: Inverted yield curve recession signal is ‘distorted’ this time around – CNBC (August 15, 2019)
  • Janet Yellen says yield curve inversion may be false recession signal this time – CNBC (August 14, 2019)

Term Premium

A yield curve inversion refers to a scenario where long-term interest rates are lower than short-term interest rates. The reason this dynamic is so unnatural is due to what’s called “term premium.”

That’s a fancy way of saying that investors typically require a higher return to hold long-term bonds instead of short-term bonds.

It’s believed that an inverted yield curve is a sign that investors have an increasingly negative view of the economy. But most pundits and strategists have their own reasons to explain why the recent inversion doesn’t matter.

And, believe me, the fancy titles and lengthy research reports from Chief Economist X or Global Strategist Y of this, that, or the other major Wall Street firm always sound convincing.

At the end of the day, the unfortunate truth is these are all variations on Sir John’s four most dangerous words.

I’m here to tell you:

This Time is Not Different

As we all know, banks borrow money via short-term deposits and then lend that money to help facilitate large purchases.

The profitability of a bank depends on the ability to pay lower short-term interest rates and charge higher long-term interest rates.

Take a look at the chart below…

As the difference between long-term and short-term interest rates narrows (a dynamic represented by the red line), bank profit margins (that’s “net interest margin,” represented by the blue line) shrink.

This is precisely why most pundits are misguided when they argue banks offer tremendous value. As yields are compressed, banks suffer, and such is reflected by their relative performance in the stock market.

Still not convinced?

Well, surely with the market much higher than before the Global Financial Crisis, banks must be, too…

If it isn’t clear, the short answer to this debate is that one should steer clear of investing in banks.

But it’s not just profitability we’re concerned with.

The Logic is Simple

Banks are the lifeblood of economic activity. When banks lend, it helps foster economic activity by allowing businesses to invest in new projects or individuals buy new homes.

So, what happens when this typical relationship is reversed? Well, what would you do if you were holding money in a savings account earning 0.05% while simultaneously paying 16% on an outstanding credit card balance?

It’s really quite simple: You either withdraw your savings to pay down the credit card (reducing the money you can spend) or you’ll run out of money very quickly.

Despite what former Federal Reserve Chair Janet Yellen would like you to believe, regardless of the technicalities, when banks can’t earn a higher return from lending money, they simply stop lending.

The Fed’s own data show clearly how bank lending screeches to a halt after an inverted yield curve; the red line in the chart below depicts growth in loans and leases…

We’ve Been Here Before

At the outset, I mentioned my fascination with history. Well, we’ve been here before – and more than once. Indeed, we’re setting up for the final installment in an epic trilogy.

First, it was Japan in the late 1980s…

Europe followed in 2007…

With the destruction these two regions have seen to their own banking systems, I can’t help but wonder how policymakers and pundits alike can believe “this time is different.”

Just Give Me Some More Truth…

Desperate times call for… “common sense” measures.

And these are desperate times… Markets are corrupted by monetary central planning. They’re confused. And the road back is going to be treacherous.

We’re looking at a major re-pricing for all financial assets. And thousand-point intraday or day-to-day swings are part of that equation. Those can be frightening… for “buy and hold” investors.

I have a different approach, one that combines strategy and tactics into a plan flexible enough for you to survive and thrive amid the coming chaos. It’s called “The Stockman Model.”

All we’re after is a little stability, perhaps a chance to pocket a windfall when opportunity presents…

If You Need Your Money in the Next 5 Years…

America is at a crossroads. The middle class is disappearing… government spending is out of control… and the implosion of Bubble Finance will cause the greatest market crash in history. So, if… Read More
David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR