Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Cries of “Deflation” Really Imply More QE

Because the developed world has been keeping rates artificially low for an extended period of time via rate curve manipulation and QE bond buying programs, it is now swimming in debt. In a report issued just a few weeks ago, the International Bank of Settlements said world debt totaled $100 trillion at the end of 2012, up from $40 trillion at the turn of the century. That’s a 150% increase in world debt, compared to real GDP growth in the low double digits over the same period. Simply put, we’re not growing fast enough to offset or pay back our mounting liabilities.

MWM 14, 3-28 Box ScoresI’m belaboring the obvious for an important reason: It should be a clue to folks that when we start hearing the financial community lament the increased risk of “deflation” or “low inflation,” as we did from both China and Europe this week, it really means that bad debts are set to escalate (Italy’s bad debts are up 28.0% since the beginning of 2012). What these debtors would really like to know is whether central banks are ready to bail out the system if credit risk gains any real traction. European policy makers were quick to reassure them. On Wednesday, a majority of ECB officials, including Germany’s Bundesbank President Jens Weidman, stated they are “ready to adopt nonstandard measures to prevent slipping into a deflationary environment.” Among those measures are outright bond purchases (aka QE).

That development, thrown in with some lackluster US economic data and the expectation of month-end performance gaming, had global stock markets sharply higher in overnight trade on Thursday. However, by the close in New York on Friday, that rally had faded – for no obvious reason. Traders may have been concerned about holding positions through the weekend or about the Fed’s seemingly relentless commitment to taper its bond purchases. Whatever the case, there has undoubtedly been some heavy selling on the rallies as of late – rumor has it, by some large hedge funds selling the high flying momentum names (e.g.,, Netflix, Facebook, Tesla, Baidu, Google). And while they’re dumping, an unsuspecting retail public is still leveraging up to buy. NYSE margin debt in brokerage accounts grew yet again by 3.2% (from January to February) to a record-high $465.7 billion.

Gold, after having sold off below its 200-day moving average during the week, continued to trade on the perception that all is well with the US economy. Yet with existing and pending home sales off nearly every month since May of last year, we can’t see how anyone could come to that conclusion unchallenged. At a minimum, the economy is split between what Wall Street can affect with its funny money and what Main Street can affect with its limited access to credit at these higher rates. Who’s winning? Given the market action, the smart money seems to be siding with Main Street in light of the Fed’s failure to control the bond market. That said, moving past the post-weather “bounce,” the metals will likely stand a better chance as we head into April.

Best Regards,

David Burgess
VP Investment Management