Watch Out for the Twin Capital Destroyers

Paraphrasing, a friend wrote to me last night and asked, “Hey Joe, is it time to invest?”  I polished me crystal ball, gazed inside and saw the charts below magically appeared:

m2-money-stock velocity-of-m2-money-stock

Pay attention to the shaded areas.  The shaded areas are recessions, destroyers of capital.  Do you see how the velocity line decreases in the shaded areas in the top chart?  What this shows is that a decrease in velocity predicts a recession.  PREDICTS a recession.  That’s an important verb, predicts.  It is not often in the life of a practitioner in the financial markets (or business manager or investor…) that you can see with clarity what is going to happen next.  And the exact timing of an event is always the most difficult part of the game.

In the top chart we have an exception to the rule.  The line bends straight down since 2011 yet no recession because of what is happening in the bottom chart.  The bottom chart shows that we printed $4.4 trillion since 2011 to prevent a recession.  PREVENT a recession.  That’s a mighty hard thing to do.  Prevent a recession.  But money supply is the only input the government controls.  So it is the only tool they have to “fix” the
economy.  And it is a binary tool – either it is on and they are pumping money into the economy or it is off and they are drawing liquidity out of the market.  This month we learned that the Fed is actually drawing money oupricet of the system.  This will accelerate the next recession.  That is government interference in the markets in action and the price we will pay is pain – material pain in the financial markets.  Great Depression-magnitude pain?  Possibly.

We should have been in a recession since 2011 based on the declining velocity of money.  If you remember the pain of the 2008-2010 recession and you can see the magnitude of the downward trajectory in the velocity of money since 2011 in the top chart, you can see that the next recession will be every bit as painful as the last recession, and, I predict, actually much worse.

As we have blogged a couple of times, the slowing velocity of money indicates that capital is being trapped or logjammed inside the financial system.  So I wrote to my friend:

When money slows, it indicates it is not being invested in productive, growing enterprises.  And if money is not being invested in productive assets, it is being invested in idle assets (read: financial engineering or speculation).  And this is a predictor of a recession (or more precisely, a bubble before a recession).  I think the drop could be 70% across the board – investment real estate included.

Today we have twin destroyers of capital working in collusion: The Fed mainlining money directly into the markets (Increasing Money Supply) and the markets plowing it into non-productive assets (Slowing Velocity of Money).  This dual action is driving prices of financial assets higher while generating no (or very little) new production of goods and services.  The twin destroyers of capital.

Be patient.  Soon you should be able to buy assets at 2008 prices.  The NASDAQ today is over 5,300.  In November 2008 it dropped below 1,500.  That would be a decline of over 70% from today’s figure!  It could get close to that number in the next downturn and while that would wipe out trillions of dollars of net worth, it will only send us back to 2008.  And somehow we all survived that setback.

Have some cash in hand but don’t rush in.  You may have an opportunity to create dynastic wealth that will transform the lives of several future generations if you can be disciplined in your approach to the market.

Business owners and capital allocators, you would do well to dust off the worst case scenario plan and focus on cash generation.  And if the storm hits as it looks like it will, give us a call.  We are experts at navigating such waters.  We can help stabilize the ship, pare back to the key drivers and help you maximize the value of your assets.  That’s how we create tangible value.

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ABOUT VERTICAL CAPITAL ADVISORS

Based in Atlanta, GA and created to help businesses survive the devastation of the Great Recession, Vertical Capital Advisors is a firm built on creating tangible value for our clients.  We work with clients in just about every industry and we work with both capital growers and capital allocators..

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

Sources: https://fred.stlouisfed.org/series/M2, https://fred.stlouisfed.org/series/M2V

 

Here Be Dragons!

It is said that ancient mariners’ maps bore legends that warned of mythical dragons beyond the horizon that would destroy any vessel venturing into their waters.

dragon-map

Many economists today feel the same trepidation that sailors of generations long past must have felt as their ships sailed beyond the known limits.  Our own Federal Reserve has minted oceans of money, trillions of dollars, out of thin air.  Our national debt stands at levels unimaginable just a handful of years ago.  Some say that our national debt is the dragon that will devour us.  By most measures, it appears that could be the case.  However our national debt is not a democrat or republican issue.  It’s a government issue – a government on a decades-long spending bender:

fed-debt-by-president

Source: truthfulpolitics.com

Yes, debt could be a dragon.

Critics of reduced government spending often say that our absolute level of debt is not a concern because our GDP and income have increased greatly over the years however when we look at our national debt as a percent of GDP, the picture is not much prettier.  Notice how it is now the highest it has been since the Great Depression?  Could be a dragon!

percent-gdp

Source: https://deutscheam.com/en-us/thought-leadership/cio-view/article/debt-curse-or-blessing?kid=disp.CIOView201610.outbrain_us.ad.focus

The real dragon in the room is deflation.  After nearly a decade of printing mountains of money, the US Federal Reserve and Central Banks the world over are not only out of bullets, they have barely kept the deflation wolf from at bay.  As we have written about in previous posts, the velocity of US money has slowed as all of the fiscal stimulus has become lodged in corporate balance sheets in the form of debt used to fund enormous stock buy-backs.  Very little investment has found its way into new property, plants, equipment or employees.

Think about it: doubling the national debt in eight years has produced a gasping patient.  With the Fed starting to soak up liquidity, the edge of the horizon is in sight.  When GDI and GDP (gross domestic income and gross domestic product) slip into negative territory, THERE BE DRAGONS!  The deflation dragon – the worst of them all!

gdi-in-us

Source: Author & unknown artist & http://www.telegraph.co.uk/business/2016/10/19/fed-risks-repeating-lehman-blunder-as-us-recession-storm-gathers/

The point?  Gather up all of the liquidity you can muster.  You probably have between a month and six months to gird your loins before the deflation dragon appears and when it does, it will likely thrash the markets for two, three or even four years – or more.  Who really knows?  We aren’t getting into this downturn on the well-worn path of the 60’s, 70’s, 80’s, 90’s and even early 2000’s.  This time we have invented a whole new breed of beast.  At the nadir, you will be able to acquire quality income-producing assets at once in a lifetime prices.  But don’t buy too early.  Channel Rothschild, JP Morgan and Joe Kennedy – buy at the bottom, after all of the liquidity that rushes into the market after the first wave is wiped out by the second and third waves.  Patience will be rewarded.

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ABOUT VERTICAL

Vertical Capital Advisors is a firm built on creating tangible value for our clients.  We work with clients in just about every industry.  And we work with both capital growers and capital allocators.

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

 

 

Would you be willing to risk a 60% loss in order to get 2.85% interest from your bank?

Would you be willing to risk a 60% loss in order to get 2.85% interest from your bank?

Italy’s 50-Year 2.85% Bonds are 300% Oversubscribed – So what?

This week Italy began selling 50-year bonds paying 2.85% and they had three times more orders than they had bonds to sell[1].

“So what?” you ask.  “That means nothing to me”.

Or does it?

Bond buyers are generally a very bright lot.  They are probably the sharpest people in the business world.  They analyze every scrap of economic data continuously, day and night.  These hyper-analytical people are willing to commit money to an investment that has a very low yield for a very long time and whose host is in dangerous financial territory.  The Italian banking system is technically bankrupt as we wrote about in earlier posts and unemployment is over 20%.  We pegged Italy as one of the likely triggers for the next recession.

The country risks are readily apparent.  The interest rate risk is even greater. interest-rate-risk

You probably know that the price of bonds is inversely related to the rate.  As rates go down, prices generally go up.  As rates go up, prices fall.  The relative price to rate movement is determined by a bond’s duration which is a function of the rate and the time to maturity.  With a low rate, there is not much room to fall but a lot of room to rise.  And 50 years is an eternity in the world of bonds.  So if rates rise just 1%, these bonds are expected to lose 22% of their value.  Now the average rate for 10-year Italian bonds since 1991[2] has been a shade under 6%, let’s call it 3% higher than the 2.85% rate on the 50-year bonds.  Investors are willing to risk losing over 60% of the value of their bond investment in order to get a paltry 2.85% return and are in fact betting that interest rates do not return to normal, because if they do, and if they need liquidity, they will lose over 60% as sure as the sun will rise tomorrow.

italy-govt-bond

Forget Brexit.  It will be conditions like this that set off the next round of creative destruction.

So, would you be willing to risk a 60+% loss in order to get 2.85% interest from your bank?  Of course not.  Why are billions of dollars flowing into these bonds, then?  Because there is no alternative.  Investors are starved for yield.  They would rather risk the devil they know over the devil they don’t.

Fortunately, we have found a few brave capital allocators who are willing to seek higher returns from unknown enterprises like yours because they have the intellectual capital to analyze your business plan and make a rational determination that the expected return is higher and the risk is lower than Italy’s 50-year 2.85% bonds.

 

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ABOUT VERTICAL CAPITAL ADVISORS

Based in Atlanta, GA and created to help businesses survive the devastation of the Great Recession, Vertical Capital Advisors is a firm built on creating tangible value for our clients.  We work with clients in just about every industry and we work with capital consumers and capital providers.

 

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

[1] Reference: http://www.wsj.com/articles/italian-treasury-sounding-out-investors-on-50-year-bond-1473260474

[2] Reference: http://www.tradingeconomics.com/italy/government-bond-yield

Church Pastors Only, Please! Lender Liquidation Auction – Church Sanctuary

Alpharetta, GA 10/7/2016 –  This email title grabbed my heart this morning:

Lender Liquidation Auction – Church Sanctuary, Gym, Parsonage.

I checked it out.  This is a beautiful church.  It must have been the spiritual epicenter for hundreds of well to do families to have been so beautiful, inviting, spacious, pastoral.    Check it out:

churches

And yet it will be auctioned to the highest bidder next Wednesday.

Pastors, stop what you are doing right now.  Before this fate is visited upon your congregation, please call us.    We have helped other churches restructure.  It doesn’t matter what state you are in, financially or geographically.  There is a solution.  Your lender does not want to end up auctioning your sanctuary.  It is the worst outcome for all parties.  Let us help you, guide you through the process.  We can’t guarantee the right outcome but we know who can!

ABOUT VERTICAL

Vertical Capital Advisors is a firm built on creating tangible value for our clients.  We work with clients in just about every industry.  And we work with both capital consumers and capital providers.

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

 

World Debt Exceeds $152 trillion – Does it even matter to you?

The IMF (International Monetary Fund) issued a report today[i] that shows we learned nothing from the Great Recession.  In fact, as the world slid into recession and growth slowed into reverse, instead of deleveraging, we collectively amped up borrowing – private borrowing by consumers and businesses and sovereign borrowing by countries – in massive quantities.  Counterintuitively, economies shrunk and debt blossomed:

global-gross-debt

The IMF report is chock full of beautiful charts and graphs and loads of scholarly research.  Really great stuff.  Exactly what you expect from a group that has such exciting committees as: Dissemination Standards Bulletin Board (DSBB), General Data Dissemination System (GDDS), Reports on Observance of Standards and Codes (ROSCs), and Special Data Dissemination Standard (SDDS).

The one thing that the IMF got right is placing the blame on globalization of banking and easy access to credit.  Which brings us to you.  And me.  The easy access to credit pre-recession was universal – consumer mortgages leading the way.  Post-recession, the credit bubble has been inflated primarily by large corporate borrowing, governmental borrowing and two areas of consumer borrowing: cars and student loans. bright-note

Notice what is missing from the above list? It is the heart of the American economy – small and mid-sized business borrowing.  It has been incredibly difficult to obtain.  The bright note today is we have found a few brave sources of capital who will work with great management teams who have a great products and better business plans.  It’s not easy, in fact it is harder than it has ever been.  And we have to navigate often unconventional terms.  When we get your deal financed, it is all worth it.

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

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[i] Source IMF  http://www.imf.org/external/pubs/ft/fm/2016/02/pdf/fmc1.pdf