June 23, 2016, 3:00pm EST

As we said yesterday, we’ve seen a slew of threatening events come and go over the course of the past seven years, and with each passing of those events, the heightened scrutiny of the economy comes and recession predictions.  Each has been wrong.  The Brexit vote is just the latest.

With the UK referendum results looming (as of this writing), today we want to revisit some of our bigger picture perspective on the U.S. economy.  The data just doesn’t support the gloom and doom scenarios.

The Fed has manufactured a recovery by promoting stability.  And they’ve relied on two key asset prices to do it: stocks and housing.  Today we want to look at a few charts that show how important the stock and housing market recoveries have been.

While QE and the Fed’s ultra easy policy stance couldn’t directly create demand in a world of deleveraging, it did (and has) indirectly created demand by promoting stability, which restored confidence.  Without the confidence that the world will be stable, people don’t spend, borrow, lend or hire, and the economy goes into a deflationary vortex.

But by promising that they stand ready to act against any futures shocks to the economy (and financial markets), investors feel comfortable investing again (stocks go higher).  When stocks go higher and the environment proves stable, employers feel more confident to hire.  This all fuels demand and recovery.  And, of course, the Fed has pinned down mortgage rates at record lows, which promotes a housing recovery, and gives underwater homeowners (at one point, more than 25 million of them) a since that paper losses will at some point be overcome, and that gives them the confidence to spend money again, rather sit on it.

Along the path of the economic recovery, the Fed (and other key central banks) has been very sensitive to declines in stocks.  Why?  Because declining stocks has the ability to undo what they’ve done.  And it confidence breaks again, it will be far harder to restore it.

The first chart here is the S&P 500.  Stocks bottomed in March of 2009, when the Fed announced a $1 trillion QE program.

june 23 spx

Sources: Reuters, Billionaire’s Portfolio

Stocks surpassed the pre-crisis highs in 2013 after six years in the hole. But even after the dramatic rise you can see in the chart the damage from the crisis is far from restored.  If we applied the long term annual rate of growth of the S&P 500 (8%) to the pre-crisis highs of 1,576, the S&P 500 should be closer to 3,150.

How does housing look?  Of course, bursting of the housing bubble was the pin that pricked the global credit bubble.  Housing prices in the U.S. have been in recovery mode since 2012.  Still, housing has a ways to go.  This is a very important component for the Fed, for sustainable recovery.

june 23 case shiller

Sources: Reuters, Billionaire’s Portfolio

Housing prices have bounced 37% off of the lows (for 20 major cities in the index) – but remains about 10% off of the pre-crisis highs.

How has the recovery in stocks and housing reflected in the broader economy?

As stocks surpassed pre-crisis highs in 2013, so did U.S. per capita GDP.

 june 23 ps per capital gdp

Sources: Reuters, Billionaire’s Portfolio

While debt continues to be a big structural problem for the U.S and the rest of the world, growth goes a long way toward fixing that problem.

And growth, low interest rates, higher stocks and higher housing prices goes a long way toward restoring household net worth.  As you can see in the chart below, we have well recovered and surpassed pre-crisis levels in household net worth…

 june 23 us household net worth

Sources: Reuters, Billionaire’s Portfolio

What is the key long-term driver of economic growth overtime?  Credit creation.  In the next chart, you can see the sharp recovery in consumer credit since the depths of the economic crisis (in orange).  This excludes mortgages.  And you can see how closely GDP (economic output) tracks credit growth (the purple line).

june 23 credit to gdp

Sources: Reuters, Billionaire’s Portfolio

What about deleveraging?  It took 10 years to build the global credit bubble that erupted in 2007.  Based on historical credit bubbles, it typically takes about as long to de-lever.  So 10-years of deleveraging would put us at year 2017.

You can see in the chart below, the average annual growth rate of consumer credit over the past 55 years is 7.9%.  Over the past five years, consumer credit growth has been solid, just under the long term average.  Meanwhile, FICO scores in the U.S. have reached an all-time high.

 consumer credit growth rate

Sources: Reuters, Fed

With any volatility in stocks, there comes increased scrutiny on the economy and people like to wave the red flag anywhere they find soft economic data. But consumption makes up more than 2/3 of the U.S. economy.  And you can see from the charts above, the consumer is in a solid position.  Still, stocks and housing remain key drivers of the recovery.  The Fed is well aware of that.  With that, don’t expect the Fed, in the current economic environment, to do anything to alter the health of the housing and stock markets.

Have a great night.

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June 15, 2016, 4:30pm EST

The Fed held rates steady today.  As we’ve talked about, this was a decision they laid the ground work for over the past two weeks.  We want to talk about a few takeaways from the Fed event, and then continue our discussion from yesterday on the Bank of Japan decision tonight (where the big news may come).

First, the Fed did indeed consider the global stability risk that comes with the decision in the UK on whether or not to leave the European Union.  The polls in recent weeks have continued to show that it could go either way.  Meanwhile, the bookmakers have had this vote clearly in favor of “staying” in the European Union all along — as much as 70/30 ‘stay’ much of the way.  But those odds have been narrowing in the past week.

Still, as we discussed yesterday, holding pat on rates today was a “no risk” decision, especially because they had an event (the weak jobs data) and the platform (through a prepared speech by Yellen just days after the weak jobs data) to manage away expectations for a hike.

With that, stocks remained steady on the decision.  And markets in general remained tame.

So now the Fed is in position to see the outcome in the UK.  There was some two way talk about the jobs and inflation data, but it looks like the Fed is most concerned with what’s going on in the global economy.  That’s clear in their reaction to the oil price bust, when they responded back in March by taking two rate hike projections off the table.  And it’s clear in their reaction now to the Brexit risk.

But their new projections on the future path of interest rates have been ratcheted down in the coming years, and in the long run.  For perspective, a year ago the Fed thought the benchmark rate would be 2.75%.  Now they think it will be 1.5.  Why?  What’s been acknowledged more and more in recent meetings is the impact of the weakness and threats in global economies on the U.S. economic outlook.  The U.S. economy has been relied upon to drive global economic recovery, but it’s being dragged down now by the weight of global economic weakness.

This all puts pressure on Europe and Japan to follow through on their promise to do “whatever it takes” to restore their economies.
As we’ve said, the most important spots in the world, right now, are Japan and Europe.  The Fed only began its campaign of removing its emergency level policies because Europe and Japan took the QE baton handoff from the Fed – picking up where the Fed left off.  And unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, they have the ingredients (primarily Japan) to make QE work, to promote demand, to promote growth.  Japan has the largest government debt problem in the world. They have an undervalued currency.  They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.

They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.

In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity.  But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth.

With that, and given the position of the yen and Japanese stocks (see our chart yesterday), along with the underperforming economy in Japan, even after three years of QE, now is the time to throw the kitchen sink at it (i.e. they should act tonight, and in a ‘shock and awe’ fashion).

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June 13, 2016, 5:00pm EST

Last week we talked a lot about the German bund yield, the most important market in the world right now.  Today we want to talk about how to trade it.

The best investors in the world love asymmetric bets (limited downside and virtually, if not literally, unlimited upside).  That’s the true recipe to building huge wealth.  And there is no better asymmetric bet in the world right now than the German 10-year bund.

With that in mind, in recent weeks, we’ve revisited Bill Gross’ statement last year, when the 10-year government bond yields in Germany were flirting with zero the first time.  He called it the “short of a lifetime” to be short the price of German bunds – looking for yields to bounce back.  It happened.  And it happened aggressively.  Within two months the German 10 year yield rocketed from 6 basis points to over 100 basis points (over 1%).  But even Gross himself wasn’t on board to the extent he wanted to be.  The bounce was so fast, it left a lot of the visionaries of this trade behind.

But over the past year, it’s all come back.

Is it a second chance?  German yields are hovering just a touch above zero — threatening to break into negative yield territory for one of the world’s most important government bond markets.

As we said on Friday, the zero line on the German 10-year government bond yield is huge psychological marker for perceived value and credibility of the ECB’s QE efforts. And that has huge consequences, not just for Europe, but for the global economy.

Given the importance of this level (regarding ECB credibility), it’s no surprise that the zero line isn’t giving way easily.  This is precisely why Bill Gross called it the “short of a lifetime.” With that, let’s take a look at the incredible risk/reward this represents, and a simple way that one might trade it.

There is a euro bund future (symbol GBL) that tracks the price of the German 10-year bund.  Right now, you can trade 1 contract of the German bund future at a value of 164,770 euros by putting up margin of 3,800 euros (the overnight margin at a leading retail broker).  If you went short the bund future, here are some potential scenarios:

If you break the zero line in yield, the euro bund future would trade up to about 165.50 (it currently trade 164.77).  If you stopped out on a break of zero in yield, you lose 730 euros (about $820 per contract).  If the zero line doesn’t breach, and yields do indeed bounce from here, you make about 1,500 euros for every 10 basis point move higher in the German 10-year bund yield.

For example, on a bounce back to 32 basis points, where we stood on March 15th, the profit on your short position would be about 4,600 euros (or about $5,200).  If German bund yields don’t breach zero and bounce back to 1%, where it traded just a year ago, you would make about 15,000 euros ($16,900) per contract on your initial risk of $820 – a 20 to 1 winner.  Of course, there are margin costs to consider, given the holding period of the trade, but in a zero rate world, it’s relatively small.

If you’re wrong, and the German 10-year yield breaches zero, you’ll know it soon.

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June 8, 2016, 2:00pm EST

We’ve talked about the bullish technical break occurring in stocks.  That’s continuing again today.

Remember, a week from this past Friday we talked about the G7 (G8) effect on stocks.  We stepped back through every annual meeting of world leaders since 2009.  And the results were clear.  If the communiqué from the meetings focused on concerns about the global economy, stocks went higher. It’s that simple.

Why?  In the post Great Recession world, stocks are the key barometer of global confidence.  Higher stocks can help promote economic recovery (better confidence, higher wealth effect).  Lower stocks can derail it, and threaten a bigger downturn, if not fatal blow to the global economy.

Policymakers can and do influence stocks.  And thus, when we’ve seen clear messaging from these meetings about global economic concerns, stocks have done well (in most cases, very well).

With all of this said, on May 27th, from the meeting in Japan, the G7 issued their communiqué and it started with global growth concerns.  They said, “Global growth is our urgent priority.”  The S&P 500 closed at 2099.  Today it’s trading 2116 and is closing in on the all-time highs set in May of last year (less than 1% away).

Now, we talked in past months about the importance of Europe.  The Fed’s best friend (and the global economy’s best friend) is an improving economy in Europe.  We’ve seen some positive surprises in the data out of Europe, but the actions taken this morning by the ECB could be the real catalyst to get the ball rolling — to mark the bottom, to get Europe out of the slow-to-no growth, deflation funk.

They ECB started implementing a new piece to its QE program today.  Of course, they promised bigger and bolder QE back in March (mostly as a response to the cheap oil threat).  Today they started buying corporate bonds as part of that ramped-up QE plan.

With that, this is a very important observation to keep in mind.  Over the history of the Fed’s three rounds of QE, when the Fed telegraphed QE, rates went lower.  When they began the actual execution of QE (actually buying bonds), rates went HIGHER, not lower (contrary to popular expectations).  Why?  Because the market began pricing in a better economic outlook, given the Fed’s actions.  We think we could see this play out in Europe as well.

Take a look at this chart of German yields.  This is probably the most important chart in the world to watch over the next several days.

germ yield

Source: Reuters, Billionaire’s Portfolio

The German 10-year yield traded as low as 3 basis points (that’s earning 30 euros a year for every 100,000 euros you loan the German government, for 10 years).  Of course, the most important visual in this chart is how close the German 10-year yield is to zero (the white line), and then negative rates.

Remember, we’ve said before that Draghi and the ECB have made it clear that they won’t cut their benchmark rate below zero. And “that should keep the 10–year yield ABOVE zero.”  Were we right?  We’ll find out very soon. If so, and if German yields put in a low today on the “actual execution” of the ECB’s new corporate bond buying program, then U.S. yields would be at bottom a here too.


Source: Reuters, Billionaire’s Portfolio

You can see in the above chart, it’s a make or break level for the U.S. 10 year yield as well (as it is tracking German yields at this stage).  While lower yields from here in these two key markets might sound great to some, it comes with a lot of problems, not the least of which is a negative message about the outlook for the global economy and thus damage to global confidence.  Keep an eye on German yields, the most important market to watch in the coming days.

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2) Ocera Therapeutics (OCRX) has a current share of $6.97. The consensus analyst price target is $17. That gives us a “street projected return of 143%. Ocera is owned by RA Capital Management, another top biotech focused hedge fund. RA Capital has returned 40% annualized since 2002, without one losing year, and is run by Peter Kolchinsky, a Harvard PhD in Virology.

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4) Infinity Pharmaceuticals (INFI) has a current share price of $15. The consensus analyst price target is $39. That gives us a “street projected return of 160%. INFY is owned by one of the best and longest running biotech focused hedge funds, Orbimed Advisors. Orbimed runs over $10 billion dollars. The fund is run by the Princeton educated Samuel Isaly, and has returned 27% annualized since 1993. Orbimed owns almost 10% of Infinity Pharmaceuticals.

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