My title today derives from a quotation attributed to rear admiral David Farragut during the 1864 Battle of Mobile Bay. The actual sequence went more like this:

Damn those torpedoes!

“From his high perch, where he was lashed to the rigging of his flagship, USS Hartford, Farragut could see the ships pulling back. “What’s the trouble?” he shouted through a trumpet to USS Brooklyn. “Torpedoes”, was the shouted reply. “Damn the torpedoes.”, said Farragut, “Four bells, Captain Drayton, go ahead. Jouett, full speed.”^[27][28] The bulk of the fleet succeeded in entering the bay. Farragut triumphed over the opposition of heavy batteries in Fort Morgan and Fort Gaines to defeat the squadron of Admiral Franklin Buchanan.”

Torpedoes, as they were known in those days, were contact mines. If you weren’t paying attention they could easily blow you and your ship out of the water.

Is the market sailing in torpedo infested waters?

Farragut’s torpedo

Absolutely. It is always sailing in a sea of known and unknown risks. Since the bottom in 2009 a legion of talking heads, pundits, the Wizards of Wall Street have been warning us about these submerged killers. For the past seven years their warnings have continued as we have marched to new secular bull market record highs.

There are two things that worry me about this: someday they will be right (in the short-term and we get a cyclical bear market) or some day they will turn bullish, thus signaling the end of this great market run and the imminent beginning of a new secular bear market.

Does this mean I’ve turned bearish or unconstructive? No. I still believe the market has much further to go (not withstanding predictable downside jolts and surprises). However, there is one area where, on a longer-term basis, I am beginning to feel a little queasy … money creation and the corollary, debt creation.

Money creation experts: The USFRB

Federal Reserve bank of the United States

During and after the 2008 the US economy was in a very precarious position. I give great credit to the Fed and Treasury for the way they moved us through and beyond that near-death experience for our economy, including the Federal Reserve’s Quantitative Easing (QE) in the years after the blow-up. During that period the Fed purchased over $3.5 trillion worth of treasuries and mortgaged backed securities.They printed the money. At the time it was a good thing and it was expected that the bonds and MBS would either be sold or allowed to mature to bring the money back out. That never happened.

Importantly, it is not just the Fed. It has been the work of central banks all over the world doing the same thing.

The nascence of our debt problem

I believe it is safe to say that the two major military operations in Afghanistan and Iraq, coupled with the financial crises of 2008, were the main culprits but it did not end there. This was followed by the Tax Cuts and Jobs Act of 2017. ‘A trillion here, a trillion there … and pretty soon you’re talking about real money.’ In the real quote from the late gravel-voiced Republican Senator from Illinois, Everett Dirksen, the amount was a ‘billion here and a billion there…’ That’s some real inflation folks! The party of the ‘Tea Party’ has seemed to have lost its way on deficit destruction. Then you have a whole raft of Democratic Presidential candidates proposing new programs and taxes without mention of getting our house in order financially.

Because we’ve had little or no inflation, no one seems to care or believe it will come back to bite us in the derrière. This is disconcerting.

The Upside

Inflation and Interest Rates

You have too much money chasing too few goods. This eventually equals demand-pull inflation. The operative word is “eventually.” I can’t say when this might happen but my guess is that it begins where the sting of globalization originated, the cheap labor markets of the far east. Big and fast-growing consuming middle classes have developed in Asia. Couple this with a secular commodity bear market that is getting long in the tooth and you have the ingredients for a resurgence in inflation.

Cheap labor abroad and technology have kept US pricing and wage growth at bay. With 3.5% unemployment wage pressure domestically and foreign inflation on the rise US corporations would have cover for price increases, something most corporations have found illusive for the past two decades … increased unit sales plus pricing, what a novel concept for continued earnings growth. This will be good for stocks until it isn’t.

The Downside

Rising inflation would eventually lead to higher interest rates, including interest paid on the current US federal debt, $22 trillion and change. Interest on the debt in fiscal 2019 was $394 billion – that is on a 2019 fiscal spending of $4.529 trillion (int = 8.7% of federal spending). What if that number went to $1 trillion (less than 5% interest on our current debt balance)? Assuming we were to hold current spending flat (unlikely) that would amount to a spend of 20% of our current budget just to cover the debt service.

In the final analysis this will all end very badly! It always does. It is the stock market’s way of the world.

Meantime …

Everyone is averting their eyes from the problem, Republicans bragging about the great (fed, deficit and tax cut induced boom, i.e. 2% GDP growth) economy and Democrats promising new improved programming. There is no one talking a little shared sacrifice to get out of this hole.

Jim Cramer cried “fire” in the crowded and panicked market of October 2008 when he broadcast to the world his warning, ‘If you need the money any time in the next five years, you need to sell now.” I bet those who took that sage advice were thrilled 5 years later after the S&P 500 had gone from a low of 741 in October ’08 to a low of 1641 in October of 2013. Now he makes this sage political observation, “Cramer: None of the Democrats at the debate seems to care about your 401(k).” I guess we all have to vote Republican or we can kiss our future financial well-being good-bye.

The Proverbial Silk Purse

It is likely we will be hearing a lot more of Mr. Cramer’s thought process by others as we approach impeachment and the fall elections. Forget about everything else. Your pocketbook is the only thing that counts. These are not the torpedoes we should be worrying about. If a Democrat wins, it will not be the end of the world, we will be fine … remember the great markets under Clinton and Obama.

Impeachment

This impeachment is not about whether the economy, market or our retirement accounts do well. It is about the soul of our democracy, and the next 11-1/2 months will be the most important test that our democracy has faced in my lifetime. This is not a trivial matter or a witch hunt. I believe our founding fathers contemplated the type of activity the president is accused of when they placed the impeachment remedy into the Constitution. I also believe a fulsome trial in the Senate where heretofore restricted witnesses are allowed to testify is the only way to handle this process. Absent a fair process in the Senate, the ballot box in November will be the final arbiter. Whatever the outcome and associated media/political noise it will probably not be a market killer.

What’s your take?

P.S. I want to thank you for your readership and wish you and yours a happy, healthy and prosperous New Year!