US consumer incomes and credit card debt
Many market commentators talk about the struggling US consumer, with rising costs forcing them to take on expensive debt, but this is not borne out by the data.
Real disposable personal income per capita (blue below) reached $50.4K in March, compared to the pre-pandemic peak of $48K in Feb 2020. The subsequent spike in 2020-21 was caused by a massive rise in government transfers (red) which have now almost completely subsided.
Average per capita income could conceal a skewed distribution towards high income-earners but median incomes don’t show this. Real median personal income fell from $41K in 2019 to $40.4K in 2020, recovering to $40.5K in 2022. Unfortunately that is the latest available data, but there is no sign of a reversal in the long-term up-trend, with the recent dip minor relative to most past recessions.
Consumer loans for credit cards and other revolving debt have climbed steeply relative to disposable personal income, reaching 5.06% in March 2024 (blue below). But the sharp fall in 2020-21 was the result of a spike in government transfers (red) and the ratio is no higher than pre-pandemic levels of 5.08% to 5.15% in 2019.
Conclusion
Government stimulus helped to soften the fall in incomes during the pandemic and assisted the post-pandemic recovery. Real per capita disposable income is at an all-time high outside of the pandemic stimulus in 2020-21 and real median personal income displays a strong up-trend. Credit cards and revolving consumer debt are also no higher than pre-pandemic levels relative to disposable personal income.
We feel that many commentators are too focused on the negatives and fail to recognize the robust performance of the American consumer.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
True cost of US debt | Niall Ferguson
Ferguson’s Law states that any great power that spends more on debt service (interest payments on the national debt) than on defense will not stay great for very long. True of Hapsburg Spain, true of ancien régime France, true of the Ottoman Empire, true of the British Empire, this law is about to be put to the test by the US beginning this very year, when (according to the CBO) net interest outlays will be 3.1% of GDP, defense spending 3.0%.
Niall Ferguson: China, Russia, Iran axis is bad news for Trump and GOP isolationists – Bloomberg, 4/21/24
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Gold, Crude, Copper and the Elephant
Gold, crude and copper is where the action is, while stocks and Treasuries take a back seat for the present.
Markets are signalling a reluctance to take on risk, while long-term Treasury yields threaten to trend higher.
We also revisit rising Treasury debt — the elephant in the room — and examine the CBO’s budget projections in more detail.
Crude Oil
Brent crude respected resistance at $84 per barrel, signaling a decline to below $80.
Nymex light crude breach of support at $78 per barrel would confirm the reversal. A decline in crude oil is likely and would ease inflationary pressures, with the expected fall in long-term yields bullish for stocks, bonds and precious metals.
Crude oil production remains steady at a massive 13.1 million barrels per day according to the EIA report for the week to May 3.
Inventories (including SPR) recovered to above 1.6 trillion barrels, while market concerns eased over Iran-Israel tensions.
Copper
Copper is testing short-term resistance at $10K per metric ton. Breakout is likely and would test major resistance (green) at $10.5K.
The rise, however, is caused by a production halt at Cobre Panama. Production could be resumed if the mine-owner First Quantum can reach agreement with the new president-elect Jose Raul Mulino. From Reuters:
Mulino, a 64-year-old former security minister, won Panama’s election on Sunday [May 5] with 34% of the vote and said his government would be pro-investment and pro-business, adding that the Central American country would honor its debts, while he vowed to not forget the poor. He won with the help of popular former President Ricardo Martinelli who was barred from running due to a money laundering conviction. Mulino, who served as security minister during Martinelli’s administration from 2009 to 2014, had been Martinelli’s vice presidential candidate and took his place.
Gold & the Dollar
The Dollar Index continues to test support at 105. Respect remains likely, with Trend Index troughs above zero signaling buying pressure, unless Janet Yellen at Treasury intervenes to weaken the Dollar in support of the UST market.
Gold broke resistance at $2350 per ounce, signaling another advance. But first expect retracement to test the new support level. Respect would confirm a target of $2500 per ounce.
Shanghai Gold Exchange domestic contract Au99.99 is trading at 553 RMB/gram, equivalent to a USD price of $2380 per ounce at the current USDCNY exchange rate of 7.2268.
Stocks
The S&P closed above 5200 on Friday but a doji candlestick and lower Trend Index peaks indicate a lack of enthusiasm from buyers.
The Russell 2000 small caps ETF (IWM) reflects the lack of broad market support for the rally, with Trend Index peaks below zero warning of selling pressure. Another test of support at 200 is likely.
Financial Markets
Ten-year Treasury yields continue to test the band of support between 4.4% and 4.5%. Recovery above 4.5% would signal another test of 4.7%.
Bitcoin is testing support at $61K. Follow-trough below say $60K would confirm the decline — initially signaled by breach of support at $64K — and warn that financial markets are moving to a risk-off position.
Commercial bank reserve balances at the Fed, however, grew by $78 billion in the week to May 8, indicating that financial market liquidity is improving.
Consumers
Consumer sentiment retreated to 67.4 in the University of Michigan survey for May 2024, but the up-trend continues.
Five-year inflation expectations jumped to 3.1% but the three-month moving average, ranging between 2.9% and 3.0%, signals little change in the long-term outlook.
The Elephant in the Room
Last week we published a note suggesting that investors were distracted by short-term noise and ignoring the elephant in the room — the precarious level of US federal debt. The bipartisan Congressional Budget Office (CBO) projects that Treasury debt will grow to a clearly unsustainable 172% of GDP by 2034.
The US fiscal deficit is projected to grow from $1.6 trillion in 2024 to $2.6 trillion by 2034. Remember: all projections are wrong, but some are useful.
Often the most useful part of a projection is the underlying assumptions.
Real GDP growth below is a modest 1.5% in 2024, reaching 2.2% by 2026 — nothing controversial there. But the inflation projection is Pollyannaish, assuming a steady CPI decline from 3.2% in 2023 to 2.2% by 2034 — totally unrealistic if the budget deficit is to remain at close to 6.0% of GDP.
Assumed inflation (above) also impacts on projected nominal interest rates, with the projected fed funds rate declining to 2.9% by 2027 and 10-year Treasury yields to a low 3.8%. Every 1.0% overshoot in inflation would be likely to cause a similar increase in both long- and short-term interest rates.
The budget projection below is equally unrealistic. Defense spending, the CBO would have us believe, declines to 2.5% of GDP by 2034. Given rising geopolitical tensions with Russia-China-Iran, defense spending is likely to exceed the long-term average of 4.2%.
Net interest is budgeted to grow from 2.4% of GDP to 3.9% of GDP by 2034 but is based on unrealistic interest rate projections.
Treasury debt is likely to grow a lot faster than projections — because of the likely understatement of both defense spending and interest costs. That means that debt held by the “public” will have to grow a lot higher than the $48.3 trillion projected by 2034. If real interest rates are too low, any shortfall in take up by the public will have to be absorbed directly or indirectly by the Fed.
Conclusion
Rising inventory and easing Middle East tensions have weakened crude oil prices. A long-term decline in crude would be likely to relieve inflationary pressures and allow the Fed to cut interest rates.
Copper is rising steeply due to supply shortages, but prices could fall just as rapidly if the Cobre Panama mine is reopened by the new president-elect.
Gold broke resistance at $2350 per ounce, signaling another advance. Retracement that confirms the new support level at $2350 would offer a target of $2500.
Long-term Treasury yields are testing support. Respect of support is likely and would confirm the recent up-trend.
Perceptions of market risk are rising, with Bitcoin testing support at $61K and the Russell 2000 small caps ETF (IWM) warning of selling pressure.
Financial market liquidity, however, recovered slightly in the last week.
Consumer sentiment continues to trend higher, while long-term inflation expectations remain steady at close to 3.0%.
The elephant in the room remains Treasury debt, with CBO projections understating likely deficits due to unrealistic assumptions for inflation, interest rates and defense spending. Debt issuance by Treasury is expected to exceed demand from foreign investors and the general public, leaving the shortfall to be absorbed by the Fed or commercial banks.
The result is likely to be higher long-term inflation, boosting real asset prices while eroding the value of financial assets.
We are long-term bullish on Gold, Defensive stocks, the Heavy Electrical sector, and Critical Materials (Lithium and Copper). The last two stand to benefit from the energy transition. We are also overweight short-term financial assets with duration of 2 years or less: Mortgages, Term Deposits and Money Market Funds.
We remain underweight Growth stocks — which we consider overpriced — and long-duration financial assets.
Acknowledgements
- EIA: Petroleum & Crude Inventory
- EIA: Weekly U.S. Field Production of Crude Oil
- University of Michigan: Surveys of Consumers
- CBO: The Budget and Economic Outlook, 2024 to 2034
- Shanghai Gold Exchange: Delayed Quotes
- CoinDesk: Bitcoin Prices
- Reuters: Exclusive-Panama’s president-elect vows to help fix canal water problems, build major train line
- Adam Taggart’s Thoughtful Money: Interview with Michael Pento
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Strong liquidity and a weak Yuan boost stocks & Gold
The S&P 500 Equal-Weighted Index ($IQX) closed at a new record high above 6800. The advance signals that the current rally is finding broader support and is not as concentrated on the top 7 mega-cap technology stocks.
Retracement on the Russell 2000 Small Caps ETF (IWM) respected support at 200, signaling a fresh advance. Our target is the 2021 high at 240. The breakout again signals that investors are growing more comfortable with risk,
Financial Markets
Bitcoin retraced slightly. Respect of support at $68K is likely, however, and would confirm an advance to test $72K.
The Chicago Fed Financial Conditions Index eased to -0.556, indicating plenty of liquidity in financial markets.
The Corporate Bond Market Distress Index reflects healthy credit markets, with Investment Grade (brown below) slightly above the 25th percentile and the High Yield Index (ocher) near record lows, below the 5th percentile on the right-hand scale.
Gold & the Dollar
The Dollar Index continues to test resistance at 104.5. Follow-through above 105 would offer a target of 107.
Gold is strengthening despite a relatively strong Dollar, with demand from China driving up prices. Breakout above $2200 would confirm our target of $2400 per ounce.
Crude Oil
Crude is retracing, with Nymex Light Crude testing support at $80 per barrel. Respect is likely and would confirm our target of $90. High crude prices are caused by (a) the Red Sea threat to shipping, forcing tankers to take the longer route to Europe around the Cape of Africa; (b) Ukrainian drone attacks on Russian refineries; and (c) OPEC extension of production cuts through June.
Conclusion
Strong liquidity in financial markets maintains upward pressure on stocks, with advances widening to include the broad S&P 500 index and small cap stocks.
Gold continues to test resistance at $2200 per ounce, driven by demand from China in response to a weakening Yuan. Breakout is likely and would confirm our target of $2400 per ounce.
Crude is retracing to test support, but respect is likely and would confirm another advance. Rising crude prices would increase inflationary pressures in the months ahead, making it difficult for the Fed to cut rates. This would add upward pressure to long-term Treasury yields and erode demand for stocks.
Acknowledgements
- NY Fed: Corporate Bond Market Distress Index (CMDI)
- CoinDesk: Bitcoin (BTC) prices
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Why China’s efforts to resolve hidden government debt could fall short | Caixin Global
Local governments make extensive use of local government finance vehicles (LGFVs) to conceal debt and present a healthy balance sheet. The hidden debt presents a major risk for central government as the economy threatens a debt-deflation spiral.
From Caixin Global, March 14 2024:
China’s central government has rolled out a new round of measures since the second half of last year to help local governments swap or restructure their off-the-books borrowing in a bid to control debt risk.
However, the sheer scale of the country’s local government hidden debt — up to more than 70 trillion yuan ($9.8 trillion) according to some estimates, more than twice Germany’s GDP — means that the measures at best are far inadequate and will provide only temporary relief to what experts say is a looming liquidity crisis for regional authorities….
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Eleven reasons for optimism in the next decade
This might seem more like a wish list than a forecast — there are always risks that can derail predictions — but we believe these are high probability events over the long-term.
Our timeline is flexible, some events may take longer than a decade while others could occur a lot sooner.
Also, some of the reasons for optimism present both a problem and an opportunity. It depends on which side of the trade you are on.
#1 US Politics
The political divide in the United States is expected to heal after neither President Biden nor his predecessor, and current GOP front-runner Donald Trump, make the ballot in 2024. The first due to concerns over his age and the latter due to legal woes and inability to garner support from the center. A younger, more moderate candidate from the right (Nikki Haley) or left (Gavin Newsom?) is likely to be elected in 2024 and lead the reconciliation process, allowing Congress to focus on long-term challenges rather than political grandstanding.
Nikki Haley & Gavin Newsom – Wikipedia
#2 The Rise of Europe
Prime Minister of Estonia, Kaja Kallas – Wikipedia
Europe is expected to rediscover its backbone, led by the example of Eastern European leaders who have long understood the existential threat posed by Russian encroachment. Increased funding and supply of arms to Ukraine will sustain their beleaguered ally. NATO will re-arm, securing its Eastern border but is unlikely to be drawn into a war with Russia.
#3 Decline of the Autocrats
We are past peak-autocrat — when Vladimir Putin announced Russia’s full-scale invasion of Ukraine on February 23, 2022.
Vladimir Putin announces invasion of Ukraine – CNN
Russia
The Russian economy is likely to be drained by the on-going war in Ukraine, with drone attacks on energy infrastructure bleeding Russia’s economy. Demands on the civilian population are expected to rise as oil and gas revenues dwindle.
Fire at an oil storage depot in Klintsy, southern Russia after it was hit by a Ukrainian drone – BBC
China
The CCP’s tenuous hold on power faces three critical challenges. First, an ageing population fueled by the CPP’s disastrous one-child policy (1979-2015) and declining birth rates after the 2020 COVID pandemic — a reaction to totalitarian shutdowns for political ends.
Second, is the middle-income trap. Failure to overcome the political challenges of redistributing income away from local governments, state-owned enterprises and existing elites will prevent the rise of a consumer economy driven by strong levels of consumption and lower savings by the broad population.
Third, the inevitable demise of autocratic regimes because of their rigidity and inability to adapt to a changing world. Autocratic leaders grow increasingly isolated in an information silo, where subordinates are afraid to convey bad news and instead tell leaders what they want to hear. Poor feedback and doubling down on past failures destroy morale and trust in leadership, leading to a dysfunctional economy.
Iran
Iranian Ayatollah Ali Khamenei – Wikipedia
Demographics are likely to triumph in Iran, with the ageing religious conservatives losing power as their numbers dwindle. The rise of a more moderate, Westernized younger generation is expected to lead to the decline of Iranian-backed extremism and greater stability in the Middle East.
#4 High Inflation
The US federal government is likely to avoid default on its $34 trillion debt, using high inflation to shrink the debt in real terms and boost GDP at the same time.
#5 Negative real interest rates
High inflation and rising nominal Treasury yields would threaten the ability of Treasury to service interest costs on outstanding debt without deficits spiraling out of control. The Fed will be forced to suppress interest rates to save the Treasury market, further fueling high inflation. Negative real interest rates will drive up prices of real assets.
#6 US Dollar
The US Dollar will decline as the US on-shores critical industries and the current account deficit shrinks. Manufacturing jobs are expected to rise as a result — through import substitution and increased exports.
#7 US Treasury Market
USTs are expected to decline as the global reserve asset, motivated by long-term negative real interest rates and shrinking current account deficits.
Central bank holdings of Gold and commodities are likely to increase as distrust of fiat currencies grows, with no obvious successor to US hegemony.
#7 Nuclear Power
Investment in nuclear power is expected to skyrocket as it is recognized as the only viable long-term alternative to base-load power generated by fossil fuels. Reactors will be primarily fueled by coated uranium fuels (TRISO) that remove the risk of a critical meltdown.
TRISO particles consist of a uranium, carbon and oxygen fuel kernel encapsulated by three layers of carbon- and ceramic-based materials that prevent the release of radioactive fission products – Energy.gov
Thorium salts are an alternative but the technology lags a long way behind uranium reactors. Nuclear fusion is a wild card, with accelerated development likely as AI is used to solve some of the remaining technological challenges.
#8 Artificial Intelligence (AI)
Scientific advances achieved with the use of AI are expected to be at the forefront in engineering and medicine, while broad productivity gains are likely as implementation of AI applications grows.
#9 Semiconductors
Demand for semiconductors and micro-processor is likely to grow as intelligent devices become the norm across everything from electric vehicles to houses, appliances and devices.
#10 Industrial Commodities
Demand for industrial commodities — lithium, copper, cobalt, graphite, battery-grade nickel, and rare earth elements like neodymium (used in high-power magnets) — are expected to skyrocket as the critical materials content of EVs and other sophisticated devices grows.
Expected supply shortfall by 2030:
Prices will boom as demand grows, increases in supply necessitate higher marginal costs, and inflation soars.
#11 Stock Market Boom
Stocks are expected to boom, fueled by negative real interest rates, high inflation and productivity gains from AI and nuclear.
#12 Save 50% on a New Subscription
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Conclusion
There is no cause for complacency — many challenges and pitfalls face developed economies. But we so often focus on the threats that it is easy to lose sight of the fact that the glass is more than half full.
Our long-term strategy is overweight on real assets — stocks, Gold, commodities and industrial real estate — and underweight long duration financial assets like USTs.
Acknowledgements
- World Politics Review, Alexander Clarkson: In Russia and Iran, External Aggression Masks Internal Vulnerabilities
- McKinsey: The semiconductor decade, A trillion-dollar industry
- ZeroHedge: Skyrocketing Battery Mineral Demand Set to Outpace Supply By 2023, February 14, 2024
- Wikipedia: China’s One-Child Policy
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Stan Druckenmiller’s macro outlook
“….We need to make an adjustment fundamentally and price wise. And if you look at the market, in the non-QE world, free world, 15 times earnings was about right. We’re at 20 times earnings. I don’t know what we’re doing 20 times earnings. It’s hard for me to get excited about the long side of the overall market with the market, say, 20% above its normal valuation. When you have a federal fiscal recklessness problem, you have supply chain problems, you have the worst geopolitical situation I’ve seen in my lifetime.
’78, ’79 was bad. But I mean, for the first time, it’s a very low probability, but you gotta put the potential outcome of World War on the table. Not exactly an environment that excites me about paying 20 to 30%, above the multiple for equity prices. The next six months, who knows? And we’re certainly washed out to some extent.”
Acknowledgements
Save 50% on an Annual Subscription.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Rising long-term rates could spoil the party
Real GDP for the September quarter reflects an annual growth rate of 2.9% for the US, well below the Atlanta Fed GDPNow estimate of 5.4%. Growth in weekly hours worked declined to 1.5% for the 12 months ended September, indicating that GDP is likely to slow further in the fourth quarter.
New Orders
Manufacturers’ new orders for durable goods, adjusted for inflation, shows signs of strengthening.
Transport
Transport indicators show a long-term down-trend but truck tonnage has grown since May 2023.
Container (intermodal) rail freight likewise grew for several months but then turned down in August..
Growth in weekly payrolls of transport and warehousing employees slowed to an annual rate of 3.6% in September but remains positive.
Consumer Cyclical
Light vehicle sales continue to trend higher, suggesting consumer confidence.
Housing
New housing starts (purple) have been trending lower since their peak in 2022 but new permits (green) are now strengthening.
New single family houses sold are trending higher.
Despite a steep rise in mortgage rates. In a strange twist, higher rates have reduced the turnover of existing homes on the market, with owners reluctant to give up their low fixed rate mortgages. Low supply of existing homes has boosted sales of new homes, lifting employment in residential construction.
The National Association of Home Builders Housing Market Index (HMI), however, reflects falling sentiment — likely to be followed by declining new home sales and housing starts.
HMI is a weighted average of three separate component indices. A monthly survey of NAHB members asks respondents to rate market conditions for the sale of new homes at the present time; sales in the next six months; and the traffic of prospective buyers. (NAHB)
Financial Markets
The ratio of bank loans and leases to GDP declined to 0.44 in the third quarter but remains elevated compared to levels prior to 2000.
The cause of ballooning debt is not hard to find, with negative real interest rates for large parts of the past two decades.
Now real rates are again positive and money supply is contracting relative to GDP, the days of easy credit are at an end. A significant contraction of credit is likely unless the Fed intervenes, either by cutting rates or expanding its balance sheet to inject more liquidity into the system.
Commercial banks continued to raise lending standards in Q3, making credit less accessible.
Conclusion
This is not a normal market cycle and investors need to be prepared for sudden shifts in financial markets.
The US economy is slowing but cyclical elements like light vehicle sales and new home sales are holding up well.
The rise in long-term Treasury yields, however, is likely to cause a sharp credit contraction if the Fed does not intervene by cutting rates or expanding its balance sheet (QE).
The Fed is reluctant to intervene because this would undermine their efforts to curb inflation. But they may be forced to if there is a credit event that unsettles financial markets.
Fed intervention is unlikely without a steep rise in credit spreads. But would be especially bullish for Gold.
Save 50% on an Annual Subscription.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
The Big Picture: War, Energy, Bonds and Gold
Two inter-connected themes likely to dominate the next few decades are War and Energy.
War may take the form of a geopolitical struggle between opposing ideologies, with conventional wars limited to proxies in most cases and nuclear exchanges avoided because the costs are prohibitive. But it is likely to involve fierce competition for energy and resources in an attempt to undermine opposing economies. The impact is likely to be felt throughout the global economy and across all asset classes, including bonds, stocks and precious metals.
War
War can take many forms: conventional war, nuclear war, proxy war, cold war, economic war, or some combination of the above.
Nuclear war can hopefully be avoided, with sane leaders skirting mutually assured destruction (MAD). For that reason, even conventional war between great powers is unlikely — but there is a risk of it being triggered by escalation in a war between proxies.
Cold war, with limited trade between opposing powers — as in the days of Churchill’s Iron Curtain — is also unlikely. Global economic interdependence is far higher than sixty years ago.
Greg Hayes, chief executive of Raytheon, said the company had “several thousand suppliers in China and decoupling . . . is impossible”. “We can de-risk but not decouple,” Hayes told the Financial Times in an interview, adding that he believed this to be the case “for everybody”.
“Think about the $500bn of trade that goes from China to the US every year. More than 95 per cent of rare earth materials or metals come from, or are processed in, China. There is no alternative,” said Hayes. “If we had to pull out of China, it would take us many, many years to re-establish that capability either domestically or in other friendly countries.”
What is likely is a struggle for geopolitical advantage between opposing alliances, with economic war, proxy wars, and attempts to build spheres of influence. This includes enticing (or coercing) non-aligned nations such as India to join one of the sides.
Such a geopolitical arm-wrestle is likely to have ramifications in many different spheres, but most of all energy.
Energy
You can’t fight a war without energy. A key element of the geopolitical tussle will be to secure adequate supplies of energy — and to deprive the opposing side of the same.
The situation is further complicated by the attempted transition from fossil fuels to low-carbon energy sources.
Since the Industrial revolution, development of the global economy has been fueled by energy from fossil fuels, with GDP and fossil fuel consumption growing exponentially. Gradual transition to alternative energy sources would be a big ask. To attempt a rapid transition while in the midst of geopolitical conflict could end in disaster.
The challenge is further complicated by attempts to replace fossil fuels with wind and solar which generate intermittent power. Base-load power — generated from fossil fuels or nuclear — is essential for many industries. Microsoft are investigating the use of nuclear to power data centers. The US Department of Defense (DoD) has commissioned Oklo Inc. to design and build a nuclear micro-reactor to power Eielson Air Force Base in Alaska. Renewables are a poor option for critical applications.
Russia’s 2022 invasion of Ukraine highlighted Germany’s energy vulnerability despite billions of Euros invested in renewables over recent decades. You cannot run a modern industrialized economy without reliable energy sources.
Low investment in fossil fuel resources — which fail to meet ESG standards — has further increased global vulnerability to energy shortages during the transition.
Inflation
War and pandemics cause high inflation. Governments run large deficits during times of crisis, funded by central bank purchases in the absence of other investors. This causes rapid expansion of the money supply, leading to high inflation.
Geopolitical conflict and the attempt to rapidly transition to carbon-free fuels — while neglecting existing resources — are both likely to cause a steep rise in energy costs.
Bond Market
The bond market has the final say. The recent steep rise in long-term Treasury yields is the bond market’s assessment of fiscal management in the US. The deeply divided House of Representatives has effectively been awarded an “F” on its economic report card.
Failure of a divided government to address fiscal debt at precarious levels and rein in ballooning deficits raises a question mark over future stability, with the bond market demanding a premium on long-term issues.
The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions. (Fitch Ratings)
CBO projections show federal debt held by the public rising from 98% of GDP today to 181% in thirty years time.
Rising long-term yields also add to deficits as servicing costs on existing debt increase over time. The actual curve is likely to be even steeper. CBO projections assume an average interest rate of 2.5%, while current rates are close to 5.0%.
Continuing large fiscal deficits in the next few decades appear unavoidable. The result is likely to be massive central bank purchases of fiscal debt — as in previous wars/pandemics — with negative real interest rates (red circles below) driving higher inflation (blue) and rising inequality.
Political instability
Interest rate suppression effectively subsidizes borrowers at the expense of savers. Only the wealthy are able to leverage their large balance sheets, buying real assets while borrowing at negative real interest rates. Those less fortunate have limited access to credit and suffer the worst consequences of inflation, further accentuating the division in society and fostering political instability as populism soars.
Commodities
Resources are likely to be in short supply, from under-investment during the pandemic, geopolitical competition, and the attempted rapid transition to new energy sources. Prices are still likely to fall if global demand shrinks during a recession. But growing demand, shrinking supply (from past under-investment) and inflation pushing up production costs are expected to lead to a long-term secular up-trend.
Gold
High inflation, negative real interest rates and geopolitical competition are likely to weaken the Dollar, strengthening demand for Gold as a safe haven and inflation hedge. Breakout above $2000 per ounce would offer a long-term target of $3000.
Conclusion
We expect large government deficits and shortages of energy and critical materials — such as Lithium and Copper — the result of a geopolitical struggle and attempt to transition to low-carbon energy sources over several decades.
Rising government debt will necessitate central bank purchases as the bond market drives up yields in the absence of foreign buyers. The likely result will be high inflation and interest rate suppression as central banks and government attempt to manage soaring debt levels and servicing costs.
Our strategy is to be overweight commodities, especially critical materials required for the transition to low-carbon fuel sources; short-term bonds and term deposits; and defensive (value) stocks.
We are also overweight energy, including: heavy electrical; nuclear technology; uranium; and oil & gas resources.
Gold is more complicated. Rising long-term interest rates will weaken demand for Gold, while geopolitical turmoil will strengthen demand, causing a see-sawing market with high volatility. If long-term yields fall — due to central bank purchases of US Treasuries — expect high inflation. That would be a signal to load up on Gold.
We are underweight growth stocks and real estate. Rising long-term interest rates are expected to lower earnings multiples, causing falling prices. Collapsing long-term yields due to central bank purchases of USTs, however, would cause negative real interest rates. A signal to overweight real assets such as growth stocks and real estate.
Long-term bonds are plunging in value as long-term yields rise, with iShares 20+ Year Treasury ETF (TLT) having lost almost 50% since early 2020.
The trend is expected to reverse when Treasury yields peak but timing the reversal is going to be difficult.
Acknowledgements
- Mish Shedlock: Bond Bulls are Getting Crushed in a Relentless Selloff, It’s Not China
- Luke Gromen: FFTT – October 12, 2023
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Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.