The Altus Insight: April, 2016

The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor

Date: April 30, 2016
FR: Forrest Jinks
RE: Fever Induced Contemplates

I spent the last week sick in bed. I can’t remember being laid up for that long since I was a child (granted, I may be suffering from a little recency and selective memory biases). While I was occasionally able to get on my computer or phone and check in with the office, one thing I can tell you for sure is that being sick is no fun. This week also happened to be my preschool aged daughter’s spring break so there were two kids (my second child is a two year old boy) and my wife running around the house doing the things they normally would do, but normally they are done outside my reality as I am never around to observe their normal life flows. The laughing, singing and playing, interspersed with the occasional periods of pure quiet nap time, made me realize again how blessed my life is.Maybe you as a reader of this article don’t have little children around the house, but I bet all of us, given the time to be reflective, can come up with our own reasons as to why we are incredibly fortunate people. It definitely puts a different perspective around the stresses and worries of my business and investment lives. I don’t mean to imply that my business life, where we are responsible for people’s livelihoods and investment futures aren’t important, because they are, and we take our responsibilities very seriously, but to not acknowledge the difference between the two would be a mistake on my part. It is okay for things to be different, it doesn’t mean that one is better or worse than the other, but by trying to shove everything into a single box and treat it the same way, I may end up treating both poorly than if they were each treated in their own unique and special ways.Since I have already started down a path, hopefully it is okay with readers if I don’t tie the content of this month’s article directly to investing. There is connection, because everything is interconnected in some way, but I don’t yet have clarity about those connections or what they may mean in the coming weeks, months, and years.  Thus, while no direct connections will be made, maybe there is still something of value that can be gleaned. If not, we can just blame it on my fever.Jeffrey Gundlach, CEO of investment firm Centerline Capital, is currently one of the darlings of Wall Street (even though based in LA). He has called several of the recent economic events with amazing prescience. The following are some excerpts from a recent interview he did (note: this interview was done prior to the Fed Board meeting and release of Q1 GDP this week):
What does that (potential economic slowdown) mean with respect to monetary policy in the United States? I have been waiting for about two years for the Fed to capitulate on their interest rate increase dreams. Now, I think they did. Federal Reserve Chair Janet Yellen basically capitulated on March 29th. So far she had been acting as if each voice at the Fed carried the same weight: One official would say this, and another official would say something different. And because there were contradictory statements being made, the markets were getting very confused.But Janet Yellen took control with her speech at the Economic Club of New York. She did a good job and said that she is not going to raise rates at the next Fed meeting in April despite all these other Fed officials saying that April is a possibility. But it’s not going to happen. We’re not going there. So you’ve gotten about as much capitulation as you can get.
Are you concerned about that? I’m not concerned about anything. My job is not to set policies. I’m not an economist or a politician or a central banker. I invest people’s money. So I’m agnostic as to what’s good and what’s bad in terms of policy. I just deal with it [emphasis added].
So how do you deal with negative interest rates and central bank capitulation? It’s all about capital preservation. If you can get a few percent return in a deflationary environment you’re doing fine.Ahhh, negative interest rates. From an economic conversation standpoint ZIRP (Zero interest rate policy) and NIRP (negative interest rate policy) are the gifts that keep on giving. First ZIRP and now NIRP are the biggest guns in the toolboxes of central bankers. Raise your hand if you knew that over 25% of the world’s sovereign debt is trading below zero interest rate. Leave your hand in the air if you knew that almost 25% of the worlds GDP was created in countries with negative interest rates. And this is all based on nominal rates, not actual rates. If we were to calculate it on real rates the numbers would explode upwards.The central banks’ reasons for NIRP (after ZIRP didn’t work) is that it will fight off deflation. I could show all kinds of stats and present all kinds of arguments why this isn’t the case but one explanation says it all. Negative interest rates are by definition deflationary. A person buys a bond or puts money into an account knowing they are going to get less back in nominal dollars than they put in. That folks, is deflation.But it doesn’t keep more and more central banks from jumping into the ZIRP and NIRP pool. Or, in the case of the Federal Reserve, staying in the pool. The notes from the April Fed Governor meeting expectedly left rates unchanged but also expectedly (at least to the cynics among us, read “Interesting Revisited” http://www.altusequity.com/node/129 for more) came up with economic justification that they are unlikely to raise rates at their June meeting either. The four expected raises this year are down to two but with only 6 months in which to do it is the same annualized rate as the originally “anticipated” four. And around an election to boot? Not going to happen folks.In past articles we have discussed ad nauseam that it isn’t our job to make forecasts, it is our job to invest based on the possible outcomes (similar to the thought I highlighted from Mr. Gundlach above), however, because this edition doesn’t have a direct tie to investing, and because I am feeling my oats now that I am back on my feet, I am going to make two predictions, both of which are likely to be inaccurate because that is the nature of predictions, but I will move forward boldly all the same:

  1. We will see the Fed rate at 0 - .25% (versus the current .25 - .5%) again before we see it over 3.5%, as it was in 2005. (Looking back, didn’t interest rates seem low in 2005?)
  2. We will see Negative Federal Fund rates before we see them at 5.25%, which is where they were in 2006 and 2007 and is nowhere near the historical highs.

How can this be? The Fed is trapped, first keeping rates low because of unemployment and when unemployment came down because of economic growth, and when economic growth came because of low inflation numbers, and now that inflation numbers have started to increase because of low economic growth. 
Things that used to be considered unfathomable are now considered normal. And things that are currently unfathomable will be considered normal in the future.

By nature, all laws and policies are discriminatory. It doesn’t matter if you agree with them or not, they are discriminating against somebody. Is it good to have a law against murder? Most people would say yes, but there are definitely some in the world that would disagree, including those in power in a handful of countries. The person that intends to commit murder is discriminated against by the laws against it. How about something like adultery? Laws against adultery were in place as far back in history as those against murder but at some point people decided adultery was okay and the laws were slowly eliminated. Today most people would find it unthinkable that adultery could be considered a crime.
A more personal example was a California ballot initiative several years ago that that changed the state tax on earnings over a certain amount. This was done RETROACTIVELY. Were people upset? Definitely.  But they were in the minority, and they were discriminated against for being a certain class (financially successful) of people. Historically laws discriminated against a minority of society that was dangerous to the fabric of that society. Over time a vocal group of those minorities would take a stand against the “discrimination” and using other peoples’ desires for similar freedoms or shame over being discriminatory, would gain the sympathies of a large enough portion of society that the “discriminatory” law would change. This continues to happen today; Saudi Arabia, Kuwait, Norway, France, and our own USA have all been in the news lately regarding this very issue. Using the quote I highlighted from the interview but with a twist to a different sort of policy, as an investor, “So I’m agnostic as to what’s good and what’s bad in terms of policy. I just deal with it”.
Things that used to be considered unfathomable are now considered normal. And things that are currently unfathomable will be considered normal in the future.
So if the unfathomable can become normal, why stay insides the bounds of the accepted norms? Despite my fearless prediction above, the following two paragraphs are an explanation of what might cause interest rates to unexpectedly go higher (and quickly) and a tongue in cheek solution to pay off the US debt:

  1. Why interest rates may go higher: Sovereign wealth funds are huge sources of investment in the US financial markets, especially debt markets, and especially T Bills. Traditionally China has also bought massive amount of US debt. China’s purchases are falling sharply as they deal with their economic slowdown and plummeting foreign reserves (although this has stabilized some over the past several weeks). Most of the sovereign wealth fund wealth is from oil producing countries or countries that directly benefit from high oil prices (Saudi Arabia, UAE, Norway, etc). Oil prices have plunged to the point where these countries that were previously growing their wealth are now having to tap into that wealth to maintain spending or protect their currency. Should the oil situation prolong or worsen, more of that money may have to be pulled out of the markets to protect the sovereign wealth fund country’s currency or for use in domestic spending. Should these larger buyers of debt exit in masse, the market prices (interest rates) could go higher due to the sudden reduction in demand. Or the Fed could step in and buy a lot more debt like in Japan, where the Japan central bank accounts for 1/3rd of all the federal government bond purchases.

2.Negative rates can lead to US government paying off, or at least paying down, its debt: It is so simple it is almost silly (and the idea is very silly), but within a few easy steps the US government could start paying down its outlandish debt load.

  1. Feds lower rates to negative
  2. Feds institutes treasury buying program purchasing all treasuries (or as necessary) at pricing to cause negative yields – pulling the interest rate curve lower across the board
  3. Because of the negative interest rates the government would be paying back the debt with fewer dollars than it received at issuance
  4. If, IF, the political parties could agree to hold spending growth below that of tax receipt growth the debt payoff would be accelerated

Existing higher interest rate debt could be “refinanced” and replaced with the negative rate debt. This would save on the existing interest expense AND create a profit center to continue to reduce the debt.
​I know, I know, you are saying it will never work and have all kinds of reasons why. But just think, the more negative the Fed took rates the faster the US government would be able to pay off its debt. 

Things that used to be considered unfathomable are now considered normal. And things that are currently unfathomable will be considered normal in the future.

 

Happy investing.

 

Forrest Jinks

Altus Equity Group, LP

off: 707/932-5887

fax: 707/544-2972

www.altusequity.com

 

About the Author: Forrest Jinks is a managing director of Altus Equity Group, LP and licensed real estate broker. Forrest has many years of experience as principal in a variety of alternative investment segments including real estate (residential rehab, in-fill development, multi-family, office and retail), debt, and small business start up (online marketing and site retail). He can be reached at fjinks@altusequity.com.