The buzz has died down. The intoxicating effects of massive money printing and debt bingeing during the coronavirus period have come and gone. But the hangover remains. And while the money printing has subsided — for now — the debt binge has continued.
The result of high consumer prices, massive government debt, and countless economic distortions was never worth it in the first place. As the last of the stimulus is exhausted and squandered, a great reckoning awaits.
What happens when the labor market flips and indebted consumers lose their jobs? We’ll soon find out.
In fact, longtime market analyst Gary Shilling predicts a recession is coming. Year-endUnemployment has risen to 7%. He also believes that stocks that have risen due to speculation could fall by up to 30%. And the decline could be violent.
“If we look at all the kinds of assumptions we’ve made so far, they represent a lot of overconfidence, and they’re usually corrected, and they’re usually corrected violently.”
As I detailed last week, we believe the United States has entered a world of ever-rising interest rates, which will continue to zigzag upward for the next 30 years – and perhaps longer.
The decisive inflection point came in July 2020, when the 10-year Treasury yield hit a low of 0.62%, marking the end of a 39-year downward trend in interest rates.
But when long-standing secular movements in credit markets reverse, it is not always immediately clear. Investors with decades of experience within a particular paradigm often do not understand the implications of a change that is happening right before their eyes.
Here’s what we mean…
Project the past
In the early 1980s, many investment experts projected the past into the future. After a decade of massive price inflation, the popular doctrine was to fill portfolios with gold coins, art, and antiques.
This was a proven and surefire way to preserve hard-earned wealth from the ravages of inflation. The recent past and simple logic indicated that consumer prices would continue to rise.
Nixon closed the gold window in 1971. Prices quickly spiraled out of control. The United States seemed headed for a full-blown Weimar.
Howard Ruff writes in his investment newsletter: Rough TimesHe predicted that the dollar would soon turn to hyperinflationary ash like a conifer in a California wildfire. It was inevitable. And that’s coming soon!
But something unexpected happened. Federal Reserve Chairman Paul Volcker’s ultra-high interest rates brought about a recession. An inflection point had occurred. Consumer price inflation had stabilized. And a new trend of rising asset prices, including rising stock, bond, and home prices, had begun. But it wasn’t immediately clear what was happening.
In September 1981, the yield on the 10-year Treasury note peaked at 15.32%. Many investors thought yields would go higher. Franz Pick declared: “A bond is a certificate of guarantee.”
But something remarkable happened: Yields ended their 39-year downward spiral in June 2020, with the 10-year Treasury yield sitting at 0.62%.
To be fair, there were a few genuine naysayers in the late 1970s who saw what was coming. Gary Schilling was one of them.
About money
Rather than the consensus view that inflation would last forever, Schilling suspected that the United States was entering a long-term era of increasingly low interest rates and low consumer price inflation. Against this backdrop, traditional inflation hedges would be a terrible thing…
…and debt-based financial assets will thrive.
With deep conviction and a desire to warn investors, Schilling wrote a book about his critical insights. The book was first published in the early 1980s, and its title asked two important questions. Is inflation coming to an end? Are you ready?
The book was a total failure. Almost no one wanted to listen to Schilling’s argument. Only a few smart people could actually understand that consumer price inflation was disappearing.
The book’s predictions were accurate. Moreover, Shilling invested his money in his beliefs. By the mid-1980s, he had achieved financial independence through aggressive investments in long-term bonds.
Shilling’s insight and capital commitment to the long-term decline in interest rates that began in the early 1980s are noteworthy, but so is his ability to successfully weather this trend even after other big investors (e.g. Bill Gross) bailed him out.
Many investors thought interest rates had bottomed out in the depths of the Great Financial Crisis in late 2008. The Fed’s purchases of mortgage-backed securities and Treasuries, made possible by $8 trillion in credit created out of thin air, continued into July 2020.
Cheap consumer goods imported from China and cheap oil and gas produced by innovative hydraulic fracturing technology have also suppressed consumer prices. But these sentiments no longer hold down consumer prices as they did a decade ago.
What you need to know about interest rates
Interest rates are now rising. But like the past 39 years of declines, they won’t rise along a smooth, always predictable slope.
If you see Long term chart In the case of the 10-year Treasury yield, there are sharp counter-trend spikes up or down along with the larger trend. These counter-trend spikes can sometimes be surprising.
For example, in 1994, there was the spike in interest rates that left Robert Citron with his pants down. If you haven’t heard of Robert Citron, he was the treasurer of Orange County, California for 25 years.
In 1994, Citron achieved a remarkable feat. Merrill Lynch “Step Up Double Inverse Plotter” He oversaw a $1.64 billion loss of public funds, which at the time was the largest municipal bankruptcy in U.S. history, and Citron was sentenced to prison.
But Citron wasn’t the only one to have his pants down due to an unexpected spike in interest rates. Notable blowouts include Long Term Capital Management in 1998 and Lehman Brothers in 2008.
The point is that interest rates have been rising for a long time, unlike 1981 to 2020. Consumer price inflation is included in the cake. The cheap Chinese consumer goods and cheap oil and gas that kids are now tangping are no longer saving the day.
Still, as we have experienced since July 2020, there will be episodes of falling interest rates. Enjoy them while they last.
Perhaps the 30% decline in the stock market that Schilling expects will temporarily lower interest rates. Even then, the 10-year Treasury yield won’t go back to 0.62%. It won’t go back to 2%.
Those days of cheap money are gone forever. The Fed can resist, but it can’t stop.
And like Citron, the US Treasury will be caught with its pants down.
[Editor’s note: It really is amazing how just a few simple contrary decisions can lead to life-changing wealth. And right now, at this very moment, I’m preparing to make a contrary decision once again. >> And I’d like to show you how you can too.]
thank you,
MN Gordon
For Economic Prism
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