Nothing is risk-free in markets

Monday, 6 September 2021 — Laramie, Wyoming

[9 min read]

Greetings, from about the spot where the Great Plains meet the Rocky Mountains. If you’ve been following along at home, you’ll know I’ve been looking for my ideal ‘bolthole’ in the American West, a place with a lower cost of living than the cities and a higher quality of life than lockdown US.

I think I’ve found it. For example, in a scene that would have brought consternation and condemnation from Victorian Premier Dan Andrews, I was able to drink a beer in public, on the street, while walking around last weekend — and this in a state where it’s legal to carry a six-shooter on your hip in public too.

Many Australians may find both ideas abhorrent. But there are places in the world not grievously afflicted with the virus of ‘safetyism’. It’s a social virus so debilitating that many people will willingly lock themselves in their own homes, in such a state of fear about the outside world that they do whatever they’re told.

I’ll come back to the proper treatment for anyone infected with the virus of ‘safetyism’ in a moment. But what’s the news from the financial world? It’s almost like an alternative universe entirely, where there is no fear and apparently, no risk either.

I mentioned last week how hard it is to price future earnings streams from stocks when the ‘risk-free’ rate of return in government bonds is negative. By ‘risk-free’, I’m using the inflation-adjusted return on 10-year US Treasury notes. That return — at present — is a negative 1.03%.

If you’re wondering how a guaranteed negative return is ‘risk-free,’ you’re on the right track mentally. Central bankers in Japan and the US have yet to set official (nominal) interest rates at a negative level (the famous ‘zero lower bound’ former Fed Chair Ben Bernanke wrote about in 2004). But they HAVE set official interest rates below the rate of actual inflation — otherwise known as financial repression.

Over time, financial repression allows governments to pay off large, accumulated debts with inflation. The real cost of paying them declines as inflation works its magic. It’s a pretty raw deal for savers and anyone on a fixed income. And as you’ve seen recently, setting the ‘risk-free’ rate so low distorts the prices of other assets, especially equities.

Hence the higher highs on the S&P 500, the Nasdaq 100, and the Dow Jones Industrials here in the US. Faced with a negative real return in some government bonds, the rational investor decides the price is too dear to pay for future growth. And here we are, with Yale Economist Robert Shiller’s Cyclically Adjusted Price Earnings (CAPE) ratio at 39.17 — just below the 2000 high of 44.

This does not mean a crash is imminent, although September is infamous for being a bad month. It’s the worst month of the year for stocks in the S&P 500, according to the Stock Trader’s Almanac. No one knows quite why. It could be tax planning ahead of the next calendar, or the reweighting of portfolios and the rebalancing of asset allocation strategies based on the nine months of performance year-to-date.

What we do know is that based on valuations, stocks are expensive. We also know that there’s plenty of liquidity in markets at the moment. And as long as THAT is true, and as long as the ‘risk-free’ rate is below the rate of inflation, certain stocks (small-caps, momentum, growth) are probably going to trade at a premium until something changes.

What will change? Inevitably, the perception of risk will change. Nothing is risk-free in markets. Ever. Governments enjoy that designation because governments can always collect taxes to at least pay interest to bondholders. And those governments with a central bank that has a printing press can always print money to pay off bondholders in nominal terms.

If you’re borrowing in someone else’s currency, you either have to pay it back or you default. But if you’re borrowing in your own currency and you control the printing press, you have a distinct advantage. You are no longer entirely beholden to the ‘bond vigilantes’ who used to police government spending.

How else is it possible that the US government could go completely off the fiscal rails, rack up nearly US$30 trillion in debt, and make plans to spend trillions more? The only way it’s possible is convincing people that the ‘risk-free’ rate is really risk-free. It’s anything but.

But as I wrote in the most recent Bonner-Denning Letter, the collapse of the US’ occupation of Afghanistan shows how quickly a false narrative can collapse. It happens gradually. And then it happens suddenly. I expect the same for the bull market and eventually, the US dollar.

What’s the safe play in that scenario? Well, here’s the bad news. Wall Street and the City and financial product providers have convinced investors that for every bad news scenario A, there is an investment alternative B that should go up. In other words, for every possible negative, there’s a positive way to turn it into a way to make money.

This is a big fat lie. When the market is distorted and overvalued like it is now, your main financial goal is not losing money. That is a win, on a relative and absolute basis.

That probably sounds like a foreign or even odd sentiment, given all the money-making opportunities we’re bombarded with. But when the psychology changes, when the social mood moves, not losing what you have is going to feel like a huge achievement.

In the meantime, the idea that every risk is actually an opportunity to make everyone safer has infected our broader society. For example, with the coronavirus, it’s become a mantra that no one is safe until everyone is safe, that you’re being selfish and maybe even murderous in exercising your individual rights at the expense of ‘the public good’.

Get ready for a new era when further encroachments on your freedom are justified on the grounds of a ‘public health emergency’. The climate crisis? A public health emergency! The obesity epidemic? A public health emergency! Systemic racism? A public health emergency!

The architecture for a permanent lockdown based on an emergency is now in place. Politicians worldwide — but especially in Australia — have shown they have no common sense and no decency in invoking ‘public health’ to suspend the Rule of Law indefinitely. They’re doing it for your own safety after all, right?

What’s the cure for the disease of ‘safetyism?’ You have to think for yourself. Turn the TV off. Recognise that you, and only you, are responsible for managing your risk of disease (or of financial wipe out). No one is going to save you but yourself.

Much of what’s left of the free world is watching what’s going on in Australia with disbelief and shock. How could so many people go along so willingly with massive curbs on their basic freedoms? The answer is always fear. People will submit to almost any indignity once they’ve been sufficiently terrorised.

Keep that in mind as we commemorate the 9/11 attacks. So much fear was present (and amplified) after that event that the US spent 20 years, trillions of dollars, and tens of thousands of lives (Afghan, American, Australian, British, and many others) fighting a war it could never win.

Don’t let your government convince you that the war on COVID is never-ending and will require lockdowns, vaccines, and booster shots for the rest of your life. Life goes on. Start living it again.

Regards,

Dan Denning,
Editor, The Rum Rebellion

The Bonner-Denning Letter is co-authored by Port Phillip Publishing founder Dan Denning and legendary investment writer and publisher Bill Bonner. It connects the dots between markets, politics, and history as one of the only macroeconomic, 'top-down' newsletters in Australia. For a big picture perspective on the past, the present, and your investment future, click here for details on how to subscribe.

‘Let’s drink to the hard-working people

‘Let’s think of the lowly of birth

‘Spare a thought for the rag taggy people

‘Let’s drink to the salt of the Earth’

‘Salt of the Earth’, The Rolling Stones

Yes, today, we say an Ave Maria for the salt of the Earth. The poor folks are going to get whacked.

By whom? Jagger and Richards, of The Rolling Stones, had that figured out too:

‘Spare a thought for the stay-at-home voter

‘His empty eyes gaze at strange beauty shows

‘And a parade of the gray-suited grafters

‘A choice of cancer or polio’

Yes, the masses need leading…but they get gamblers…jokers…and grey-suited grafters instead. The deathly cancer of Trump…or the crippling polio of Biden. Take your pick.

And this just in, Breitbart on the War on Terror:

‘Brown University’s Costs of War project reveals the cost since September 11, 2001 exceeds $8 trillion and that wars have directly killed an estimated 897,000 to 929,000 people.’

One of the questions surrounding the US’ appalling retreat from Afghanistan is: Seeing how easily the Taliban took over the country last month, why didn’t they do it sooner?

That question was answered by Matthew Hoh, former US Marine Corps captain. The US was spending millions of dollars every day on the war in Afghanistan. Much of it was going to — well, the Taliban.

‘We’re talking about a fountain of money that the Taliban were happy to take. Whether they took it directly or it was the Taliban commander’s cousin that was the contractor, it doesn’t matter. The absurdity of all this — and everyone knew it was going on!’

No ticker tape parade

Our Diary is longer than usual today. We’re trying to understand more clearly how the US’s ‘hard-working people’ get ripped off.

Every society has its elite. The common people depend on it. After all, who has time to understand how a nuclear reactor really works? But we still live with atomic power.

And who knows which of the Afghan tribes are friends and which are enemies? We have experts to keep them straight, right?

And which King of Queens or Family Guy really understands what the Federal Reserve is up to? We expect those with PhDs in finance and economics to make sure it is doing the right thing.

But did the common foot soldier gain anything from the elite’s US$27 trillion forever wars?

Do you remember the ticker tape parade when our troops marched through the centre of Manhattan, celebrating their victory in the wars against poverty and drugs? How about the war against COVID-19?

Elites versus the common man

A hunter-gatherer tribe might not need an elite. Everybody knows approximately the same thing.

But the more advanced a society becomes, the more it depends on the few people who know how things work — its politics, as well as its nuclear submarines.

Then, as an empire ages and expands, the elite becomes further and further removed from the people it is meant to serve.

The rich and powerful live in special zip codes — especially those around the Capital Beltway. They shop at Saks, not dollar stores. They drink pinot grigio, not Old Milwaukee. And they insist on remaking the whole world in their own grotesque image.

Worse, they cheat the common man in order to take more money for themselves. They stab him in the back with their Wall Street bailouts (three so far this century!).

And they despise him for his beliefs…and his naivete. Didn’t he invade the Capitol to hijack ‘our’ democracy? Doesn’t he refuse to believe ‘the science?’ Doesn’t he drive a carbon-spewing pickup?

But now, it is getting late in the cycle. The elite has become incompetent and degenerate. It loses its wars. Its ‘investments’ all go bad. And it’s desperate to keep its privileges.

Who pays?

But who will pay for its mistakes…its lies…and its larcenies?

‘Hey…all this money printing,’ Fed chief Jay Powell might admit, ‘…it was just to enrich Wall Street, Washington, and the elite. But now, we’re getting rising inflation…so we’re going to have to stop.’

Honesty would be easy, but expensive. The elite would have to give back much of its ill-gotten gains. Stocks would crash.

Government spending would be slashed. The goofy boondoggles — along with the contracts and jobs that go with them‚ would have to end.

So would the preposterous ‘wars’ that benefit only the insiders. Forget the US$1.2 trillion ‘infrastructure’ bill. Forget the US$3.5 trillion ‘human infrastructure’ budget. Forget the ‘pivot’ to Asia; it would be time to mind our own business.

In other words, the costs would fall primarily on those who deserved to pay — the elite.

Social insecurity

But they are the deciders. And they will never decide to do that. Truth will have to wait, while the costs of three decades’ worth of foolish ‘investments’ get passed on to…can you guess?

The rich have their portfolios. The professors have their tenure. The politicians and bureaucrats have their fat pensions.

What does the common man have?

Social Security. He trusts the elite to make sure it is solvent…so he will get what is coming to him. But the Committee for a Responsible Federal Budget reports:

‘The Social Security and Medicare Trustees released their annual reports on the long-term financial state of those programs.

‘The Medicare Trustees’ report shows that the Part A Hospital Insurance trust fund will be insolvent in just five years, the trust fund faces a shortfall of 0.77 to 1.61 percent of payroll, and Medicare spending will grow significantly over the next few decades. […]

‘Along with the two Social Security trust funds and the Highway Trust Fund, all four major trust funds are headed for insolvency in the next 13 years.’

Of course, even those gloomy projections are based on a remarkable premise: that nothing goes wrong.

How it goes wrong

But something will go wrong. And the results will be worse than expected. The feds will continue ‘printing’ money. And inflation will run riot through the economy.

Social Security payments are pegged to inflation…but only as the feds compute it. Inevitably, the ‘adjustments’ will lag.

Already, the official US inflation rate is 5.4%. But as we saw yesterday, housing is going up at an 18% annual rate. Used auto prices have gone up by more than 40% the last year. And global producer prices for food, according to the IMF, are rising at a 25% rate.

There is no way the US$28 trillion in national debt…not to mention the other US$57 trillion in corporate, household, and other debt…will ever be repaid. Not in honest money.

Bad solution

The only ‘solution’ is inflation.

The elite must ‘print’ more money to keep the jig going.

Social Security payments will be reduced — by inflation.

Medicare support will be another victim.

Prices for housing, transportation, food, and just about everything else, will keep going up.

And standards of living for most people — the uncounted masses…the wavering millions…the faceless crowd — will go down.

Trusting soul

So, this Labor Day weekend…say a prayer for the labouring masses…the salt of the Earth.

The common man is a trusting soul…long suffering…and loyal. Most of the time, the chain around his neck rests lightly. No matter how he is mistreated, he still licks his master’s hand.

His sons and daughters still answer the call…and put on uniforms, ready to attack whatever poor, helpless third world nation the elite targets.

And he goes to the voting stations in the belief that his ballot will change things.

Even when he is kicked, he still wags his tail.

But watch out…

Kicked too many times, he may show his teeth.

Regards,

Bill Bonner,
For The Rum Rebellion