Why Negative Rates Could Be Coming to Main Street

The next chapter of 'NIRP'... The first bank is preparing to charge depositors on their cash... Why negative interest rates could be coming to 'Main Street'... Another reason for caution... This rare signal suggests turbulence ahead...

Regular Digest readers know we've been plenty critical of negative interest rate policy ('NIRP')...

Thanks to its widespread adoption by the central banks of Europe and Japan, roughly 25% of all outstanding government debt now trades with a negative yield.

This includes half of all European sovereign debt... 85% of Germany's debt... and as of last week, all of Switzerland's outstanding debt. That's right, the entire Swiss government bond market – ranging from maturities of one month all the way out to 50 years – now trades with a negative yield.

Worse, we're now seeing yields on some European high-yield corporate (or "junk") bonds begin to dip into negative territory. This is complete and utter madness.

After all, there are conceivable reasons why some banks and funds might choose to hold negative-yielding sovereign debt. But as my colleague Dan Ferris explained in the July 16 Digest, junk bonds are an entirely different story...

This is the stuff you buy when you're willing to take on more risk for more yield. You don't buy junk bonds if you're going to have to pay for the "privilege" of owning them. The No. 1 reason that investors buy these bonds – like any risk asset – is to make more money.

I can almost wrap my head around the extreme levels of groupthink that resulted in the buying and holding of negative-yielding sovereign debt. But junk debt?! That's deep in territory that even George Orwell might not recognize.

I have no idea how this will all end, but I don't see how it can be good.

If there's a 'silver lining' to this madness, it's that we've avoided the worst-case scenario so far...

Yes, NIRP has helped drive up the prices of many financial assets. Along with quantitative easing ("QE") and other central bank stimulus programs, that's made it next to impossible for income investors to earn a decent return on their savings today.

But as longtime readers may recall, when NIRP first took hold in early 2016, our greatest fear was that banks would begin to pass negative rates along to customers directly.

In other words, instead of being paid to save capital, individuals like you and I would be forced to pay just to keep the money we've already earned. And this could easily trigger a massive, global "run on the bank" as folks rush to withdraw as much currency as possible to avoid these penalties.

Instead, banks have borne the brunt of the negative consequences to date. The European banking system in particular – which was already struggling to recover from the euro crisis earlier this decade – has been decimated by NIRP.

Yet despite their struggles, most banks have still been reluctant to pass the costs of negative interest rates along to individual depositors.

Unfortunately, that could be changing now...

As the Financial Times reported yesterday...

UBS plans to levy a negative interest rate on wealthy clients who deposit more than [2 million Swiss Francs], as lenders hunker down for a period of ultra-loose monetary policy.

Several banks in Switzerland and the eurozone already pass on the cost of negative official rates to corporate depositors, although most large players have refrained from doing so with individual clients.

According to the report, UBS will begin charging clients 0.75% a year on individual cash balances above this threshold, beginning in November.

Why now? Well, it appears banks had still been holding on to hopes that NIRP was just a temporary measure. Now that global central banks have suddenly turned "dovish" again, those hopes could be starting to wane.

We suspect most folks won't be too concerned about this news...

After all, interest rates still remain in positive territory here in the U.S. Who cares if a European bank is charging millionaires to hold their cash?

But we urge you not to dismiss this too quickly.

The Federal Reserve has already been discussing the use of negative interest rates. And you can bet that if NIRP continues to spread, banks will eventually start charging "mom and pop," too.

Stay tuned... we'll be watching this closely. In the meantime, it's one more powerful reason to be sure you own some gold.

Yesterday, we reminded you that the Federal Reserve's latest interest rate cut may not be the bullish tailwind some folks seem to believe...

In short, history shows that Fed "cutting cycles" are highly correlated with recessions... and they've typically been a bad omens for stocks.

The last two big bear markets in stocks – from 2000 to 2002 and 2007 to 2009 – are prime examples.

In each case, the Fed slashed interest rates dramatically. In early 2000, the short-term federal-funds rate was well over 6%. By the end of 2002, it was below 2%. In early 2007, rates were above 5%. By early 2009, they were close to zero.

Yet that didn't prevent stocks from losing half their value or more during each of those periods.

Of course, this historical relationship isn't the only reason we believe investors should be more conservative than usual today...

We're also seeing a handful of near-term warning signs that suggest at least a temporary market top is possible.

Dan shared a couple of these from our friend Jason Goepfert – editor of the excellent SentimenTrader service – last month. As he noted in the July 18 Digest...

Jason said his "Dumb Money Confidence" indicator just "poked above 80%." And while it has been higher at various times in recent years, it's now "in the top 2.3% of all readings." Jason said these levels have preceded market downturns in the past.

He also noted that Investors Intelligence's bull ratio – a weekly survey that indicates market sentiment – is in the top 5% of all readings in the past 30 years.

But elevated investor sentiment isn't the only thing troubling Jason today...

He also mentions that we've seen a rare combination of technical signals.

These are the ominously named "Hindenburg Omen" and "Titanic Syndrome" signals. Each of these signals is triggered by slightly different criteria. But in simple terms, they use the number of stocks making new highs and new lows to judge the internal "health" of the broad market.

The idea is that in a healthy bull market, most individual stocks in the market will be participating. When the market is rising, yet the performance of individual stocks is diverging significantly, it's a sign that something isn't quite right.

Now, to be clear, these signals are controversial. Many "serious" investors dismiss their value entirely. But Jason believes this is due largely to misunderstanding.

In reality, these individual signals aren't that rare. And they don't necessarily portend a stock-market crash as their names imply. But that doesn't mean they're worthless.

For example, he notes there have been 200 individual Hindenburg signals since 1965. Yet, according to his research, even a single signal has resulted in negative one-, two-, and three-month returns nearly 70% of the time.

That's an impressive near-term track record. But Jason also notes these signals are especially powerful when several are triggered within a short time.

These "clusters" are extremely rare. In fact, Jason says there have only been four times in which at least six combined Hindenburg and Titanic signals have been triggered over a seven-day period.

The first three occurred in early 2000, the summer of 2007, and the summer of 2015. The fourth occurred last week.

As always, we'll remind you not to make investment decisions based on any single indicator...

Just because the market sold off sharply after the three previous clusters, there's no guarantee it will do the same this time around. And as we saw following the last one in 2015, even a sharp correction doesn't necessarily mean this long bull market is over.

However, the broad market is historically expensive today... investor sentiment is getting a little "frothy" again... and a rare technical signal suggests the market could struggle over the next few months.

If you've not yet taken our advice to raise some extra cash – and perhaps "hedge" with a few short sales – this probably wouldn't be a bad time to do so.

New 52-week highs (as of 7/31/19): Axis Capital (AXS), Nuveen Municipal Value Fund (NUV), and Wells Fargo – Series W (WFC-PW).

In today's mailbag, one reader offers some advice to paid-up subscriber Mathew B... while a second has a suggestion for a "new" research service. What's on your mind? Let us know at feedback@stansberryresearch.com.

"Mathew B. the hate you have for Trump must be eating you up inside. I'll bet as soon as you saw Trump's face on those Tweets you went ballistic. Your hate consumed you so much that you couldn't even see who authored Monday's Digest. CHILL OUT MAN! It's just politics... presidents come, and presidents go...

"Wishing for a 2008 style stock market crash and having millions of innocent people's retirement portfolios disintegrated, including your own, just so you could blame Trump?? That's bad.

"My advice to you is to seek help from a therapist... because if Trump wins again in 2020 a family member will be trying to talk you down from the proverbial ledge." – Paid-up subscriber K.S.

"Sirs, I am a long-term subscriber, over 10 years, at least, I can't remember, to your stuff. Currently I am watching your Stansberry's Credit Opportunities, but think it is too soon to be buying any of this stuff.

"I have an idea of a service that you might offer. There has been much talk about 'Zombie Companies' those whose income does not cover their interest expense. I have tried everywhere to get a list of those tickers. All I have been able to get so far are a couple of images that I can't even print legible copies of.

"I want a list of the ticker symbols so I can do some meaningful research on them. I think shorting these companies might be a very smart thing to do. Actually, shorting is my bag. What I would do is try to buy long-duration puts on them.

"I think you could sell a service like your Credit Opportunities that suggests puts to buy on these stocks. If you do not want to do this, could you please get me a list of these tickers in some form that I can do something with?" – Paid-up subscriber David G.

Brill comment: David, the service you describe already exists... In Stansberry's Big Trade, editor Bill McGilton and his team seek to build a diversified "portfolio" of long-dated put options on a list of the market's most-troubled companies. They believe these companies – which they've dubbed the "Dirty Thirty" – are most likely to fail when the credit cycle turns over. You can learn more about a subscription to Stansberry's Big Trade right here.

Regards,

Justin Brill
Baltimore, Maryland
August 1, 2019