Trump Says the Fed is Loco … Here's Why He May be Right

Trump Says the Fed is Loco … Here’s Why He May be Right

Over the last 2 weeks the stock market has been on a wild ride, and for the most part a downward slope.  Last week the Dow dropped for 6 straight days, including an 831-point drop which was the 3rd largest of the year, and the biggest since February.

Long ago we reported to you that the stock market had decoupled from the main economy.  This occurred during the previous Administration in the wake of the 2008 financial crisis.  Banks did not lend into businesses for the purpose of business expansion, but used government bailouts to trade bank stock and financial paper.  This was great for the stock market – which continued to rise and allowed your 401K to rebound from the collapse.

But it was lousy for the economy – GDP grew at less than 2% for that 8 year period … wages remained stagnant … job growth was non-existent.  The unemployment rate came down, but because more people went on government assistance in all forms, including disability, and stopped looking for work.  Bottom line – instead of stock market gains from a new invention, a new drug, or increased demand, we instead had artificial inflation due to money printing and quantitative easing.   The market had decoupled from main street.

Fast forward to the Trump Administration – tax reform and massive deregulation allowed the stock market to not just go up, but explode skyward!  This was on the back of real GDP acceleration – main street was creating jobs again … wages expanded 2.8% – first time in a decade … businesses were expanding … this is real economic growth, the vibrancy of capitalism unleashed from government intervention.

All of those upward trend-lines are at risk, however, if non-market factors return as the dominant player, and that is happening as the Federal Reserve continues to raise interest rates, and hint there are more to come.  It was that decision that prompted the most recent sell-off, and remains the primary concern of traders on Wall Street.

Our readers know the Fed raises rates when the economy appears to be overheating, or if the value of the dollar begins to significantly decline.  Since we remained at zero interest rates for virtually the entire post-financial collapse period of 2009-2017, it was natural to begin to see the Fed move off their accommodating policy and begin to tighten the money supply.  This began in the final year of the previous Administration.

This was a sign of a healthy and strengthening economy, and a normal process to undertake.  Federal Reserve rate policy helped price the dollar at a stronger position, and despite raising the cost of borrowing, the economy continued to expand.  This was the Trump-Bump effect!

But taking long-overdue steps to normalize rate policy does not mean the Federal reserve is making the right decision to continually raise rates in such short time span.  It could derail the expanding economy as jittery business owners spooked by rising borrowing costs slow their hiring decisions and potential investment back into the business.  Trump says the Fed is “loco” … here is why he may be right!

 WHY TRUMP MAY BE RIGHT – LONG-SUPPORTED FED RATE HIKES MAY BE COMING IN TOO FAST FOR NOW:

 1. “Fed’s dual mandate could cause both to get worse”: The Federal Reserve has a dual mandate – keep inflation in check and keep unemployment low.  So monetary policy – and what the Fed does with interest rates – is to serve these two policy objectives.  The problem is both are impacted and driven by a myriad of factors beyond just what the Fed does, and often times they are their own driver of particular outcomes in the economy.  Raising rates to stem the tide of inflation can result in higher costs for government debt service … which in turns drives the government to borrow more money to service that debt …  which in turn leads to a larger money supply… which in turn – you guessed it – drives up inflation.  Inflationary pressure squeezes profits – and that squeezes wages and hiring.  That also leads to greater unemployment.

2. “Fed rate increases have not hurt the economy – yet”: Markets remain elevated at record-setting levels and the US economy has been on over-drive during the last 2 years.  The Fed has increased rates 8 times since December 2015 – taking us off zero and bringing the fed funds rate to 2.25% as of September of this year.  This remains historically low – the federal reserve has typically maintained rates between 4 and 6% when experiencing expanding GDP.  We have been in a government created expansion between 2009-17, and market driven expansion the last two years, but the rates have remained historically low.  So increasing rates is bring them within the normal historical range.

However…..

Raising rates too quickly in such a volatile environment runs the risk of off-setting the gains of the last two years.  25 basis point is not a huge number, but the market is pricing in more rate hikes and higher rate increases thanks to commentary coming from the Fed.  That lays the groundwork for a correction.

3. “The evidence confirms fed rate hikes are slowing housing and auto sales”: Despite an on-fire economy, sales in housing and autos were down year-over-year in the last quarter.  These two data points are the “canaries in the coal mine” for potential negative downturns in the economy.  The Fed right now has a direct hand in the potential negative shift in the market, and in the GDP numbers.

Despite some correction numbers occurring in the stock market over the last two weeks, the economy has been humming along.  Decoupled from Wall Street, businesses no longer prioritize their stock broker when looking for funding.  The market dip does affect balance sheets, portfolios and retirement accounts, and the raising of interest rates right now is beginning to take its toll.

Want protection from market downsides such as in the recent negative dip?  Call now for protected principal alternatives. (877) 912-1919

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

The month of September has some chilling reminders that the world is not immune to global catastrophe.  We took time this week to remember the fallen from the cowardly terror attacks on September 11, 2001.  That day, much like Pearl Harbor, will always be a day of infamy in American and world history.  The “Global War on Terror,” continues to this day and wartime operations continue in Afghanistan, making it the longest war in US history.

But September also is the month of the most momentous economic calamity of this century, and perhaps second only to the Great Depression.  We have described the events leading up to the “Financial Crisis of 2008” in previous blogs in July and August, and they reflected a rolling crisis over an extended period dating back to the 4th quarter of 2007. However, the grand tsunami of financial catastrophe can be traced to the bankruptcy filing of Lehman Brothers on September 15, 2008.

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

 Lehman Brothers had been an American banking icon on Wall Street since 1850.  It is hard to understate its role in American finance. They were involved in some of the most important and most lucrative deals in US history!  Just consider Lehman’s history:

The History of Lehman Brothers included some of the biggest moments in global finance:

  1. It issued the stock for some of America’s most iconic brand names: W. Woolworth Company, Macy’s, Gimbel Brothers, Inc., The Studebaker Corporation, B.F. Goodrich Co., RCA, Compaq Computers, among many others.
  2. Lehman arranged the first financing for major oil companies often in the news such as Kerr-McGee and Halliburton.
  3. Famous merger in 1983-1990 with Shearson/American Express in 1984 and then Shearson/Lehman merged with EF Hutton in 1988 (“When EF Hutton talks, people listen.”)

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008

  1. Lehman backed the take-over bid by the management team of F. Ross Johnson and RJR Nabisco, ultimately losing the bid to Kohlberg Kravis Roberts in what was then one of the largest “leveraged buyouts” in Wall Street history. It was dramatized in popular culture by the famous book and then movie – “Barbarians at the Gate.”

The Day Lehman Died – The 10th Anniversary of the Financial Crisis of 2008 

Lehman was in the same category as Salomon Brothers, Goldman Sachs, KKR, during Wall Street’s hey-day.  They were among the giants of Wall Street.  Their movement into mortgage origination in 1997 would become the most profitable department within the bank.  By 2006, mortgage loans and mortgage backed securities were generating almost $250 million a month in revenue.

Lehman, however, was exposed to – and some would say helped create – the contagion of sub-prime mortgages.  The government’s reduction of lending standards, requirements to lend into poor credit neighborhoods, and the government’s willingness to underwrite the paper on many sub-standard loan packages, led to a collapse in credit quality and underwriting standards.  We created an over-sized market of bad credit debt.  When adjustable rates adjusted upwards, people stopped paying.  Foreclosures commenced, the value of the mortgages dropped, the values could not be priced as they all dropped at the same time.  In the first quarter of 2008, Lehman was sitting on $680 billion of mortgage notes, and only $22.5 billion in firm capital to back it up.

 

The Timeline of the Lehman Brothers collapse:

  1. “August 2007 – closure of sub-prime office BNC Mortgage”: Twelve-hundred positions and 23 branch offices were all eliminated due to “deterioration” in the mortgage market.  Lehman would continue underwriting mortgage backed securities.
  2. “September 2007 – the last gasp of profitability”: The stock price jumped 46% on a report that Lehman would still conclude its 55th straight quarter of profitability.  The moves out of sub-prime were being rewarded by the market.
  3. “June 9, 2008 – the days appear numbered”: Reporting a substantial loss for the first time in years, major staff shake-ups were announced.  CEO Richard Fuld, who had been with the company since starting in the basement as an intern, remained in his position, but was isolated from other management staff.  The stock got a bump in August when reports of the Korean Development Bank (KDB) were considering buying into the company.  But when talks broke off in September, there were signs of storm clouds closing in, as KDB officials were quoted in the Wall Street Journal as saying they “….could not properly price the firm’s capital holdings, and therefore could not make an informed decision on an offer sheet.”
  4. “September 9, 2008 – KDB is out, stock plunges”: When the news hit the public, Lehman’s stock price collapsed, dropping 45% in one day and driving the S&P down 3.4%.  It was clear that Lehman’s size would have a direct and proximate impact on the overall marketplace…. the original “Too Big to Fail” bank.
  5. “9/11 – Down Goes Lehman”: A very sad day indeed.  Lehman Brothers had occupied several floors in the Twin Towers 7 years earlier when the terrorist attacks occurred.  Hundreds of employees lost their lives.   9/11 would be another dark day in Lehman’s history, as the stock price dropped 40%, and the Federal Government announced they would not bail out the company.
  6. “9/13 – Paulson, Geithner, steal Lehman’s deal”: In an emergency meeting at the New York Federal Reserve offices, a deal was negotiated to save Lehman through a merger/acquisition by Barclay’s Bank in England and Bank of America.  The Brits, however, after agreeing in principle, backed out, under pressure from their own government.  Bank of America, fearful of taking on a deal they could not underwrite, went to the Hank Paulson, the US Treasury Secretary, and Timothy Geithner, Chairman of the New York fed, asking for a bailout, or another partner.  Fearing problems with Morgan Stanley, the Feds let the BOA withdraw, leaving Lehman without a bailout savior.
  7. “9/15 – The Board votes to liquidate”: Infuriated that the Feds would not grant a bailout, despite doing so in the past (Bear Stearns, Long Term Capital Management), and blaming Paulson and Geithner for not keeping Bank of America at the table, the Board of Directors for Lehman voted at 1 AM, on September 15th, to put the company in bankruptcy.  The collapse of real estate prices had destroyed the value of the mortgage securities market, and Lehman did not have the capital to support what it owed.  Thousands of employees would be laid off the next morning.Lehman Board votes to liquidate
  8. “September 2008 and what followed – The Financial Fallout”: The bankruptcy filing announcement precipitated the worst intra-day drop in the stock market’s history (over 1000 points) and finished down 554 points.   While the volatility continued with up and down days through the remainder of the year, the downward trend and sense of dread in the larger economy was a constant feeling.  The market would drop again 449 points on 9/17 … again dropping 774 points on 9/29 … the Dow would end up down 13% by the end of October.

Lehman’s employees were immediately let go on the day of the bankruptcy filing.  Scenes of employees leaving with personal items in boxes was an indelible portrait of the fearful times which followed.  Although the stock market would continue to decline until reaching bottom in March 2009 (Closing at 6443, a 50% drop since October 2007), the hinge-point in the Financial Crisis was the Lehman Brothers collapse.  The Feds – so willing to bail out banks and everyone else on Wall Street after Lehman – most likely could have prevented the entire crisis by saving Lehman Brothers that September 2008. 

 Since then, Congress enacted a great deal of regulation to help prevent the next crisis from occurring.  But most analysts will tell you – big banks are bigger than ever, they are too big to fail, and the next crisis we may not be able to bail ourselves out of.  The public will not be in the mood to bail out anyone, and much of our political division comes from the Financial Crisis:  bankers were bailed out by Main Street – the taxpayer.  Now, the same people are richer than ever, but Main Street lost their homes, their savings – no one bailed them out.

Our financial system is the greatest system of wealth creation ever conceived by mankind.  But that does not prevent the system from malfunctioning thanks to government intervention.  Policies that force banks to lend to poor credit quality note-holders was doomed to fail, and it did.

Capitalism and the free market are the only systems that work for a free society, but what goes up will come down.  We have been in a 9-year bull market, super-charged by the pro-economy policies of the current Administration.  History, and common sense, suggest we are due for a correction.  Is your money protected? We may be able to help. Give us a call at (877) 912-1919 or visit TyJYoung.net.

The Booming Economy vs. Real-World Danger

The Booming Economy vs. Real-World Danger

“You can’t handle the truth!”

 Everyone’s favorite courtroom scene from Jack Nicholson – portraying Colonel Nathan R. Jessup – while he spars with Tom Cruise’s character in the military/legal drama, “A Few Good Men.”

It was riveting theater, and for those who have seen the movie, almost all agree it was great acting and superior story-telling. Colonel Jessup’s line was to point out that the world had many dangers, and to keep the dangers out we need walls. It was people like Jessup who stood on the walls to keep the barbarians at the gates, not inside them.

But in today’s real world geo-political conflicts, there are neither walls nor gates, nor anything else that is keeping real danger from reaching the homeland. This week we saw a book released once again describing the Trump White House in less than flattering terms. The Brett Kavanaugh hearings for confirmation to the Supreme Court were riddled with obstruction from the Democrats and outside protesters. These distractions are trying to keep the body politic from focusing on the good and bad news which should most matter to them.

Contrast this less than rosy picture with an economy which continues to boom at Reagan-era levels of growth. It begs the question as to what will eventually win out:  the booming economy or real-world threats that the American people have little understanding or knowledge of.  North Korea may get the foreign policy headlines – but other serious risks have grown and are now rising to the forefront.

So, what gives – unrestrained optimism or actual geopolitical threats?  Here are our top three of each:

I. Top Three Indicators that The Economy will Keep on Booming:

  1. “Institute of Supply Management has another record month!”: ISM has manufacturing production in the United States rising to 61.3% capacity, the highest number since 2004! This is a direct result of deregulation, tax reform, and steel industry policy. This is great and continued good news for America.
  2. “Construction spending up 5.8% year-over-year”: The housing market price level has recovered from the 2008 banking collapse, and prices have remained elevated for some time. Construction spending has remained a consistent positive marker for the economy and GDP growth. And speaking of GDP growth…
  3. “3rd Quarter GDP growth projections are now at 4.7%!”: Back to back 4%+ growth? Everyone said this would be impossible!  New normal … secular stagnation … all of the media reports that America could no longer grow at Regan-era levels of growth appear to be wrong.  We still have September before the 3rd quarter ends, but the projections appear to be heading towards a rising growth number for the economy.

II. Top Three Real-World Dangers that are Flying Under the Public Radar:

  1. “Russian adventurism is more than just Ukraine”: The American public gets most of their Russia news through one filter – The Mueller Probe of alleged Trump-Russia Election Collusion. On the periphery, the invasion of the eastern part of Ukraine remains a major concern in the European theater, as does Russian deployments in the Middle East.  But their growing alliance with Iran … the movement of an entire fleet into the Mediterranean for the first time since 1989 … they have cheated on, and no longer abide by the INF Treaty – this was known by the previous administration and now NATO General Secretary Jens Stoltenberg has stated that Russia could launch a first strike using battlefield nuclear weapons and defeat NATO within 24 hours.  The US and NATO have never faced such a predicament, since pre-INF the US had equivalent forces in theater to respond.  Not anymore.
  2. “Chinese Navy now controls South China Sea”: The Chinese have ignored international law, court rulings, and treaties to seize several islands belonging to the Philippines. They spent the better part of 2010 through 2014 building artificial islands in the South China Sea with zero push back from the United States.  There nuclear force has increased in size, and now has Multiple Re-entry capacity (MIRV’s) that can send multiple warheads onto multiple targets. Leading members of the PLAN (People’s Liberation Army Navy) have been quoted as saying they are war-planning for nuclear strikes on the US homeland.  Russia and China have nuclear stockpiles that, combined, could overwhelm a US defense system and defeat US ballistic missile forces. The majority of the American people believe we have the largest, most advanced arsenal in the world. That is no longer the case, and our enemies continue to build more and more.
  3. “North Korea, Iran, failed states, Venezuela …. the list of large problems for American policy is not shrinking”: It is very hard to understand the fact that while progress has been made on North Korean nukes, we are where near a resolution … the US gave Iran billions of dollars for the now defunct Iran deal, and they have used it to expand terror activities throughout the Middle East … Russia, Iran and supposed NATO member and ally, Turkey, have been devising the plans for the final rebel holdout in Syria, as all parties inch closer to Israel.

The economic boom is unprecedented, and with obvious structural strength, not inflated money printing.  But your optimism must be off-set by an ever-increasing set of dangers on the global stage.  Whichever direction the market goes, having your money in principal protection products is a safe strategy for your portfolio. Give us a call at (877) 912-1919.