Dawn Bennett, Host of Radio Show "Financial Myth Busting," Interviews Michael Belkin, Consultant to Hedge Funds and Institutional Investors Worldwide
Washington, DC -- (ReleaseWire) -- 07/24/2015 --BENNETT: Michael Belkin is a consultant to hedge funds and institutional investors worldwide. He is also the publisher of the Belkin report, some of the smartest and most honest research out there. We're going to start out by talking about one of the most unfair economic deals cut this week, which I think will all but destroy an entire country, and that's Greece. Michael, welcome to Financial Myth Busting.
BELKIN: Hey, thanks for having me, Dawn.
BENNETT: Michael, at this point, I think the Greek crisis is beyond farce. You could not have made up this absurd story and sold it to Hollywood. But interestingly, U.S. stocks moved higher last week on this news, and so did the U.S. dollar. Is this likely due to the fact that while Greece will remain in the euro, Greek banks are actually going to remain insolvent, so the U.S. dollar looks better?
BELKIN: Yes, I think there is a big problem with the Greek banks. The story on Greece changes every day. You know, if you've been watching this, one day it's a deal, next day it's a deadline. Now it seems like they have a deal, but I think the real Achilles' heel of this whole situation is that the Greek banks are completely bankrupt. There are four major Greek banks. They have about 40% to 50% non-performing loans, which is an insane number. The whole Greek financial system, you know, everybody's stopped paying everybody else, and that was on top of having 45% non-performing loans before that, so the number's probably a lot higher than that. Also, about half of their tier one capital is something called tax loss carryforwards, which are intangible, just nothing. It shouldn't be accounted as capital, and the European bank regulators are cracking down on it. They want to stop counting it as capital, so the Greek banks are vulnerable. What I'm hearing is that they are going to be rejiggered into probably two institutions, meaning that the current shareholders will be wiped out and probably the depositors will have what's called a bail-in, where you find out that you surrender part of the value of your deposits in the institution, because you happen to have kept your money there. So I think that it's going to be kind of a shock, because the Greek banks are sort of a more advanced case of what the Spanish banks and Italian banks are doing. They have high non-performing loans, and they have this tier one capital that's not really capital. I mean, capital is something you're supposed to fall back on, you know? It's something substantial. So I think that there's still the potential for a scare in the financial system in Europe, where European banks, second tier, third tier, not necessarily the large ones, but sort of a row of dominoes, where if investors in Greek banks are hit, investors in other European banks are going to be taking a hard look at if it could happen to them.
BENNETT: Do you think that Portugal and Spain and Italy and France are facing, as you stated, similar debt crises? Are they going to emerge as the next Greece? And if that happens, what's going to happen to the markets?
BELKIN: Well, it's a slow motion row of dominoes, and we're in this world of bail-outs, where every time something goes wrong, the central banks come in and try to paper it over. It's happening in Europe, it's happening in China. They pump up a bubble in China, and then the bubble starts to deflate, and the central bank starts buying stocks. So it's hard to keep your bearings as an investor—are these real markets, or are they just some policy instrument of central banks? And I'm of the opinion that the market ultimately wins, and it's taking a long time in the current situation, but I would not be an investor in Europe. I just returned from a trip, visiting hedge fund and institutional clients in New York City, and I heard some great stories about what people are thinking. You know, major investors have sort of been anaesthetized because of what central banks do, whereas most investors should look at the fundamentals of something, most have instead been forced to just do whatever the central banks say, or else they lose their job or their investors pull their money. But there's a lot of cynicism out there about the process that's going on. I actually had a major player, a major guy at a household name family office, looked at me directly before I left on Thursday and he asked me, 'Mike, do you think academics at central banks will be prosecuted in the future for malfeasance, for how they're mismanaging the economy?'
BENNETT: What did you say?
BELKIN: I said, 'Of course.' So, Janet Yellen, if you're listening, that's you.
BENNETT: And Bernanke. There is an ever-trending debate out there about what role central banks, governments, and even centralized control, should have in the financial market today. What is the very nature of markets anymore? I know you're saying that they'll come back, but this isn't what I would consider a market. It doesn't seem like they're serving their purpose anymore.
BELKIN: Yeah, it does seem like that on the surface. Now, if you're looking at the stock indexes, the stock indexes are doing one thing, but individual stocks are doing something else. For instance, in the Belkin report I have a recommended long list, a recommended sell and short list of 36 names, and my shorts have been working. So, you know, the S&P was up 2.5%, the NASDAQ set a new high last week. You know, what was happening last week? Netflix was up 18%, Google was up 26%. That was the major story, that's what drove the NASDAQ up. Beneath the surface, you had names like Quantum—which is a hard disk storage company, cloud storage—down 19%; Applied Materials down 5%; Cliffs Natural Resources steel company down 8%; SandRidge Energy—energy stocks were killed last week—down 13%; Stone Energy down 14%; Aeropostale—retailers getting killed—down 10%; Sears Holdings down 7%. So there's kind of a two-tiered market, where one characteristic of a high, like in 1929 or 1987, is a lot of stocks are already going down, while the indexes make a new peak. That is exactly what is going on in the US market, where you can make money as a short seller, if you're careful. Not with Netflix and Google, certainly, last week, but with a lot of other names, particularly cyclicals. So materials were down on the week last week, industrials were barely up. Materials, industrials, and energy, the cyclical component of this market, underperformed by 2% to 3% last week. And so what's happening is the market is saying that the economy is moving into a recession, and you certainly wouldn't get that idea from looking at the stock indexes or listening to CNBC or Bloomberg, but that's the cyclical component, the cyclical sectors of the S&P 500 are already declining and underperforming massively.
BENNETT: Industrial production in the second quarter of 2015 contracted at a headline of 0.3%, and this, in my opinion, reflected the second straight month of no growth in manufacturing. The last time this happened, the US economy was in a collapse. I wonder, why aren't the markets showing this? Why aren't the Dow and the S&P showing this? As you say, it's showing up in some individual stocks, but why isn't it there in the indices?
BELKIN: That's how tops are. I mean, this is a long, drawn-out top. You know, I used to work at Salomon Brothers, and I remember walking on the trading floor one day, and a guy who'd been there for a long time said, 'Michael, the market will do whatever it can to cause the largest amount of pain to the largest number of people.' And so I think that's what's happening. I think people are being drawn into a false sense that the stock market is okay. Really, it's a bubble. There've been bubbles in Japan, China, the US, and Europe, and really they're not really going up anymore. Yeah, there was a new high in the NASDAQ, but I think we're past the peak in the indexes in China and Japan and in Europe. They've been going down for a few weeks or a few months. And back to your idea about the economy, there's a story in Sunday's New York Times called 'The Economic Forecast for 2016: What it Means for the Election'. Of course, the people who are in power are trying to turn the dial and pull the levers and dangle the strings and make the puppets move, so that the economy looks good for the elections. That's the game plan in Washington DC, in your neck of the woods. But I don't think it's going to work. I think this economic cycle is 73 months long, which is tied for the last economic expansion, which is about 30 months longer than the normal economic expansion. As you said, industrial production is turning down, retail sales, rate of change is going down, and while the planes are still full of people—flying back from New York, there wasn't an available seat, and in New York City, the streets are clogged with tourists and everything—the industrial component of the economy has turned down. China, the economic growth is plunging. Emerging markets that used to export to China are not sending boatloads of iron ore to China anymore, so US exports to emerging markets are falling. The dollar is strengthening; that's bad for corporate profits. I think we're in kind of a slow decline that will accelerate into a contraction, economic contraction, which usually lasts about 18 months.
BENNETT: You wrote this week that China's economic sell-off and market sell-off is unprecedented in scope. I think what's interesting is how the Chinese authorities are so centrally involved, in their stock markets. I mean, the fact that if you were short selling, you'd be in jail right now and I wouldn't be talking to you, if you were in China. But you reported that in April, the government boasted that its bull market was just beginning, and today we're seeing the government frantically trying to plug the hole. Is the lesson here that if you try to engineer a bull market, like the US has and Europe and Japan and China, that you're actually going to face this nasty kind of correction, and you can't stop that from happening?
BELKIN: Yes, I think that's exactly the situation that China finds itself in. And they are doing everything in the book to keep their market up, but the problem is the increased leverage. Bubbles are about margin debt and leverage, so they they invited everybody into the market, and margin debt went to an insane 18% of market cap. Just to put that into perspective, 3% of market cap is margin debt has been the peak in the US bubble, you know, like 2007 and now. So something like six times as much leverage in the Chinese system. And you know, crashes and bear markets are about deleveraging. The price goes down, somebody else gets a margin call, they have to sell, it drives the price down, somebody else gets a margin call, and so on. That's what 1929 was about. The Shanghai composite index has balanced on its 200 day average, as have most other global indexes in Europe and the U.S. But the crash in 1929 came after the break of the 200 day average, so we're not even there yet in China. And you know, they're doing everything in the book...
BENNETT: And more.
BELKIN: 30% of their stocks aren't trading, and the People's Bank of China, that's the central bank of China, they're actually buying stocks and trying to get more leverage into the market. And the best they can do, I think, is end up with a stair step pattern instead of a crash, so it goes up a little, goes sideways, down, sideways, down, sideways, down. I think there's probably something like 30%, 40% downside risk in the Chinese market.
BENNETT: America's Secretary of Treasury, Jack Lew, said last week that China's markets were largely disconnected from the rest of the global economy, and we don't need to worry about the sell-off here in America. What do you think about that?
BELKIN: Well, everything's connected, and the machines, this high frequency trading, trades from one market into another. And I think it's affecting the base metal market; coppers, things like that, are selling off because they're collateral on stock trades. There is sort of a contagion effect, for sure; when a bubble bursts, it does feed in. We haven't even really talked about emerging markets, but I think markets that are related to China—places like Thailand, Korea, Taiwan, Philippines, Malaysia—I think they are short. Anything that depends on Chinese growth for its economic strength is vulnerable at this point in time. And again, US corporations, the big growth story was supposed to be exporting to the new middle class in emerging markets. That story's dead. So it's going to affect US corporate earnings, is the bottom line.
BENNETT: And it already has. Speaking of Japan and China, they have this overaggressive governmental monetary stimulus. What about our own quantitative easing? How does Janet Yellen expect to escape what's going on right now in China?
BELKIN: Good question. Major hedge funds I just saw in New York City, they told me about a major bond fund that runs—it's a 250 billion dollar US emerging market bond fund. It's called the Textron Global Bond fund. They have one third of their AUM, assets under management, in totally illiquid things like the Ukraine debt.
BENNETT: Oh my.
BELKIN: And they have one day of liquidity, they have one day of redemption, so they promise their investors, 'You can get out in one day,' and they have a totally illiquid book. This could turn out to be like 2008.
BENNETT: That's insane...
BELKIN: After Fannie Mae and Freddie Mac, you thought it was all over, and then boom, it went to Lehman Brothers. So it was a row of dominoes. This fund right here is the biggest global bond fund, and they're totally invested in things that are illiquid. And when the redemptions start... By the way, junk bonds were down last week, so Janet Yellen and her merry little band of pranksters invited everybody to go into high yield debt. And that policy developed things like illiquid bond funds that will not be able to meet redemptions. So that's just one potential domino that will start the decline and deleveraging in the US market.
BENNETT: This week Yellen gave this bizarrely rosy economic forecast. She predicted growth would pick up in the latter half of 2015, and that she'd raise rates, of course, "if our good progress continues." Do you agree with that?
BELKIN: She sounds like Chauncey Gardner, 'There will be growth in the Spring.' I think she's dead wrong. I know Janet Yellen; not personally, but we both hail from the University of California Berkley Hass Business School. I had to sit through her snoozing presentations to the alumni association that put everyone in the room to sleep. The bottom line is I think the Fed's totally out of sync with the markets. When she was doing QE for no reason—QE3 back starting in 2012—was the time when interest rates should have been rising. They totally got it wrong. Now every Fed official is saying, 'We're going to raise rates, we're going to raise rates.' It's a carrot and stick kind of thing, where they're under a lot of pressure because they shouldn't have done QE and they know it now. Unfortunately the economic cycle has moved against them, and I show financial markets moving in the opposite direction of what they are expecting. I now like bonds. I've changed from being short to long on bonds. I think government bonds are going to rally. The 30 year bond future is on its 200 week average, and I have my forecast turning up, 2 year bonds turning up. So that means interest rates are going to come down, government rates, but not junk bonds. This credit spread that's starting to widen. Basically I see financial markets moving in a risk-off direction. It's not just bonds. The dollar's moving up; that's a margin call on the world. Beneath the surface of the market, the most defensive stuff is out-performing. That's consumer staples, things like Procter and Gamble. That's where you want to be as a fund manager. You want to overweight stuff like that and underweight cyclicals and tech, even though tech had a big bounce last week. In risk-off, bonds rally, interest rates go down, the defensive outperforms, the dollar rallies, and eventually gold—which has been acting terrible; it's gotten caught up in the deliquidation of materials—I think will begin to come into favor as a defensive play. I think that's a real bargain here in the markets. I've started a new retail service called the Belkin Gold Stock Forecast, and you know, a lot of gold stocks are outperforming. They're not at new lows, while the GDX and gold are in the last week or two. Australian gold stocks were actually up on the week, so I think the place to be is buying the dip, taking the opportunity of declines in the gold stock space, and selling the market and shifting in the defensive direction. And I just think the Fed has got it completely backwards. I think the economy will be weaker by the election, and bonds will be rallying, interest rates will be falling. And I don't know how interest rates will do below zero, which is where the Fed has pegged short term interest rates for how many years now? Six years, seven years. They're out of sync with the economic cycle. They just totally missed it. They thought they could control the economic cycle, and the markets are leaving them behind.
BENNETT: Do you think the weakness in gold has been 100% due to the dollar?
BELKIN: Yeah, I think a lot of what happens in the markets these days is high frequency trading, the machines. And places like Renaissance Capital, the big hedge fund, they just trade the wiggles in the chart. And so a lot of the order flow comes from machines. And I'll tell you, the machines are selling the cyclicals now, and that's a preview of coming attractions about what's going to happen to the overall market. It's not like the machines are always buying. When something starts going down, they jump on it, so I think they jumped on gold. And the only thing that worries me about gold is that it might be collateral for in China, so when you get margin calls in China, they have to sell gold, like they have to sell copper and base metals and things like that. But on the other hand, the Chinese government wants to accumulate gold on weakness. Gold assets are down, some of the gold stocks are down 80% to 90%. There's nothing like that out there, except for the Greek stock market, which I'm looking to turn positive at the Templeton "point of maximum pessimism." It isn't quite there yet.
BENNETT: It looks to me that technically the US dollar's broken out and up, but this whole thing feels a bit like the summer of 2008. I'm wondering, is the dollar signaling another 2008 type crash coming to the US markets?
BELKIN: I don't know if I want to use the word 'crash' because they'll do everything in the book to prevent that from happening. But a deleveraging of global financial markets is under way, it's already happening. Emerging markets are going down; China peaked, it's down 20%, 30%; defensive assets are outperforming; bonds are starting to get a bid; that is, government bond futures, not junk bonds. I think we're in a deleveraging environment in the global markets. And like I said, there are players out there, like this Franklin Resources Templeton Global Bonds Fund, that are potentially systemically dangerous. If you've got your money invested in this bond fund and you think it's a money market fund and you can't get your money back, then they have to sell a lot of illiquid stuff, it could have a really convulsive impact on financial markets.
BENNETT: Thanks, Michael.
All data sourced through Bloomberg
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett or firstname.lastname@example.org
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