Month: April 2018

Scott Ritter is arguably the most experienced American weapons inspector and in this interview with Dennis J. Bernstein he levels a frank assessment of U.S. government assertions about chemical weapons use.

Ritter: “They just make it up.”

Authored by Dennis Bernstein via ConsortiumNews.com,

In the 1980’s, Scott Ritter was a commissioned officer in the United States Marine Corps, specializing in intelligence. In 1987, Ritter was assigned to the On-Site Inspection Agency, which was put together to go into the Soviet Union and oversee the implementation of the Intermediate Nuclear Forces Treaty. This was the first time that on-site inspection had been used as part of a disarmament verification process.

Ritter was one of the groundbreakers in developing on-site inspection techniques and methodologies. With this unique experience behind him, Ritter was asked in 1991, at the end of the Gulf War, to join the United Nations Special Commission, which was tasked by the Security Council to oversee the disarmament of Iraq’s weapons of mass destruction. From 1991 to 1998, Ritter served as a chief weapons inspector and led a number of teams into Iraq.

According to Ritter, in the following Flashpoints Radio interview with Dennis Bernstein conducted on April 23rd, US, British and French claims that the Syrian Government used chemical weapons against civilians last month appear to be totally bogus.

Dennis Bernstein: You have been speaking out recently about the use of chemical weapons in Syria. Could you outline your case?

Scott Ritter: There are a lot of similarities between the Syrian case and the Iraqi case. Both countries possess weapons of mass destruction. Syria had a very large chemical weapons program.

In 2013 there was an incident in a suburb of Damascus called Ghouta, the same suburb where the current controversy is taking place. The allegations were that the Syrian government used sarin nerve agent against the civilian population. The Syrian government denied that, but as a result of that incident the international community got together and compelled Syria into signing the Chemical Weapons Convention, declaring the totality of its chemical weapons holdings, and opening itself to be disarmed by inspections of the Organization for the Prohibition of Chemical Weapons. Russia was chosen to be the guarantor of Syria’s compliance. The bottom line is that Syria had the weapons but was verified by 2016 as being in 100% compliance. The totality of Syria’s chemical weapons program was eliminated.

At the same time that this disarmament process was taking place, Syria was being engulfed in a civil war which has resulted in a humanitarian crisis. Over a half million people have died. It is a war that pits the Syrian government against a variety of anti-regime forces, many of which are Islamic in nature: the Islamic State, Al Nusra, Al Qaeda. Some of these Islamic factions have been in the vicinity of Ghouta since 2012.

Earlier this year, the Syrian government initiated an offensive to liberate that area of these factions. It was very heavy fighting, thousands of civilians were killed, with massive aerial bombardment. Government forces were prevailing and by April 6 it looked as if the militants were preparing to surrender.

Suddenly the allegations come out that there was this chemical weapons attack. It wasn’t a massive chemical weapons attack, it was dropping one or two so-called “barrel bombs,” improvised devices that contained chlorine gas canisters. According to the militants, between 40 and 70 people were killed and up to 500 people were made ill. The United States and other nations picked up on this, saying that this was proof positive that Syria has been lying about its chemical weapons program and that Russia has been behind Syria’s retention of chemical weapons. This is the case the US made to launch its missile strike [on April 14].

There are a lot of problems with this scenario. Again, why would the Syrian government, at the moment of victory, use a pinprick chemical attack with zero military value? It added nothing to the military campaign and invited the wrath of the West at a critical time, when the rebels were begging for Western intervention.

Many, including the Russian government, believe that this was a staged event. There has been no hard evidence put forward by anyone that an attack took place. Shortly after allegations of the attack came out, the entire town of Douma was taken over by the Syrian Army while the rebels were evacuated.

The places that were alleged to have been attacked were inspected by Russian chemical weapons specialists, who found zero trace of any chemicals weapons activity. The same inspectors who oversaw the disarmament of Syria were mobilized to return to Syria and do an investigation. They were supposed to start their work this past weekend [April 21-22]. They arrived in Damascus the day after the missile strikes occurred but they still haven’t been out to the sites. The United States, France and Great Britain have all admitted that the only evidence they have used to justify this attack were the photographs and videotapes sent to them by the rebel forces.

I have great concern about the United States carrying out an attack on a sovereign nation based on no hard evidence. The longer we wait, the longer it takes to get inspectors onto the site, the more claims we are going to get that the Russians have sanitized it. I believe that the last thing the United States wanted was inspectors to get on-site and carry out a forensic investigation that would have found that a chemical attack did not in fact take place.

DB: It is sort of like cleaning up a police crime scene before you check for evidence.

SR: The United States didn’t actually bomb the site that was attacked. They bombed three other facilities. One was in the suburbs of Damascus, a major metropolitan area. The generals said that they believed there were quantities of nerve agent there. So, in a building in a densely populated area where we believe nerve agent is stored, what do we do? We blow it up! If there had in fact been nerve agent there, it would have resulted in hundreds or even thousands of deaths. That fact that nobody died is the clearest evidence yet that there was no nerve agent there. The United States is just winging it, making it up.

One of the tragedies is that we can no longer trust our military, our intelligence services, our politicians. They will manufacture whatever narrative they need to justify an action that they deem to be politically expedient.

DB: Isn’t it also the case that there were problems with the allegations concerning Syria using chemical weapons in 2013 and then again in 2015? I believe The New York Times had to retract their 2013 story.

SR: They put out a story about thousands of people dying, claiming that it was definitely done by the Syrian government. It turned out later that the number of deaths was far lower and that the weapons systems used were probably in the possession of the rebels. It was a case of the rebels staging a chemical attack in order to get the world to intervene on their behalf.

A similar scenario unfolded last year when the Syrian government dropped two or three bombs on a village and suddenly there were reports that there was sarin nerve agent and chlorine gas wafting through the village, killing scores of people. Videotapes were taken of dead and dying and suffering people which prompted Trump to intervene. Inspectors never went to the site. Instead they relied upon evidence collected by the rebels.

As a weapons inspector, I can tell you that chain of custody of any samples that are to be used in the investigation is an absolute. You have to be at the site when it is collected, it has to be certified to be in your possession until the laboratory. Any break in the chain of custody makes that evidence useless for a legitimate investigation. So we have evidence collected by the rebels. They videotaped themselves carrying out the inspection, wearing training suits that would not have protected them at all from chemical weapons! Like almost everything having to do with these rebels, this was a staged event, an act of theater.

DB: Who has been supporting this particular group of rebels?

SR:  On the one hand, we have the actual fighters, the Army of Islam, a Saudi-backed fundamentalist group who are extraordinarily brutal. Embedded within the fighters are a variety of Western-trained and Western-funded NGOs such as the White Helmets and the Syrian-American Medical Society. But their primary focus isn’t rescue, in the case of the White Helmets, or medical care in the case of the Syrian-American Medical Society, but rather anti-regime propaganda. Many of the reports that came out of Douma originated with these two NGO’s.

DB: You mentioned “chain of custody.” That’s what was most ridiculous about sending in inspectors. The first thing you would want to do is establish chain of custody and nail down the crime scene.

SR: I was a participant in the Gulf War and we spent the bulk of that war conducting a massive aerial campaign against Iraq. I was one of the people who helped come up with the target list that was used to attack. Each target had to have a purpose.

Let’s look what happened in Syria [on April 14].  We bombed three targets, a research facility in Damascus and two bunker facilities in western Syria. It was claimed that all three targets were involved with a Syrian chemical weapons program. But the Syria weapons program was verified to be disarmed. So what chemical weapons program are we talking about? Then US officials said that one of these sites stored sarin nerve agent and chemical production equipment. That is a very specific statement. Now, if Syria was verified to be disarmed last year, with all this material eliminated, what are they talking about? What evidence do they have that any of this material exists? They just make it up.  

If I had been a member of that inspections team, I would have been able to tell you with 100% certainty what took place at that site. It wasn’t that long ago that the allegations took place, there are very good forensic techniques that can be applied. We would be able to reverse engineer that site and tell you exactly what happened when. Let’s say an inspection team had gone in and we found that there was sarin nerve agent. Now, the US government can say, there is not supposed to be any sarin nerve agent in Syria, therefore we can state that the Syrians have a covert sarin nerve agent capability. But still you don’t know where it is, so now you have to say we assess that it could be in this bunker.

We bombed empty buildings. We didn’t degrade Syria’s chemical weapons capability. They got rid of it. We were among the nations that certified that they had been disarmed. We just created this phantom threat out of nothing so that we could attack Syria and our president could be seen as being presidential, as being the commander in chief at a time when his credibility was being attacked on the home front.

DB: Amazing. That helps clarify the situation. Of course, it also leaves us terrified because we are so far away from the truth.

SR: As an American citizen who happens to be empowered with knowledge about how weapons inspections work, how decisions are made regarding war, I am disillusioned beyond belief.

This isn’t the first time we have been lied to by the president. But we have been lied to by military officers who are supposed to be above that. Three top Marine Corps officers stood before the American people and told bald-faced lies about what was going on. We have been lied to by Congress, who are supposed to be the people’s representatives who provide a check against executive overreach. And we have been lied to by the corporate media, a bunch of paid mouthpieces who repeat what the government tells them without question.

So Donald Trump can say there are chemical weapons in Syria, the generals parrot his words, the Congress nods its head dumbly, and the mass media repeats it over and over again to the American public.

DB: Are you worried that we might end up in a shooting war with Russia at this point?

SR: A week ago I was very worried. If I am going to give kudos to Jim Mattis it will be because he took the desire of Trump and Bolton to create a major crisis with Russia over the allegations of Syrian chemical weapons use and was able to water that down into putting on a show for the American people. We warned the Russians in advance, there were no casualties, we blew up three empty buildings. We spent a quarter of a billion dollars of taxpayer money and we got to pat ourselves on the back and tell everybody how great we are. But we avoided a needless confrontation with the Russians and I am a lot calmer today about the potential of a shooting war with Russia than I was a week ago.

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WTI has just broken above $69, spiking from as low as $67 earlier, following accusations from Israeli PM Netanyahu that Iran had a secret plan to build nuclear weapons…

 

And as war looms, gold is bid…

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At 8pm local time (1pm EDT) and after a customary delay, Netanyahu is set to address Israel and the world, presenting “dramatic news about Iran” and is expected to reveal documents which show how Iran cheated on the Nuclear deal.

As Axios’ Jonathan Swan said, Bibi’s speech’s will be “hugely helpful for Trump” as it “builds the public case for Trump to blow up the Iran deal on May 12 by reimposing sanctions on Iran’s oil exports and central bank.” Here Swan adds that “the Trump administration has so far done woeful job building case.”

In other words, it is up to Bibi to provide the media cover for the next regional conflict: that between the US, its allies, Saudi Arabia and of course Israel on one side and Iran, Syria, Russia, and potentially China on the other.

Or, as some would say, a true potential world war.

Watch live.

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Back in February, in the immediate aftermath of the Feb. 5 volocaust, we quoted a troubling – for stock bulls – statement from outgoing NY Fed president Bil Dudley, who revealed that not only was the recent market correction not “a big drop”, but that the Fed’s “Powell Put” was far lower.

Specifically, commenting on the February rout, Dudley said an equity rout like the one that occurred in recent days “has virtually no consequence for the economic outlook” and added that, if the market continued to go down sharply, “that would affect my view,” he said at a New York event, but “this wasn’t that big of a bump in the stock market” and ” is not a big story for central bankers yet.”

In other words, the Fed’s “Powell put” is well lower from the current S&P level… but how much lower?

That is the question Deutsche Bank’s derivatives strategist Aleksandar Kocic, who had been discussing where one can find the new “Fed put” for weeks, believes he has answered in a note released overnight.

Following a lengthy introduction in which he admits that the Fed’s new role has basically transformed to be the market’s Chief Risk Officer, although using far more words to get to the same point, to wit…

It appears as if the Fed, on top of inflation and growth, now has to worry about, or at least be cognizant of, a wide range of issues – from re-emancipation of the markets, tail risk, convexity flows, and balancing of the policy mix, to maintenance of global stability and financial conditions. Although the Fed does not control asset prices, they are relevant indicators of financial conditions and, as such, they can be on the Fed’s radar screen. In the past, through its actions, monetary policy acted indirectly as a source of market volatility. Now, it appears that the Fed needs to be occupied with its “management”, during both easing and tightening cycles. Monetary policy has become exaptive: A tool or an institution that was conceived and developed to serve one particular function but has subsequently been coopted to serve another. (Exaptation example: feathers in prehistoric animals that may have been used for attracting mates or keeping warm later became essential for modern birds’ flight.)

… Kocic then lays out his empirical approach of quantifying the new Fed put, which is another way of stating how high will the Fed raise rates before it relents amid rising market volatility and instability.

Rate hikes serve as brakes against an economy that is overheating. While this is a way of controlling inflation, hikes reduce leverage and slow growth. As such, they go against the grain of risk asset. From an equities point of view, rate hikes should not be aggressive to overpower positive economic developments. If financial conditions tighten too much, risk assets are likely to pull back. This implicit “agreement” is embedded in the Fed’s pace and reflects the  logic behind the “Fed put”.

Since the way Kocic’s thought experiment is structured has just one variable, it is easy to plot various manifestations of short rates vs the S&P. Seen in this light, “stock prices show alignment with the short rate across different cycles (at least, that was the case in the past).”

Specifically, to demonstrate his point, Kocic shows a chart of of 2Y swaps vs. the Log(S&P) levels “to keep things in scale.” Here, it becomes obvious that where there “collinearity between the two has been rather compelling in the past”, the Fed’s QE broke the correlation starting with the financial crisis, and continuing roughly through 2014:

The anomalous dispersion captures the QE period between 2009 and 2013 and is an echo of unprecedented distortions introduced by the stimulus.

Breaking up the chart above into three distinct time frames, roughly defined as pre-QE and after, reveals that historically short rates vs the S&P scaled appropriately for two Fed cycles: 1999-2000 and 2004-2007. Specifically, Kocic calculates In both cases the beta is about 10 – for a 1% rise in rates, there is a 10% appreciation in S&P.

In striking contrast, the next chart focusing on the post-2014 period, shows a dramatic rise in S&P to 2s beta, roughly 30x. The chart also shows something else: a sharp, post-January divergence between the two. To Kocic this is “the market’s restriking of the Fed put.“

 

Which brings us to the crux of the argument: calculating the actual strike price of the Powell put.

According to Kocic, “one can estimate this strike in two different ways.” First, delta neutral, in which a rise in vol is compensated with lowering of the strike in such a way that the underlying is unchanged. Using this approach we find that the S&P drop started at the point when S&P was at 2800 which places the new strike of the Fed put somewhere in the 2300 — 2400 range.

Here, as Kocic explains, the “Fed put is embedded in the beta, which represents response of stocks to rates rise. Higher strike, i.e. lower deductible, implies a more protective Fed; lower beta corresponds to a higher deductible or a lower strike of the put.” And as shown above, where previously the beta was 10, it has since jumped to 30, meaning that the Fed remains highly protective (as Bank of America repeatedly showed before). According to Kocic, “this is a residual of the Fed’s awareness of the distortions caused by QE as well as the market’s vulnerability to stimulus withdrawal.”

In quantitative terms, this would sugges that using the old beta of 10, the SPX should have been around 2300. To the Deutsche analyst this means that the current restriking of the Fed put is not very far from what the “old” striking would imply.

In simple English, what all of the above means stated simply is that the S&P has no less than roughly 300 points of downside from here before the Fed even bothers to intervene; it also means that if stocks demand Fed intervention as they often have in the past, the S&P will have to drop to the revised Fed put level of 2300-2400 before the requested response is triggered.

* * *

But wait there’s more, because as Kocic further explains, it is very unlikely that the market will sell off in a calm, cool and collected manner from its current level to 2,300; in fact, the drop would likely be far more stormy as a result of unwinding convexity flows, which push investors out of equities and into bonds. His explanation below:

Restriking of the Fed put is a withdrawal of convexity from equities. It is effectively a removal of a put spread from the market. However, in the environment where everything is bound to sell off (a market mode that is a mirror image of QE), volatility is one of the key decision variables. More volatile equities are less desirable than less volatile duration. In that environment, convexity withdrawal creates a reinforcing loop where more turbulence in risk assets tends to cause stability in fixed income. The figure shows the convexity flows across the two markets.

The implication of these cascading convexity flows is that as equities tumble, there would be an outsized bid for all fixed income instruments:

Restriking of the Fed put is re-syphoning of convexity. Withdrawal of convexity from equities means higher volatility and their underperformance, which fosters preference for bonds and reinforces their stability. This becomes a supply of convexity to rates and, as monetary policy remains in place, this means: higher real rates, stronger USD, and lower expected inflation (which reduces the tail risk of the bond unwind). All of these make bonds more desirable than risk assets.

However, even here there is a peculiar paradox, because as flows flood into fixed income, they create the kinds of curve vol distortion and migration we discussed last week in “The Key Story For The Bond Market Is About To Play Out“, a process which as Kocic explains once again, makes rate hikes less effective at a parallel shift in the curve, instead assuring curve flattening and subsequent inversion.

On the other side, as normalization of the curve is countering the fiscal shocks with monetary tightening, it is pushing duration investors to the long end. At the same time, as the long end remains anchored, rate hikes appear less effective, forcing the Fed to continue with rate hikes and thus increasing the probability of overshooting and disrupting equities further, which is effectively further withdrawal of equities convexity. Pension fund flows in this context only reinforce preference for bonds.

The implication here being that the mere act of lowering the Fed’s put activates feedback loops processes that  destabilize the market, threatening a potential waterfall of selling, which coming in a time of rising rates, leads to further curve flattening/inversion, and ultimately concerns about Policy error, which result in even more selling.

In other words, unless Powell promptly and actively approaches the market to assure it that the Fed strike price has not been lowered, a very unpleasant feedback loop may emerge in which selling of stocks results in more selling of stocks… until eventually the strike price of the Fed’s new “put” is reached. What happens then will be up to Powell: will he once again bail out markets and investors, or will stocks continue to drop in light with his striking comments from 2012. After all, recall that it was Powell who said 6 years ago the following:

I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.

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Authored by Nick Cunningham via OilPrice.com,

China’s new oil futures contract is gaining some momentum as a fixture on the global oil market, although hurdles remain before it can become a key benchmark for Asia.

China launched its yuan-denominated oil benchmark in March to much fanfare, after years of planning and delays. The logic of starting up an oil futures contract in China is obvious. China is the largest crude oil importer in the world, and its growing appetite for crude has increased the urgency to establish a contract based on local supply and demand conditions. Importing such heavy volumes at dollar-denominated prices exposes Chinese refiners and consumers to currency risk. A yuan contract mitigates some of that risk.

Beyond those concerns, the yuan contract also augments the global status of the Chinese currency. China is the world’s second largest economy and shifting more global trade into yuan advances Chinese influence.

However, the new contract on the Shanghai International Exchange still has to overcome some hurdles before it can be taken seriously as a premier benchmark in the global oil market. Just because the contract was launched does not mean it will become dominant, or even relevant. Previous contracts have failed to garner sufficient liquidity and ultimately have been discontinued or have wallowed in irrelevance.

The Dubai Mercantile Exchange’s Oman futures contract has been somewhat reflective of conditions in the Asian market, incorporating medium and heavy sour blends. But “its daily traded volume and open interest (number of contracts outstanding) have remained at low levels since its inception in 2007, indicating it is not actively used among market participants,” the EIA wrote last week.

As Reuters noted in early April, there are several ingredients for success. First, the contract must serve a need for hedging. Second, it has to attract enough traders in order to build liquidity. Finally, restrictions on trading, speculation, and capital controls must not be too onerous.

Because China is already the world’s largest oil importer, the Shanghai contract can obviously meet the need for hedging. It also has a sizable pool of refiners and traders, which should allow the contract to build liquidity. An added advantage is that China imports medium and heavy sour crudes, while Brent and WTI generally reflect lighter and sweeter varieties. The need for some differentiation is there.

Reuters notes the biggest uncertainty is over intervention in the market from the Chinese government, which could deter investors. But the desire by the Chinese government itself to successfully build the Shanghai benchmark might be a strong enough incentive to allow trading to proceed largely uninhibited.

As such, the prospects look good for the Shanghai oil contract and trading volumes have picked up.

For China, the trading of oil contracts in yuan reduces currency risk for Chinese consumers, and thus, the Chinese economy. Yet, with the rest of the world buying and selling oil in U.S. dollars, for oil traders, a contract denominated in yuan creates new currency risk. That could be a big deterrent and obstacle for the growth of the Shanghai contract, an obstacle that other futures contracts did not have to overcome. For instance, the USD/CNY exchange rate has appreciated 8 percent over the past year, the EIA points out.  

However, the global oil trade is gradually shifting east since that is where demand is rising the fastest. In 2017, the EIA says that Asia and Oceana accounted for 35 percent of global demand for oil and other liquid fuels, up from just 30 percent in 2008. That portion will continue to expand with China and India accounting for an outsized portion of demand growth going forward.

That puts additional weight on the importance of a benchmark that reflects supply and demand conditions in Asia. Over the longer-term, the potential peak and decline of oil demand in the OECD West makes Asia even more important as a hub for the oil market.

Already, the Shanghai contract has seen more trading volume for September 2018 delivery than the Oman contract. But volumes are still a tiny fraction compared to WTI and Brent. It could be a while before the Shanghai contract becomes a truly global benchmark. But it is on its way to becoming an important regional benchmark at least, reflecting medium and heavy sour conditions in Asia.

(Click to enlarge)

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As President Trump prepares for his own summit with North Korean leader Kim Jong Un, South Korean leader Moon Jae-in said U.S. President Donald Trump deserves a Nobel Peace Prize for his efforts to end the standoff with North Korea over its nuclear weapons program, a South Korean official said on Monday.

Just a few short hours after the historic first crossing south of the border by Kim to meet Moon pledging to end hostilities between the two countries and work towards the “complete denuclearization” of the Korean peninsula, Reuters reports that Moon told a meeting of senior secretaries, according to a presidential Blue House official who briefed media:

“President Trump should win the Nobel Peace Prize. What we need is only peace.”

This follows Moon’s comments in January that Trump “deserves big credit for bringing about the inter-Korean talks. It could be a resulting work of the U.S.-led sanctions and pressure.”

Moon’s Nobel Prize comment came in response to a congratulatory message from Lee Hee-ho, the widow of late South Korean President Kim Dae-jung, in which she said Moon deserved to win the prize in recognition of his efforts, the Blue House official said.

Moon responded by saying Trump should get it.

As a reminder, in December of 2009 – less than one year after taking office, President Obama – to many people’s surprise – won the Nobel Peace Prize for his “extraordinary efforts to strengthen international diplomacy and cooperation between peoples”.

In 2015, Geir Lundestad – ex-secretary of the Nobel committee from 1990 to 2015, told the AP news agency that awarding the Nobel Peace Prize to US President Barack Obama in 2009 failed to achieve what the committee hoped it would, its ex-secretary has said.

Mr Lundestad, writing in his memoir, Secretary of Peace, said even Mr Obama himself had been surprised.

“No Nobel Peace Prize ever elicited more attention than the 2009 prize to Barack Obama,” Mr Lundestad writes.

“Even many of Obama’s supporters believed that the prize was a mistake,” he says. “In that sense the committee didn’t achieve what it had hoped for”.

So the question is – would the establishment-led Nobel committee ever consider President Trump for his (as Moon has said) role in bringing North- and South-Korea together for the first time in 65 years?

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10Y Yields are back at 10-day lows and once again…

And the earnings-based, hope-strewn opening gap up in stocks has been erased once again…

S&P slides into the red after Gartman turns bullish https://t.co/xyaGWAdMxk

— zerohedge (@zerohedge) April 30, 2018

Perhaps of most note is that 30Y Yields are now lower since The Fed hiked rates despite 2Y remaining notably higher…

 

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Authored by Lance Roberts via RealInvestmentAdvice.com,

David Ranson recently endeavored in a long research report to simply declare that “bull markets do not die of old age.”

“The life expectancy of bull markets can be inferred from history. Fourteen bull markets in U.S. stocks have come and gone since 1927, and their mean lifetime is 55 months. But this calculation can be taken further. From the age of one year to the age of eight years, there’s no overall tendency for life expectancy to decline as a market advance gets older. The present stock market advance, which began 105 months ago, is no more likely to end within the next twelve months than it was when it was only twelve months old. Bull markets do not die of old age.”

Think about this for a moment.

This is the equivalent of suggesting that since the average male dies at 88-years of age if he lives to be 100, he has no more chance of dying in the next 12-months than he did when he was 40-years old.

While a 100-year old male will likely expire within a relatively short time frame, it will not just “being old” that leads to death. It is the onset of some outside influence such as pneumonia, infection, organ failure, etc. that leads to the eventual death as the body is simply to weak to defend itself. While we attribute the death to “old age,” it was not just “old age” that killed the host.

This was a point that my friend David Rosenberg made in 2015 before the first rate hike:

“Equity bull markets never die simply of old age. They die of excessive Fed monetary restraint.”

First, averages and medians are great for general analysis but obfuscate the variables of individual cycles. To be sure the last three business cycles (80’s, 90’s and 2000) were extremely long and supported by a massive shift in a financial engineering and credit leveraging cycle. The post-Depression recovery and WWII drove the long economic expansion in the 40’s, and the “space race” supported the 60’s.

But each of those economic expansions did indeed come to an end. The table below shows each expansion with the subsequent decline in markets.

Think about it this way.

• At 104 months of economic expansion in 1960, no one assumed the expansion would end at 105 months.

• At 118 months no one assumed the end of the “dot.com mania” was coming in the next month. 

• In December of 2007, no one believed the worst recession since the “Great Depression” had already begun. 

The problem for investors, and the suggestion that “bull markets don’t die of old-age,” is that economic data is always negatively revised in arrears. The chart below shows the recession pronouncements by the National Bureau Of Economic Research (NBER) and when they actually began.

The point here is simple, by the time the economic data is revised to reveal a recession, it will be far too late to do anything about it from an investment perspective. However, the financial market has tended to “sniff” out trouble

The Infections That Kill Old Bull Markets

Infection #1: Interest Rates

As noted by David Rosenberg, with the Fed continuing to hike rates in the U.S., tightening monetary conditions, the previous 3-year time horizon is now substantially shorter. More importantly, the “average” time frame between an initial rate hike and recession was based on economic growth rates which were substantially higher than they are currently.

Furthermore, as interest rates rise, so does the cost of capital. In a heavily leveraged economy, the change in interest expense has been a good predictor of economic weakness. As recently noted by Donald Swain, CFA:

“What if marginal interest expense pressures are the true recession signal (cause of economic weakness) and the yield curve is just a correlated input to that process? If so, for the first time, the Fed is hiking into what is already the most hostile refit period in 35-years.”

The point is that in the short-term the economy and the markets (due to momentum) can SEEM TO DEFY the laws of gravity as interest rates begin to rise. However, as rates continue to rise they ultimately act as a “brake” on economic activity. Think about the all of the areas that are NEGATIVELY impacted by rising interest rates:

1. Debt servicing requirements reduce future productive investment.

2. The housing market. People buy payments, not houses, and rising rates mean higher payments. 

3. Higher borrowing costs which lead to lower profit margins for corporations.

4. Stocks are cheap based on low-interest rates. When rates rise, markets become overvalued very quickly.

5. The economic recovery to date has been based on suppressing interest rates to spur growth.

6. Variable rate interest payments for consumers

7. Corporate share buyback plans, a major driver of asset prices, and dividend issuances have been done through the use of cheap debt.

8. Corporate capital expenditures are dependent on borrowing costs.

Infection #2: Spiking Input Costs

When rate hikes are combined with a surge in oil prices, which is a double whammy to consumers, there has been a negative outcome as noted by Peter Cook, CFA last week.

“A better record of predicting recessions is achieved when Fed has hiked rates by 2.00%-2.50%, AND oil prices have at least doubled. The price of money and energy are major financial inputs to financial planning, so when they simultaneously rise sharply, consumers and businesses are forced to retrench. Based on the Fed’s well-communicated strategy, it plans to raise rates another 0.75% during 2018 on top of the previous 1.50% over the past few years. If crude oil stays above $50-60, both conditions for a recession would be met in the second half of 2018.

Yet neither the Fed, or any high-profile economist, is predicting the beginning of a recession during 2019, let alone 2018. Answering the inflation/deflation question correctly is the most important issue of the day for investment portfolios. If recession/deflation arrives before growth/inflation, a major adjustment in expectations, and capital market prices, is coming within the next year.” 

This shouldn’t be surprising.

In the past, when Americans wanted to expand their consumption beyond the constraint of incomes they turned to credit in order to leverage their consumptive purchasing power. Steadily declining interest rates, and lax lending standards, put excess credit in the hands of every American. Such is why, during the 80’s and 90’s, as the ease of credit permeated its way through the system, the standard of living seemingly rose in America even while economic growth slowed along with incomes.

As I recently discussed with Shawn Langlois at MarketWatch:

“With a deficit between the current standard of living and what incomes, savings and debt increases can support, expectations of sustained rates of stronger economic growth, beyond population growth, becomes problematic.

For investors, that poses huge risks in the market.

While accounting gimmicks, wage suppression, tax cuts and stock buybacks may support prices in the short-term, in the long-term the market is a reflection of the strength of the economy. Since the economy is 70% driven by consumption, consumer indebtedness could become problematic.”

Infection #3 – Valuations

Lastly, it isn’t an economic recession that is truly problematic for investors.

If asset prices rose equally with increases in earnings, in other words the price-to-earnings ratio remained flat, then theoretically “bull markets” would last forever.

Unfortunately, since asset prices are a reflection of investor psychology, or “greed,” it is not surprising that economic recessions reveal the mispricing between the premium investors pay for a stream of earnings versus what they are really worth.  As I noted just recently:

“Bull markets are born on pessimism, grow on skepticism, and die on euphoria.” -Sir John Templeton

Take a look at the chart below which is Robert Shiller’s monthly data back to 1871. The “yellow” triangles show periods of extreme undervaluation while the “red” triangles denote periods of excess valuation.

Not surprisingly, 1901, 1929, 1965, 1999, and 2007 were periods of extreme “euphoria” where “this time is different” was a commonly uttered phrase.

Conclusion

What the majority of mainstream analysis fails to address is the “full-cycle” of markets. While it may appear that “bull markets do not die of old age,” in reality, it is “old age that leaves the bull defenseless against infections.”

It is the impact of an exogenous event on an over-leveraged, extended and over-valued market that eventually leads to its death. Ignoring the “infections,” and opting for “hope,” has always led to emotionally driven mistakes which account for 50% of investor’s under-performance over a 20-year cycle.

With expectations rising the Fed will further tighten monetary policy, the vulnerabilities of an “aged bull market” will be an issue for investors in the future.

“In investing, the man who wins is the man who loses the least.” – Dick Russell

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