This was written on October 8 of 2018, I've decided to leave it as I wrote the initial draft then but update it with strikeout and comments.
the previous post History of Financial crises (as the value of leveraged assets declines the leverage ratio increases and threatens insolvency at those institutions, and functionally all institutions are highly leveraged).
The gas peddle of low-interest rates has worked for housing and had restored housing prices to the levels they were 8 years ago, "recovering" to the valuations common in 2007. Money has been cheap. As the money supply tightens, borrowing becomes more expensive and housing prices will begin to fall merely for that reason, an economic decline will compound that. Housing prices are already in decline and Mortgage rates are going up, currently, an average mortgage is around 5%.
As of December 22, it seems likely that the S&P500 will also be in bear market territory before long while the Russel2000 has already tread firmly into bear market territory. What isn't clear is if the economy will also decline and if so to what degree. A bear market in a strengthening economy would likely mean an opportunity for the value investor while an economy that is losing steam or declining presents an opportunity for the trader and speculator (as volatility continues to increase there are more equities with more price movement to bet on or against).
Revolving credit levels are approximately the same in 2018 as 2008 ($1,019B June 2008 vs $1,039B May 2018) but distributed differently - mostly credit card and student loan debt. Credit card debt might create a similar surprise to consumers as ARMs did, widespread credit defaults are less likely to be contagious however will mean decreased spending and an anti-inflation pressure and recession pressure. Consumer spending makes up 68% of the economy, floating credit card debt is up so interest rate rises will eventually effect spending. Potentially taking up to a year. What is clear is that as the prime rate goes up credit card's interest rates also increase, and even without defaults, this will decrease consumer spending which may stop inflation itself.
Historically the Fed and government directly intervene when a problem already clearly exists rather than as prevention. There is currently no clear and present danger so and no reason to believe one will develop within the next year (excluding Brexit and rebalancing portfolios out of equities). Without a sudden shift, a crisis is unlikely, but it's impossible to know when a sudden shift will occur. It's easy to observe however that we're not well poised to absorb a sudden shift and while a sudden shift will eventually occur, there's no way to know when it will occur.
As of this holiday season, consumer credit card spending and debt are up which should correlate to reduced spending in 2019 potentially weakening one of the legs warding off economic decline or recession.
There's an Ireland problem, because there's two of them and re-establishing a border may lead to violence. And with no border between Northern Ireland and the rest of the UK, that seems impossible if the UK actually wants to keep immigrants out - the stated goal of Brexit. (This issue lead to the vote of No confidence in Theresa May on Dec 12, 2018 which she somehow survived.)
Other countries will likely investigate leaving the EU in the wake of Brexit, but this would likely prove disastrous for them as well so I believeit's actual exits a low probability. Except in the case of Greece and possibly Italy as they're just crazy enough to do it. Civil unrest, revolution, and civil war are all possible in any scenario in which Portugal, Italy, Greece, or Spain, leave; but, other than spillover violence, this issues poses little risk to the global economy but will produce short-term volatility for both traders and value investors. These faltering economies are also at risk in the next global recession anyway, so these risks are non-zero no matter what occurs.
The falling Pound will likely increase the purchasing power of the USD which should assuage Chinese disinterest in bolstering the USD. Gold is likely to increase in value. US UK trade will likely suffer, and some US businesses will see a reason to move into a proper EU country as discussed above. Ireland is a top contender for an ad hoc replacement in the EU, but New York is likely to supplant the City of London as the English speaking financial hub in the near term. But in 25 years I wouldn't be too shocked if it turned out to be a city in Ireland.
I don't know enough about EU or UK politics to have any strong positions or have more than the general thoughts listed above. My only strong position about the UK and EU is that they should remain together and Theresa May decided to make real the nonbinding resolution was a mistake of pure hubris. Along that line, a new referendum should be held in a bid of Democracy or an executive decision should be made not to leave the EU, handwaving optional. The UK leaving the EU is a bad idea, though importantly I have no stake and Idon't care merely academic interest.
the previous article part 1.
Cryptocurrencies: While if one of the digital currencies could be digital gold would be ideal compared to GLD and would likely be incredibly valuable, and Fiat currencies all have inherent problems (refresh yourself with my Fiat Currency Explained article, it has a lot to do with inflation). The only problem is that Cryptocurrencies are currently a Ponzi scheme. The Bitcoin bubble may have already burst, but if a global recession threatens it will likely see an uptick. However, on the whole, I believe it has further to fall. It will face increased pressure from fly by night gambler mindset traders who lose disposable income, but the influx of cash could be seen as a possible hedge. I have no idea which way it will break and currently don't care to speculate, except to say that some cryptocurrency or other is likely to gain traction as a hedge in any forthcoming downturn - but I have no idea which. I would give odds that it's probably in this basket: BitCoin, LiteCoin, Etherium, Ripple, or EOS. But they wouldn't be good odds. Additionally, to the extent BitCoin does go mainstream it becomes regulated making its purpose questionable. I might prefer to just light my cash on fire.
USD: As the global reserve currency we've enjoyed exceptional benefits, and no one is likely to quickly supplant us. However, China has indicated it is interested in doing so and it probably will eventually. The specific exchange rate, timing, and nature of the change is vitally important if this were to be considered strategically.
Energy prices are likely to continue to increase in the short term. We haven't exited the fossil fuel economy which is extremely susceptible to terrestrial forces. Renewable sources have the potential to challenge this and will become more economical both as the technology advances and if as fossil fuel prices increase. Natural gas should continue to be profoundly cheap in the US unless regulation upends that market. Crude will likely increase, and as an essential commodity could serve as a strong hedge in a downturn. $120/barrel seems likely, and will certainly head toward $100/barrel as Iran's oil is removed from the market under US pressure and amid increasing inflation.
The tax cuts haven't done anything positive for the economy yet, though they've been a boon to investors and improved the window dressing on stock valuations. Some of the effects are mostly conjectured to be beneficial but there isn't strong evidence, only strong arguments.
If the changes to the individual deduction don't change, this will put strong deflationary pressure on home prices as the mortgage interest rate deduction becomes irrelevant. This likely won't come relevant until 2020 but a home bought post-2017 for $260k at 5% interest will only get $900 of deduction as a single person as opposed to the $6k they could've previously taken. Even if they pay less tax overall, in general, this should still have a deflationary impact on home prices - especially on the upper ends of home prices. This is actually a great tax reform for taxes in general, but bad for anyone who bought a home before 2018 as home prices will no longer be subsidized indirectly by the government. It's about time this happened as the home interest rate deduction has been a subsidy to the wealthy long enough.
I'm also a big fan of the eliminations of most deductions, as I'm a fan of eliminating all deductions. The Cap of 10k state level deductions might impact the left coast and New York, but won't have any economic impact of note.
Plenty of time, after the start of any crash the bottom isn't generally reached for 1 to 3 years. I believe it's reasonable to speculate we've started a market downturn although it is unclear if this will turn into a crash or affect the economy.
In part 3, the Economy itself, the future of small towns vs Urban centers. Possible portfolio compositions (currently I'm mostly in short, <1 yr, and intermediate, 2-5 year, bonds and CDs at interest rates around 3% as Jerome Powel has applied the breaks and a hard correction might've been avoided).
Outlook for 2019
Cheap money for nearly a decade has likely already caused asset bubbles, likely in housing and equities. Equities are slightly less of a "classic bubble" as low yields have pushed money into the stock market, however rising interest rates will reveal this to be merely a different flavor of the "classic bubble". As yields increase in the bond markets, for example, money will leave equities producing additional pressure upon perpetual growth. This will have a cascade effect on highly leveraged institutions as discussed inThe gas peddle of low-interest rates has worked for housing and had restored housing prices to the levels they were 8 years ago, "recovering" to the valuations common in 2007. Money has been cheap. As the money supply tightens, borrowing becomes more expensive and housing prices will begin to fall merely for that reason, an economic decline will compound that. Housing prices are already in decline and Mortgage rates are going up, currently, an average mortgage is around 5%.
As of December 22, it seems likely that the S&P500 will also be in bear market territory before long while the Russel2000 has already tread firmly into bear market territory. What isn't clear is if the economy will also decline and if so to what degree. A bear market in a strengthening economy would likely mean an opportunity for the value investor while an economy that is losing steam or declining presents an opportunity for the trader and speculator (as volatility continues to increase there are more equities with more price movement to bet on or against).
Revolving credit levels are approximately the same in 2018 as 2008 ($1,019B June 2008 vs $1,039B May 2018) but distributed differently - mostly credit card and student loan debt. Credit card debt might create a similar surprise to consumers as ARMs did, widespread credit defaults are less likely to be contagious however will mean decreased spending and an anti-inflation pressure and recession pressure. Consumer spending makes up 68% of the economy, floating credit card debt is up so interest rate rises will eventually effect spending. Potentially taking up to a year. What is clear is that as the prime rate goes up credit card's interest rates also increase, and even without defaults, this will decrease consumer spending which may stop inflation itself.
Historically the Fed and government directly intervene when a problem already clearly exists rather than as prevention. There is currently no clear and present danger so and no reason to believe one will develop within the next year (excluding Brexit and rebalancing portfolios out of equities). Without a sudden shift, a crisis is unlikely, but it's impossible to know when a sudden shift will occur. It's easy to observe however that we're not well poised to absorb a sudden shift and while a sudden shift will eventually occur, there's no way to know when it will occur.
As of this holiday season, consumer credit card spending and debt are up which should correlate to reduced spending in 2019 potentially weakening one of the legs warding off economic decline or recession.
Brexit
The UK has until March 29, 2019, to negotiate a trade deal, but has no leverage to negotiate a deal better than it had as part of the EU. So it's possible it'll be worse. To minimize friction, EU laws will be copied onto UK laws and the UK will be free to repeal and replace them at that point, but may choose not to. A non-Brexit Brexit is the most likely result, that is a Brexit where basically nothing changes. Except perhaps immigration and a superficial Visa program to allow those who currently didn't require Visas to remain in the UK. This would be a Mix of Hard and soft Brexits, where soft is giving the UK the same deal as Jersey or Norway, and Hard is complete independence. Hard Brexit probably comes with Tariffs, however, and since 1/3 of all of the UK's food comes from Europe I find it unlikely, despite the grandstanding that will come with the opposite message, that the UK will allow itself to suffer food shortages in order to get a better deal. Either way, internal inflation is likely. The City of London, the English speaking Financial hub of Europe, will likely stumble but remain largely unchanged as there is, as yet, no alternate English portal available. However, I suspect the City of London will lose some population & finance business to some combination of Frankfurt, Luxembourg, or Zurich. While it would need to be built from the ground up, Ireland is geopolitically well positioned as a drop-in replacement to the City of London and English gateway to the EU, just without 1,200 years of Mercantile and Banking expertise. If this occurs it might just default to Dublin. The only thing really important the UK contributes to the world is Banking, and Brexit will hurt the banking Sector.There's an Ireland problem, because there's two of them and re-establishing a border may lead to violence. And with no border between Northern Ireland and the rest of the UK, that seems impossible if the UK actually wants to keep immigrants out - the stated goal of Brexit. (This issue lead to the vote of No confidence in Theresa May on Dec 12, 2018 which she somehow survived.)
Other countries will likely investigate leaving the EU in the wake of Brexit, but this would likely prove disastrous for them as well so I believe
The falling Pound will likely increase the purchasing power of the USD which should assuage Chinese disinterest in bolstering the USD. Gold is likely to increase in value. US UK trade will likely suffer, and some US businesses will see a reason to move into a proper EU country as discussed above. Ireland is a top contender for an ad hoc replacement in the EU, but New York is likely to supplant the City of London as the English speaking financial hub in the near term. But in 25 years I wouldn't be too shocked if it turned out to be a city in Ireland.
I don't know enough about EU or UK politics to have any strong positions or have more than the general thoughts listed above. My only strong position about the UK and EU is that they should remain together and Theresa May decided to make real the nonbinding resolution was a mistake of pure hubris. Along that line, a new referendum should be held in a bid of Democracy or an executive decision should be made not to leave the EU, handwaving optional. The UK leaving the EU is a bad idea, though importantly I have no stake and I
Asset bubbles
Stocks: It's simple, low-interest rates means corporate and natural persons put money into stocks to preserve and grow capital, when interest rates are high they will naturally leave stocks. Large amounts of money leaving stocks means their prices necessarily fall (every sale needs a buyer). This could prove to be the sudden trigger for a financial crisis due to leveraging as discussed in this andCryptocurrencies: While if one of the digital currencies could be digital gold would be ideal compared to GLD and would likely be incredibly valuable, and Fiat currencies all have inherent problems (refresh yourself with my Fiat Currency Explained article, it has a lot to do with inflation). The only problem is that Cryptocurrencies are currently a Ponzi scheme. The Bitcoin bubble may have already burst, but if a global recession threatens it will likely see an uptick. However, on the whole, I believe it has further to fall. It will face increased pressure from fly by night gambler mindset traders who lose disposable income, but the influx of cash could be seen as a possible hedge. I have no idea which way it will break and currently don't care to speculate, except to say that some cryptocurrency or other is likely to gain traction as a hedge in any forthcoming downturn - but I have no idea which. I would give odds that it's probably in this basket: BitCoin, LiteCoin, Etherium, Ripple, or EOS. But they wouldn't be good odds. Additionally, to the extent BitCoin does go mainstream it becomes regulated making its purpose questionable. I might prefer to just light my cash on fire.
USD: As the global reserve currency we've enjoyed exceptional benefits, and no one is likely to quickly supplant us. However, China has indicated it is interested in doing so and it probably will eventually. The specific exchange rate, timing, and nature of the change is vitally important if this were to be considered strategically.
Energy is not a bubble
Trump's Tax reform
I'm basically a fan other than the expected deficits. However, other than increased M&A, it doesn't really matter to the economy in the short term, except how the Trump tax plan affects you personally. The US holiday season is a commercially important one, what is Christmas if not a celebration of capitalism? So I guess we can wait and see if that has any robust effect on the economy, but I doubt it.The tax cuts haven't done anything positive for the economy yet, though they've been a boon to investors and improved the window dressing on stock valuations. Some of the effects are mostly conjectured to be beneficial but there isn't strong evidence, only strong arguments.
If the changes to the individual deduction don't change, this will put strong deflationary pressure on home prices as the mortgage interest rate deduction becomes irrelevant. This likely won't come relevant until 2020 but a home bought post-2017 for $260k at 5% interest will only get $900 of deduction as a single person as opposed to the $6k they could've previously taken. Even if they pay less tax overall, in general, this should still have a deflationary impact on home prices - especially on the upper ends of home prices. This is actually a great tax reform for taxes in general, but bad for anyone who bought a home before 2018 as home prices will no longer be subsidized indirectly by the government. It's about time this happened as the home interest rate deduction has been a subsidy to the wealthy long enough.
It does mean that buying a home in the next five years for more than $280k/$560k won't make much sense economically as both interest rates and the lack of a deduction will push prices down possibly hitting appreciation hard.
I'm also a big fan of the eliminations of most deductions, as I'm a fan of eliminating all deductions. The Cap of 10k state level deductions might impact the left coast and New York, but won't have any economic impact of note.
Plenty of time, after the start of any crash the bottom isn't generally reached for 1 to 3 years. I believe it's reasonable to speculate we've started a market downturn although it is unclear if this will turn into a crash or affect the economy.
In part 3, the Economy itself, the future of small towns vs Urban centers. Possible portfolio compositions (currently I'm mostly in short, <1 yr, and intermediate, 2-5 year, bonds and CDs at interest rates around 3% as Jerome Powel has applied the breaks and a hard correction might've been avoided).