Dear PGM Capital Blog readers,
In this weekend blog edition we want to elaborate on the huge stock and bond market bubble in the West.
If you are an investor, your big concern should not be about stocks and stock markets in bubble territories, but also about the bond and currency markets and about the consequences if a bond bubble goes bust.
THE STOCK MARKET:
The last two years have been extraordinary. The stock markets in the west, have surged higher as corporate profits climbed due to aggressive QE3 bond-buying program in the USA and Abeconomics in Japan, which was announced in September 2012.
Charted side-by-side, the relationship between higher stock prices and cumulative Fed and Bank of Japan bond purchases mirror each other closely as the S&P 500 and the Nikkei-225 have gone on to gain more than 40 percent.
Aside from the magnitude of the market gains, the smoothness of the rise has been noticeable as the steady flow of cheap money squeezed out volatility.
As can be seen from below chart, the S&P 500 hasn’t even touched its 200-day moving average, – the green line in below chart – since September 25, 2011.
The fact that the S&P-500 hasn’t even toughed its 200-day moving average – consistently totaling 810 trading days and counting – is a type of consistency that has only been seen three other times since World War II: In 1998, 1965 and 1956.
Based on this most investors might be asking themselves the following questions:
Does the bull market in the S&P-500 reflect the state of the underlying USA Economy or have things gone too far? And are they set to change?
THE BOND MARKET:
For 30+ years, Western countries have been papering over the decline in living standards by issuing debt. In its simplest rendering, sovereign nations spent more than they could collect in taxes, so they issued debt (borrowed money) to fund their various welfare schemes.
This was usually sold as a “temporary” issue. But as politicians have shown us time and again, overspending is never a temporary issue. Today, a whopping 47% of American households receive some kind of Government benefit. This is not temporary, this is endemic.
All of this spending is being financed by borrowed money… hence, the bond bubble, the biggest bubble in financial history: an incredible US$100 trillion monster that is now growing by trillions of dollars every few months.
For example, the US alone has issued over US$1 trillion in NEW debt in the last eight weeks.
The reasons it did this? Because it doesn’t have the money to pay off the debt that is coming due from the past, so it simply issues NEW debt to raise the money to pay back the OLD debt.
This Sounds a lot like a Ponzi scheme, doesn’t it?
Due to the world-wide phenomenon that governments are buying bonds to keep their countries moving along economically, bonds are at ridiculous levels,
The irony of this is, that although the debt burden for countries in the West increases every day, the costs of borrowing (interest rate) has declined the last 5 years as can be seen in below chart of the yield of the 10-year US-treasury note.
PGM CAPITAL COMMENTS:
Regarding the bond market bubble the USA is not alone. Globally, the sovereign debt bubble is over US$100 trillion in size. Just about every major nation on the planet is sporting a Debt to GDP ratio of over 100 percent and that is just including “on the balance sheet” debts.
When we include unfunded liabilities like Medicare or Social Security the total sovereign bubble might exceed US$ 500 trillion.
This is why the Fed and every other Central Bank on earth is terrified of interest rates rising; because anything even resembling the normalization of interest rates, will balloon this debt with the consequence of entire countries going bust.
Remember when interest rates move, they tend to move quickly. Consider Italy. It was considered one of the pillars of the EU since it adopted the Euro in 1999. Because of this, the markets were happy to allow Italy to borrow at stable rates with the yield on the ten year Italy government bond well below 5% for most of the last decade.
Then, in the span of a few weeks, everything came unhinged and the yields on Italy government bonds spiked, rising over 7%: the dreaded level at which a country is considered to be insolvent and set for default. It was only through extraordinary lending mechanisms from the European Central bank (the LTRO 1 and LTRO 2 programs to the tune of hundreds of billions of Euros… for an economy that is €2 trillion in size) that Italy was saved from potential systemic collapse.
Again, Italy went from being a former pillar of Europe to insolvent in a matter of weeks, all because interest rates spiked a mere 2% higher than usual.
Italy is not alone here. Western nations in general are in a similar state. This is why QE has been such a popular monetary tool for the Central Banks (since 2008 they’ve spent US$11 trillion buying assets, usually sovereign bonds).
QE was never meant to create jobs or generate economic growth, it was a desperate ploy by Central Banks to put a floor under the bond market so rates wouldn’t rise.
It’s also why Central Banks have kept interest rates at zero or even negative: again, they cannot afford to have rates rise. In the US, every 1% increase in interest rates means between US$150-US$$175 billion more in interest payments on their debt per year.
Forget stocks, forget your concerns about this or that valuation metric!
The REAL issue is what happens when the Bond Bubble pops. When that happens it won’t be individual banks going bust, it will be ENTIRE NATIONS.
Sooner or later, rising rates will come, and a bull market in bonds, running more than 30 years long at this point, won’t end in pretty fashion.
Based on this we believe that the current bubble in the bond market will end in a very bad way.
For the sake of humanity, we hope and wish that our analysis as written in this blog is completely wrong, nevertheless we advise our reader to hope for the best but plan for the worst by having a great portion of their assets in tangible assets with a history as a storage of value such as Gold and Silver.
Until next week.
Yours sincerely,
Eric Panneflek