While the rest of the market may be dreading the eventual taper by the Federal Reserve, it does make sense that at some point, the central bank desperately needs to regroup and stabilize after such a long period of being overextended. In our latest interview with John Mauldin of Mauldin Economics and Millennium Wave Advisors, we discuss the impending pullback in the Fed's bond purchases, and what happens if we enter the next crisis.
EQ: In a recent newsletter, you wrote about the market more than likely hitting a top in the near future. How much of that is related to the Fed’s impending pullback of QE, which is expected to hit as early as September?
Mauldin: Some of it is because that’s always a catalyst, but the market has just gone too far, too fast and it’s looking for another catalyst. When you see days where everything goes down—gold, equities, bonds, commodities, etc.—that’s characteristics of a market that is over leveraged and very nervous. There was no flight to safety; there was a flight from everything. That was because of margin calls.
When you start seeing days like that it means the cyclical bulls’ days are numbered. Now, how far will the correction go? Who knows? But I would certainly think there has to be one. Valuations are just really too high. The only way you can get to somewhat reasonable valuations is to start using forward operating earnings with high estimates that don’t reflect the slow growth of the economy.
EQ: Just looking at earnings this past quarter, the non-financials showed a lot of weakness. From a fundamentals standpoint, how much does that concern you?
Mauldin: The housing numbers that came out last week were very weak. We’re talking about 1991- or 2001-type weak. Those were just ugly numbers. The internals weren’t pretty either. We’ve seen interest rates move up a whole 1.5 percent on mortgages in a period of just five months. That’s crazy. That’s an absurd move. It’s especially absurd in the middle of a very slow growth economy. This economy’s growing at less than 2 percent.
That is not a normal approach to getting us back to a normal interest-rate regime. The Fed isn’t telling us that they’re going to raise rates; they’re simply saying that they may stop buying bonds. Those are two different things. The guidance they’re giving is that rates are going to stay low. So either we’re going to get a yield curve that’s ridiculously steep, or rates on long bonds will have to come back down, which I think is going to happen.
As an aside, I will have to be financing a mortgage sometime between now and next June on a 30-year basis because I bought two apartments and I have to combine them into one mortgage sometime late this year or next year. If I had the opportunity to do that 30-year mortgage today, I wouldn’t do it. I’d wait because I think rates are going to come back down. So while I’m frustrated that I couldn’t lock in rates in March or April when I was writing and telling people to secure it, I may have another chance at lower mortgage rates than we have today. Now, I don’t know if it’ll be all-time low rates, but I expect them to come back down a bit from here.
EQ: Treasury yields have spiked to almost 3 percent recently as investors anticipate the upcoming taper. Is this a good time to look at fixed income and bond assets?
Mauldin: Interest rates are now getting back to where bonds could be a buy for traders. Medium-term bonds are becoming more attractive, which is what you’d like them to be. You’d like savers to be able to make a little money.
EQ: You’ve discussed the instability of the current economic system, and how policies designed to deal with one crisis typically overcompensate and lead to the next bubble. Could the next phase of this cycle be a stimulus bubble?
Mauldin: Bubble is a tough word. You don’t see those very often. Let’s just say we’ve gone too far with our stimulus, and it needs to be pulled back. We need to try to get the Fed to a more normal regime.
The problem is we know that there’s going to be another crisis. There always is. That’s the rule. We may not know what will cause it or when it will come, but there will be another one. If the Fed were to encounter another crisis, at today’s monetary regime, what the hell would they do?
You can’t take rates lower; they’re already buying $1 trillion worth of debt a year and that’s not doing any good. They’re running out of bullets. They need to reload their gun and the economy isn’t doing great, but it’s not falling out of bed either. So they should’ve been reloading the gun a long time before now.
I just hope that we haven’t overstayed our welcome and don’t get into a situation where they don’t have any bullets left during the next crisis. If we enter another crisis, and the people think the Fed doesn’t have anything they can do…that will be very ugly.
EQ: The global economic recovery was based on a joint stimulus effort by many of the major central banks. With the U.S. beginning its tapering process, do you think this will have significant ramifications for softer markets like Europe and Asia?
Mauldin: They’re running in their own rhythms now, but Europe is already down, and you can’t say European stocks are overvalued. There’s some value there, but the European economy is weak. I can easily see where they could go into a crisis because of the problems with France, which is becoming extremely overextended in its debt and government cycles.
That’s going to become the true existentialist moment for Europe. That’s when we’re going to see whether the euro is really a currency or an experiment. If the euro gets past the crisis in France, it’s a currency. But it’s just as possible that France is the one that leaves the euro and not Greece, Italy, or Germany.
EQ: Earlier this week, a government panel said Japan’s economy may have bottomed in late 2012. You’ve commented on how extraordinary the nation’s reflation policies are. Is it working?
Mauldin: I think first we have to define what we mean by “working.” Are they trying to reflate their economy? Yes, so in that sense, it’s working. But they’re going to have to keep doing what they’re doing to keep it working. They’re not in a situation where the Fed is going to have the possibility of pulling back. They’re going to have to be doing more and more and more. So my assessment hasn’t changed.
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