The 'Party' Is Almost Over

A December rate hike is becoming more likely... Central banks warn of higher inflation... Has the bond bubble already popped?... The buyback 'party' is almost over... A different way to protect your portfolio...

Expect a rate hike "relatively soon"...

The minutes of the Federal Open Market Committee meeting were released last Wednesday, with several U.S. central bankers saying a rate hike was needed soon. As Bloomberg reported...

"A growing number of committee members are pulling in the direction of hiking, so it's becoming increasingly harder for Yellen to hold them back," said Roberto Perli, partner at Cornerstone Macro in Washington and a former Fed economist.

Federal Reserve Bank of Boston President Eric Rosengren – formerly considered one of the Fed's biggest "doves," or proponents of easy-monetary policy – voted in favor of raising rates in September. He noted...

A failure to do so could require the Committee to raise policy interest rates faster and more aggressively later on, which could shorten, rather than lengthen, the duration of the economic expansion.

Fed officials next meet November 1-2, a week before the U.S. presidential election. Few analysts expect the Fed to raise rates ahead of the election and risk political accusations (though skeptics would note that the policy is inevitably political). Instead, most analysts are targeting December for a modest hike.

Fed fund futures are pricing in a higher-than-69% chance for a December interest-rate increase, versus a less-than-8% chance in November. However, a December rate hike may be more about Fed officials saving face than an honest assessment of the economy.

Last year, the Fed increased rates just once – in December. And this year, despite expecting to hike interest rates four times, the Fed is only likely to do so once – again, in December.

But if you think this means the Fed – or any other major central bank – is likely to significantly tighten monetary policy anytime soon, think again...

Central banks set off a bond-market rout...

Global bond yields jumped sharply higher again this morning following a large rally on Friday.

The yields on benchmark 10-year government debt in the U.S., Germany, and the U.K. hit their highest levels since June. Here in the U.S., 10-year Treasury yields climbed as high as 1.814%.

The latest rally is being blamed on new dovish comments from central bank officials last week...

On Friday morning, Bank of England Governor Mark Carney said his bank will tolerate an "overshoot" of its inflation target to slow rising U.K. unemployment following this summer's "Brexit" vote.

Federal Reserve Chair Janet Yellen made similar comments in a speech at a Boston Fed conference later that day. While the speech didn't address the Fed's current policies, Yellen said the Fed may need to run a "high-pressure economy" – and let inflation rise significantly above its long-held 2% target – to return the economy to growth.

This reaction in bonds is logical... After all, inflation is terrible for bonds. But regular readers may recall that the big bond-market selloff earlier this month was blamed on virtually the opposite reason...

At that time, the financial media pointed to fears of central-bank tightening, following comments from the central banks of the eurozone and Japan suggesting they may consider "tapering" their quantitative-easing bond-buying programs.

In other words, bonds have been selling off on worries of both central-bank tightening and continued central-bank easing. What should you make of this apparent conflict?

First, as we mentioned in the October 5 Digest, it is further evidence that central banks aren't likely to stop. Inflation remains well below their targets in every major economy. Central banks may adjust their policies going forward, but there is virtually no chance that governments will stop easing or stimulating until (or unless) inflation moves significantly higher.

Second, it illustrates just how unstable the bond markets have become. And as we discussed on Friday, it may be the first sign that central bank manipulation has pushed prices up to unsustainable levels... and the massive bubble in credit is already beginning to collapse.

"The party is almost over"...

Speaking of unsustainable, Barclays is warning that the debt-fueled corporate-buyback and dividend boom is about to unravel...

According to a recent note from Jonathan Glionna, head of equity strategy at Barclays, S&P 500 companies are on track to spend more than $1 trillion on buybacks and dividends this year for the first time in history. This would represent a 300% increase in buybacks and a 100%-plus increase in dividends since only 2009.

Like Porter, Glionna believes this boom is largely responsible for the new record highs in stocks over the past few years. Unfortunately, he also agrees it's unlikely to continue much longer. In fact, he notes that while payout growth has averaged 20% a year since 2009, it will "all but disappear" next year.

Why? Again, the answer may sound familiar to regular Digest readers (emphasis added)...

For the S&P 500... dividends plus buybacks exceed net income. After funding capital expenditures, dividends plus buybacks also exceed cash flow from operations. This is true even after accounting for equity issuance.

But so what? Why can't companies continue to pay out more than earnings, even if it reduces book value? Why can't companies continue to spend more than their cash flow if the investment-grade credit market is willing to provide cheap financing? We see a compelling reason – leverage ratios will get too high...

The vast majority of companies in the S&P 500 are investment-grade rated and they want to stay that way. Being investment grade brings with it access to cheap, reliable, and plentiful funding. Few investment-grade companies, in our opinion, would be willing to adopt a high yield leverage profile just to facilitate buybacks. Therefore, the increase in leverage ratios must soon come to an end.

Said another way, companies have already borrowed so much money that borrowing even more could put their credit ratings at risk... even if interest rates stay low for a while longer.

In short, one of the biggest drivers of higher stock prices in the past several years is running out of steam. Without this support, lower prices are likely... And if interest rates do begin to rise in earnest, it will only hasten the declines.

In this type of environment, you can take many steps to protect your portfolio... all of which we've detailed in the Digest: owning gold, hedging your portfolio appropriately, diversifying across a wide range of industries and asset classes, making sure you don't have too much money in any one position, and using trailing stops.

But you can also trade your way through a crisis...

How to reduce risk and generate income with short-term trades...

Our colleague Jeff Clark is one of the best "fast action" traders we know... and he has been for more than 30 years.

Back on the Friday afternoon before the 1987 "Black Monday" crash, he made an incredible 10 times his money in a single day. (He wrote about the specifics of the trade in our free DailyWealth e-letter several years ago.)

Jeff has managed hundreds of millions of dollars through his own brokerage firm. And he has helped Stansberry Research subscribers trade their way through a number of major market declines...

No one has a better bear market track record than Jeff. For example, during the crazy market volatility of 2008, he logged more than 10 different 100% gains... and helped a lot of Stansberry readers make a fortune. (In fact, Jeff won "MVP" at Stansberry Research that year.)

And one of the most valuable ways you can get Jeff's up-to-the-minute thoughts is through his Direct Line real-time trading website... where he shares updates and trades throughout the day. And it is included with every subscription to Jeff's Stansberry Research Pro Trader service.

Again, we believe the Direct Line is one of the most valuable services we offer at Stansberry Research, especially during bear markets. As Porter highlighted in his annual Stansberry Research Report Card earlier this year...

Jeff shot the lights out during the bear market period. He racked up big gains in resources as the market bounced. He had a great win rate (77%) and his average return (7.9%) crushed the S&P 500. With Jeff's short-term trading, you would generate annualized returns well over 100% with that kind of average return and high win rate.

Jeff initially launched his service to focus exclusively on buying puts to bet on the downside of the market. But today, he uses a variety of options strategies to trade both the long and short sides of the market – depending on what idea offers the best risk/reward setup at the time.

His returns... especially in his Direct Line service... are exceptional.

And his real-time communication to subscribers allows him to move with enough dexterity to take advantage of super-short-term moves... scalping trades on quick upticks in a bear market or a quick breakdown in a bull market.

Today, Jeff is warning about a major market "aftershock" that is essentially guaranteed to hit this year... what he calls an "M Wave."

To learn more – including how you can try Jeff's service today, absolutely risk-free and at half the regular price... plus get full access to his "live streaming" Direct Line website where he shares real-time trades through the day – simply click here. (This does not lead to a long video presentation.)

New 52-week highs (as of 10/14/16): ProShares Ultra MSCI Brazil Capped Fund (UBR) and short position in Hertz Global (HTZ).

Nothing much in the mailbag over the weekend. What's on your mind? Drop us a line at feedback@stansberryresearch.com.

Regards,

Justin Brill
Oakland, Maryland
October 17, 2016