CMG

Wealth through ingenuity

Linkedin

On My Radar: Default, It’s Nuclear

  • Share This:
Print Friendly, PDF & Email

October 11, 2013
By Steve Blumenthal

“It would be insane to default, but it’s no longer a zero-percent probability,” said Simon Johnson, a former chief economist of the International Monetary Fund who teaches economics at the Massachusetts Institute of Technology and is a columnist for Bloomberg View.

To be clear, I believe it to be a very low probability but recall Lehman too was a low probability.  Money is emotional and times such as this causes major indigestion.  I can only imagine that you are fielding a number of questions about potential default.  It is a confusing subject indeed.  Let’s keep today’s piece short and simple.

This week, I share the following relevant research:

  • Default – Some Helpful Talking Points for Your Clients
  • Dr. Ron Paul – A Great Interview by Chris Martenson
  • Trade Signals – Investor Sentiment and Cyclical Trend Charts Remain Favorable

On Government Debt Default – Some Helpful Talking Points for Your Clients

The following are selected highlights from Bloomberg:

  1. “If it were to occur — and it’s a big if — one would expect a series of legal triggers, potentially transmitting the default to many other markets,” said PIMCO’s Mohamed El-Erian
  2. “All this would add to the headwinds facing economic growth. It would also undermine the role of the U.S. in the world economy.”
  3. “If we miss an interest payment, that would blow Lehman out of the water,” said Tim Bitsberger, a former Treasury official and current managing director at New York based BNP Paribas SA. “Lehman was an isolated company, and now we are talking about the U.S. government.”
  4. The $12 trillion of outstanding government debt is 23 times the $517 billion Lehman owed when it filed for bankruptcy on Sept. 15, 2008.
  5. As politicians butt heads over raising the debt ceiling, executives from Berkshire Hathaway Inc.’s Warren Buffett to Goldman Sachs Group Inc.’s Lloyd C. Blankfein have warned that going over the edge would be catastrophic.
  6. “It should be like nuclear bombs, basically too horrible to use,” Buffett, 83, said in an interview published by Fortune magazine last week.
  7. One unexpected consequence of Lehman’s collapse was the seizing up of the repurchase agreement, or repo, market — a form of secured, short-term borrowing used by Wall Street banks and investment firms. Many of Lehman’s trading counterparts discovered the collateral they believed was backing their loans wasn’t there to grab as rules allowed. That scared investors in the rest of the market, closing off other trades and leading to fire sales of securities and further price declines.
  8. A government default could freeze the repo market more than Lehman’s collapse because U.S. debt forms its backbone. At least $2.8 trillion of Treasuries serve as collateral for repo and reverse-repo loans, according to Fed data.
  9. Here is the math: The Treasury has $120 billion of short-term bonds coming due on October 17, according to data compiled by Bloomberg. An additional $93 billion of bills are due on October 24. On the last day of the month, $150 billion needs to be paid back, including two-year and five-year notes that mature. The total due from October 17 through November 7 is $417 billion.
  10. In 2011, the last time Congress was gridlocked over the extension of the debt ceiling, repo rates rose as money-market funds pulled back because they didn’t want the risk of holding a security in default.
  11. People have typically turned to Treasuries as a safe haven, but what will happen when they realize it’s not safe anymore,” said Jim Grant, who has followed interest rates since the 1970s. “Financial markets are all confidence-based. If that confidence is shaken, you have disaster.”
  12. Treasury Secretary Jacob J. Lew has said the government will have only $30 billion of cash left by October 17 to meet its commitments. Those can run as high as $60 billion a day, which means the Treasury will need to borrow more to meet its liabilities, Lew said.  Goldman Sachs expects the Treasury’s cash balance to be depleted by October 31 and “possibly quite a bit sooner,” analysts at the bank wrote in an October 5 report.

Unfortunately, this is based on political ideology and positioning.  We are playing Russian roulette with the global economic system.  We are messing with the plumbing of the entire financial system that can result in cascading failure and multiple defaults.  Treasuries and everything priced off of Treasuries that act as collateral will be difficult to exchange.

It is not as simple as saying, “it is the U.S. Government, all will be ok”.  There are many moving parts and we have grown dependent of foreigners to finance our spending.  Chinese Premier Li Keqiang sent a clear message to U.S. Secretary of State John Kerry on Thursday.  Li told him that for “China the issue of the American debt ceiling [is of] great attention”.  The real risk of technical bankruptcy at this point in time is very low. The probability of this happening each time the debt ceiling needs to be raised is the real issue.

When Walmart buys items from a Chinese manufacturer, they pay in dollars.  The manufacturer then goes to the Chinese government to exchange those dollars for Yuan so that he can pay his employees in local currency.  The Chinese government ends up with surplus dollars and buys U.S. Treasury bonds with those dollars.  Today money moves across boarders at astonishing speed.  Money will move to where it is treated best.  There are unintended consequences to our actions.

There is a powerful game of currency manipulation that goes on around the world as different countries posture to gain competitive trade advantage.  We are no different here.  My point is to simply say that there are many moving parts and this is no small game.  Today, the world trades in dollars for we have the deepest capital market structure.  China and others are positioning to compete on the global stage and are thinking long term while we think short term.  We have fixable problems but they require long-term structural solutions.

I think of my favorite quote from my friend and famous author, James Rickards, “they think they are adjusting a thermostat but they are playing with a nuclear dial”.  Amen brother.

Dr. Ron Paul Interview 

In discussing Washington and the Fed, Dr. Paul believes that the good news is that people are realizing that this current system is deeply flawed.  He is encouraged by what might come out of this but thinks that we will go through the ringer first.  As he shares, “collapse will come but the more people that are prepared the better off we’ll be”.   Ultimately, he believes that rejecting authoritarian government is our greatest priority.

Trade Signals – Investor Sentiment Remains Favorable. Here is the link to the charts.  Note – Trade Signals is posted to our website every Wednesday at 6:00 pm.  The research is free.

Included in this week’s update:

  • Sentiment Charts – The short-term trend remains favorable supporting a continued rally.
  • Cyclical Bull Market Charts – The cyclical bull market trend remains favorable

As I close today’s piece, I can share that if dividend yields, inflation and interest rates were higher and PE valuations much lower, there would be less need to focus on risk.  It is simply that the forward expected returns for the traditional 60% stocks and 40% bonds are at the lowest level in more than 14 decades at just 4.10% – click here to see the chart.

Given this low expected return, combined with the global debt and entitlement headwinds and central banks massively manipulating the markets, risk is significantly elevated so we need to respond and construct our portfolios differently.  Today, 60/40 is in trouble.  Tactically shift your mix.  I like 33/33/34.

I thoroughly enjoyed listening to the Ron Paul interview and share his optimism.  If you get a chance this weekend, grab your iPad or cell phone, plug in your headphones and listen to this outstanding 19 minute interview.  You’ll be glad you did.

I’m thrilled with the recent gains in the stock market.  Our tactical strategies remain positioned long equities, our global equity strategy remains long and unhedged and the recent HY buy is working well.  Long/Short is mixed to flat but not all ships rise at the same time.  It is why we diversify.

Like you, I nervously watch the default debate with much concern.  In fact, I think I might need some Tums.

Please feel free to share this piece with your clients if you find it appropriate.  Wishing you the very best.

Have a great weekend!

With kind regards,

Steve

Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax

 

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk.   Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.

Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date.  Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions.  Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing.  CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.

This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note:  In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends.  The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.

CMG SR Tactical Bond FundTM , CMG Global Equity FundTM and CMG Tactical Equity Strategy FundTM:  Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Equity Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Equity Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.

Hypothetical Presentations:  To the extent that any portion of the content reflects  hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and,  (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model.  Please Also Note: Past performance may not be indicative of future results.  Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market.  Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation.  Included are the common stocks of industrial, financial, utility, and transportation companies.   The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model  meets, or continues to meet, his/her investment objective(s).  A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.

In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.

Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note:  The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy.  A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).