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Sunday, February 23, 2020

Reality check 2020

The 30-year Treasury yield this week dropped to its all-time low of 1.89%. The Bond market is sounding alarm bells of a recession. Turns out investors are Ok to settle for 1.89% on their investment for the next 30 years. This is in-spite of the government annual inflation number being 2.3%. What this essentially means is - the investor who buys the 30-year and decides to hold it for next 30 years is guaranteed to lose money. In bonds the price and the yields move in opposite direction. So the lucrative offer is yields fall further and the price of the bonds surge more and then our investor can dump the 1.89% yielding Treasury to a new investor. One day or the other, you really run of fools. Because of government mandating banks to buy the long-term securities as investments - this forced buying creates a market. But with exploding US debt - again at historic highs, there is never short of these papers in future. US Government has already borrowed close to $23T and there is no sign from Washington DC that the spending is going to slow anytime soon. President Trump doesn't give any importance to national debt and so are the democratic nominees who will challenge him in November. We are in a phase historically where this is a complacent notion - Debts doesn't matter. Greece's debt didn't matter until they mattered. The debt market is a lender's market. Under consumption creates savings. Savings create lenders. Buyers would always be there. The existence of lenders is a pre-requisite for a debt market.

Banks buy Treasury as long term securities. They are mandated to do that. Without the mandatory rule to buy it, there is no natural want for it. Foreigners are also piling into the US treasuries. They are looking for yields outside their currencies. With interest rate either being zero or less, the 1.89% is more lucrative to say a Japanese investor or a European investor. Unlike before, these trading are happening without a hedge and poses a dangerous pattern. With their local currency (Yen or Euro) gaining against the Dollar will wipe out this thin wafer of < 2% interest and this essentially has become a necessary requisite for the boom to continue.

Switzerland Sovereign being amongst the top 10 investors in Apple is the same story but they choose the more risky route in Stocks.

The Fed has been buying short term securities from the overnight repo market. There are 2 things that are distinctly noticeable here. First, the Fed does not want to call these purchases QE. It continues to maintain a stand that these purchases do not amount to a QE program where they bought long-term bonds for $85B every month, Secondly they are unable to hide the balance sheet accumulation of nearly $500B since September of 2019. This is the same effect as the previous three QE programs except that the accumulation is without any upper limit. Any QE(n) program needs more money than QE(n-1) - this has always been the case. It is no different this time and hence it QE for sure. Banks like JP Morgan and Bank of NY Mellon - who have tremendous advantage being primary brokers benefit disproportionately from these overnight repos. They peddle money for the Fed basically, and it shouldn't be a surprise that JP Morgan reported its best ever profit during this time.

With all indexes - Dow, S&P and Nasdaq all hitting all time highs everyday, the stock market keeps going higher and higher. Just as trees do not grow to the sky., this will have to stop at some point.
Tesla stocks vaulting to $900 is the new mania around. It is the heavily shorted stock in American history. The excess flow of liquidity is chasing these speculative stocks. It has not only overtaken the market share of a car-major  like Volkswagen in a few trading days, but is in a striking distance from going ahead of Toyoto. Usually when bubbles are at its peak., we see mania companies going this way signaling its climax. Tesla story really looks one. The tech IPOs drying up is also notable after the weWork fiasco. From $90B valuation to being bailed out by its bigger investor just within few weeks. Even in 2000 bubble, the dotcoms failed first and the Nasdaq crashing was after a while. With Nasdaq about to hit the 10K mark - it looks it has ran out of steam.

The rise in price of gold this year is more than 8%. It is probably the best performing asset class of 2020. Gold has hit an all-time high against pretty much every currency except for the US dollar. An ounce of gold is at $1662 which is almost $300 less than its all time peak. The recent surge of gold may not be surprising for some people like me, but the surge of the DXY along with it to 100 is very interesting. Usually they trade opposite to each other because gold is traded in US dollars and they tend to go in opposite directions. One has to finally cave in. The Argument to gold is - if it can rise at this pace with the dollar getting strong., it should rise a lot faster on a sliding dollar which may happen soon. So looks gold finally is coming out as inflation hedge.

Coronavirus is still in its early stages and its impact may be longer and harder looks like. Car sales in China has plunged by 92% since the new year. This looks a pandemic that might have economic impact. As of now, even though it looks serious enough., to me I think, that market has used this reason to rectify an over-bought, genuine sell-off. Coronavirus looks very nastier than initially thought. It definitely can put China's economic order out of place temporarily and this obviously will have an impact on the rest of the world.

It is very possible that the US fed might intervene and reduce rates citing Coronavirus. When that happens, we will all know that the Fed has not only economic cures but also medical cures. Let's wait and see on this. It is possible that the Fed may reduce rates and keep inflating the bubble. Whether investors will buy it this time also is a serious doubt.

The US market has not priced in anything yet, on a Bernie Sanders Presidency which increasing looks very possible. Republicans who think Sanders is the easiest democratic candidate to beat for Trump should be really cautious what they wish for. This is exactly what the democrats thought of Trump in 2016 and we all know what happen after that. Bernie has been a life long socialist. If he wins, it would be an admission that 29 years since the collapse of the Soviet Union in December of 1991, finally Socialism has made it to the shores of the United State of America. Bernie is not hiding the fact that he is a socialist. He has been a socialist all his life and is on record all his life saying He doesn't believe in capitalism and believes in cooperation instead. If Bernie's appeal resonates with ordinary US citizens and they vote for him, it should be admission of failing capitalism in the US. Unlike candidates who promise socialism and govern from the center., Bernie is very different I suspect. He will govern from the left. Any democratic system leads to a socialistic society eventually. This is because there are more employees who vote that employers. That is one reason, the US constitution notably doesn't have a word called democracy. It was founded as an republic. Somewhere in the last half-a-century, the democratic political system in the US has lead to socialistic leaders. 

An economic slowdown is long overdue in the US. Market is just looking for an excuse to sell. The excuses can be - Coronavirus impact in China and rest of the world, Dollar index sliding by 10-20% on sign of a US slow down, Opinion polls that indicate Trump losing Presidency in November of 2020, Earnings shock and bursting of the junk bond/corporate bond market. One of them might happen sooner than you think. There is no rule they don't happen all at the same time.


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