What We Expect

Rates up, prices up, corruption and chaos to reign...

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Bill Bonner, reckoning today from Poitou, France...

U.S. bond yields hit 17-year high following Federal Reserve's interest rate stance

…two-year U.S. Treasury note yield reached 5.2% …, marking a 1.4 percentage point increase since May and its highest level since 2006. The 10-year Treasury note yield is also nearing a 16-year high of 4.5%. 

However, due to ongoing economic strength and a tight labor market fueling persistent inflationary pressures, the Federal Reserve is expected to continue its tightening policy well into 2023. This could potentially lead to further decreases in bond prices as markets anticipate a higher peak in the federal-funds rate this year and fewer cuts in 2024.

Today, we will try to put this in perspective. Where are we in the Inflate or Die story? What chapter? What page?

Muddy Waters

We are still in a transition period. From the bull markets of 1980 – 2020, we are now entering into bear markets. Or so we believe. Bonds topped out with a yield of only .11% on the 2-year Treasury note in July 2020. Now, the rate is nearly 50 times higher. Stocks reached their peak in December 2021. Since then, they are cheaper, but less dramatically so.

Are they going down or up? In this transition period, it is impossible to know.  Prices react to the facts…and to the fictions. The fact is, hard to know. Interest rates are higher…which means, capital values should be lower. But a whole generation grew up when interest rates were going down and stock and bond prices were going up. They learned to “buy the dip” and not much else.    

What are they to do now?  

The confusion deepens.

First, even though the turnaround in stocks began almost 2 years ago, stocks are still very expensive. There’s a relationship between income and capital prices. A shrewd landlord, for example, may spend 8-10 times rents to buy an apartment building. Likewise, the relationship between the stock market and GDP forms what has become known as the ‘Buffett Indicator.” Warren Buffett figures that stocks should be worth around 80% of GDP.  He uses that measure to know when the stock market is over-, or under-,valued. Today, the ratio is at 167% – more than twice the historical norm.

Enough Rope

And here’s our friend, MN Gordon, with another way to look at it:

Another guide for determining the overall value of the stock market is Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio. This accounts for inflation-adjusted earnings from the previous 10 years. Currently, the CAPE ratio is over 30, which is well above its historical median of 15.94.

The current CAPE ratio is about where it was when the stock market peaked in 1929, just prior to the onset of the Great Depression. The only time the CAPE ratio has been higher is at the peak of the dot com mania, in December 1999, and in late-2021.

Adding further confusion… while we have been in a tightening cycle for 18 months, actual monetary policy is still very ‘loose’. David  Stockman:

Surprise! During the 186 months through August 2023 the Fed funds rate was negative in real terms fully 97% of the time (180 months). But apparently, all it took was just three months of barely positive readings for the Fed to throw in the towel on its rate normalization campaign.

That’s right. As recently as May, the inflation-adjusted Fed funds rate was still minus 0.48% and turned ever so slightly positive in June and July. Yet the Y/Y trimmed mean CPI still posted at +4.47% in August, meaning that yesterday’s freeze of the target funds rate at 5.33% yielded a real rate of just +0.48%.

Coffin Nails

Plus, you have to add the effect of the federal government’s inflationary spending. This year, the US deficit will be around $2 trillion. Aurora Research has this update:

• …About $10T worth of debt has accumulated since the pandemic.

• The national debt is likely to exceed $50T by the end of the decade if nothing substantial is done.

• Many federal programs passed by the Biden administration are costing more than expected. Here are two examples:

• The Inflation Reduction Act of 2022 was supposed to cost about $400B over 10 years. The reality is that it may cost more than $1T. The government simply underestimated the generosity of energy tax credits in the act.

• The Employee Retention Credit was supposed to cost about $55B. It has already cost $230B. Recently, the IRS froze the program to stop fraud.

• Estimates are that the Federal government will be paying over $10T in interest over the next decade.

• For the first 11 months of the fiscal year, the federal deficit stands at $1.5T, a 61% increase over the same period last year.

• The U.S. national debt equals over $254,000 per taxpayer.

• In addition to the national debt, the government has unfunded liabilities. These liabilities now total over $193T. This equates to over $577,000 per U.S. citizen

What does it all mean? Hard to say. But as new Primary Trends assert themselves…and as more and more real resources are taken away from the real economy…     

…we expect real interest rates to go up…consumer prices to rise…corruption and political chaos to increase…and asset prices to fall. That is not a forecast for next week or next month…but that is what we see coming in the years ahead. 

We’d be happy to be proven wrong.

Regards,

Bill Bonner