Is This the End of Negative Interest Rates?

The Bond God's favorite recession indicator is flashing... Gundlach calls a top in the bond market... Sjuggerud: Interest rates are going higher... Is this the end of negative interest rates?... The two roads ahead...

Editor's note: If you missed Porter's latest "must read" Friday Digest – "There Is a 100% Chance of Recession Next Year" – drop everything and catch up here.

Porter's recession call is in good company...

Last month, the government's official unemployment rate moved back above 5% for the first time since hitting a new post-crisis low of 4.7% in May...

As Porter noted on Friday, this is a terrible sign for the U.S. economy, as well as the stock and bond markets...

I'm 100% certain we're going to enter another recession next year...

I've been writing about the warning signs for a long time – falling industrial production, declining trade, falling corporate profits, and rising corporate defaults. And I told you that employment would roll over next. It has. The jobs report today showed that unemployment ticked up to 5%...

That's the last nail in the coffin. Next year is going to be ugly for stocks. But it will be even worse for corporate bonds.

But Porter isn't the only analyst who's getting concerned about a recession next year...

Friday's jobs report also triggered one of "Bond God" Jeffrey Gundlach's favorite recession indicators. The move back to 5% has officially pushed unemployment above its 12-month moving average...

Now, it's important to note that Gundlach says this trigger doesn't mean a recession is necessarily imminent. But as he noted to Bloomberg on Friday, it is one of the first indicators that puts him "on alert" that a recession is approaching.

Gundlach "doubles down" on higher rates...

Regular readers know this isn't the only controversial call Gundlach has made of late. As we wrote in the July 13 Digest, he has also called a long-term bottom in interest rates...

Gundlach doesn't just believe bonds are forming a near-term top... He thinks the entire, decades-long bull market in bond prices is ending. And while he doesn't think yields will soar higher immediately, he doesn't believe rates will go much lower.

He agrees that sentiment has become extreme. He says he has fielded more investor questions about buying Treasurys recently than at any other point in his career. He also noted that no one he talks to thinks interest rates can go higher today... and said it's often when most people say something "can't happen" that it's most likely to occur.

He then reiterated this call in his latest monthly investor webcast, noting...

This is a big, big moment... Interest rates have bottomed. They may not rise in the near term as I've talked about for years. But I think it's the beginning of something, and you're supposed to be defensive.

Steve Sjuggerud agrees...

Gundlach's call is about as contrarian as they come. But he isn't alone...

In this morning's edition of our free DailyWealth e-letter, our colleague Steve Sjuggerud explained why he agrees interest rates could be headed higher from here. Here's Steve...

Since 1981, we've been threatened with the fear of higher interest rates from "experts" every year... "Better act fast," your friendly realtor/banker/financial planner tells you. "Interest rates are going up any day now."

Your local experts were well-intentioned, I'm sure. But they were wrong. Interest rates have fallen relentlessly for 35 years. Don't feel bad about it... Everyone believed along the way that higher interest rates were just around the corner.

So... let me ask you, if the "experts" have gotten it wrong, why should we trust Gundlach now? What could cause interest rates to spike from here? A lot of things, actually...

As Steve noted, regardless of who wins the presidential election this November, government spending – particularly "real" spending on things like infrastructure projects rather than financial programs like quantitative easing – is likely to soar. Both Hillary Clinton and Donald Trump have promised massive infrastructure programs.

In theory, this massive new spending could push rates much higher. After all, more government spending would require more government borrowing. This means the government will have to issue a lot more bonds, which should push down prices, and push up interest rates. (Remember, bond prices and interest rates trade inversely. Lower bond prices result in higher interest rates, and vice versa.)

Now, as Porter explained on Friday, excellent new research has shown that this may not be the case... at least not when most of the government's spending is directed toward transfer payments and financial programs like quantitative easing as it has been in recent years. (More on this in a moment.)

But Steve says there's an even simpler – and more important – reason to believe rates could move higher from here, even if we haven't seen the ultimate bottom just yet. In short, he says the bond market is "overly loved" today...

Investors recently placed their largest bets in 18 years on lower interest rates. (You have to go back to 1998 to find a time when speculators had a larger "long" position in 30-year Treasury bond futures than they had recently.) Typically, when bets reach an extreme, the trend is nearing an end, and the opposite tends to happen.

So... what happened after 1998 – the last time investors placed huge bets on lower interest rates? Interest rates bottomed out soon after... They went from 4.7% in late 1998 to a peak of nearly 6.8% in early 2000. We saw a similar instance in 2012 – though not as extreme – with similar results.

The point is that while making interest-rate predictions is hard, the facts back up the case this time. The "Bond God" believes the bottom in rates is behind us. And I agree.

Is a "pivot" in government policy next?

As we mentioned earlier, new research that Porter highlighted on Friday shows government spending has not been working as intended. Despite issuing trillions and trillions in new debt in recent years and pushing short-term rates to record lows, the economy has remained stagnant. As Porter explained, there's likely a simple explanation for this...

Just think about what the government spends money on... Our government (and all the other major western democracies) has embraced the kind of social-spending programs that bankrupt every nation that adopts them.

Our government is no longer building bridges and enforcing contracts. It's simply taking money from Peter to pay Paul. And as you'd expect, that kind of economic activity (aka stealing) has a negative multiplier. Taking lots and lots of capital from productive hands and giving it to unproductive hands might meet political goals, but it's not good for the economy.

Ready for this shocking conclusion? Socialism doesn't work. And manipulating interest rates makes it a lot worse...

But Gundlach thinks a change in policy could be coming. Why? In a word, banks.

Super-low short-term rates and quantitative easing programs have done little for the real economy. But as we've discussed many times, they have crushed the profit margins of banks around the world.

In Europe in particular, negative rates have helped push even major banks – like Germany's Deutsche Bank (DB) – to the verge of collapse.

But Gundlach thinks officials have seen enough. As he noted during a presentation at the Grant's Interest Rate Observer conference in New York City last week...

You cannot save your faltering economy by killing the financial system... There's something about big banks being in the single digits that makes people nervous.

He believes central banks will be forced to reverse negative interest-rate policy and curtail their massive quantitative easing programs... or risk a complete collapse of the global banking system.

Instead, Gundlach predicts governments will begin to shift toward more direct stimulus efforts like large infrastructure projects – like those both presidential candidates are proposing – or even "helicopter money" or outright money-printing.

The latter has long been seen as a last resort for stoking inflation. It's akin to playing with fire... and has typically been reserved for bankrupt third-world nations. But Gundlach believes Western governments are running out of options.

While these programs won't create real economic growth or prosperity either, they could have a huge effect on inflation (and interest rates). As Gundlach joked last week, "I can bring back inflation by 5 p.m. by giving everyone $1 billion. The lines at BMW lots would be a sight to see."

Two roads, one destination...

In summary, two likely paths remain ahead...

As Porter put it on Friday, governments and central banks could keep "doubling down." Interest rates will continue to stay low... the economy continues to get weaker and weaker... and major banks will begin to fail... until the whole thing blows up. Or authorities step in sooner rather than later to "save" the system with massive inflation.

In either case, the result will be the same... Hundreds of billions of dollars' worth of bad debts will be wiped out, and gold – the only money that is no one else's liability – will go much, much higher.

Again, Porter and his research team are launching a brand-new service – Stansberry's Big Trade – to help subscribers profit from the unavoidable crisis ahead. In fact, they just published the first "beta" issue of this service – including their proprietary list called "The Dirty Thirty," a group of companies that are especially troubled – last Friday. Porter believes subscribers could earn 10 to 20 times their money as these companies inevitably fall.

If you would like to join them – and be among the first to access this brand-new research before it officially launches next month – click here to learn more.

New 52-week highs (as of 10/7/16): Procter & Gamble (PG) and ProShares Ultra MSCI Brazil Capped Fund (UBR).

Several readers respond to Porter's latest must-read Friday Digest. What did you think? Let us know at feedback@stansberryresearch.com.

"Porter I almost fell out of my chair when I started reading today about Dr Lacy Hunt. Dr Hunt attended our credit union strategic planning session in early September. He told us what you talked about today. At the time I thought he was the most honest economist I had come across. Some members of our board didn't understand and thought he was selling doom and gloom. I listened and thought he made a lot of sense. My advantage was I have been listening to you and I understood the issues. I am a Flex Alliance member and I plan to subscribe to the 'The Big Trade.' I know bad times are coming but thanks to you and your team I feel confident I will pull through." – Paid-up subscriber E.C.

"Porter, thank you for this Digest, everything in it was amazing. I know firsthand how much money has been taken from my parents by the zero interest rate policies, they are now down to transferring princ. to the nursing home. I also found Dr. Hunt's investment strategy interesting, because back when interest rates were 10%, I put most of my long term retirement investments into Canadian government zero coupon bonds, after my Alliance membership that was the second best investment I ever made. Thank you." – Paid-up subscriber Neil Silver

"I am writing to ask for permission to forward a copy of [Friday's] Digest to a small but select group of friends with the sole purpose of strongly urging them to sign up with Stansberry's publications in order to protect themselves from the coming financial crisis. May I have your permission to do? Thanks in advance for your consideration." – Paid-up subscriber Steve K.

Porter comment: Steve, of course... And thanks.

"Porter and Crew, About 5 years ago I made the mistake of loading up on resource stocks, primarily gold, silver, and oil stocks, while they were at their peaks. I didn't know about stop losses. I didn't know how to cut my losses and move on. Needless to say, I took a hard hit in my retirement portfolio. Fortunately for me, I have time on my side as I still have 30 years of work left to go.

"A couple years ago I stumbled upon your research. If I remember correctly, the first newsletter I subscribed to was the World Dominators written by Dan Ferris. Looking back, probably the only thing I really knew about investing was the importance of compound interest. Thus, reinvesting dividends seemed like a smart move. Since that first newsletter, I have now branched out and subscribed to Income Intelligence, True Wealth, Stansberry Resource Report, Bear Market Survival Program and Trader, and of course the Stansberry Digest.

"I just wanted to take a moment to say thank you for all the work you put into your newsletters. Over the course of the last few years I have truly taken the time to be a learner when reviewing your materials. Unfortunately I am not in the financial position to take advantage of some of the more lucrative newsletters, but through your newsletters, I have learned how to take a more macro level approach at investing. Seeing things from different perspectives, and taking little 'gold nuggets' in your newsletters to make my own strategies.

"For example, most recently you have been discussing the 'Big Trade' and the criteria you have used to identify the 'Dirty Thirty'. I don't have the resources as you do to do that kind of homework, but just those simple three 'gold nuggets' of their overall debt, negative free cash flow, and market capitalization has helped me learn things I can use as screening tools on my own to identify stocks that may have shorting opportunities in the future. Those are opportunities I would never had looked at prior to your newsletters, and would potentially be missing out on them.

"So even though I don't have the funds to participate in the True Wealth China Opportunities or Stansberry's Big Trade, the education you provide to anyone who is willing to take the time to learn is invaluable. For those that just want things handed to them, well, they'll pay for that. For me, I can't thank you enough for the wealth of knowledge you provide and I appreciate everything you do to make me a better investor and learner. Thank you." – Paid-up subscriber Chris Mayhew

Regards,

Justin Brill
Baltimore, Maryland
October 10, 2016