Royal Bank of Scotland to investors: 'Sell everything'

Oil doesn't lead the economy. ... or equity markets. It's almost always a symptom of things going on in the world, not a cause.

Everything is about rates. This is worth watching. He's the reasoned voice among the idiocy.

Is this the beginning of a bear market for bonds?

He doesn't talk about equity markets. ... but as I have said over and over again, when rates spike up, it's game over. Like every bubble in history, the asset price inflation we have seen (and this is not just about U.S. equities) is all about borrowing, credit and leverage. Just like in 1929 it was about leverage. The last decade has been predicated on unprecedented manipulation of the debt markets to make it artificially cheap to borrow for a very long time, at artificially low rates that we have never seen before -- in the trillions of dollars.

Rates have been spiking recently. In the U.S., which has been affecting rates globally. They actually bottomed out in 2016. The last few days, in particular, they have rocketed higher (considering they usually move like glaciers). There is a level -- I don't know the exact level, but we are not that far away -- that the bubbled up equity markets can't stand up to higher rates and it is going to collapse. Cheap money is what created this epic bull market. Not earnings. Not a good economy (the expansion coming off of 2008 has been extraordinarily weak). The 10-year treasury got to about 3.25 percent yesterday. Jeff Gundlach (bond fund manager with most assets under management in the US) has said for a few years now that if you get two closes over 3.25 percent, it all collapses. Stocks and bonds will move down hard in tandem. I don't know if he is right about the level. It may be 3.5 percent, 3.75 percent. But it is likely not too far from where we are -- if this is the sustained move up that is going to happen eventually.

The only thing that keeps this all propped up is some monetary mandarins that few people have a clue about, having their thumb on the scales of finance -- and suppressing rates to encourage reckless amounts of debt and leverage. That has been the world's central banks. But the U.S. Federal Reserve has been slowly raising its overnight rate (even though in real terms, after inflation, it is still free to borrow at their curent level). And the 10 year is still yielding half of its historical level in real terms. At the same time, the ECB and the Bank of Japan, which carried the torch for the last several years (after the sell off that started this thread, they stepped in and stepped up massive quantitative easing programs -- creating money out of thin air and buying up huge amounts of debt to keep rates globally suppressed and to reinflate the bubbles), have started stealth tightening. Even if they are still both making it so there are negative rates in places. Particularly the BOJ -- in terms of the stealth. The ECB has essentially run out of debt to buy. They own everything already. Oh, and in the U.S., because of the tax cuts our government is selling way more bonds than ever. At the same time that the Federal Reserve is letting bonds roll of their balance sheet rather than buying new ones to replace the expiring ones. It's a piddly amount, given the massive size of the balance sheet they accumulated, but it's essentially a small bit of quantitative tightening. Add it together, and they are trying to get out of the hole they dug. But there is no way out.

They have created a mess for themselves. We have created trillions of dollars of money out of thin air worldwide, and that money was used to create a corresponding amount of debt and leverage. The fact that it drove up the U.S. equity market into a bubble is just one consequence of that. One that people will get at some point. Since that is what people are focused on, when the broad indexes lose 40, 50, 60 or more percent of their value when the wave of defaults come from higher rates, you should at least understand what is behind the massive boom and then the bust.

One reason they are backed into a corner. My mistake since they announced the first round of quantitative easing in 2009 was believing that they couldn't get away with it for too long. We are a decade in now. If, in the face of a stock market collapse, they announce QE4 (Maybe this time they intervene directly in the stock market and start buying equities directly like Japan did), maybe they can buy more time. Or if one of the other major central banks finds a way to prop it up longer. But I don't see how at this point. The problem for the Fed is that they have already committed to reducing their balance sheet and slowly hiking their overnight rate little by little, so they can't do an about face without looking clueless and not in control (and they are not controlling anything at this point). So they are primed for an accident -- kind of like when Greenspan tried to hike in the late 90s and popped the dot-com bubble he had created with rates that were too low, and then had to reverse course and it created a confidence problem that took stocks down even farther. This is what they have set themselves up for now. And this time? We are talking about debt and leverage levels worldwide that are much, much greater than what they created to form past bubbles. Which means that the deleveraging is going to need to be even greater, unfortunately.

 

You are looking at nominal rates. When real rates, and the amount of bad debt, are what matter.

When you as much money misallocated as we have built up, it requires ZIRP (zero percent interest) in order for it to keep building and for that debt to stay afloat without defaults. That has been the story of the last decade. At current levels, we are not much above zero percent in real terms. So it is still essentially free to keep borrowing and servicing your debt. That can keep zombie companies alive. Keep governments from acting fiscally responsible. Keep consumers building up more and more debt. In that environment, it doesn't take much of a rise in REAL rates (not nominal rates, which is a relatively meaningless number for the purposes of this kind of conversation) to put people in dire straits and start a wave of defaults.

In 2008. they had created so much debt by suppressing interest rates, that what we needed was a deleveraging. A lot of pain. Instead, the world's central planners stepped in and via money creation, didn't allow that deleveraging to happen. Instead, they answered a debt crisis by digging in deeper and creating more debt -- trillions of dollars, beyond anything the world has ever seen. All of that debt has become misallocated capital all over the globe. Money that will never be repaid.

You have governments that have run up huge amounts of debt, and the only thing holding off default is that they can KEEP borrowing (because central banks are creating money and buying their debt directly in what will be considered an inconprehensible scheme when people look back), and rates are being kept near zero so their interest payments don't cause defaults. You have businesses around the world that lose money ,but have stayed in business for years borrowing more and more money. Corporate balance sheets are way overleveraged just in the U.S. You have ghost companies around the world that have run up massive amounts of debt and haven't defaulted, because they could keep borrowing and rates have been so artificially low (negative in parts of the world) that they didn't have to worry about drowning in interest payments. See the Tesla thread. And you have consumers that are maxed out. We have student loan debt, for example in this country that is at more than $1.5 trillion. That is going to largely end with defaults. Subprime auto credit has flowed liberally for the last decade, creating more than $1.25 trillion of auto loan debt and an average car note of more than $500 a month in the country, many owed by people who don't earn much. Credit card debt at record levels. It's on and on.More than $13 trillion of consumer debt overall. And that is just in the U.S. In China, their whole economic boom has been a story of debt, for example.

In terms of the stock market, what you have seen over the last 7 or 8 years is leverage creating a mania. Just like the 1920s.

In any case, the two major difference from what you are talking about in the 1980s: 1) the debt levels were not at the extreme we have now, and there weren't misallocations of that capital we now have globally. This is unprecendented. 2) And more importantly, REAL rates are what matters. And real rates today, not nominal rates, are still essentially zero globally -- even with the little bit of tightening we have started to see. When it's free to borrow, no problems. When it is no longer free to borrow and credit tightens (whatever the nominal of level of rates is where you cross the line), after a decade of this, you have trillions of dollars of bad debt and people can't keep borrowing more for nothing to keep the charade up.

 

Here is Peter Boockvar who gets it. ... from Thursday. He's talking about what I have been saying. He may make more sense to you than I am.

The last thing he says, "Just small changes in interest rates on a large pile of debt ends up equalling a lot of money." Think of it that way, maybe.