September 29, 2023
By Steve Blumenthal

 

The current set of conditions is not new to mankind, but it is new to most of us alive today. How the conditions will get resolved, how severe the problem may turn out to be, and who are the leaders needed to resolve the problem all remain unknown. Nonetheless, the problem is advancing.

Many believe we can simply pile on more debt and print our way out of the problem. That’s naive; I’d encourage further research if you share that view.

Here are a few resources:

• “How the Economic Machine Works” from Bridgewater Associates
• Ray Dalio’s, Principals for Navigating Big Debt Crises 
• The Price of Time by Edward Chancellor 

The Great Reset

Think of the Great Reset as a debt restructuring. Corporations restructure all the time. It’s painful and results in loss, but it can also lead to opportunity. As Ray Dalio likes to say, “Pain plus reflection leads to progress.” I do like that.

We can look at hundreds of years of history to better understand debt cycles and government restructurings. Most have been some combination of debt monetization, bankruptcies, reduced entitlement benefits, money creation, and increased taxes, and have resulted in some form of a new currency. The cycles have been long and slow, and there are winners and losers. If you know what to look for, it’s easy to see that we’re currently on a similar path.

What is debt monetization? It’s when the Fed prints new money to buy either newly created or existing U.S. government debt or both. The debt sits as an asset on the Fed’s balance sheet and a liability on the Treasury’s balance sheet. Woosh, clap hands, gone… it zeros out. Legal? Not really. Is it part of the game plan? Yes, so I was told by a former senior Fed insider in 2019. 

For hundreds of years, leaders and governments have mostly chosen to create new money. In crisis, it appears to be the easiest thing to do and tends to be what the masses want. But it also tends to lead to inflation and the problems that come with it. Those newly printed dollars buy newly created government debt, and then the government uses the money they’ve raised to fund infrastructure projects, defense contracts, entitlement payments, bail out big institutions, and, as the U.S. has done over the last few years, print $10 trillion and helicopter much of it directly to individuals. There is no current cap on the debt limit, and a government shutdown appears likely; however, the spending problem in Washington is worsening, and the spike in interest rates is making the picture worse. A shutdown will be resolved, and the march to $50 trillion in debt will quicken. The math is the math, and the math is not looking good. 

Think of it this way. If you had the power to print new money and use it to buy $100,000 of a government bond from me, you’d own the bond, and I’d have $100,000 in cash to reinvest or spend. That newly printed money, printed out of thin air, found its way into the system. If, on the other hand, you sold an asset for $100,000 and used it to buy my bonds, you simply moved money that already existed within the system from one place to another. No new money was created.

Create too much new money, and challenges mount. As Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.” Inflation is caused by too much money chasing after too few goods. We’ve seen the story before. Like a rerun of an old play, the current story is one of too much debt and money printing, leading to periods of higher inflation and persistently lower growth. There’s no straight line. History advises caution.

Monitoring the actions of central banks and governments will help us confirm or change our view. At this point in time, there is no change in my view.

Our team is currently writing a series of papers with the goal of educating investors on various types of investments they can use to navigate the challenges ahead. If we’re correct in our outlook, we believe your wealth—depending on portfolio positioning—can get through the 2020s in fine shape. If we’re wrong, the types of asset classes we are focusing on have the potential to perform regardless. Why in the world would someone own a 4.50-percent 10-year U.S. Treasury bond in a high-inflation, rising-interest-rate world when that someone can allocate to a high single-digit to low double-digit yielding, short-term, floating rate, senior-secured, asset-backed investment?

The first paper is titled Specialty Finance: Understanding Private Credit. Click on the link below if you’d like a copy. The other papers will explain the following asset classes that we believe are important exposures for the period ahead:

• Specialty Finance: Understanding Private Credit
• Specialty Finance: Trade and Insurance (Income)
• Specialty Finance: Tax Liens (Income)
• Hedge Funds: Equity Long Short (Absolute Return)
• Hedge Funds: Multi-Strategy (Absolute Return)
• Hedge Funds: Distressed Credit Long Short (Absolute Return)
• Real Estate: Multi-Family Housing (Income and Growth)
• Real Estate: Farmland – Agriculture (Income and Growth)
• Real Estate: Opportunity Zone (Income, Growth, Tax Advantage)
• Equities: High and Growing Dividend Stocks (Income and Growth)
• Equities: Active Investment Management
• Private Equity and Venture Capital
• Digital Currencies and Blockchain Technologies
• Hard Assets and Commodities: Gold, Uranium, Oil & Gas
• Energy Services and Infrastructure: Pipelines, Transportation

CLICK HERE TO SIGN UP TO RECEIVE THE SERIES OF PAPERS (FREE TO READERS)

(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)

1. Debt and Interest Rates
2. External Geopolitical Challenges
3. Internal Conflict Challenges

Debt and Interest Rates:

• In the early 1980s, Fed Chair Paul Volcker fought to whip inflation. His fight took the Fed Funds rate to an all-time high of 20% in March 1980. Since then, we’ve benefited from declining interest rates. It’s been a strong wind at our backs and was an incredible buying opportunity for long-term Treasury bonds. Think about what declining interest rates did for businesses, individuals, and asset prices in general. The winds have shifted.
• Today, the U.S. national debt is $33.1 trillion and rising rapidly. Total Federal spending is at $6.2 trillion annually, while total tax receipts are approximately $4.34 trillion annually, making the national deficit approximately -$1.77 trillion.
• As of August 2023, the interest on our national debt is approximately $708 billion, or 12% of total spending. Much of it is financed with short-duration debt that is being refinanced at higher rates. That $708 billion will reach $1.2-1.5 trillion when the debt is refinanced at 4% or 5%. The 12% allotment of total spending may become 24% in a blink. The lawyers running the government think it doesn’t matter. We economists and financial experts—you included—know it does.
• Social Security makes up 21% of total Federal spending. Medicare and Medicaid make up 26% of Federal spending. National Defense makes up 13%. Together, the four largest budget items make up 72% of the national budget.
• There is no sign of fiscal discipline on either side of the aisle. If you’re a domestic or foreign investor buying of U.S. Treasury bonds, does the behavior of legislators in Washington instill confidence?
• And think about this: Since the founding of the Republic in 1776, it took 247 years for the U.S. to print $10 trillion dollars. In the last two years alone, the U.S. has printed another $10 trillion—that’s half of all dollars ever created in our nation’s history.
• In the book The Price of Time: The Real Story of Interest, Edward Chancellor wrote an exhaustive study of 4,000 years of interest rates. When other countries have gotten themselves into similar debt challenges, in most cases, the chosen path was to create new money and monetize the debt. After all, what politician wants to pull the punchbowl away? (And who among the masses would vote for them if they did?)
• This is an inflationary path, which puts the value of the U.S. dollar on a negative trajectory. How will this impact the decisions the stewards of capital make? Current financial misbehavior by legislators is a poor way to attract the buyers the U.S. needs to buy the bonds.
• The government is selling hundreds of billions of Treasury bills, notes, and bonds each week. China and other foreign nations—historically, major buyers of U.S. debt—are sellers of U.S. debt today.

External Geopolitical Challenges (and Energy Prices):

• We’re now in the phase of a rising power challenging an existing power. It is abundantly clear that China is preparing for war. The peace dividend that existed for the past 30+ years is gone, and with it, the long-term deflationary benefits of outsourcing production to China. Friend-shoring and reshoring is the new state of play, which is arguably more expensive.
• For the economy: Inflationary!
• Rising expenses pressure corporate earnings: Stagflation!
• Oil and gas prices are rising again. We are years away from the green-energy solution most of the developed world is striving for. The world needs oil for years to come.
• The depletion of the Strategic Petroleum Reserve (SPR) for political purposes was a mistake. Needing to replenish this important asset, the U.S. government has put a floor under the price of oil while OPEC and Russia have cut production.
• We have a great dependence on oil, natural gas, and liquid gas. Petroleum products include transportation fuels, fuel oils for heating and electricity generation, asphalt and road oil, and feedstocks for making the chemicals, plastics, and synthetic materials that are in nearly everything: solvents, ink, boats, upholstery, sweaters, bearing grease, ballpoint pens, insecticides, tires, golf bags, perfumes, dishwasher parts, caulk, transparent tape, antiseptics, antihistamines, vitamin capsules, deodorant, cortisone, dyes, life jackets, skis, paint, refrigerant, mops, speakers, candles, trash bags, shampoos, etc. As I said: nearly everything.
• Furthermore, of the approximately 7.21 billion barrels of total U.S. petroleum consumption in 2016, 47% were motor gasoline (including ethanol), 20% were distillate fuel (heating oil and diesel fuel), and 8% were jet fuel. Green energy has done little to reduce this dependency.
• It’s not just at the pump. Higher oil and gas prices mean the cost to make and transport everything goes up. This is also, as you might have guessed, inflationary.

Internal Conflict Challenges:

• The U.S. is more divided, impatient, and angry with each other than at any point since the 1970s.
• Workers’ and unions’ negotiating power is on the rise. The wealth gap is extreme, with pressure mounting to bring it back in balance. From Hollywood to UPS to the UAW, strikes are proving successful, resulting in wage gains. More inflation!
• Rising costs reduce corporate earnings. More stagflation!

There are many positives, of course. Advances in healthcare, genomics, longevity health, technology that makes our lives easier and more productive, love, family, friends, theater, sport, and humanity’s ability to create. And isn’t creation great fun?

The Great Reset is a slow event that we believe will reach a point resulting in the restructuring of the debt, pension, and monetary systems. Reading about history shrinks the timeline of events in our minds. What took a long time for those who experienced it feels much quicker to us when reading a story. Live it, and you know it was a long time in the making. The point – the current challenges won’t be resolved overnight.

Our job as investors is to begin with a framework and watch the behavior of the important policymakers and those who elect them as time progresses. The objective is to avoid making big mistakes and position assets in a way that preserves wealth and provides a good return. Of course, all investing involves risk; diversify in a thoughtful way, so no one thing blows up your ship. 

If you would like a copy of the longer paper on Understanding Private Credit, click on the following link, and we’ll send it to you via email next week, with more to come on other asset classes in the future. The privacy of your information is important to us and, we know, important to you. We will not share your information with anyone outside of CMG. 

CLICK HERE TO SIGN UP TO RECEIVE THE SERIES OF PAPERS (FREE TO READERS)

 

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“If they are going to have lower volumes and higher rates, there will be stress in the system. We urge our clients to be prepared for that kind of stress,”
– Jamie Dimon:

Click here or on the next photo to read the Barron’s article:

 

Slowing economy? Buying a new home? The monthly mortgage payment looks like this… 

 

Danielle DiMartino Booth and Dr. Lacy Hunt – click on the photo to watch. I’ll be breaking this down into bullet point note format this weekend with the intention of sharing a summary review with you next week. The discussion is about an hour long:

 

The Fed is Always Late:

 

 

Concentrated and Overvalued:

 

On Inflation and Currency Debasement:

 

Creative Destruction and why it is a good thing:

 

Follow me on X (formerly Twitter). Truthfully, I’m a bit addicted. I like how you can follow your favorite thinkers. When I see something that seems worthy to me, I like it or retweet it.  You’ll be able to see what I find notable.  @SBlumenthalCMG

Personal Note: Sports Update

“A coach is someone who can give correction without causing resentment.”

“If you’re not making mistakes, then you’re not doing anything…”

– The late great Coach John Wooden

The season stands at 3 wins, 3 losses, and 1 tie, but for the boys, the heart of the season begins next Tuesday when league play begins.  

Yesterday’s game against a strong Holy Ghost Prep team was an exciting end-to-end battle that was 1-1 at the end of regulation time. After two five minutes of overtime, the MP Friars lost by a goal.

There were 17 fouls, three yellow cards, and a red card for the opponent and about half that for the Friars. Not a good showing for either side. One of our younger players should have received a red card for an unsportsmanlike foul. In soccer, a red card is an ejection from the game, and the player is not allowed to play in the next game. The referee didn’t see the incident. But others did. In the heat of the battle, life throws some opportunities at you. In this case, a learning opportunity for the young man. Something we all hope he better understands as he matures. He has had a few hard conversations today, and for next Tuesday’s league home opener, Coach Sue will keep him firmly planted on the bench. A learning opportunity indeed.

Last Saturday night, Susan and I sat with a senior educator at a wedding. It was by chance, and we talked about sports. Susan told him that one of the boys on the team, a senior, was being recruited to play Lacrosse at Cornell, and the Cornell coach was going to watch his soccer game. He’s a good soccer player but not a starter. He’s an excellent Lacrosse player. Why would a college Lacrosse coach want to come to the boy’s high school soccer game? Our friend Ron had an interesting answer, and it speaks the one’s character. He said the coach was coming to watch to learn about the boy. To watch his behavior in the heat of competition. How does he respond to a positive situation? To a negative situation? What is his behavior like? Head high, head low? His level of effort. Competitive drive. His relationship with his teammates and his leadership. Is he a good sport? Will he be a good teammate? Will he represent the school? 

That is good information to share with all athletes. And it is a wonderful message to share with the young man on the bench. I’m looking forward to that conversation. Sports are a good thing. Football is life! I see a rerun of Ted Lasso in the near future. Watch it if you haven’t seen it… It’s a happy pill.

Some golf this weekend as the weather looks to be good. Saturday is with some very good friends, and daughter Brianna will be home early Sunday and will join Wade, Jack, and me at Stonewall. I can’t wait for that… 

Best to you and yours! 

 

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Trade Signals: A Market Meltdown Can’t Be Ruled Out, Remain Defensive

“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.” 

– Charlie Munger

Notable this week:

To give you a sense of the price decline in the Treasury Bond market, the following chart is the Vanguard Extended Duration Treasury ETF.

• The popular ETF (ticker symbol EDV) is down more than 56% since the September 2020 high. (Large red circle in the chart.)
• It is down approximately 25% Since March 2023. • When interest rates go up, bond prices go down.
• This astonishing value loss matches the U.S. equity market declines during the Great Financial Crisis (2008-09).

Look at the chart again: The other thing to note is the amount of volatility shown in the chart (2017 to present). Green bars highlight up trends in price (not actual trading performance).

• For active traders, this is an ETF to consider. The red arrow, bottom right, indicates the current trend in yields remains up. The next chart is an update on the chart I posted in TS last week.
• Look at the spike in yield once it broke above the 4.33% red line. • The yield on the 10-year Treasury note closed at 4.63% today. (At 5.57% at the time of today’s post).
• This will likely have some knock-on effects on all risk assets.

(Side note: For subscribers, you’ll find when you log into your Trade Signals account that both Zweig Bond Model also remains in a “sell” signal.) 

 

The dashboard of indicators and the stock, bond, developed, and emerging market charts, along with the dollar and gold charts, are updated each week. We monitor inflation and recession as well. If you are not a subscriber and would like a sample, reply to this email, and we’ll send you a sample. The letter is free for CMG clients. You can SUBSCRIBE or LOGIN by clicking on the link below.

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The views expressed herein are solely those of Steve Blumenthal as of the date of this report and are subject to change without notice. Not a recommendation to buy or sell any security. 

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With kind regards,

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Private Wealth Client Website – www.cmgprivatewealth.com
TAMP Advisor Client Webiste – www.cmgwealth.com

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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.

Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.

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