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All you need to know is two little words, resulting in one big problem...

Duration risk:

• Duration measures a portfolio’s price sensitivity to interest rate changes.
• The higher your portfolio duration, the more its price will fall when interest rates rise.
• Time to maturity and coupon rate are two factors affecting duration.

Why does this matter? Because it's what's driving the financial problems threatening the system (at least, for now, at this first stage of the expected decline).

For example, when the Bank of England completely reversed policy direction in a single day to bail out their failing pension system, the culprit was duration risk. The historically sharp rise in interest rates caused a crash in the guilt markets. The pension funds held massive duration risk in derivatives connected to guilts which caused losses large enough to threaten the solvency of the entire pension system.

When Silicon Valley Bank faced withdrawals from the tech and venture capital industry, it forced liquidation of their long dated Treasury Bond portfolio at a loss. That portfolio had zero credit risk, but it still retained massive duration risk. The losses were so severe that it forced the bank into insolvency.

The same story repeats, with slight variations, for all the banks under threat right now. And there are many.

These banks and pension funds invested in long duration assets, which lost lots of money because of the historically severe rise in interest rates last year. But special accounting rules for these institutions allow them to not mark-to-market those losses on their books... until those losses are realized.

That's why the real news today is how depositors are fleeing the banks, because that capital flight forces these institutions to sell those assets at a loss to pay off depositors, which then materializes insolvency seemingly out of thin air. Presto!! An institution can be stable one day because of bogus (but legal) accounting, only to become insolvent the next day (literally, one day later!)

The duration risk problem first showed itself with the U.K. pension system, but that was easy to discount as an outlier because of the irresponsible derivatives usage.

The recent bank failures from Silicon Valley to Switzerland show the problem is deep and wide. It's systemic.Unfortunately, it's also far, far from resolved, because this problem is not limited to a few outlier banks.

The fact that interest rates were irresponsibly low for way too long caused the adoption of massive duration risk across many sectors of the economy. The pension funds, investment banks, and regional banks are the current examples in the media. Less obvious is venture capital, long duration tech, leveraged corporate balance sheets, and commercial real estate, which we will likely see more of in the future if interest rates remain elevated.

For regional banks, the problem is still growing because depositors are still running to the exits (for good reason). These banks lost $120 billion in deposits the week ending March 15 while inflows to money market funds totaled $121 billion the same week and $117 billion the following week.

Depositors are simply taking rational action. They are moving money from institutions with credit risk that are also paying below market interest to institutions with no credit risk paying much higher interest rates. There is absolutely no rational reason that process should stop until the incentives change. However, those incentives aren't likely to change in the foreseeable future because the banks need that spread in interest rates for their profit margin. So depositors are doing the smart thing by fleeing.

The only question is whether this will force the regional banks to realize enough losses on long duration assets to force insolvency, or if they manage to find sufficient liquidity to meet withdrawals through other channels?

Lurking in the shadows of this developing banking problem is a knock-on commercial real estate problem because of the resulting lending standards tightening and credit spreads widening. The commercial real estate industry has more than $1.5 trillion in commercial real estate debt maturing in the next 3 years, and more than 80% of all commercial real estate loans are held by these very same banks with fewer than $250 billion in assets.

The problem for commercial real estate is most of these deals were last financed in the zero-percent interest rate era, but Interest rates are now higher, occupancy is declining, and property values are lower, all of which making refinancing tough. Add tightening credit standards to the mix and you have a potential dead body ready to float.

Which is probably why real estate is now the most shorted industry across global equities, and the third most shorted sector in the U.S. The short-sellers have sniffed out the problem and see blood in the streets. You'll hear more about it in the conventional media soon.

In summary, duration risk is the problem you see today that's starting a cascade effect that is not apparent yet. It's spreading from pension funds to banks to commercial real estate (and probably a lot more, but that's the obvious stuff right now).

This is a natural consequence of an extended period of artificially low interest rates followed by the sharpest rise in interest rates in recent history. That combination is the grim reaper for duration risk.

Even venerable Charles Schwab is seeing it's stock get hammered as customers flee the insultingly low interest rates of their sweep account system in favor of much higher yielding treasury money market funds with zero default risk. The Fed and FDIC may restore short-term confidence with their bailouts, but they're not doing anything to solve the economics that are driving the liquidity problem in the first place.

Meanwhile, lending standards tighten and credit spreads widen, which tightens the noose around commercial real estate, which is already bleeding from decreased occupancy and declining property values.

All of which puts the Fed in a REALLY hard place...

Inflation is nowhere close to tamed yet, but stuff is starting to break causing declining liquidity and tightening lending standards, all of which is highly deflationary. That's why they're putting policy on hold to let some time heal wounds (hopefully). They don't know how these competing forces will play out.

Nobody does.

It's an epic battle between inflationary Godzilla and deflationary King Kong. Inflation is structurally embedded in the system (as explained in previously newsletters) so it's not going away anytime soon, but there is a massive deflationary force appearing on stage that's growing rapidly and could temporarily throw a wrench in things.

A lot of people have a lot of opinions about how this will all resolve, but the truth is nobody knows the future (including the Fed).

As I stated in the first newsletter of 2023, the theme for this year is "uncertainty." The instability brewing underneath the current illusion of calm is now severe. Stuff is starting to break as "dead bodies" float to the surface. Volatility is the only safe bet, and that's not good for conventional passive investment strategies that can't manage market risk.

That's why I have stated numerous times that it's prudent to diversify at least a portion of your portfolio assets into my recommended investment solution using tactical asset allocation. I told you 18 months that it's the best way to manage portfolio risk and pursue a positive return net of inflation for the next 10-15 years of epochal change. Subsequent performance has confirmed that truth, and I expect this trend in relative out-performance to only accelerate in future years. It's definitely not too late to start (if you haven't taken action yet).

Many readers dismissed my continual rantings during late 2021 and all of 2022 because they couldn't see how the investment epoch changed or what it meant. My call was a bold and risky position to take because it meant the investment environment you knew from the prior 40-50 years was literally changing on a dime. The odds were infinitesimally small that I would be right.

Of course, 20/20 hindsight has proven every claim true, but of course, people are slow to change:

• The rise of structural inflation was probably not enough to convince you. Few people understand the connection between inflation, deflation, and valid investment strategy.
• Next in line was the Ukraine war, which could easily be dismissed as coincidence.
• But the historic rise in interest rates should have gotten your attention. Unbelievably, the mass narrative remains that the Fed move is only cyclical and a pivot to to easy money is right around the corner. Nobody is looking at the round of inflation that will follow after that expected pivot and how it will force the Fed's hands again. Even fewer are seeing how this is likely to resolve to stagflation and economic repression.
• Next was growing tension with China, which accelerated the move to onshore manufacturing and supply lines. Few connected how the opposite action, offshoring and global economic cooperation, was a primary source of the deflationary backdrop that allowed the Fed's easy money policies for four decades.
• And now stuff is starting to break - pension fund crisis, banks failing worldwide, and a commercial real estate problem lurking in the shadows.
• Yet the Fed still raised interest rates at the most recent meeting because Inflation remains structural, so it's not tamed yet.
• And I haven't even touched on the future role of shadow banks, leveraged corporate balance sheets, Fed solvency risks, treasury market liquidity risks, and Eurodollar risk as just a few items lurking under the surface waiting to appear.

Is it clear to you now that the investment epoch changed at the end of 2021, exactly as claimed?!?

This list of developments to date should make that fact abundantly clear, and more evidence continues to accumulate.

My claim that the smart investment strategy for this new economic regime is tactical asset allocation, as provided by this service here, was equally accurate as proven by subsequent investment results.

My private Expectancy Wealth Planning community was coached and prepared two years in advance for this changing economic regime, so they could continue to prosper in the face of adversity.

How about you? How has the last 18 months worked out financially?

Equally important, this new economic regime is still only in the first inning of a nine inning game. You can still take action.

My suggestion is you put my resources to work for you (my Expectancy Wealth Planning course & my recommended tactical asset allocation service for your investment portfolio) sooner rather than later. The cost to purchase is almost ridiculously low compared to the cost of making decisions without this knowledge. 

The longer you wait, the more the delay will cost you.

Enuff said. Now let's get to this week's educational resources.

The theme for this month is "surprise," as explained below...

Age of Easy Money - PBS Frontline (Full Video on YouTube)

I was surprised at how accurately Frontline explained the decades of developments that led to the current financial crisis. Conventional media usually sucks, but they were more-or-less spot on with how they put the puzzle pieces together. They correctly labeled the Fed as both arsonist and firefighter. They also correctly pointed out how the Fed has taken too big a role in the economy thus causing systemic risk (or as I like to say, they've foolishly exchanged several decades of healthy one standard deviation risks for a 20 standard deviation problem that puts the whole economic system at risk.) I also liked how they made Neel Kashkari look like a fool. Well deserved. In short, this is a surprisingly solid and entertaining resource for understanding what brought us to this point of epochal change. 

The Banking Crisis- Edward Chancellor Interview on Spotify

I wrote, edited, and finalized this newsletter before listening to this interview with the highly respected author and financial historian, Edward Chancellor. You can imagine my surprise when the first half of this interview follows my writing almost perfectly - logic structure, points made, phraseology, everything. Amazing! The second half of the interview is equally compelling, but you'll have to listen to the full interview to get the details since I won't be writing about those things until we get closer. Particularly poignant was how Edward closed the interview with his conclusion that there's no easy way out of this mess. I fully agree, and it's why I've been emphasizing this new epoch will take 10-15 years to work through with tons of volatility along the way. It's why I've been pushing you to adopt this investment solution historically proven to prosper during both normal times and the greater volatility of epochal change expected ahead. If you agree the investment game changed, then not taking action to protect and grow your investment portfolio is irrational.

Take Action Now So You Can Grow Your Wealth During Epochal Change:

1. This investment software solution includes two of Todd's top investment systems. You'll learn the smart, proven way to manage portfolio risk during epochal change. Once you understand it, you'll wonder why you tolerated the unmanaged risk in your  old "buy and hold" investment strategy.

2. My Expectancy Wealth Planning group coaching program shows you how to maximize the expected growth of your wealth in every market condition regardless of epochal change. My students were prospering during the good times, and they're still prospering during this adversity. Join this smart community of active wealth builders to secure your financial future.