In PodCasts
  • Fed now purchasing virtually everything including corporate bonds
  • Dodgy debts, CLO’s, & Poison Apples
  • FDIC considering scrapping quarterly bank reports…


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Fed’s Money Man Can, Just Like The Candy Man Can
July 1, 2020

Mood is everything when it comes to politics, because now we’re talking about the mob. And if there is anything we’ve learned in the last three to six weeks, is the mob can be happy on Tuesday, very unhappy on Thursday. Will it be the defining factor in November? Adequate liquidity between here and November influencing social mood such that it is the determining factor in who wins or who loses?

– David McAlvany

Now here are Kevin Orrick and David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. Dave, I couldn’t get this song out of my head, “The Candy Man” back from the sixties or the seventies, but I’m thinking about the Federal Reserve. They “can take a sunrise and sprinkle it with dew and cover it with chocolate and a miracle or two…” You know, the Federal Reserve Man, the money man, the money man can. And you know, I thought about it. The money man can cause he mixes it with liquidity and makes the world taste good. You know what we’re seeing right now, if I were to go into the bond market corporate bond market and try to buy Bond. Guess who I’m competing with. I’m competing with the Federal Reserve man, the candy man, the money man, the people who can actually just print money and buy it right out from under me, even corporate bonds right now!

David: There’s a lot to talk about in the debt markets and the lion’s share of the Fed purchases are still focused in the ETFs where the structure of the product is unstable when investors are selling, very stable when investors were buying. But again, if you’re unable to accommodate liquidations, there’s a structural issue. So the Fed has stepped in and they are the buyer of first last resort whatever for ETFs. But now they’ve started the corporate bond purchases and, you know, thank you for smoking, they’ve bought some Philip Morris and a little bit of everything. They want to represent a bond index. The problem is, when you’re talking to the average middle class man or woman, you say, well, we’re also buying Daimler Chrysler, we’re also buying some foreign corporate bonds. It doesn’t necessarily make sense, but then again, maybe it doesn’t have to make sense as long as the candy man is making us all happy.

Kevin: You think about a bubble. Okay, a bubble, the substance of a bubble is almost zero, okay, but it looks large and it’s empty inside. I think about the European Central Bank over the last few years just buying everything. And now what we’re seeing is the same thing. So we’re continuing to try to keep this bubble inflated. I heard a story, a lady we know was getting married, and her father wanted her to have a particular dress. Well unfortunately from the time that she picked the dress out to the time that she was going to buy the dress, the wedding shop went out of business and it was owned by the creditors. And now this lady was very fortunate because her father had the wherewithal to buy the whole inventory so that she could get that dress. So are we getting our entire financial system out of hock? Is it a similar situation right now with the Federal Reserve just buying everything?

David: Let’s hope it’s a happy wedding because frankly, when the Fed gets involved, oftentimes it’s more of a shotgun wedding type of a thing. And you know, the forced issue is what we’re concerned about. You’ve got yield curve management, it’s not like it is the first time we’ve seen it. They’ve talked about it, the Federal Reserve has, but they’re following the cues of the Japanese who have been doing this since 2016. First it was the short rates that they wanted below zero, then it was the 10 year Japanese government bonds (JGBs) that they wanted just slightly above zero, leave a little bit of difference between the two, little bit of margin for the banks using that model of borrowing short lending long. It’s been a very, very paper thin margin, and banks in Japan have suffered from low profitability because of that. So, you know, the difference between negative and nearly negative rates. There’s no surprise that with Bank of Japan promising to continue what they call the YCC policy or yield curve control, the yen has been a very predictable funding currency for carry trade dynamics, speculative carry trade dynamics, where you are borrowing in the currency where the money is cheap and you invest where the rates are higher and you capture the spread between the two rates. We’ve got it now, we’ve got a carry trade dynamics and those carry trade dynamics ebb and flow with market volatility, as you kind of perceive risk could take you out. And we’ve seen the carry trade crowd ease back into speculating with borrowed money. But whether it’s on that side of the pond or this, it’s still this issue of control.

Kevin: Do you remember, this was like 25 or 30 years ago, the carry trade was just a sure bet and there was a trader at Barings Bank. If I remember right, Barings Bank was the oldest British bank at the time and one trader, because the carry trade shifted, one trader took the whole bank down. You don’t ever hear about Barings Bank anymore cause it isn’t anymore.

David: A fascinating book called The Sixth Great Power is kind of a history of Barings Bank. And how if you’re talking about international clout, they were considered to be number six behind the number five greatest nations. You know, they really were a big deal in their day. Yeah, you get a few pennies wrong on a leveraged basis. and it makes all the difference in the world. Frankly, I wonder if the same is not ultimately going to be true with the Federal Reserve. Jim Grant put together some very interesting numbers combining the $3 trillion in securities which the Fed has purchased with the other balance sheet assets that they’ve acquired through the years, $7 trillion in central bank assets. And yet there’s only $38.9 billion worth of central bank equity. And so what he’s basically saying is these numbers don’t allow for a lot of change in price.

Kevin: No wiggle room.

David: A decline of as little as 6/10 of a percent in the value of the current portfolio of bonds, bills and mortgages renders the Bank of Powell, he calls it, insolvent.

Kevin: You know this last week we talked to a listener who also owns a bank and, he actually was talking about oil shale and said, you know, when the borrowing is no longer allowed or when the funds are no longer available, the whole oil shale industry is over, and we see Chesapeake, at this point we’re actually seeing some of the things that you talked about a few months ago, Dave, even before the COVID thing, you talked about just how little wiggle room, in fact, there was virtually no wiggle room in the shale industry, and now we’re seeing it.

David: Well, exactly, Chesapeake is done. That energy company has been officially wiped out. As Lila on the wealth management team has described, it’s the upside down balance sheet where assets are not worth what they once were or were believed to be and liabilities are still there, so kind of going back to the adage from Richard Russell years ago, asset values fluctuate debt is permanent. That’s the problem with an upside down balance sheet. When the assets change, all of a sudden it looks really ugly. And again, that would be the case if we got an accurate mark to market with the assets on the Fed balance sheet because they’re at, in terms of assets to capital, 182:1. Kind of a staggering ratio. But thinking about Chesapeake as Lila was sharing her thoughts about Chesapeake and their inability to sell assets in this environment and thus bail themselves out. I was thinking about, because sometimes I do think about food…I’m back in the training mode again, and so it’s kind of a constant battle how to to get enough calories.

Kevin: (laughs) Always hungry.

David: So she’s talking about the upside down balance sheet, and I automatically went to the pineapple upside down cake, you know, so you’ve got things that sink to the bottom, and then they’re finally on the surface again. And in this case, it’s too much debt and assets that have been remarked to market values in a depressed energy environment. And it becomes terminal. So you add injury to insult, nobody was there to buy the assets that they could have put to market for sale and to eliminate a part of their their debt burden. So it’s the liquidity crisis once again that leads to the solvency crisis, and on Sunday we’ve got a watershed in US shale history. Chesapeake declared bankruptcy on Sunday, and they were the number two in shale behind Exxon Mobil years ago. So this is one company, it’s shale predominately natural gas. But this week we also have Shell announcing a write down of between $15 and $22 billion in asset value. So again, you’ve got these ratios which can change quickly leverage ratios and we’re intrigued by energy as a potential investment and as a place where we will put more emphasis as wealth management group. But we remain very cautious, and we remain very liquid, wanting to see how this continues to play out.

Kevin: There are certain things you say sometimes, Dave, when we do this commentary that are worth repeating for memorization purposes because this is an adage. This is something that we all should know. Liquidity crisis, once again, leads to solvency crisis. And so, you know, you look back in the Great Depression back in the 1930s and you think about the people who made it through. They had liquidity. Real estate was lost to not being able to pay taxes. You could be real estate rich in the 1930s and still walk away without anything. But if you had liquidity and could hold on to it, it turned into one of the greatest assets of the 20th century.

David: You know, oftentimes we talk about our perspective triangle, which is, you know, a very simple back-of-the-napkin asset allocation model. And really, the assets themselves matter less than the mandates that we talk about. Liquidity is one of the three mandates. Insurance is another mandate and the growth in income. And what you’re doing is you’re changing your mindset to see that you can ask your assets to do different things for you. Wall Street generally sees growth and income is really the only mandate necessary.

Kevin: It’s either stocks or bonds, stocks or bonds…

David: But its growth and income. And never do you hear the conversation about insurance or liquidity and liquidity does have its own value, whether you’re managing a business managing, household or opportunistically, looking at that optionality embedded within a liquidity portion within a within a portfolio.

Kevin: Well and the insurance mandate, of course, is golden and silver. That’s the main element of the insurance mandate.

David: Yeah, yeah, so I mean, we just can’t neglect liquidity, and too often it is neglected because it feels like it’s just sitting there doing nothing. But in terms of physics, it’s like potential versus actual energy. There’s a lot to talk about as it relates to potential energy and how you deploy it, how you get it to work. Again, I mentioned our energy interest. We’re interested in it as an allocation within our wealth management group. But we’re also very cautious as to how we deploy that liquidity, knowing that not only is cost basis matter but also having some idea of what is on the horizon also matters. And quite frankly, you can’t say with any degree of certainty what that translates into in terms of that view on the horizon when it comes to energy, because we still have no idea on the demand side how the U.S. economy or global economy come back into play post COVID.

Kevin: Well, not just energy. You look at the companies right now that are in liquidity crisis that have a solvency crisis. At this point, there’s an awful lot of re-amending the terms of the payback of these loans.

David: It’s a fascinating thing. U.S. companies, this was a Financial Times report looking at May and the record levels of amendments made to leverage loan metrics, again so for U.S. companies there are a record number of covenant amendments, which is like a restructuring, a restructuring on a voluntary basis where creditors willingly change the terms of a loan because they want to lower the odds of a bankruptcy event. And there can be, in a bankruptcy event, kind of a free for all for who gets what in terms of creditor priority and whatnot. So sometimes these sort of let’s go to the table ahead of time and adjudicate outside of a, you know, Chapter 11 type restructuring, that’s the amending that’s happening right now.

Kevin: And that makes sense, but we’re hitting record level amendments. We’ve never seen anything like this before.

David: Yeah, exactly. And we’re seeing it happen because earnings are not in line. And what’s interesting is there’s different stages of a credit crisis. The early stage, you’re seeing voluntary amendments being made. There is a mind switch in a creditor, and all of a sudden it’s like they go from being friendly to…it’s like a carrion burger barbecue. I mean, you’re feasting on the assets left over from the bankruptcy, and we’re not there yet. It’s still a gentleman’s game to this point, but our best guess is the real issues emerge this fall as institutions sitting on lots of CLOs, collateralized loan obligations, just like the CDOs or very similar to the CDOs of the 2004 to 2007 timeframe came before, you know, ultimately they were problematically repriced. And so the next wave of covenant amendments will be less comfortable for creditors, and I think it will bring out sort of the inner vulture in them. And it’s fascinating because if you look at Bloomberg just this week, you’ve got a reprieve, as Bloomberg writes about it. CLOs get a Volcker rule reprieve to buy more than leverage loans. So now collateral loan obligations can have up to 5% of bond buckets. And there’s other changes that may allow for CLOs to hold equity like assets as well, according to Bloomberg. So again, it’s kind of like CLOs in the credit market are becoming the sausage factory. Don’t ask what goes in, you really don’t want to know. And you know, I think The Wall Street Journal pointed this out last week, not too insightfully by the way, that companies have loaded up on debt in recent years. That, of course, is an obvious thing. We know that. What was interesting is that they were commenting on how a lot of the dodgy debts, the riskier stuff has been repackaged by Wall Street into portfolios of debt. You got it. This is the CLOs.

Kevin: It’s what we saw back, you know, 10, 12, 14 years ago, where you just take bad debts, you put them in with a couple of good debts and you call it all good and it’s a game that’s played. The problem is, it’s junk inside, it’s like a poison apple. It looks like an apple. It tastes like an apple, but it kills you.

David: Or you could say one bad loan is a bad loan, two bad loans is two bad loans, ten bad loans is a great financially structured product, which all of a sudden doesn’t carry the same risk as one or two loans. And there’s like an implied a reduction of risk because of the diversification. But if you look at the composition that still is an issue, so you know, again CLOs, when you combine the loans, it’s no longer considered a bag of garbage. Instead, they’re considered less risky, and they are bought by banks, insurance companies, and investors all over the globe. Once Wall Street’s structured finance guys put a bow on it, there’s no need for a sniff test, and it’s safe enough for pensions. It’s safe enough for banks, and, you know, it’s a cleverly leveraged opportunity.

Kevin: So cleverly leveraged opportunity. That’s the new CLOs.

David: That’s what I would call it, particularly if you’re the one selling it. It’s very cleverly leveraged as an opportunity.

Kevin: I’m going to still call it a poison apple, okay, because you can’t identify it. But if it’s poison, it’s poison. You know, okay, but the economy disconnected from the financial world, okay, if we’re blowing up a bubble right now with printed money, we we’re talking about the candy man, the money man, the Federal Reserve man. The problem is, the Federal Reserve man can’t make earnings go up. That’s more economic, isn’t it?

David: Yeah, so sounding a bit like a broken record can’t help but point out that reported earnings have declined, which obviously ties to corporate profitability slipping. But the possibility of significant improvement later this year is also slipping. You’ve get sales, which are, you know, if you wanna say, stuck in the slow of despond, they’re not improving, and the risk is not that we experience sort of the business cycle ebbs and flows. The risk is this disconnect you mentioned, Kevin. The risk is always that markets are misjudging the environment.

Kevin: Well, they’re perfectly priced for perfect outcomes right now.

David: Yeah, so we get overconfident in pricing assets for that perfect world and then discover oh, whoops, there are imperfections.

Kevin: Then it has to adjust, then is when the market has to come down unless you continue to fuel the bubble with printed money.

David: Yep, so the IMF is warning of the disconnect between financial markets on the one hand and the real economy on the other. And again, it’s kind of a logical series of dots to connect. Expect a correction in asset prices as a consequence of the disconnect between the financial markets and the real economy. In their projections for the full year, the IMF is looking at a bigger GDP contraction than they were even just a few months ago, and they’re also lowering their expectations for 2021 as well.

Kevin: So let’s say you’re a skeptic and you say, all right, I get you guys. You’re right. I agree. Earnings are not going up. We’re going into a recession, depression, what have you, but the Fed’s got my back. I mean, that’s really what the market is saying at this point. It’s not like people don’t understand that the economy is in trouble. That’s not what the market’s telling us. What the market is telling us is that it trusts the Fed.

David: Yeah, I mean many investors, again I can’t help think about raising kids these days because I just watch the cleverness involved and the boldness sometimes of wanting to sort of test limits. And they do believe that they can play the game and they’re playing it effectively. And they don’t believe that I’ve played the game and see right through it. So I mean, yeah, we’ve had massive monetization that’s helpful for propping up asset prices. But with that comes a widening gap between the real economy’s lack of recovery and the asset markets pricing in a full recovery. So speculators are out there saying, yeah, but I can walk the line, I can play this game. Fed’s balance sheet expansion got us here and only the Fed’s balance sheet expanding further is going to take us further. And I think this is one of the things that is very interesting. If you look at the last two weeks, you know it’s not sales and revenue projections that are moving the needle. In fact, we’re in this interesting place where over the last two weeks actually currency swaps have declined cumulatively over that two-week period by about $90 billion. So the balance sheet at the Fed has actually contracted over the last two weeks. And it’s not that they’re any less active, but on a net basis, what they’ve purchased versus what’s rolled off in terms of those currency swaps, there’s actually been a little contraction.

Kevin: Yeah, but let’s not call it a taper because the market would have a taper tantrum.

David: You’re likely to get more Central Bank gen right? It’s just going to have to be circumstantially driven. But here we have the index has kind of stalled out, not moving, except with NASDAQ being the the standout… not moving to new all time highs. Excess liquidity is going to rise all boats. Liquidity shrinkage is going to do the same for prices helping them get to lower levels and liquidity is key.

Kevin: Last September, when you just now said liquidity is the key, last September we warned our listeners, we sent emails out to our clients saying there is something wrong. There’s a liquidity crisis in the repo markets. It wasn’t showing up in the actual market pricing, but it turned out that you know what will be blamed on COVID actually started back in September in the liquidity markets. There’s another thing that we can actually say. We start to smell something in the wind, and that is, Dave for 30-some odd years, we’ve paid every quarter every quarter for all the FDIC bank ratings, credit unions got added to that. We give bank ratings to our clients for free. Using those statistics, and that looks like that’s going to be taken away. It almost reminds me…remember when M3…they came out and they said, well, we’re not going to measure M3 anymore. It was one of the most useful measures, and they just they took it away. How long have these banks had to give the reporting that they’ve had?

David: It has been over 100 years that banks have been giving quarterly reports of the FDIC as a measure of the credit risk in each institution and those quarterly reports are what get translated into these sort of throw-the-bank-under-the-microscope and see how they’re doing.

Kevin: And it’s been useful. It has been useful. We have seen banks that were ready to fail and gotten people out of them in time.

David: Well, you’re talking about the M3 moment. This, again a few years ago, there was a disagreement the Fed was like we don’t need it. This is a statistic that’s no longer relevant. And yet, if you read the financial press at the time, the European Central Bank and the Bundesbank were like, that’s probably the most critical variable we used for long term planning, but no, you guys can ignore that. That’s fine, if that’s what you want.

Kevin: They just don’t want us to see it. That’s the problem.

David: (laughs) I think so. With M3, it was the end of an era, one of the tools that you might have used to project growth in inflation, the end of an era, a silencing of a signal, and we make it the equivalent of signal reduction for banks tied to the FDIC. As they consider, again they’re considering scrapping their quarterly bank reports. That’s what the FDIC see is is working on now. And they say they’re looking for a more timely and targeted data set to measure credit exposure and deposit information. And so they’re flipping it out to third parties. They’re bidding the project to a variety of data and technology firms to crunch the numbers, provide something for them in real time, and that may be of incredible value, but when you change the measure…I think this is kind of what bothers me. Change the measure when you need to remeasure success. And perhaps it’s on different terms, that measurement of success.

Kevin: Sometimes it’s a signal that something’s coming that’s much worse than what we see today.

David: Well, remember Sheila Bair was hiring like mad at the FDIC staffing up in the first quarter. This is sort of January-February 2008, months before the global financial crisis was an obvious market killer, and go back to that idea of, ah, you know shotgun wedding, what have you, where we had, you know, B of A and Merrill and a whole group of financials that were forced to merge. The FDIC was staffing up in early 2008. All I’m saying is the FDIC has today policy changes. Policy changes are rarely without reason. Perhaps it is coincidence that the FDIC wants to measure banks on a new standard after over 100 years. If you are responsible for ensuring deposits, how would you want to manage the liability of deposits?

Kevin: Yeah, but aren’t deposits just skyrocketing right now? I mean, the cash going into banks is huge.

David: But that’s a function of fiscal stimulus. Ironically, you have massive government fiscal interventions. Bank deposits for the month of April spiked $865 billion…

Kevin: Wow, almost a trillion bucks.

David: They’re up $2 trillion since January, right. So you’ve got the largest surge in bank deposits ever seen. And, yes, think about the equation. Increase in bank deposits, yes, the FDIC is in that universe. Surging deposits are also surging potential liabilities for the FDIC because they are the insurer of last resort for bank deposits.

Kevin: Well, and let’s look at that because one of the measures that we use with these banks with this reporting is something called hot money. It’s one of the most valuable measures for a bank because banks will compete back in the old days, remember when banks actually paid interest?

David: Everybody was paying interest. So you had to compete on the basis of a Sunbeam toaster. You open an account, we’ll pay you 5% and you get a Sunbeam toaster.

Kevin: (laughs) But for the people who only came for the toaster, and we’ll pull their money out afterwards, that’s called hot money.

David: Well, exactly. If you’re shopping for the highest rate, you’re not somebody who is looking for a long-term banking relationship. You’re there opportunistically, and you could be gone tomorrow. So when you’re looking at the stability of bank deposit or the base of deposits, hot money does factor in because you want to know are these folks that are going to be there…you’re in an unstable business to begin with, you’re borrowing short lending long, you’re making long term obligations on money that can be put on demand immediately.

Kevin: And you’re saying $2 trillion has been added since January? So could that be hot money? Talk about a liability.

David: Well, yeah. I mean, those deposits could be categorized as the single largest increase in hot money flows into the U. S. Banking system of all time. So hot money ratios are never good when you are again measuring a stable deposit base. That’s one of the factors that goes into a bank stability score. Look, it may be a stretch to connect the FDIC’s desire for a made-to-measure real time credit report, replacing the old quarterly procedures, connecting that to the massive increase in deposits, which again throws all banks into a weird place of having a ton of new deposits. What do you do with them? Sounds like a great problem to have, but it does create a little chaos. U.S. banks are clearly different than emerging markets. Keep in mind how destabilizing big inflows and outflows can be. For banks, you get all this money in and the question is how to deploy it. Do you invest in fixed income securities? How about CLOs? And yes, banks are investing in credit loan obligations, leveraged loans, packaged and prettified—lipstick on the pig, so to say—and you increase your mismatch. This is what happens with a major inflow, potentially, of hot money. You increase your mismatch of long-term loans with deposits that are very short term in nature. Given the short-term nature of hot money flows, this is where it’s not good. Everybody loves money coming in, but it’s the destabilization which happens with outflows, which are catastrophic. If you look at many of your emerging market debt crises, it was hot money. It was the outflow of hot money which required them to, you know, the equivalent of gate, create capital controls. And I think what you’re talking about is the real possibility of destabilizing outflows not unlike emerging markets, but within the U.S. banking system.

Kevin: Could this be, then, possibly why they’re looking at polling this quarterly rating? You know, if you change the parameters, let’s say that you know something’s not going to make the grade anymore. You just change the parameters you say okay, well, our tolerances…you see this in engineering sometimes, right? You can have tight tolerances. You can drive that BMW or that Mercedes. Or you can have loose tolerances, which I don’t know that I even want to name a brand after, you know, all the comments that come in on the commentary when we do.

David: How about a VW bug? The old-fashioned VW bug, everything was a little looser.

Kevin: A little…especially the older got.

David: Yes, well, I mean, I don’t think it’s a stretch. I could be wrong about the hot money flows and the FDIC change, but I don’t think it’s a stretch of imagination at all to see the forbearance period coming to a close.

Kevin: Yeah, explain what that is. The forbearance period is the delay of needing your debt paid back, right?

David: These are banks that say basically you owe us the money, we understand because of COVID you’re not going to be able to make payments right now.

Kevin: That’s coming to an end.

David: And so we’re going to give you 90 days grace period. You don’t have to do anything for 90 days, but at the end of 90 days, we’re going to go back into that mode, and that forbearance period comes to close, the FDIC shifting its measures of financial stability within the market. And I do think it’s like a widening of tolerances. If you’re a mechanical engineer, this is up your alley. If you widen tolerances, you can lower costs. If you’re talking about fabrications of things, the flip side is equally true: If you tighten your tolerances, or if you’re talking about even the strength of a particular steel or what have you, you tighten tolerances and your costs rise exponentially. In this case, it’s the FDIC insurance payment costs. Why not widen the tolerances, reduce the risk of payment, and do that now?

Kevin: One of the things that we saw back 10 years ago…actually it was more like 2007, so about 13 years ago…we saw a lot of mortgages that couldn’t pay anymore. In fact, remember they were underwater, and it became very apparent that the real estate market was going to go through a huge change. I’m wondering about the forbearance periods right now on mortgages.

David: Well, I’ll be very interested to see what the new outsource report looks like. Because for us, as you said earlier there’s a conversation that we have with clients on a quarterly basis, at least on an annual basis, we provide that service for free. Getting a bank rating, we’ll do that free. If you’re listening right now, call us for a bank rating. Not a problem. That’s what we do because we want to assess risk in those kinds of deposits, but we’re quickly moving to the end of the loan forbearance periods. And it’s not just sort of individual loans, we are talking about a huge amount of mortgages. 4.68 million homeowners—this is CNBC’s numbers— 4.68 million homeowners are in those forbearance plans and again, three months delay of payments, bank’s are saying, look, we’re not going to put you under the gun…

Kevin: What percentage of all the mortgages is that?

David: Less than 10%, it is about 8.8% of all mortgages. It represents a trillion dollars of unpaid principal, and that’s a part of the forbearance deal. Add to that what Bloomberg reports separately as mortgage delinquencies, because if you’ve been given forbearance, you’re not delinquent. But if you’re talking about mortgage delinquencies, these are borrowers who are more than 30 days, late that is now up to 4.3 million homeowners. Now you’ve got a total of 16.8% of all mortgages, which are either past due, in foreclosure, or are weeks away from facing the music with forbearance coming to an end and then having to scramble for liquidity to keep the bank at bay.

Kevin: Do you think that’s possibly what the bank stocks have been signaling? I mean, bank stocks have done terrible this year.

David: Absolutely. I mean, if you look at the recovery in the equity indexes, we talked about this last week where you’ve got five companies that are the lion’s share of the increase for the S&P 500, 495 have not done very well at all. Bank stocks have been weak all year long, even as the indexes have recovered off of the February to March lows, that period of 27 days of chaos, what a terrible 27 days it was. Not to minimize it but…

Kevin: It’s not over. That’s why you’re doing it.

David: Well, and it’s minor by comparison. Banks are still down 36.5% year to date. Okay, banks are down 36.5% year to date. Last week was no exception. We had the stress test results, and they finished the week down 8.4%. And a part of the pressure on bank stocks came from the Fed curtailing with massive buybacks and dividend hikes, which they’ve seen that the end of each stress test in recent years. So they passed with flying colors and then they’re given permission to pay out huge dividends and buy back shares. And the Fed this time around said no, we’re going to tie your dividend hike to an earnings metric and bank stock investors all of a sudden were like wait a minute, that’s different.

Kevin: No more playing games?

David: Yeah, so between the Fed’s restraint on permissive bank payouts and the FDIC changing how it measures the credit worthiness of banks it insures, I think it’s enough to say something is brewing.

Kevin: Which makes me go back to what I always go back to Dave. Should a person have a little bit of gold? I don’t know, am I being sarcastic here?

David: You know, being on a personal gold standard is something that an individual investor can do and should do. There is no chance, not a snowball’s chance in hell we’re ever going back to the gold standard in the United States because politicians won’t take the constraints put on them by having to balance a budget.

Kevin: But what your government won’t do, you can.

David: That’s right. So as we play out the consequences of errant fiscal and monetary policy, the average investor does not have to just sit there and take it. You can put yourself on a defined gold program, a gold standard, a personal gold standard. It’s one of the reasons why we created vaulted. is a great way to get that done or do it someplace else. Do it some other means, but medals in any form…just don’t be sourcing your bars from China.

Kevin: In fact, Wuhan, I think, is where those bars came from, not just China.

David: A few tons of copper plated in gold coins…

Kevin: Coins sometimes help.

David: My take away is know where your gold is coming from.

Kevin: Right.

David: Prominence is everything. As we’ve said with a vaulted program, one of the reasons why we’re working with the Royal Canadian Mint is because they’re the only place in the world to guarantee gold from conflict-free sources, you know, and we’re not talking about the nefarious nature of knockoffs, which is, I mean, come on, when you think China, don’t you think knockoff? I mean, this is like a Rorschach test. I say China, you say…And you want to get your gold from there? I don’t think so, but I mean so the Royal Canadian Mint conflict-free gold, that’s important. That’s important because I don’t want to support you know, whether it’s child labor in the Congo or…there are just a whole host of things you have to be savvy on as an investor, and they I think it’s worth paying attention to some of those details.

Kevin: So don’t get your bars from Wuhan, China. But also let’s…

David: (laughs) Don’t get your COVID from…

Kevin: Well, let’s go to COVID, okay, because obviously everybody’s got their ideas to whether it’s going to be worse, better if it’s overplayed, underplayed, what have you. But I think you have to look at the statistics to make your own decision.

David: Yeah, I mean, we discussed last week, there is sufficient concern with COVID cases increasing for there to be a real cost, economically speaking, from the changes in consumer behavior. You know, some people would say this whole thing is a hoax. But, come on. Just look at the change in consumer behavior and know that there is a price to pay, regardless of what side of that argument you land on. There is a change in patterns of travel and entertainment. And those changes are still evolving. I read a statistic from Joe Biden’s office. Actually, I heard it from the horse’s mouth.

Kevin: It scared me, 120 million…

David: We’re at about 120 million dead from COVID.

Kevin: Yeah, yeah, now that was right out of Biden’s mouth, wasn’t it?

David: Actually, I think he’s using a special calculator. Special people use special calculators, politicians are very special people. That’s my syllogism for the day. So ok, there are a number of reasons that Biden isn’t allowed to deviate from the teleprompter.

Kevin: So what’s the real number?

David: 500,000 worldwide. Not quite 120 million. 500,000 worldwide is the current casualties, and I think there are a couple things of worthy note as it relates to COVID. A: there is a massive increase in cases. But, B: the death rate is in steady decline, and C: in the states that are seeing the largest resurgence…again so in Texas, you’re talking Arizona, you’re talking Florida, even California, okay, a big increase in cases, but most of the resurgence is in counties that are on the border.

Kevin: On the border, yeah.

David: And so if you look at high population, non-border counties, very low. Even though the states have opened up. But there is now a differentiation in terms of the counties and their proximity to the border.

Kevin: Well, and some of the testing is picking up asymptomatic cases. I mean, it’s not all sick people. It’s people maybe carrying it.

David: Well, that’s true. So big spikes, I guess the point is, they’re not equally spread across the states in question. So I mean, I’d love to see a little bit more healthy—I use this word carefully today—healthy discrimination in terms of how this is done, but more testing needs to be done, but a little bit more discrimination in terms of how these states are either opened or closed and perhaps sort of targeted. Where there is a need for closure, close. Where there’s not a need for closure, don’t close and just engage intellectually in the process. You’re right, the point on asymptomatic cases. You’re getting higher case rates as more testing is done and it’s picking up the asymptomatic cases. It still doesn’t make sense to me that heavy testing and selective quarantine isn’t a part of the mitigation strategy. There are high risk areas that need more attention, low risk areas that don’t need the same level of restrictions and business closings. And I think distinctions would be nice. The problem with that, if I’m going to self-critique, one of the many problems, perhaps, is by having a methodology that maximizes economic results, there still are going to be casualties. There’ll be casualties regardless, but the one size fits all approach covers your basis. It’s a CYA approach. We live in a litigious society. No one is implementing a policy, no one wants to take on the liability associated with discretionary application of testing and seclusion. So everybody is going to be a part of the closure, right? So we’ll close down a city, we’ll close down a county, we’ll close down a state, as opposed to saying we have this one pocket here which needs to be addressed. And actually, the Chinese have been a much better job of addressing this where they are, perhaps in a heavy handed fashion, but they’ll say, okay, we don’t have a problem across China. We have a problem in this city, in this part of the city, therefore lockdown.

Kevin: You know, we’re facing this as a family right now, and I know a lot of families are facing this, but it makes no sense to me that you have certain things like beauty salons and facial places open. I have no problem with that, but what really is hurting us right now is my wife’s father has dementia. He had an injury, he had a hip injury last week. No one can go see him and he can’t go in. He doesn’t understand without having somebody in the family with him, but they can’t be with him because it’s this litigious thing. They’re scared to death to be sued, so it really doesn’t make sense and people should be able to make their own personal decisions on these things.

David: Yeah, and I think it’s worth watching the rate of infection versus the death rate, the death rate is in steady decline. As long as that stays the case, that arguably is a good thing. There’s a healthy aspect to herd immunity. Likely the decrease in death rate has to do with again more people being out and getting it, but it being a younger demographic getting the virus, it’s not as catastrophic in terms of the event.

Kevin: Well, and you seem to see the spikes, even with the younger people, you seem to see the spikes in these community gatherings that are not necessarily necessary like restaurants.

David: Yeah, JP Morgan ran a study looking at Chase debit and credit card usage in cooperation with a Johns Hopkins Case Tracker, and found a very high correlation between increased restaurant spending in a state and new infections three weeks later in those areas. So that the data studied was, you know, on 30 million cardholders, and it was the in-person restaurant spending which the researchers described as particularly predictive for future COVID cases. So again, this comes back to…I don’t care what you think of COVID, if you care about investing and finance, and I’m not trying to separate the catastrophic life consequence here. I’m just saying that if consumer behavior is changing and it’s this type of spending detail and data aggregation that JP Morgan and Chase did in cooperation with Johns Hopkins which is going to shape the consumption patterns in the months ahead. And I don’t think you can argue for an improved economic outlook coming into year end. Which again, you come back to the IMP proposition, which we should see a correction in asset prices. The other thing that you might say will close the gap is an improvement in economic outlook between now and the end of the year. And yet you can’t make the case for an economic improvement between now and the end of the year with the uncertainties that are factored in. Therefore, one gives and one has to close the gap. I think it’s asset prices moving lower, not economic activity moving higher.

Kevin: Could this be Biden’s only chance then, if the economy continues to slow down?

David: Yeah, I mean, Biden’s only chance is that we are smack dab in the middle of an economic depression. Again, I don’t care what side of the aisle you stand on. This is just political facts and political games will be played with the facts, whether it’s COVID facts or it’s just that is the nature of politics. It gets nasty. The closer you get to November, the more of a mudslinging contest it becomes. And you know, already you see the polls, which are showing a favorable swing to Biden. And it’s the same pattern we saw in the last election, Hillary a couple years ago. The issue with these polls, then as now, is that there is an oversampling of Democrats as the numbers are put together. In one poll I looked at, the swing in favor of Biden was a 12 point swing, but the oversampling of Democrats was by 17%.

Kevin: It’s that interesting? So Biden had an advantage of 12% but it was 17% more Democrats that were being polled.

David: So create your own momentum. Just like last week, we were talking about creating a new set of fundamentals. The polls are supposed to create a new reality, and they just neglect the fact that there are a bunch of people who look at the polls with a bit of a jaundiced eye to begin with. And they are more like propaganda than a legitimate statistical indication of voter sentiment. I mean, we’re talking about, you know, 12% point swing in the direction of the great hair sniffer for what reason? There certainly is room for criticism in terms of how the social conflicts are being handled today, how COVID is being handled today. Everybody has an opinion, whether you’re Fauci or ask any doctor what their opinion is and for every doctor you ask, you’ll probably get a different opinion. There’s not a lot of consensus. And so it’s easy to say, yeah, Trump should be losing a couple of points.

Kevin: Well, and I wonder, too, if it’s not so much about Biden because, you know, he seems to be obviously slipping, at least to me. I’m looking at his eyes, and his eyes seemed to be looking more dementia like as as we go, but V.P…

David: Do you feel like you’re extra sensitive to that. Maybe even too sensitive to that, just because of your family experience and what you’re going through with your father?

Kevin: I have seen it and you can see that there’s a change and, you know, this will make people mad, we will probably get a bunch of comments on it, but I’ve seen it in the interviews. But here’s the thing. The VP, the VP could be critical on this.

David: Oh sure, yeah, I mean, right now we don’t know who we’re voting for as president, because if you’re right and he ends up being sidelined for health reasons, then it really is about who the vice president is, the president to be.

Kevin: Well Dave, on this program we’ve tried to stay away from politics and whether it’s being pro-Trump or not pro-Trump or pro-Biden. But the point is, we have to look at the facts the way the facts are. We try to be as objective as possible because what we’re doing is we’re trying to give analysis from an economic standpoint, you have to face the music the way it is when you’re dealing with economics.

David: Let’s bend back around to where we started the conversation with liquidity, with Fed interventions because we may be defining a political outcome as we come into this election cycle, depending on how much liquidity is flowing. And if people feel pretty good, if the stock market is still ebullient and prices in the bond market and then banks are improving, guess what? I think you’ve got a good shot of Trump being reelected. On the other hand, if there’s a tightening of liquidity at all, it changes the mood and mood is everything when it comes to politics, you can see it because now we’re talking about the mob. And if there’s anything we’ve learned in the last three to six weeks is the mob, the mind of the mass of people can be happy on Tuesday and very unhappy on Thursday. We saw this with with Bear Stearns and Lehman, plenty of liquidity on Tuesday, broke on Thursday. Will it be the defining factor in November, adequate liquidity between here and November influencing social mood such that it is the determining factor in who wins or who loses?

Recent Posts

Start typing and press Enter to search