Posts Tagged ‘Norway’

 

A major international police operation to bust child predators involved police sharing child pornography with over a million unsuspecting online subscribers for a year after investigators took control of the dark web’s largest child abuse forum. Though hundreds of pedophiles were arrested after the site was shut down, the police sting involved undercover officers sharing extremely disturbing content and encouraging followers to engage in sexual acts with children. But police say it was worth it.

A new report reveals that Australian police were running the largest pedophile and child pornography forum on the internet for a year as part of a joint initiative between Australian, European, and Canadian police as well as the US Department of Homeland Security to track down the site’s administrators and child porn producers. Over the weekend the Norwegian newspaper VG published its bombshell investigation which confirmed that between October 2016 and September 2017 a special police task force based in Queensland, Australia was able to quietly hack the site “Childs Play” which had reached over a million registered accounts and had thousands of active users.

Queensland police at Taskforce Argos, including investigator Paul Griffiths (pictured). Image source: Kinsa.net

The task force was able to identify the site’s top tier administrators, leading to hundreds of international arrests and criminal investigations, but not before crossing what critics see as a significant ethical line: to expose those behind the site, police themselves posted child pornography and facilitated what was essentially a pedophile online meet-up.

The site has existed since April 2016 on the dark web, which made it next to impossible to identify users and administrators as the dark web operates based on layers of encryption which ensures complete anonymity. Not only did the forum include over one hundred active producers of child pornography who would daily post videos and images, but even more disturbingly involved a smaller inner circle who shared child torture videos.

Among this inner circle were Childs Play administrators ‘Warhead’ and ‘Crazymonk’ – later revealed to be 26-year old Canadian Benjamin Faulkner and 27-year old Tennessee native Patrick Falte, according the VG report. Both had previously worked as internet security professionals and were active technical support providers for pedophilia related internet sites – the two had initially met, for example, through a website called the the “Pedo Support Community.” The Australian child abuse task force had begun tracking the two by assembling profiles of their previous digital footprints in relation to child abuse related chat on the open web.

Source: Norway’s VG

Faulkner (Warhead) for example, had in 2012 posted the following to a chat forum under his previous online identity, CuriousVendetta:

A little about myself to establish credibility here: My name is CuriousVendetta, and I work as a JR forensics consultant and penetration tester for an IT security firm. On the side, I do what I can to cause general mischief on the internet with a few friends of mine…

At the pool is where I am free, and where I can generate my fantasies. I have more girls in my ‘fan club’ than I can even count.

Faulkner was working as a youth swimming instructor in the small Canadian city of North Bay in Ontario and though it appears some parents had become suspicious of his proclivities, no police reports were ever filed. Patrick Falte had lived all his life with his parents a half an hour outside of Nashville and was the more advanced technical expert of the two. Both Warhead and Crazymonk as administrators of the Childs Play dark web forum had promised subscribers increased security measures. For example users knew that should

Warhead, the site’s leader, ever miss one of his routine postings to the community which involved a message stamped with a pornographic image, it would be a signal that the community had been infiltrated by police.

But police did infiltrate the community and took it over, partly due to mistakes made by the administrators. The forum transacted in Bitcoin – common for the dark web – but Crazymonk had his bitcoin wallet linked to his personal email address, making it easy for the US Department of Homeland Security to locate him. Other mistakes which helped police included both site leaders posting identifying information in various on the open web which helped investigators build profiles for the two. From there police not only began monitoring the pair – even installing tracking devices on their vehicles – but were also able to observe all communications and postings on the site through a backdoor. It was soon understood that the two would occasionally drive for over 10 hours to meet multiple times a year. After months of monitoring, the two met in person at a usual spot

in Manassas, Virginia, where one of Childs Play’s users had regularly offered the men his 4-year old daughter to rape while being video taped.

It was in Manassas that US federal agents finally made the arrest, but only after the 4-year old had already been raped in a Virginia home. Authorities told VG that they had no way of knowing of the rape beforehand, citing online messaging as not indicative of that information. The video tape would later be used to convict Faulkner and Falte, who were given life sentences for both the rape and running the site. After the arrests, the Australian task force, known as Argos, then moved in to assume the identities of the arrested site administrators. Investigators studied the pair’s online language styles and characteristics, eventually posting an admin message so that users wouldn’t get suspicious, which of course required the child pornography image stamp.

The site’s server was located in Australia, which was important to the international investigation as Australian law gives police broad leeway to commit crimes in

pursuit of investigations, especially in relation to catching child pornographers. Task force Argo’s officers not only uploaded the image, thereby convincing subscribers that nothing was wrong, but according to VG issued the following message to the community:

“I hope that some of you were able to give a special present to the little ones in your lives, and spend some time with them. It’s a great time of year to snuggle up near a fire, and make some memories.”

Police, while running the site, also continued to share images and videos while undergoing their year-long investigation which identified numerous video producers as well as consumers of the content. For example the task force posted a video of an eight-year-old girl being raped only two weeks after taking over the forum, which was viewed 770,617 times, according to the report. Such extreme police tactics, which authorities argue was necessary to rescue victims and put predators behind bars, have outraged some of the victims’ families.

VG reporters were able to speak to a mother of one the victims whose video was used by police as part of the operation: “My daughter

should not be used as a bait… It is not right for the police to promote these images,” she said. But police investigators told VG in response to criticism that, “There is definitely a balance between what we want to achieve and how we go about it.” And added, “Eventually we get to the point where it isn’t worth running the forum any more. But as long as we’re identifying victims, producers and abusers, we will keep running it.”

A similar investigation by the FBI in 2015 of a site significantly smaller than Child’s Play’s size made 870 arrests and rescued 259 children after agents kept it online for just two weeks. The FBI came under fire for actively sharing, promoting and facilitating the transfer of thousands of images and videos. But the Australian task force ran a site which was over five times the size and content volume for close to a year.

Advertisements

After several months of aggressive selling of stocks in late 2015 and early 2016, the culprit for the indiscriminate liquidation and concurrent market swoon was revealed when it emerged that the seller was not only China (which was forced to sell USD-denominated reserves to offset a surge in capital outflows following the Yuan devaluation), but also Sovereign Wealth Funds belonging to oil-exporting countries, who were dumping billions in risk assets to offset the collapse of the price of oil, which in turn exacerbated current account and budget deficits.

Among the prominent sellers was Norway and Saudi Arabia, arguably the biggest casualties of the death of the Petrodollar to date, as well as Abu Dhabi, Kuwait and most other SWFs, listed on the tabel below.

 

As JPM calculated back in January, the SWF equity selling was inversely proportional to the price of oil: according to the bank, SWF’s would liquidate some $75 billion in equities in 2017 assuming oil at $31 per barrel. Needless to say, the lower oil goes, the more selling there would  be.

“This prospective $75bn of equity selling by SWFs in 2016 is not huge but becomes significant after taking into account the potential swing in equity fund flows,” JPM continued, in an attempt to discuss the impact this will have on markets. “Last year retail investors bought $375bn of equity funds globally. This year we expect an amount between 0 and $200bn. Subtracting $75bn of selling from SWFs would leave the overall equity flow from Retail+SWF investors barely positive for 2016.”

Then starting in February, oil – which had just tumbled to the low-$20s, its lowest price in over a decade – underwent a miraculous surge catalyzed by erroneous, if constantly reiterated, narrative of an imminent OPEC supply cut, a short squeeze, an algo stop hunt, an unprecedented Chinese importing spree to replenish its now almost full Strategic Petroleum Reserve, and even speculation of central bank intervention to prop up the “black gold.” In fact, just a few months after February, oil had doubled, reaching $50 even as we and many others warned, that there simply is not enough demand and far too much supply to sustain such a price.

No matter the cause, the biggest benefit of this oil surge is that the same SWFs which were actively selling stocks in early late 2015 and early 2016 put their liquidation on hold as oil rose above $40. And in this illiquid, low volume market, the absence of a determined seller is all that it took to push the S&P to all time highs, and as of Friday’s close, just shy of 2,200, a level which even sellside brokers such as Goldman believe is effectively in bubble territory and in the 99% percentile of all overvalued metrics.

However, just a few weeks later we are now back in a crude bear market, with oil briefly dipping under $40, on the back of concerns about a gasoline glut and fears that the resurgent dollar will further pressure oil. Worse, with oil returns back to the $40 range and threatens to accelerate the move to the downside, it also brings back with it the specter of SWF liquidations, because as JPM’s Nikolaos Panigirtzoglou points out in his latest weekly note, that’s where the wealth fund selling returns.

Here is why as oil approaches $40, the price of crude suddenly matters a lot to equity bulls:

 We had noted in F&L April 22nd what the impact would be of a $45 average Brent oil price on SWF behavior. At the time, we noted that the stability in oil prices meant that the pressure on SWFs to abruptly sell assets would diminish over time. In addition, we argued that SWF selling should focus more on fixed-income securities during the last three quarters of the year, given that SWFs mostly liquidated equity and HF mandates during last year and the first quarter of this year. However, given recent declines in oil prices, we revisit the analysis assuming an average oil price of $40 for 2016 vs $45 before. The YTD average has already fallen to $42.

In our previous analysis based on a $45 average oil price for 2016, we projected the current account balance for oil-producing countries to worsen from around -$70bn in 2015 to -$140bn in 2016. This estimate is based on the same sensitivity of the current account balance to the change in oil prices as last year, i.e. between 2014 and 2015. However, the depletion of official assets could be higher than the current account deficit if these countries also experience capital outflows as it happened last year. If we assume $80bn of capital outflow for 2016, the same level as last year, we project a depletion of $150bn in FX reserves and a depletion of $50bn in SWF assets.

If we assume an average oil price of $40 for 2016 instead, using a similar sensitivity analysis and assumptions as described above, we project the current account balance for oil-producing countries to worsen from around -$70bn in 2015 to -$183bn in 2016. This would imply depletion of $170bn in FX reserves and a depletion of $75bn in SWF assets.

 

The differences in the SWF selling using the two different average oil price assumptions can be seen in Figure 9.

 

 

A $40 average oil price, and assuming that these reserve managers and SWFs sell in accordance to their average allocation, would imply selling of $118bn of government bonds and $45bn of public equities. If we assume reserve managers and SWFs are mostly done with selling equities and that they are more likely to liquidate fixed-income mandates, this would imply selling of around  $120bn-$160bn of government bonds and $10bn-$15bn of corporate bonds. However, should oil prices continue to fall further below $40 on a sustained basis, SWFs would face greater pressure to sell equity mandates, similar to the end of last year and the beginning of this year.

Indeed: the lower the price of oil drops, the faster what until recently had been a paradoxical disconnect (and even a negative correlation between oil and risk assets as we showed earlier), will recouple. And it’s not just the SWF selling: recall that earlier this week, JPM’s head quant Marko Kolanovic warned that should oil return back to the $30s, it would also trigger program selling of stocks.

 CTA signals for oil recently turned from strongly positive to moderately negative. This has contributed to past-month divergence between S&P 500 and oil (~1.5 standard deviations) and is closely monitored by equity and high yield credit investors. It is our view that the risk of CTAs significantly increasing oil shorts over the next 1 month is low. For oil momentum to further deteriorate, oil would need to drop to ~$30 at which point the medium term momentum (strongest signal) would turn negative and trigger selling.

To summarize, if oil were to drop back under $40, not only would it precipitate even more selling of oil as momentum strategies flip, but it would catalyze a liquidation by those SWFs who thought they were done selling equities, leading to a return of the same sellers that pushed the S&P back to the low 1,900s a short 6 months ago.

So for all those curious where stocks are going next, the simple answer is: keep an eye on what oil does next.

The Brexit vote is history, and so is David Cameron’s reign as Britain’s prime minister whose gamble to allow an EU referendum backfired spectacularly. And today, in what Bloomberg earlier dubbed his “last summer” Cameron had the unpleasant task of telling his Eurocrat peers during what is hist last Brussels summit why he failed. Only he didn’t and instead, as the FT writes, Cameron flipped the tables and told European leaders he lost the EU referendum because they failed to address public concerns over immigration, as tensions rose ahead of looming Brexit negotiations.

The British prime minister said at his final summit in Brussels on Tuesday that fears of mass immigration were “a driving factor” behind the vote and free movement would have to be addressed in Brexit talks. While he did not call her out by name, Cameron was effectively blaming Angela Merkel, whose overly accepting immigration policy in 2015 unleashed a historic refugee wave which ultimately ended up being the deciding factor behind the referendum outcome.

As the FT writes, Angela Merkel, the German chancellor, and other leaders “blocked British demands before the referendum for an “emergency brake” on migrant numbers and the idea remains anathema to many member states.  Cameron, who announced his ­resignation after last week’s referendum, said that he wanted Britain and the EU to retain “as close an economic relationship as possible”. But, at an emotional dinner, he warned that the UK could not continue to accept large numbers of EU migrants, even if that meant losing access to the single market.”

His remarks underscored the hard task facing both sides in reaching a new accord. Addressing the German Bundestag before the Brussels summit, Ms Merkel warned the UK that there would be no “cherry picking” in its Brexit negotiations. European Commission president Jean-Claude Juncker underscored this when he said that he wants the article 50 “letter to be sent as soon as possible.” Giving the UK instructions on how to proceed, Juncker said during a press conference that “if someone from the Remain camp will become British prime minister, this has to be done in two weeks after his appointment. If the next British PM is coming from the Leave campaign, it should be done the day after his appointment.”

 Juncker urged the UK “swiftly” to clarify its position regarding its plans to break from the EU, warning that the bloc could not be “embroiled in lasting uncertainty”. He also hit back at criticism of him in some parts of the British press, claiming he was not a “faceless bureaucrat” and “would like to be respected”.

More importantly, Cameron’s resignation – not literal but figurative – suggests that any hope the Remain camp may have had for a redo of the referendum has been extinguished.

It wasn’t just Cameron: even before the session began there had been signs of renewed hostility towards Downing Street. After a heated debate, which at one point degenerated into catcalls and boos for Nigel Farage, the UK Independence party leader, the European Parliament voted for a resolution calling on Britain to begin divorce proceedings immediately.

Some of Mr Cameron’s fellow EU leaders made similar testy remarks. “Married or divorced, but not something in between,” said Xavier Bettel, the Luxembourg prime minister. “We are not on Facebook, with ‘It’s complicated’ as a status.”

As explained over the weekend, the pace and nature of Britain’s exit from the EU together with the triggering of Article 50, have become the most contentious issues in both London and Brussels since last week’s vote. Most of the leaders of the UK’s Leave campaign, who are likely to form the core of a new British government, have said they want to begin Brexit negotiations before invoking Article 50 of the EU treaties, which would formally trigger two-year exit proceedings.

Merkel made it clear that she and other EU leaders have refused to engage in negotiations until Article 50 is invoked, setting up the first of what could be years of difficulties facing Cameron’s successor. Mark Rutte, the Dutch premier and formerly one of Mr Cameron’s closest allies, argued for Britain to be granted “some space”. But he was unforgiving in his reasons why, saying: “England has collapsed politically, monetarily, constitutionally and economically.” Which, incidentally, is what Brussels calls a victory for Democracy.

Manuel Valls, the French prime minister, said it was not for Britain to dictate the pace of talks. “It’s not up to the British Conservative party to set the agenda,” he told the National Assembly in Paris.

What happens next?

On Wednesday, Mr Cameron will be asked to leave the summit while the remaining 27 members hold informal talks on how to approach Brexit negotiations and how to stop them from stretching out over many years.

 Addressing the German Bundestag before the Brussels summit, Ms Merkel warned the UK that there would be no “cherry picking” in its Brexit negotiations, her toughest response yet to the Leave campaign’s hopes of securing access to the EU’s internal market while limiting freedom of movement.

She spelt out that the EU’s internal freedoms were indivisible: if Britain, like Norway, wanted access to the internal market then, like Norway, it would have to accept freedom of movement, she said.

Which goes back to the original point Cameron made, namely that it is Merkel’s stickiness on freedom of movement that led to the victory of the Leave camp.

The winner today, however, was Nigel Farage, who stole the limelight when he was booed after he called on the EU to take a “grown-up and sensible” attitude to negotiations with the UK. He claimed the result would offer a “beacon of hope” to “democrats” across Europe and threatened that  “the UK will not be the last member state to leave the European Union.

As we showed earlier, Farage concluded: “When I came here 17 years ago and said I wanted to lead a campaign to get Britain to leave the European Union, you all laughed at me. Well, I have to say, you’re not laughing now, are you?”

 

Farage’s moment in the spotlight aside and Cameron’s apparent concession on the possibility of a second referendum, the reality is that while all EU leaders would be delighted to see Britain reverse course and choose to stay, most would be loath to offer any concessions for fear that succumbing to blackmail would encourage others.

Cited by the FT,  a senior adviser to one the eurozone’s most powerful leaders said that “this is a matter of survival for us. We cannot allow these tactics to succeed.

Countries such as France and the Netherlands that were once sympathetic to Britain’s plea for curbs on free movement of workers would now be some of the most opposed to further concessions.

As the FT adds, yielding to British pressure would be a gift to anti-EU politicians that the French and Dutch leaders are trying to defeat in elections early next year. Eastern European leaders, meanwhile, appear as implacably opposed to overturning cherished free movement rights.

Then again, as we reported last night, it is now too late, and most likely by design: sensing the Brexit crisis “opportunity”, Italy is already planning how to bend Eurozone rules against the use of public funds for bank bailouts, and is strategizing how to funnel €40 billion of European cash into its insolvent banking system. Should Europe reject Italy’s overture? Then Italy’s PM Renzi will simply threaten with his own referendum, which considering the recent shocking wins by the Euroskeptic 5 Stars Movement in the Rome and Torino mayoral election, will be all he needs to say to get his way.

Or rather not his way, but the way of the person who is quietly covering up all his tracks: after all why are Italy’s banks insolvent? Well, who was governor of the Bank of Italy from 2005 to 2011 when he blessed all of the hundreds of billions of now non-performing loans? Why former Goldman Sachs employee and current head of the ECB, Mario Draghi of course, who just may end up the biggest winner from the Brexit crisis. Because as everyone knows, one should never leave a crisis go to waste.

I stumbled upon an article by Day of the Jackal author Frederick Forsyth, published last week in the Daily Express, that I think every Briton and European and everyone else should read. Forsyth doesn’t delve into the American pressure to form a European Union as a counterweight to the Soviet Union, he sticks with ‘founding father’ Jean Monnet and his reasoning behind the particular shape the Union took. And that is bad enough.

All Forsyth has to do is to quote from Monnet’s work, and I have to admit that while reading it I increasingly got the feeling that it’s quite remarkable that no-one, especially no journalist, does this. It’s there for everyone to see, but that means little if and when no-one actually sees it.

I have repeatedly talked about how the very structure of the EU self-selects for sociopaths and/or worse, but perhaps not enough about how that was deliberately built into the design. A feature not a flaw.

And I don’t think Monnet ever thought about how structures like that develop over time, in which the flaws in that design become ever more pronounced and the more severe cases of sociopathy increasingly take over the more powerful positions. A development that is well visible in present day Brussels.

For me, as I’ve written before, being here in Athens these days is plenty testimony to what the EU truly represents. Not only do we need to help feed many tens of thousands on a daily basis, depression levels are up 80% or so and life expectancy is plunging because proper health care is ever further away for ever more people in a country that not long ago had a health care system anyone would have been proud of.

That is the EU. And, yeah, Britons, do reflect on the NHS. Sure, you can argue it’s not the EU but Cameron and his people that are breaking it down, but it’s also Cameron who is pleading with you to vote to stay in the union.

If it can do this today to one of its member states, it will do it tomorrow to others, and more, if it sees fit. The benefits of the union flow to a select few countries, and to a select few within those countries. And ever fewer are selected as economic policies continue to fail.

It is frankly beyond me to see why anyone would want to be part of that. It’s not about Boris Johnson or Nigel Farage or George Osborne, that is just more deception. It’s about being ruled by midgets, as Forsyth puts it.

Here are some snippets from Frederick Forsyth’s article:

Birth of superstate: Frederick Forsyth on how UNELECTED Brussels bureaucrats SEIZED power

 There was nothing base or inhumane about Jean Monnet, the French intellectual now seen as the founding father of the dream, nor those who joined him: De Gasperi the Italian, Hallstein the German, Spaak the Belgian and Schumann the Frenchman. In 1945 they were all traumatised men. Each had seen the utter devastation of their native continent by war and after the second they swore to try for the rest of their lives to ensure nothing like it ever happened again. No one can fault that ambition.

First Monnet analysed what had gone wrong and became obsessed by one single fact. The German people had actually voted the Austrian demagogue into the office of chancellor. What could he, Monnet, learn from this? What he learned stayed with him for the rest of his life and stays with us today in the EU.

The continent of Europe, from western Ireland to the Russian border, from Norway’s North Cape to Malta’s Valletta harbour, must be unified into one huge superstate. Politically, socially, economically, militarily and constitutionally.

There could be no war between provinces so war would be banished. (For a man who had witnessed the Spanish Civil War that was an odd conclusion but he came to it. And there was more).

As coal, iron and steel were the indispensable sinews of war machinery, these industries should be unified under central control. Thus would also be prevented any single state secretly rearming. That at least had the benefit of logic and the Coal and Steel Community was his first success.

But the big question remained: how should this Europe-wide single state be governed? Then he came to the conclusion that still prevails today. In the 1930s democracy had failed. In Germany, Italy and elsewhere desperate people had flocked to the demagogues who promised full bellies and a job in exchange for marching, chanting columns.

So democracy must go. It could not be the governmental system of the new Utopia. It was not fit to be. (He was already president of the Action Committee for the Superstate, his official title. There is nothing new about the word superstate).

Instead there would be a new system: government by an enlightened elite of bureaucrats . The hoi polloi (you and me) were simply too dim, too emotional, too uneducated to be safely allowed to choose their governments.

It never occurred to him to devise a way to strengthen and fortify democracy to ensure that what happened in Italy and Germany in the 1920s and 1930s could not happen again. No, democracy was unsafe and had to be replaced. (This is not propaganda, he wrote it all down).

He faced one last stigma as he sought the support of the six who would become the kernel of his dream: Germany (still ruined by war), France (fighting dismal colonial wars in Indochina and Algeria), Italy in her usual chaos, Holland, Belgium and tiny Luxembourg. How could the various peoples ever be persuaded  to hand over their countries from democracy to oligarchy, the government of the elite? Let me quote from what he wrote:

 “Europe’s nations should be guided towards the Super-state without their people understanding what is happening. This can be accomplished by successive steps, each disguised as having an economic purpose, but which will eventually and irreversibly lead to federation.”

In other words he could not force them (he had no tanks). He could not bribe them (he had no money). He could not persuade them (his arguments were offensive). Hence the deliberate recourse to government by deception. Both nostrums continue to this day. Study the Remain campaign and the people behind it.

Almost without exception they are pillars of the establishment, London-based, accustomed to lavish salaries, administrative power and enormous privilege. None of this applies to 95% of the population. Hence the need for deception.

At every stage the Remain campaign has stressed the issue is about economics: trade, profits, mortgages, share prices, house values – anything to scare John Citizen into frightened submission. The gravy train of the few must not be derailed. Some of them are already sticking pins into a wax figurine of David Cameron for being soft enough to offer the proles a chance to recover their parliamentary democracy and thus their sovereignty.

Forsyth then continues with a bunch of typically British issues, and ends with:

[..] You have repeatedly been told this issue is all about economics. That is the conman’s traditional distraction. This issue is about our governmental system, parliamentary. Democracy versus non-elective bureaucracy utterly dedicated to the eventual Superstate.

Our democracy was not presented last week on a plate. It took centuries of struggle to create and from 1940 to 1945 terrible sacrifices to defend and preserve.

It was bequeathed to us by giants, it has been signed away by midgets.

Now we have a chance, one last, foolishly offered chance to tell those fat cats who so look down upon the rest of us: yes, there will be some costs – but we want it back.

 

 

In the long run, as someone once said, we are all dead, but in the meantime, as BofAML’s Michael Hartnett provides a stunning tour de force of the last 5000 years illustrates long-run trends in the return, volatility, valuation & ownership of financial assets, interest rates & bond yields, economic growth, inflation & debt…

The Longest Pictures reveals the astonishing history investors are living through today: lowest interest rates in 5000 years; lowest UK base rate since 1705; a negative Japanese bond yield for the 1st time since 1870; all-time highs in corporate bond returns; slowest Chinese nominal growth in over 20 years; US stocks at 60-year highs vs Europe; bank stocks at 75-year relative lows; largest losses from commodities since 1933.

On Dec 16th the Fed raised rates for the 1st time in almost a decade, ending the longest run of unchanged policy since Fed founded in 1913. The Longest Pictures illustrates how unprecedented monetary stimulus in recent years has failed to deliver recovery, how the global “War on Deflation” has been retarded by excess Debt, aging Demographics, technological Disruption, and why the current Fed hiking cycle could be “one & done”.

Electorates are increasingly voting for policies to address wage deflation, immigration & inequality. The great investment question of our time: will coming “War on Inequality” (via taxation, protectionism, helicopter money) mark secular inflection point for inflation & bond yields (last one was 1981)? Regime change required first, but secular contrarians would be long “inflation assets” (commodities, TIPS, EAFE/EM, banks, value, cash, active) & short “deflation assets” (bonds, IG, US, consumer, growth, “yield”, passive).

The Longest Picture…

…interest rates are at their lowest level in 5000 years.

Why?
1. Policy: unprecedented central bank policies of QE, ZIRP & NIRP
2. Macro: failure of monetary policy to engender sustained economic recovery
3. Risk: deflation risk from excess Debt & Deleveraging, technological Disruption, and aging Demographics.

Since the Global Financial Crisis the “War on Deflation” has been fought exclusively with monetary policy…

…654 rate cuts since Lehman bankruptcy
…$12.3tn of purchases of financial assets by global central banks
…central bank balance sheets expanding to $23.4tn (i.e. >GDP of US+Japan)
…$9.9tn of global bonds are currently yielding less than zero.

Yet global economic growth remains anemic by historic standards. And 8 years after the “War on Deflation” was launched, inflation rates are extremely low…

US CPI = 1.1%
Eurozone CPI = -0.2%
Japan CPI = -0.3%
China CPI = 2.3%
Debt & Deleveraging thwart the War on Deflation.

Debt levels remain high, as high as they have ever been in peacetime for the US government. Banks continue to deleverage.

Savings thus encouraged, borrowing discouraged, and “animal spirits” of household & corporate sectors repressed.

Note that even the highly profitable US corporate sector currently has record cash on balance sheet of $1.7tn (equal to the GDP of Texas or Brazil).

 

Disruption thwarts the War on Deflation. Tech disruption is deflationary.

The “Amazonification” of the retail industry exerts downward pressure on prices.

The acceleration of robots & AI (the number of global robots is forecast to rise from 1 million in 2010 to 2.5 million in 2020) exerts downward pressure on wage expectations.

The increase in life expectancy via biotech & genomics puts upward pressure on saving for a longer retirement and higher health care costs.

 

Demographics thwarts the War on Deflation.

In the next 10 days 112,000 people will reach retirement age in the US, Europe & Japan). A world of zero rates is making saving for retirement extremely tough.

And by 2020 (Chart) the world will experience “peak youth”…for the first time in human history with the number of persons aged 65+ expected to outnumber children under-5 by the end of this decade.

Today’s “deflationary expansion” means the greatest bull market in bonds rages on.

From an all-time peak of 15.8% in Sep’80, the US 10-year Treasury yield fell to 1.45% in 2012, the lowest since 1945.

In the past 4 years bond yields have remained stubbornly low in the US…

…while government bond yields in Japan, Eurozone & Switzerland have, in the past year, all fallen into negative territory for the first time ever.

The cocktail of QE, ZIRP & NIRP has been a potent one for Wall Street & the price of financial assets in the past 8 years…

…especially intoxicating for financial assets that offer “yield”, “quality” & “growth”, scarce assets in a world of low economic growth & interest rates…

…returns from US Investment Grade bonds hit an all-time high in recent weeks…

…and on April 28th, 2016, the bull market in US stocks became the 2nd longest of all-time.

The chart shows how the 10-year rolling return from stocks in Feb’09 fell to its lowest level since Aug’39 during the GFC, a good reminder that investors should always buy “humiliation”.

The global “deflationary expansion” has been very positive for US assets relative to RoW…

…US is the Great Disruptor, US population aging less quickly that in Europe, Japan & China, and US potential real GDP growth still close to 2%…

…US stocks are close to all-time price relative highs vs EAFE index (Chart) and already at 60-year highs vs European stocks.

And yet the bull market has waned in the past 18 months, there has been no “normalization” of growth, rates & asset allocation, no “Great Rotation”, and bonds & stocks have been trapped in a Twilight Zone of volatile trading ranges…

Driven by:
1. Policy: fears of Fed hikes as well as Quantitative Failure in Japan & Europe
2. Profit recession: driven by China & oil
3. Valuation: as an era of excess returns ended with the era of max liquidity & max profits.

Bank stocks (the chart shows the relative performance of US banks close to a 75-year low) are indicative of world stuck in a minimum growth, minimum rate backdrop.

(Indeed, the chart of relative bank performance could easily be mistaken for a chart of interest rates).

The collapse in the rolling return from commodities to the lowest level since 1939 similarly indicative of asset class that has been a “deflation loser”.

Commodities, banks, value stocks, TIPS, cash… are today’s humiliated asset classes, the new secular contrarian “longs”.

But the secular case for these “deflation losers” requires a catalyst (it was QE for stocks in 2009).

On Dec 16th last year Fed hiked rates for 1st time in a decade, ending longest run of unchanged policy since Fed founded in 1913.

The chart shows Fed tightening cycles end with “events”. Recent history (Japan, Sweden, Euro area, New Zealand, Australia, Norway, Iceland) shows how monetary tightening attempts have been quickly punished, aborted & reversed in a deflationary backdrop.

Note asset prices respond very well to “one & done” Fed hiking cycles (there have been 7 since 1926).

But The Longest Pictures shows that monetary policy has failed to deliver the knockout blow to Deflation.

Wall Street has boomed; but Main Street has not (wages continue to fall as % GDP).

Unsurprisingly electorates are increasingly voting for policies to address wage deflation, unemployment, immigration and inequality.

Income inequality is clearly unlikely to be solved via a further sustained rise in asset prices.

Investors must thus start to discount a “War on Inequality” via:

1. Regressive Taxation: tax rates, most particularly for the highest tax brackets, are likely to increase in coming years.
2. Trade Protectionism: tariffs, as well as restrictions on the flow on labor & capital across borders.
3. Helicopter Money: to finance fiscal stimulus (infrastructure spend, tax cuts/reform, higher minimum wages).

The great question for investors coming years: will the coming “War on Inequality” mark a historic inflection point for inflation and bond yields? (Last great inflection point was 1981).

Some policies (helicopters) more likely to induce inflation expectations than others (protectionism & regressive taxation).

Regime change required first, but the secular contrarian positioning for the War on Inequality should be long “inflation assets” (commodities, TIPS, EAFE/EM, banks, value, active, cash) & short “deflation assets” (bonds, IG, US, consumer, growth, “yield”, and passive managers).