BANKS

Regional banks are still in the news, and still they are a’failing.  On Wednesday this week, as Fed chairman Jerome Powell was (avoiding) speaking about the regional banks which have failed, and how it will certainly (not) spread to the rest of the banking sector, news broke that Pac West Bank was looking at the same options to raise funds that Silicon Valley Bank and others were looking at before they went into receivership and sold.

The Fed is already engaged in various forms of QE to prop up the sector.  And it must, because we know that cash always flows to where it is treated best.  In this case, given the choice of checking or savings accounts yielding 0% vs money markets yielding north of 4%, the choice is clear. According to Fed data, the last two weeks have seen over $100B of inflows to MMAs. This will leave the Fed with no choice but to support the depositors whose fiduciaries go bankrupt, and to support the banks who buy the assets of those going bankrupt.  This is also apparent in Fed data.

And leave it to the Fed to worsen the problem instead of doing nothing (which would be best), or do something that is actually productive.  The Fed raised its benchmark again yesterday, Wednesday March 3, to 5.00-5.25%.  It means that raising rates by 5.00% in the last 18 months created the problem, but raising rates even more will end the problem in their eyes.  This is actually akin to the arsonist firefighter arriving on the scene of his handiwork with the rest of his fire house buddies, and dousing the flames with gasoline.  The Fed raising rates will accelerate the outflows from not just regional banks, but all banks.

As noted in my last post, in a rising rate environment with the banks all valuing their assets at par instead of at market, depositors will take their money out and the bank goes under.  They don’t have enough money on hand to pay all the depositors, and they must then mark to market the assets they sell in order to pay depositors.  

It’s a pretty simple math problem.  You can use a free bond valuation calculator like I did.  If a bond was bought at par value for $1000 two years ago, yielding 1%, and the bank must now sell the bond in a market environment of 4%, the bank will recover only $800.  On top of that the bank only put up $100 to buy that bond because they used 10:1 leverage to maintain their 10% reserve requirement.  Over the last two years, they collected $20, now they collect $800, for a total of $820.  But they owe the lender $900 and the depositor $100, for a total of $1000.  To make up the difference of $180, the bank will need to sell another bond.  If enough depositors demand their money at the same time, the bank won’t be able to pay the lenders and the depositors in full.

This will actually cause all banks to begin to mark to market all of their bonds, CRE loans, MBS, and all other yield based assets on the books. We are literally standing at the precipice of a major realignment of the banking industry, for better or worse.

Make no mistake, every bank in the USA is insolvent.  

No matter what the talking heads say, no matter what JP and Yellen tell Congress, and no matter what they tell Peter Ducey when pressed during the Q&A sessions. And the likes of Peter Schiff and Jeff Gundlach will once again be considered clowns, though I suspect all those who follow the Austrian school of economics never lost that title to begin with.

One more point on the banks and the economy.  The basic business model of a bank is to get paid back on the loans the make, and to make it profitable, they borrow short term from depositors to lend long term to borrowers.  Traditionally, a healthy bank and a healthy economy would see lower interest rates for shorter term loans than it would for longer term loans.  Afterall, there is more risk with a longer repayment period.

When you and I take a loan to buy a house, it’s usually 30 years, and very often 15.  When businesses borrow, however, it’s usually not more than 5 years.  As businesses are refinancing their loans into a market that is now 5% higher than when they took out those loans, it makes it much more difficult to repay.  Remember, loans that were taken 5 years ago at 2-3% are now being refinanced at 7-8%.  This makes it all the more difficult for businesses to make decisions on discretionary spending, as they have far less cash now to spend.  Things like expanding product lines, replacing equipment and office furnishings, hiring additional employees, etc.  This is no different than if you have credit card and your minimum payment suddenly jumps from $124 per month to $224 per month. It is that much less that you can spend on discretionary purchases.

For companies who borrowed at 2-3% and couldn’t pay, and then borrowed from a second bank to repay the first, what will happen now that they must refinance at 7-8% or higher.  These companies, called zombie companies by the IMF, will handily go bankrupt in no time. We are seeing this begin to happen at a highly accelerated pace.  By the end of April this year, there were already 70 companies filing for bankruptcy in America.  The only time in history this was outpaced was during the GFC!  It is for this reason that I have stated on the record, many times, that junk bonds is a good place to park your money.  Not on the long side of the trade; you’ll lose on this side.  Rather, on the short side of the trade.  Speaking of the bond market…

BOND MARKET

The Fed thinks we will possibly have a mild slow down, and that will be the cause of inflation slowing to the stated  2% target.  Bond traders disagree. They think the Fed will crash the bond market and cause a mild recession, and that will be the cause of inflation going back to 2%.  They’re correct in anticipating the Fed crashing the bond market, but wrong about a mild recession.  

The Fed will crash bonds, that’s for sure. We will have a brief period of deflation in asset values and therefore prices, including bonds, bond proxies, CRE, stocks, housing, etc.  So too will the economy will pull back.  Everyone thinks the Fed is in the middle of engineering a soft landing with either a mild slowdown or a brief and mild recession. Instead, this will actually cause the Greater Depression.  The Fed will be left with no choice but to reinflate everything, as it is already in the middle of doing.  We will be right back to QE and easy money policies, which will cause the greatest inflation of our lifetimes (far worse than the late 1970’s-early 1980’s), and possibly the death of the dollar as we know it.

In fact, QE is the only weapon in the Fed’s arsenal.  The fight to stop inflation is soon coming to an end, and we will see a dramatic repricing of everything from groceries to clothing, cars to homes, assets, eyeglasses, lawn mowers, home heating gas, and everything we need on a daily or frequent basis.  Regardless of the name they call it, QE is still QE.  The Fed would rather political expediency instead of doing the right thing.

And by the way, don’t leave Congress out of this equation.  The current debt ceiling debate is only over how much to raise it by, not if it should be raised.  This debate will soon take second fiddle to the action that our senators and reps must take in the next Fed manufactured crisis.  Never to sit on the sidelines, Congress will act because “we have to do something, we have to pass this so we can read it and find out what’s in it.”  Monetary policies of the Fed only enable Congress.  The fiscal policies they will enact in the next 12-24 months alone will probably take our national debt to $40T or more.

SMART MOVES

(Note: You must engage in your own due diligence, and anything I say in this section is for instructional purposes only.  None of this is a recommendation for you to do it right now or at any time in the future. I am listing the moves that I am making for my own benefit, and sharing these moves so that perhaps you can learn something from it.  This is not an offer to buy/sell securities or an offer for services.)

At this time, it is generally worth while to begin looking to short regional banks through either shorting shares of an ETF and/or buying put options on the ETF, or going long shares of an inverse ETF and/or buying calls on the inverse ETF.  For full disclosure I am already in put options on XLF. Remember that you must always buy options when they are severely underpriced, because this significantly increases the chances that you will profit.  Buying at fair value or higher increases the chances to lose money.  We’re here to make money, not lose.  

Additionally I am already short housing through an inverse ETF (DRV), and I think going short CRE is worth it also.  Watch the stock market carefully bc it will soon be time to short the market.  The easiest way to do this because the volume will be there to support your moves, is by utilizing SPY and its options.  You can sell shares short or buy put options.  Again, the time has not come yet. If the S&P gets up to about 4310 that could be time to give serious consideration, unless there is a major black swan event before hand, similar to a Lehman moment or LTCM.  the S&P could easily go down to 3000, and I think it can quickly go to 1800 or lower.  

In the long term I think commodities will be in a bull market for a long time.  I am long oil and gas thru both XLE and AMLP, I am long uranium in UROY, and I am long PM in EPGFX.  Uranium is a unique case because Japan has realized that they must restart all of their reactors, China and India are slated to build several hundred new reactors over the next 10 years, and the rest of the world is waking up to realize that wind and solar will leave everyone in a cold dark house.  Given the choice it seems logical that the populations of the world will push their government to go nuclear because it is the safest and most cost effective way to provide power, especially to all those EVs the governments are trying to force upon us. In fact, the first reactor in several decades has now been commissioned in America in the state of Georgia, and I suspect there will be several more to follow very soon.

Precious metals entered a new phase of a bull market in 2016 when gold and silver bottomed.  The chart currently says that we could soon see $2400/oz in gold and $36/oz in silver.  Both charts look like a cup and handle on the daily candles over the last 12 months, with gold having already begun its move up in earnest, and silver just getting started.  I do NOT recommend IAU, GLD, SLV, or any of these ETFs.  You can’t redeem, and your shares will be diluted year after year.  Not to mention the third party counter risk.  You should rather buy the metal, and stay out of numismatics.  American Eagles and bullion bars are the best choice.

Finally, where to park your extra cash.  Your cash will do well in short term bonds of 90 days or less, or high yield money market accounts which provide liquidity.  Both options leave you liquid in case you need to patch your roof, and both options reduce the risk of interest rate shock.

One more smart move.  Leave all the FOMO and YOLO chats you are in on FB, WhatsApp, “investors” websites, and the like.  Create your own trading plan and stick with it, and be ready to change your plan as the markets dictate.

There’s always a bull market somewhere in the world, and on the opposite side of every crisis lies opportunity.

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