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Weekend Edition

Don't be fooled by the biggest lie in today's economy
Saturday, September 27, 2014

The Weekend Edition is pulled from the daily S&A Digest. The Digest comes free with a subscription to any of our premium products.
 
 There's a lot to be nervous about in the world today...
 
But you wouldn't know it looking at the market. Low volatility and a steadily rising market have lulled investors into complacency.
 
The market is near its all-time highs... interest rates remain near zero... we haven't seen a 10%-plus correction in the market in nearly three years... and the Volatility Index (the "VIX") – the market's fear gauge – is low...
 
All signs point to a rosy global economy.
 
 The reality is different. Yes, we're seeing a gradual economic recovery. But there are problems bubbling beneath the surface.
 
Europe's economy is a wreck... The European Central Bank is currently trying to paper over that problem, though its efforts have yet to spur inflation. China is also pursuing massive quantitative easing (QE) to boost its lagging economy, including the recent announcement of an $81 billion liquidity injection for banks. The U.S. will soon see how the economy reacts to the end of QE, and, eventually, rising interest rates.
 
 It's not much better on the geopolitical front, where the U.S. has engaged with terrorist group ISIS. Russia continues its conflict with Ukraine. Argentina is in default. Scotland nearly seceded from the United Kingdom. Catalonia may look to gain independence from Spain in a couple months. The Ebola virus is running rampant in West Africa.
 
And yet, the markets rise.
 
The Federal Reserve has made it impossible to earn a decent return in bonds. But fear not... If you need income to live, just take on debt and buy more junk bonds at record-high prices.
 
Don't worry about the fleeting values in equities... Just buy shares of Alibaba – the Chinese Internet company that recently completed the largest initial public offering (IPO) in history, raising $25 billion. The IPO was reportedly oversubscribed by six times.
 
 It seems obvious that buying risky assets at inflated prices calls for caution. But investors continue to throw mountains of cash at any new equity or bond offering.
 
Unfortunately, most investors have no choice... Negative interest rates have forced them to gamble. Pair that with the huge amount of cash sloshing around today's economy thanks to the Fed's QE, and you have the recipe for what's happening in the market.
 
 Just look at what happened earlier this week...
 
The U.S. bombed terrorist group ISIS in Syria. Israel shot down a Syrian war plane. Russian Prime Minister Dmitry Medvedev urged the BRIC countries (Brazil, Russia, India, and China) to conduct transactions in national currencies to avoid the U.S. dollar. Russia is conducting a military "drill" with a ridiculous 155,000 troops and 4,000 armored vehicles. Plus, manufacturing in Germany and China contracted... And monthly U.S. housing sales slowed in August.
 
But the markets didn't budge.
 
 Several of the world's best investors have noted a similar phenomenon...
 
We already noted the views of billionaire real estate mogul Sam Zell, hedge-fund titan David Tepper, and distressed-debt investor Howard Marks... Tepper says the bull market in bonds is over. Zell and Marks are worried about mounting risks around the world.
 
Today, we'll share the views of billionaire hedge-fund manager Seth Klarman. Klarman is a value investor who founded Baupost Group, one of the most successful hedge funds in history. He has returned around 19% a year since his fund's inception in 1982... And he has achieved those returns often holding a large portion of the fund – currently around $25 billion – in cash.
 
 Like us, Klarman is worried about the malaise in today's market... In a recent letter to investors, he said we're in a "Goldilocks stock market as a result of relentlessly low interest rates." He says investors are ignoring warning signs of inflation, low volatility, and a U.S. gross domestic product (GDP) revision to minus 2.9%... "Contrary to claims from the Obama Administration," he wrote, "the world is not a tranquil place at present."
 
 Investors no longer fear a slowdown... "Investors have grown weary of worrying about risky scenarios that never seem to materialize or, when they do, don't seem to matter to anyone else."
 
Still, Klarman warns that risks to investors are rising but are not yet priced into the markets...
 
The higher the level of valuations and the greater the level of complacency, the more there is to be concerned about. Even as reported inflation remains subdued, signs of cost increases are more evident. We are seeing them, for example, in apartment rents and construction costs.

According to Klarman, bond yields in European countries are at multi-century lows and yields on junk bonds can't go much lower. Even a hint of instability – such as a sudden change in interest rates or investor sentiment – may throw markets in turmoil...
 
While we are not predicting imminent collapse (market timing is not our thing), we are saying that a selloff, greater volatility, and investor losses would hardly be surprising from today's levels.

 Note that Klarman isn't trying to time the markets. The smartest investors rarely do. Instead, they understand risk and adjust accordingly. They raise cash to take advantage of future opportunities. They dump risky assets and prepare for adverse scenarios.
 
Howard Marks is currently raising $10 billion for a new distressed-debt fund... He plans to invest $3 billion and hold $7 billion on the sidelines. In addition to corporate debt, the fund will invest in distressed shipping, power plants, and real estate.
 
According to Oaktree's managing principal, John Frank, "Aggressive extensions of credit of the sort we're seeing today have always been a precursor to substantial distressed-debt opportunity."
 
 We repeat this message not to scare you, but to warn you. We want you to understand there is risk in the market today... and any number of negative scenarios could send prices plunging. We want you to be prepared.
 
 With that said, if you want to understand what's happening in the economy today, I can't recommend financial expert Jim Rickards' new book – The Death of Money – highly enough.
 
Jim is a hedge-fund manager, a lawyer, and a financial consultant for the government. He has seen how monetary policy operates from the inside.
 
In The Death of Money, Jim lays out a clear case for why current monetary policy will lead to inflation, and which assets you need to own to protect yourself in the future. Plus, he wrote a special chapter for Stansberry Research subscribers.
 
You can get a free copy of The Death of Money by clicking here. (We only ask that you pay $4.95 to cover the shipping and handling.)
 
Regards,
 
Sean Goldsmith




This Week's Winners
S&P 500 Symbol Change
Sigma-Aldrich SIAL +31.1%
Vertex Pharmaceuticals VRTX +13.3%
Clorox CLX +5.8%

Countries Symbol Change
Japan EWJ +0.3%
Thailand TTF +0.1%
Indonesia IF -0.6%

Sectors Symbol Change
Biotech PBE 0.0%
Nuclear NLR -0.5%
Big Pharma PJP -0.9%

Commodities Change
Sugar +6.6%
Cocoa +4.4%
Coffee +3.6%
Date Range:9/18/2014 to 9/25/2014
This Week's Losers
S&P 500 Symbol Change
Cliffs Natural Resources CLF -23.1%
CarMax KMX -11.2%
U.S. Steel X -9.2%

Countries Symbol Change
Brazil EWZ -6.1%
South Africa EZA -6.0%
Latin America ILF -5.8%

Sectors Symbol Change
Clean Energy PBW -5.2%
Homebuilding ITB -4.7%
Oil Services PXJ -4.3%

Commodities Change
Cotton -8.1%
Silver -5.8%
Soybeans -5.0%
Date Range:9/18/2014 to 9/25/2014
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