The Good News In All The Bad Data

News & Current Events Public News & Current Events
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Today's financial markets make a mockery out of sanity and logic. The difference between what SHOULD happen and what IS happening is perhaps the greatest it has been in our investing lifetimes.

If you're perplexed, flummoxed, frustrated, stymied, enraged, bored, irritated, insulted, discouraged -- any or all of these -- by the ever-higher blind grinding of asset prices over the past several years, despite so many structural reasons for concern, you have good reason to be.

Something Wicked This Way Comes

For most of those reading this, I don't need to re-hash all of the reasons you already read at PeakProsperity.com and similar sites on a regular basis. Suffice it to say there's an overwhelming plethora of reasons beyond the simple 'reversion to the mean' laws of math: weak economic growth, geo-political risks, sky-high valuations, goosed stock earnings, record-high margin debt, insider sales, consumer confidence, retail buying, high energy prices, continued central bank interest rate suppression, etc, etc, etc...

Here's a smattering of recent headlines on the current macro environment:

Are these the sort of headlines that should justify a stock market hitting new highs week after week after week for the past 5 years, with nary a pullback of material proportion?

No, they decidedly are not.

Instead, these are all warning signs that merit caution, and at least some degree of de-risk. They are factual, data-driven signals indicating that the stability of the status quo is unlikely to be sustained. Yet, they continue to deflect off of the Kevlar surface of the reality-distortion field today's markets have surrounded themselves with.

The fundamental issue at hand is: risk is being mis-priced WAY too low in both the stock and bond markets right now. Therefore, the prudent investor will want to reduce their exposure to the inevitable mathematical reversion of prices.

The Good News In All This Bad Data

And now we arrive at the main point of this article: The current crazy/frustrating/scary/pick-your-expletive level of instability in today's market is actually GOOD news.

The disconnect between financial asset prices and fundamentals simply must -- per the laws of Nature -- resolve itself. And given the interruption-free 45-degree ramp the markets have experienced since 2009, we can definitively say that we are closer to the coming correction than we have been at any time in the past half-decade (here's a chart of the S&P 500 from its 2009 lows): 

The bullet has been dodged for five straight years -- given the instability and the inevitability, how much longer can it be dodged? Not for long, is our conclusion. And given the uninterrupted rise to record highs, the potential energy stored in the system now should be much more kinetically destructive than it would have been had it happened sooner. So, we are at a time in the markets when confidence is high that a big move will happen soon, and happen to the downside.

This is as close as we're going to get in our lives to reading tomorrow's stock prices today. While we can't divine exactly what they're going to be, the odds are very favorable that prices will be lower -- likely a lot lower -- for most assets in the next 6-24 months than they are today.

So, what to do with this insight?

TIME is your great ally here. Wait for the correction to occur, to bring asset prices back down to the point where the math to purchase them again make sense.

This was the main point of the presentation from John Hussman we recently highlighted. Simply wait and let market forces/reversion to the mean remove the risk for you. By opting to take very little risk in the immediate term (i.e., sit on the sidelines), your odds of being able to enter at much safer and much more attractive price points in the not-too-distant future are very high by historical measure.

If the above logic resonates with you, now is the time to build dry powder and to develop your action plan for the correction.

The Case for Cash

Market corrections are deflationary. They create demand for safety and -- as long as the major fiat currency regimes are still in place -- a tremendous scramble for cash.

The falling asset prices and lost income that come with such a correction result in, on a relative basis, fewer people being "cash rich" (especially if we think of the actual paper bills). And these falling incomes and prices, if severe enough, can create negative feedback loops (such as margin calls) that exacerbate the need to raise cash quickly. This will be true both domestically and abroad, and so the hunger for cash -- especially US dollars -- will be high (Charles Hugh Smith has written about this at length).

So this is why in a deflationary environment, cash is king.  And why our advice is: Be royalty.

The big picture for the Economic "E" we discuss here at Peak Prosperity is the inevitable Great Wealth Transfer that is underway. These transfers have happened many times in history (Chris and Jim Rickards have an excellent historical discussion in this podcast), and are the "blood in the streets" episodes where good assets can be obtained for pennies on the dollar. During these moments in history, it's vastly preferable to be one of the folks holding the dollars (or whichever assets have retained their purchasing power).

It's for this reason that, at this particular moment in time, the combination of dry powder + patience is likely the single smartest financial investment to make.

Somewhat surprisingly, it's a difficult step for many investors to embrace. After decades of being marketed to that "investing" means holding stocks and bonds, many investors fail to realize that, sometimes, cash can be THE best investment for the near-term. It's important to be able to recognize those times. Our conclusion here at PeakProsperity.com is that now is one of them.

Remember, both mathematically and emotionally, it's much better to avoid loss than miss out on gain.

Moreover, in a market like today's where asset prices are being driven higher by central bank liquidity much more than anything else, you have two big challenges. The first is that, as everything rises, it's much harder to identify which ones are the stars and which are the dogs. The liquidity flood is obscuring the details (as Warren Buffet famously said, until the tide recedes, you can't tell who's swimming naked). And the second is that, as prices get driven much higher than fundamentals merit, it's hard to know what "fair value" is. It becomes a much more subjective call, versus an empirical exercise. 

Which is why our advice is to build cash and wait. Wait until the mathematically-inevitable correction occurs, and then start considering re-entering the financial markets. You will have the twin benefits of buying the same assets at lower prices AND have a much easier time evaluating the "slam dunks" from the stinkers using tried-and-true quantitative methods of valuation. Remember, too, that bubble burstings over-correct on the downside, so your odds of finding exceptionally good entry prices will be unusually high. Moreover, if you have discretionary capital to invest as a market decline is clearly underway, it gives you the opportunity to make speculative bets to the downside (this shorting strategy is discussed in greater detail in the Stocks & Bonds section in Part 2 and most definitely is NOT appropriate for everyone).

As you increase your cash positions, take measures to protect them should they become large enough. For instance, if they come to exceed the $250,000 limit covered by FDIC insurance ($500,000 for joint account), place the excess in a new account; ideally in another bank. At (and definitely above) that level, it begins to make sense to diversify your cash holdings into multiple currencies. Consult your financial advisor about good strategies for this.

Many of you may be wondering: But isn't cash a risky asset in the long term? After all, we spend a lot of time here at PP.com writing about the loss of fiat purchasing power and the inevitability of a currency crisis. And about the dangerous of wealth confiscation through government measures like the bank "bail-in" seen in Cyprus. Have those concerns changed?

Not at all. But timing is key in this story. We can easily experience a deflationary rout before a subsequent hyperinflationary one (see the Ka-POOM theory), which would first see cash treasured, and then later reviled. This is more or less what Chris and I see as likely to happen.

But since no one -- including us -- has a crystal ball, we will be tracking monetary developments closely every day here at PeakProsperity.com and will issue alerts to our enrolled members as we see outcomes becoming more or less certain.

And in the meantime, we'll continue advising the build-up of dry powder.

Why Planning Is The Top Priority Now

He who fails to plan is planning to fail.

~ Winston Churchill

Fortune favors the prepared mind.

~ Louis Pasteur

As Pasteur implied, having a "prepared mind" when others are losing theirs greatly increases your odds for success. Bubble corrections are vicious and always occur much faster than the run-ups that preceded them. During them, time is short and emotions are hot. So you'll want to be as cool-headed and surgical in your decision-making as possible.

To do that, you'll need a good plan devised well in advance of the chaos. 

Your plan should cover positioning for:

  • Pre-correction: notably, where to best protect the purchasing power of your wealth (relevant to everyone) & speculative bets to the downside (for experienced investors with discretionary capital ONLY)
  • Intra-correction: less speculative bets once downside momentum is clearly in play (for experienced investors)
  • Post-correction: identifying attractive target assets and favorable entry price points for deploying dry capital (for everyone)

Some steps of your plan will be taken in the near term, which will be relatively easy to perform while the environment is stable. Others will be put in place now, but lie in wait, ready to be triggered by market developments. When it comes time to deploy them, there's likely to be a lot of stress, confusion and uncertainty in the air -- which is exactly why you want to make your decisions now, in advance, calmly and logically. 

It should go without saying that such a plan is best developed working with a solid professional financial adviser who appreciates the market risks raised within this article. Most people reading this (myself included) are not well-positioned from an experience and/or bandwidth standpoint to construct AND manage plan deployment on their own, and especially once volatility and trading volumes return to the markets. Work with your adviser, or find a good one if you don't already have one. (Having trouble finding a good one? Consider talking to our endorsed adviser). But do it soon.

In Part 2: How To Position Yourself Now, we lay out a detailed roadmap of the specific strategies and vehicles a good action plan should consider for stocks & bonds (both long & short), real estate, precious metals & miners, debt management, income, local investing, and more. Our longest report of the year so far, it offers useful structure and guidance for the investor to follow in building a customized plan around their own goals and risk tolerance.

With the current wide discrepancy between asset prices and fundamentals, don't be caught as vulnerable as you were in 2008. And, with a little planning and prudence, position yourself to take advantage when reality returns.

Click here to access Part 2 of this report (free executive summary, enrollment required for full access)

This is a companion discussion topic for the original entry at https://peakprosperity.com/the-good-news-in-all-the-bad-data/

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Hey Adam,
I thought I read somewhere that the FDIC had quietly changed the rules about protection limits since 2009. My understanding is that the limit now applies per person/couple, regardless of which bank holds the cash. That is, I personally only get $250K coverage, whether I have money in 1 bank/1 account or 5 banks and 10 accounts. When I have time later I'll try to see if I can find a reference.

Derek

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Derek -
I'm pretty sure that's not the case.

From the FDIC's website:

The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the United States government that protects the funds depositors place in banks and savings associations. FDIC insurance is backed by the full faith and credit of the United States government. Since the FDIC was established in 1933, no depositor has lost a penny of FDIC-insured funds.

FDIC insurance covers all deposit accounts, including:

  • Checking accounts
  • Savings accounts
  • Money market deposit accounts
  • Certificates of deposit
FDIC insurance does not cover other financial products and services that banks may offer, such as stocks, bonds, mutual funds, life insurance policies, annuities or securities.

The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.

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And here's the actual 'account ownership category' page: Link to FDIC page
Basically each account type, and for each owner, there's a $250,000 limit.

For example, if you own a single savings or checking account with a single named owner then the $250,000 limit applies.

But if it's a joint account with two named owners, then the account limit is $250,000 for each owner for a $500,000 limit on that one account.

 

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My concern is less the limit amount than who is really backing it. If there were a failure and you put in a claim, how long would it take to recover your funds?  And how is the balance sheet of the FDIC looking these days.
I assume the FDIC payout would simply be from more money printed out of thin air and loaded onto the back of the taxpayer. These are assumptions of course and not facts …just sayin!

Coop

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I agree with ckessel.  I know FDIC doesn't have the funds to handle anything bigger than the usual trickle of banks that close every year plus a little cushion.  If something really big happens (and that's what we're expecting, right?) the FDIC promise will have to be "modified." angry  As I understand, there is no timeliness guarantee on how fast FDIC can/will make your account whole, and even if there was I, for one, would not believe them capable of keeping that promise either.  In a big crash, the FDIC promise would have to be delayed or broken for most people, and then everyone would have to wait until Congress voted to approve a bailout of FDIC with printed-out-of-nothing currency.  And as part of that whole disaster, someone at the White House or in Congress would get the bright idea to bail in the banks using law already in place or simply writing new law to suit themselves, stealing a large percentage of private deposit accounts ala Cyprus.  In Cyprus, the threshold was Euros100,000.  I wonder what it will be in the US?  Whatever it is, they won't get anything from me.  I wouldn't count on FDIC, except in a normal environment (like the last 20 years). I have zero confidence in FDIC for the next 20 years.
Tom

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Tom-
I'd guess that the massive deflationary impact from a failure of FDIC to make good on its guarantees would be something the Fed & Treasury would try hard to avoid.

Reserve currency + printing press + treasury borrowing = FDIC is probably good, although quite possibly the accounts would be locked up for a bit while things get sorted out.

Total basic savings + checking deposits in the US: $8.95 trillion.  Total bank debt in the US: $10.4 trillion.  Of course, its the derivatives that are the scary bit.  Let's hope they don't break.

FWIW.

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I have a good friend that's been worried about the FDIC failing to honor its guarantees, but as I tell him, my view is that you might as well count on it coming through, because if it doesn't, then it won't matter anyway - it'll be essentially game over for confidence in US dollar-based financial system at that point, and possibly the political system as well.  If the money isn't printed, the required funding bills aren't passed, the various t's crossed and i's dotted as required, etc., you'll have an abused public turn into a much harder to control, raging public.   That'll cost a lot more to deal with than just printing imaginary money, which is so easy.  When the chips were down in 2008, they raised the FDIC guarantee 250% based on money from nowhere in order to absolutely maintain confidence in the system.  Confidence is the most important product now in every economy - otherwise the dollar (euro, yen) becomes just a piece of paper and savings literally become worthless numbers on a computer print out.  If you've got 90% of the population counting on their savings being guaranteed as withdrawable, spendable, valuable legal tender as advertised, that's critical good will and confidence that you absolutely don't want to lose if you want to continue to function, harvest campaign dollars, pull a cush salary, attend those nice bureaucratic luncheons.
Haircuts on savings are another story.  Already, in some respects, the $250K limit represents a limit beyond which those with greater wealth are "on their own" - which is why money goes into US Treasuries that pay less than the rate of inflation - the negative real return is the "cost of insurance" that you'll be repaid your principal in nominal dollar, (euro, yen) value, come what may.  It's true, though, that how changes in FDIC insurance are implemented becomes a sliding scale for a potential lessening in the guarantee and could happen, though risks a lessening in confidence.  Any haircuts on wealth or savings (per Cyprus) would be risky for confidence and willingness to hold asset value in ways targeted for confiscation if it's done in a major economy - the resulting financial movements could generate a lot of instability, no matter how high up the food chain they started.  

My guess is they're more likely to just continue to print money like all get out, pray, and let market instability take its own course, eventually, within the parameters that already exist. Then they can pretend the next financial upheaval is a natural occurance, kind of like the Sunnis and the Shites fighting in Iraq and potentially disrupting the oil supply or price.  Then they can say it's no one's fault, but just one of those things that has gone on for centuries, like 100 year floods (that now happen every decade or so), and hopefully keep their jobs by providing detailed economic analyses and reports that describe why they couldn't see it coming, and once again, pretend to plan new policies and laws to avoid it happening next time.   Economists and policy makers are yet another example of a depression-era make-work jobs program:  they dig financial paper holes and fill them back in, and pretend something's being accomplished.  Their salaries do add to the GDP, though, and therefore let them issue cheerier reports than otherwise :wink:

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Aloha! If the world were a perfect place where all laws were obeyed and everyone were ethical and moral and lived by the Golden Rule then we would not need an FDIC. Essentially the FDIC has been a tool used by banks to insure their failures in more ways than one.
There are limits in a Bank Emergency as FDR found out the hard way. Still America was lucky on the first Great Depression as there was hardly any government debt or private debt compared to modern times. I just read that student loan debt is now over $1.3TRIL, a number that even FDR would have a heart attack over if he were alive today! FDR did not have to worry about student loans in 1933. He did not have to worry about $345TRIL in interest rate derivatives. He did not have to worry about rehypothecation of assets. It was an easier time where "failure" was allowed. Now with CDS "default" is something that needs a court to define on a case-by-case basis. Even the FASB has redefined what general accounting is and when is a loss really a loss. The sheer basics of business has been turned upside down by politics. The number one issue small business owners have now is "politics"! Obamacare has redefined our freedom to just basic healthcare. Politics threatens our future. The tangled web of some 80,000 pages of rules and regulations in the Federal Registry is testament to Tacitus. Started in 1935 the US Registry codifies all those pages. The US Printing offices charges you $929 per year to subscribe to their annual update service. What would our Founding Fathers think of their government of "We the people" today?

It's fairly easy to figure things out on an individual basis right now … One depositor, one account, one bank = $250k insurance. Still banks have moved into so many other services.  What about trust accounts? There are even services that fall outside bank accounts and the FDIC. What happens if you are selling your home, your car or boat and the bank that issued your loan goes under? Need a Lien Release? Where's the records and how long does it take to get them? Make sure you understand the nuances and limits before you assume your money and assets are safe.

The FDIC puts out this video that reassures Americans that it can handle any sort of bank disaster and even shows you how they covered the 526 bank failures from the 2008 crisis.

FDIC VIDEO: https://www.youtube.com/watch?v=dBOFiDpmESI#t=93

Anyone see a problem with that?

First of all does anyone really believe that banks don't charge depositors for the FDIC premiums? While there may not be a line item on your bank statement the very act of "discount window" at 0.75% and loans at 5% is an easy way for banks to cover FDIC premiums and then some! In desperate times what bank did not go the US Fed discount window? Do you really think Exxon does not pass on government fees to its end users?

If taxpayers are not involved then why is there a line item on the US Treasury called Deposit Insurance Fund(DIF)? I looked and FY2014 YTD for the US government's federal reserve account for DIF looks like this:

YTD Deposit - $10.2BIL

YTD Withdrawal - $2.1BIL

It is dangerous to think that funds coming into the US Treasury will still be there in an emergency. What usually happens in the past is that revenue and fund deficits along with budgets get filled with debt. 

Remember the S&L mess in the 1980s and government is still spending money to pay that. The YTD for Resolution Corp Funding is $2BIL.

If your memory is not good enough to recall the 1980s then maybe you recall the 2000s and TARP. Banks are still paying into TARP even today. For YTD FY2014 banks have paid into the US Treasury $16.1BIL and banks are still taking TARP out too, so far YTD $2.9BIL. I thought all that was paid off! Or is that another fraudulent "Mission Accomplished"?

What of "bail in"? In 2008 we got "bail out"! Remember there were long lines at some of the failed US banks in 2008 as well as Europe also. What happens when "bail in" is instituted in the US? Certainly that would deal a fatal blow to the banking industry.

In the FDIC video they mentioned the ultimate guarantor of all banks was the "full faith and credit of the US government". Who is the US government? 

I find it odd that there is a new Table on the US Treasury Statement called "Table V-Short Term Cash Investments". It just came into being this fiscal year. While Table V now has a bunch of $0 on it there must be an upcoming event it was designed for. What could that be?

 

 

 

 

 

 

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Considering that the Fed has recently essentially admitted that they manipulate all markets all the time, I wonder if we'll ever get a deflationary crash or just go straight into hyperinflation once there's no more gold left and Russia and China come out to officially announce that they have all the gold and then shun the US Dollar. Why would stock prices have to ever come down? Today's bubble is from money printing; if they're still printing money couldn't it go higher? The Fed can print up as much digital money as it wants to keep share prices up, and the current disconnect between fundamentals and the markets could be resolved via very high inflation. Who knows though, maybe they'll allow a deflationary crash to happen so they can mop up the blood, but considering they are professional counterfeiters, their greed should be satisfied via money printing, I can't imagine why they'd need to take such a political gamble on a horrible deflationary environment that could blow up in their faces.

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My understanding is that we trust the FDIC with our deposits because they are the only thing we have. That being said I trust the FDIC with my money about as much as I trust the FDA with my health. I think its become EXTREMELY clear that none of these entities are in place to benefit you or your common citizens. They are here to hold up the status quo and of course foundations in those systems. Anyway in todays world trusting any institution of this size is risky to say the least in any situation. I guess my point is that if your going to put your cash in the bank well then that is all you've got. Holding cash is always risky in a bank or under a mattress… Holding 250,000+ cash under a mattress is probably a bit more nerve rattling than giving it it Bank of America ??? That is up to you. Having it ready to use in the markets seems worth the risk. That is if this phony baloney government we live under doesn't crash down this Orwellian police state that we all know is coming. I told my friends 15 years ago that if you followed the recommendations of the FDA, you would have cancer by age 45. It appears I was right. 
Fasten seat belt and put tray tables in upright position. 

~ Roan