A Force Greater Than the Fed

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Yesterday the Donald announced he’s ready to reduce North Korea to dust.

Today the Fed announced it’s ready to reduce its balance sheet to normal.

Neither is good for stocks.

So how did they take the news?

Exactly as you’d expect — with another record setting day.

The Dow closed today day 42 points higher… eclipsing its previous high.

The S&P scratched out another record of its own.

Only the Nasdaq ended the day in red. And only by five points.

The larger question:

Why are stocks setting records in the face of such uncertainty?

The news is noise, say the optimists…

“Stocks are making record highs because the U.S. economy is on a roll,” says Yahoo Finance.

It’s because exports are rising… corporate earnings are soaring… and sales are booming, adds one analyst at Contrarian Outlook.

Stocks set records “not because central bank balance sheets are so expansive, but because companies are still lean and profitable, and corporate shares still represent value compared to other assets,” chirps the editor of Momentum Strategies Report.

Perhaps they’re right.

We bring a disbelieving outlook to the business… and a jaundiced eye.

It may blind us to the booming sales, the corporations representing value, the rising exports… the economy on a roll.

But the Atlanta Fed’s GDPNow updated growth forecast came out yesterday.

It projects third-quarter growth at an annualized rate of 2.2%… down from a projected 4% at quarter’s start.

The New York Fed releases its own updated estimate Friday. Its last estimate had third-quarter GDP even lower… at 1.3%.

Meantime, Kiplinger estimates full-year growth will total 2.1%.

Are these the numbers of an economy “on a roll”… or an economy at a crawl?

If the latter, what force is thrusting stocks to record heights?

Is some unseen hand working unseen levers… some mysterious alchemy transmuting Main Street lead into Wall Street gold?

One possible clue:

The Fed has taken the federal funds rate to 1.25%, from just about zero in December 2015.

Still low. But higher than zero. And trending higher.

Yet… the Goldman Sachs U.S. Financial Conditions Index is now at its lowest point since 2014.

So despite the Fed’s tightening and all of hell’s angels, money is looser and cheaper than at any point in three years.

The Fed Tightens, Money Becomes Easier

How can this be?

Bank of America’s Michael Hartnett may have the answer…

The Fed is not the world’s sole central bank.

It shares the road with the European Central Bank (ECB), the Bank of Japan (BOJ), the Bank of England (BOE), the People’s Bank of China (PBOC) — to name some.

And Hartnett notes that central banks have purchased nearly $2 trillion of financial assets year to date.

That nears the amount of assets the Fed purchased under QE1… during the breathless and foot-free days of the Great Recession.

Those foreign central bank purchases translate to a vast sea of liquidity supporting stocks.

Hartnett calls it the “supernova of liquidity”… the “flow that conquers all.”

By our lights, it better explains today’s record markets than rising exports… booming sales… or the “rolling” economy.

We are not alone.

Analyst Tony Cherniawski, for example, argues:

Stocks have continued to rise, hitting new all-time highs in both the U.S. and globally, oblivious of any news and fundamental developments — as one would expect from a massive asset price bubble, and in line with what Hartnett has dubbed a liquidity supernova.

Some months back, MarketWatch even scoffed:

Quantitative tightening? Oh, please. Central banks, courtesy of the eurozone and Japan, are still buying financial assets with both hands.

The “liquidity supernova” may explain today’s record stocks.

But what about the future?

The BOE completed its own QE program this spring. The ECB has indicated it will begin to taper its asset purchases this autumn. The BOJ has backed off its own in recent months.

As we first reported this summer, the “flow that conquers all” will eventually stop rising… level off… and finally recede.

When?

By the third quarter of next year — under a year from today.

And stocks may wash away with the ebbing tide.

But Hartnett thinks it could start long before the tide rolls out next year…

He believes the “most dangerous moments for markets” actually occur within the next two months, when markets suddenly grasp the reality of falling liquidity.

Hartnett expects the S&P to rise an additional 100 or more points, to 2,630, before the tide recedes later this fall.

Peak Market?

We make no prediction of course.

But it was Warren Buffett who said, “You only learn who has been swimming naked when the tide goes out.”

When the great liquidity tide goes out… we fear much of Wall Street will be caught in the buff…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Trump’s Now ‘Blowing Kisses to Janet Yellen’

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David Stockman joined Fox Business network to discuss his latest analysis on the economy, the political

Stuart Varney started his segment noting that David Stockman is traditionally bearish toward the market and continues to miss out on the Dow rally as it hit an all-time high. Varney began his entry to the former Reagan economic official by stating that if he had listened to Stockman, he would’ve lost out on significant earnings. Stockman began by reverberating, “If you had taken my advice in March 2000, you would’ve dodged a bullet. You could’ve taken my advice in November and dodged another bullet.”

“We have a Federal Reserve, the U.S central bank, that is responsible for creating repeated bubbles that last seven or eight years. This one we’re in has gotten to the point of absurdity. The market is trading at 24 times reported earnings at the 100-month point in the business cycle. Nobody has outlawed a recession. It is going to happen. The market will crash.”

When asked how he can continue to make such remarks when there is a cycle of recession Stockman remained level. He noted, “when the pullbacks come they remain at 20, 30 or 40%.”

Varney, in either negligent or confused tone, then asked what the point of warning of such a threat was if he could not get a specific time period. Stockman remained focused noting, “I cannot predict what the Federal Reserve is going to do. I cannot predict a black swan. I can predict that there’s an orange haired swan heading right the financial system right now. Washington is going to be in chaos within two or three months.”

Stockman went on to warn that Donald Trump was a threat to the market and a destabilizing factor.

The Fox Business host prompted the former Reagan official on what Trump could do to produce such a devastating crash.  Stockman, in clear and sober fashion, leveled, “He’s done nothing right. He’s wasted nine months. The top one, two and even three things wrong and hurting America today falls to the Federal Reserve. He was blowing kisses to Janet Yellen. She’s a menace. She should’ve been asked to resign in January.”

“Second, he should’ve got the budget under control. He is now going to preside over the biggest increase in the national debt in the history of the United States.”

“Third, he should be trying to bring in the expansionist, imperialist foreign policy. He said he would do it during the campaign. Instead of working with Putin and greater relations, he’s running away. Now he is focused on the North Koreans, the Iranians and everyone else. We don’t need another war – we’re bankrupt.”

David Stockman Fox Business Yellen

After being pushed from Varney, who seemed to be in a perplexed mood by the sober speaking, Stockman looked directly into the camera to urge clear and collected thinking. “Sell the bonds. Sell the stocks. Get out of this market. It is a dangerous casino. You have maybe 5% upside and a 40% downside.”

“The risk-reward ratio is terrible. We have a government that is out of control. We have a Federal Reserve that is making dead promises. Put it in cash or anywhere safe – but get it out of Wall Street.”

When asked by the Fox Business host how he could make such claims while others are still making considerable gains in the market, the former Reagan official continued the course. “Good for you on the gains. On the other hand, just because “the world did not end” at this moment today, it does not mean that there is not another drop to fall.”

“I hope you are ready for the crash when it drops because you’re going to have to get out of the way of the thundering crash. Why won’t there be, when you have a market that is so overvalued. Instances of this craziness can be seen in stocks like Netflix that is currently trading at 220 times earnings. It is nothing but a cash burning machine.”

Switching gears the host then went on to ask case specifically for the scenario that Stockman warns of. He began by asking whether Microsoft was in on the craziness. “Microsoft is a little more reasonable. It is trading around the same level it was in 2000 despite the fact that trading is up four times and earnings are up five times. Good companies get massively overvalued during bubbles.”

When asked about his views toward the big tech companies, including Facebook, Apple, Amazon, Netflix and Google (FAANGS), the best-selling author did not turn away from his bearish position. “While I don’t have a big view on Apple, what I do know is that most of the FAANGS, including Facebook, are way overvalued.”

“This market is crazy. This is a classic mania. This is fantasy land. While you smile, you would’ve been doing the same thing at the top of the bubble in March 2009 when everyone was saying ‘this time is different.’ But this time it is worse.”

“The Federal Reserve has nowhere to go. It has already announced that it would be normalizing its books, shrinking the balance rate and raising rates. The European Central Bank (ECB) will follow. The Bank of Japan is now lost. We have a world economy that is in very rough shape. I don’t understand why people don’t see that.”

Find the full interview with David Stockman on Fox Business discussing Janet Yellen’s Federal Reserve, and more here.

Thanks for reading,

David Stockman
for The Daily Reckoning

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ALERT: The Market’s Weakest Sector is About to Break Out

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The market is beginning to reveal a surprising new leader…

The energy sector!

The days of $100 oil are long gone. But energy stocks are beginning to quietly come back from the dead. In fact, the sector just posted its strongest trading week of the year. While most investors remain fixated on the tech sector and the cryptocurrency boom, energy is looking like strong bet heading into the final trading months of the year.

As oil tops $50 a barrel for the first time since May, many forgotten energy names are starting to shine again. The market is telling us it’s time to rotate into the sector as lazy summer trading winds down.

You already know how critical it is to have your trading dollars in the correct stocks and sectors. If you aren’t catching a ride with the market’s most powerful trends, you won’t have a shot at beating a passive investment strategy.

For instance, the first half of 2017 would have been a total bust for our trading portfolio if we bottom-fished for energy stocks instead of riding the tech stock boom. Semiconductors and the other big tech names listed on the Nasdaq were fueling the market’s motor during the first and second quarter. Our positions in stocks like PayPal Holdings (NASDAQ:PYPL), Facebook (NASDAQ:FB), and Amazon.com (NASDAQ:AMZN) powered our portfolio and made up for any of the small losses we incurred.

On the other end of the spectrum, energy stocks weighed down the market’s performance. Oil was slumping to new 52-week lows as recently as June, threatening to tumble into a new bear market. The energy sector was faring even worse as oil continued to slide.

By mid-June, the Energy Select Sector SPDR (NYSE:XLE) has dropped more than 16% from its December highs. Meanwhile, sizzling comeback plays like the SPDR S&P Biotech ETF (NYSE:XBI) had jumped a staggering 29% over the same timeframe.

Digging a little deeper, we uncovered more grim energy stats. Bespoke Investment Group noted over the summer that the energy sector underperformed the S&P by more than 23% over the past year. Such a wide performance gap is quite unusual. Since 2000, Bespoke notes that this margin of underperformance has only happened twice.

Poor energy stocks just couldn’t catch a break. The latest summer slump comes on the heels of an oil price that was consistently victimized by a whipsaw market last year. In summer 2016, oil prices quickly jumped above $50 a barrel for the first time in nearly a year. U.S. stockpiles were down and China demand came in stronger than anticipated. Both factors helped push oil over the hump.

But these gains were short lived. Oil bears were just taking a quick nap. After topping out, oil prices fell for six straight days. It was the longest bearish run for oil since early 2016 when prices plummeted below $30 a barrel.

As you would expect, the once-popular energy stocks have not flourished in the new era of cheap oil. Just last year, the sector’s attempted comeback was cut short in December. It’s remained in a nasty downtrend ever since while the broad market has maintained its strong performance.

But that’s all changed over the past four weeks…

The Energy Select Sector SPDR has gained 8.5% over the past month, compared to a gain of a little more than 3% in the S&P 500. The sector is now above its July highs and looking to snap its 2017 downtrend.

This month’s action in the energy sector gives you a great shot at getting in on a burgeoning turnaround play.

Sincerely,

Greg Guenthner
for The Daily Reckoning

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Home Depot Is Just The Beginning…

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“Frank, do you smell smoke?”

My mother-in-law was in the kitchen and something just wasn’t right.

Frank, my father in law walked over to the garage door. He definitely smelled it too. And when he opened the door, he was met with a wall a billowing black smoke.

Immediately, the smoke alarms went off.

There were three kids in the house. Frank bolted upstairs to grab the baby. Patty (my mother-in-law) grabbed her two grandsons in the playroom.

By the time everyone made it out the front door and turned around to look at the house, there were flames shooting out of the roof. Within minutes the entire house was engulfed in flames.

As Patty hugged her tearful grandchildren, she whispered in their ear: “things can be replaced… but people can NEVER be replaced.”

It’s sobering to think of the tragedy that could have happened that day…

The story above really happened to my brother and sister-in-law.

By the time the fire department made it to the house, all they could do was contain the blaze.

In just a few short minutes, my relatives lost everything. Their home, their pictures, the kid’s toys, their cars… everything!

I’m so thankful everyone escaped unhurt. It’s hard not to think what could have happened if Patty didn’t smell smoke when she did.

Today, two years later, the family’s fire is nothing but a horrible memory.

Actually, if you talk to my brother-in-law, he’ll tell you that while tragic, this event turned out to be a good thing for their family.

After all, the insurance company took care of everything including a new house, new furniture, new vehicles and toys for the kids and more. And the entire experience gave them the inspiration to start neighboraid.com — a non-profit group to help families affected by disasters like floods fires, tornadoes etc.

So why am I telling you this story today?

Because tens of thousands families in Texas and Florida are facing a similar situation following Hurricane Harvey and Hurricane Irma.

Today, these families are starting to receive insurance payouts to cover their losses from these storms. And as families spend cash to replace the things they lost, a handful of specific companies will be selling furniture, flooring, fixtures and more…

As an investor, you should be able to profit from an advance in the stocks of these companies. And hopefully, you’ll use some of those profits to help someone in need following these terrible storms.

Demand Surges for Repair and Replacement Stocks

Earlier this month, we asked the question “is it ethical to profit from a hurricane?

As an investor, I think it’s perfectly fine to buy shares of companies that will benefit from the cleanup following Harvey and Irma. But I also think we have a responsibility to be generous to those less fortunate than us.

And this is true all the time – not just after disasters like the ones we’ve seen in the last few weeks.

Shares of home furnishing and home repair stocks should do particularly well over the next few months, thanks to demand from hurricane victims.

Think about the thousands of homes that will need new carpet, hardwood floors, couches, beds, appliances and more. There are dozens (if not hundreds) of companies that will profit from new purchases related to the recent storms.

I expect these profits to be exceptionally high, and to continue for several quarters as insurance settlements are reached.

Insurance companies will be paying policyholders enough cash to replace all of the items that were lost during the storms. And these payments should usually cover the cost of new items (such as new flooring, new furniture, new washers and dryers etc.). So the amount of demand for new items could far exceed the actual value of the things that were lost due to flooding or wind damage.

Of course with so many claims to be filed and reviewed by adjusters, the process will take a long time. Not to mention the fact that homeowners will often take their time picking out just the right items to replace what was lost.

So home furnishing and repair companies should not only see demand surge right away, but that demand should continue to be high for months and months to come. And that’s why I expect many of these stocks to trend higher for some time to come…

A Great Spot to Find Disaster Relief Profits

With so many companies potentially benefiting from a surge in home repair and home furnishing purchases, investors have lots of stock opportunities.

If you’re looking for shares that will benefit from this surge in demand, I’d suggest checking out the SPDR S&P Homebuilders ETF (XHB).

Now, I’m not suggesting you buy shares of XHB. As a general rule, instead of buying the whole fund I’d rather you pick the best stocks that they hold.

Morningstar.com has a great resource that allows you to see the top holdings of any mutual fund or ETF. By looking at these holdings, you can see a great list of companies that are included in the fund, and pick your favorite stocks to buy in your own account.

To find this list, go to morningstar.com and put a fund’s ticker in the “quote” box at the top of the page. Once you’re on the fund’s page, click on “portfolio” for that particular fund. Finally, click on the “holdings” tab for the fund and you’ll see the top positions held by that fund.

In the case of XHB, there are a few companies that caught my attention (see list here):

  • Mohawk Industries (NYSE:MHK) is a leader in flooring and should sell more carpet and hardwood flooring to customers in Florida and Texas.
  • Tempur Sealy (NYSE:TPX) is a mattress company that should benefit as insurance companies pay to replace waterlogged bedding.
  • Home Depot (NYSE:HD) and Lowes (NYSE:LOW) will both profit not only from hardware to renovate damaged homes, but also from appliance sales such as dishwashers, refrigerators, washers and dryers.
  • Williams Sonoma (NYSE:WSM) is a niche retail store that should sell more decorative items as customers try to make newly renovated houses look and feel more like “home”

If you check out Morningstar’s page for this homebuilder / home furnishings fund, you’ll find some other great companies that are worth checking out. I think you’ll find quite a few worthwhile investment ideas.

Here’s to growing and protecting your wealth!

Zach Scheidt

Zach Scheidt
Editor, The Daily Edge
TwitterFacebook ❘ Email

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Big Brother Is Coming for Bitcoin

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Interest in bitcoin is red-hot right now. It’s impossible to open a website, listen to a podcast or watch a video in the financial space without hearing about the meteoric rise in the price of bitcoin.

I know about the bitcoin frenzy firsthand.

I’m a frequent guest on financial television and do many online interviews. Sooner or later in almost every interview, the anchor will turn to me and say, “Jim, I have to ask, what’s your opinion on bitcoin?” And away we go.

The fact is I actually don’t like talking about bitcoin; it’s one of my least favorite topics. But I can’t avoid it!

Of course, bitcoin is just one of many cryptocurrencies. There are hundreds in total with names like ether, dash, dogecoin and blackcoin.

For convenience, I will refer to all cryptocurrencies here as “bitcoin.” But you should understand that the analysis offered applies to the other cryptos as well.

Maybe you know a “bitcoin millionaire” who bought 500 bitcoins a few years back for $50,000 and is now sitting on a bitcoin fortune worth over $2 million. It’s true, those people actually do exist.

While I’m not a fan of cryptocurrencies, I am a believer in the power of the technology platforms on which the cryptocurrencies are based. These are usually called the “blockchain,” but a more descriptive term now in wide use is “distributed ledger technology,” or DLT. There’s no denying that fortunes have been made and still will be made in various DLT applications.

When it comes to cryptocurrencies like bitcoin, I take a laissez-faire approach. Do your own thing. If you want some bitcoin in your portfolio as part of a diversified bundle of assets, that’s up to you. If you want to speculate in some of the other lesser-known cryptocurrencies, that’s fine, too. You might make a lot of money.

My only admonition is caveat emptor. Please take the time to understand how it works and what the risks are.

I am not a technophobe and I’m not a bitcoin basher. I understand bitcoin very well at a technical level. I’ve read the original technical papers on bitcoin from 2009 and many commentaries since.

I even worked with a team of experts and military commanders at U.S. Special Operations Command (USSOCOM) to find ways to interdict and disrupt ISIS use of cryptocurrencies to fund their terrorist activities and caliphate.

My opinion is straightforward. Again, I’m not telling anyone not to own cryptocurrencies, but I don’t own any bitcoin and I don’t recommend cryptos to investors. My reasons have to do with bubble dynamics, potential for fraud and the prospect of government intrusion.

The latter is especially important.

There is every indication that governments, regulators, tax authorities and the global elite are moving in on cryptocurrencies. The future of bitcoin may be one in which Big Brother controls what’s called “the blockchain” and decides when and how you can buy or sell anything and everything.

Furthermore, cryptocurrency technology could be the very mechanism used by global elites to replace the dollar-based financial system.

Regards,

Jim Rickards
for The Daily Reckoning

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This Puzzling Breakout is Back on Track…

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It’s been one of the most difficult breakouts we’ve tracked this year.

Yet despite all the waiting and false starts, small-cap stocks are once again ripping higher.

So we have to ask: Are we finally witnessing the signs of an epic small-cap comeback?

For the second time in less than four months, small stocks have taken the express elevator from the basement to penthouse.

Back in June, it took just three days for the small-cap Russell 2000 to move from the brink of a breakdown to less than 1% from its all-time highs. By July, the small stock index was pushing to never-before seen levels. At the time, it looked like we were in for one hell of a run…

But the party didn’t last. All it took was a little broad market weakness to send small stocks crashing back down to earth. After topping out in late July, the Russell 2000 tripped and fell nearly 7% in just three weeks. It was a terrifying drop for small-cap investors. A false breakout followed by a quick collapse kicked the Russell below its 200-day moving average for the first time in more than a year.

But the Russell’s near-breakdown was enough to shake out most of the weak hands. The brief trip below its 200-day moving average didn’t slow small-caps for long. In fact, they’re back to doing what they do best: beating the pants off the S&P 500.

The Russell 2000 has jumped more than 6% since it bottomed out on August 21st. Meanwhile, the S&P 500 has squeezed out a gain of about 3.4%. Any investor hanging onto small-caps this summer was forced to endure an insane, get-wrenching round-trip.

The market action we’ve witnessed proves just how choppy small-cap stocks have been since the unprecedented post-election rally.

To be fair, the November small stock rally was just as shocking as Trump winning the White House. As of early December, the small-cap Russell 2000 had jumped 40% above its February lows thanks in part to an incredible 14-day run to cap off November trading. It was the index’s longest winning streak in more than 20 years.

At the time, I told you the action is exactly how big changes in trend happen. One second, everyone hates small-caps. Just when the last seller leaves the building, a monster rally begins to take shape.

But the small-cap rally moved too far, too fast. Here’s an updated version of the chart I showed you back at the close of the second quarter:

Small-caps followed up their furious November rally with more than nine months of range-bound action (the false breakout back in July couldn’t officially bust open the wide trading range).

Now signs are pointing to another round of higher prices.

At the very beginning of the year, I told you every shred of evidence I have collected is pointing to an extended surge in smaller stocks. Even though we haven’t seen any strong follow-through after the November surge, the choppy, sideways action in the Russell hasn’t swayed our longer-term thesis.

Sincerely,

Greg Guenthner
for The Daily Reckoning

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A “Financial H-Bomb” Has Exploded

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Somebody exploded an H-bomb last week, and it wasn’t North Korea. It was the U.S.

This was not a kinetic H-bomb, the kind that leaves a mushroom cloud.

It was a financial H-bomb.

Financial warfare has its weapons, tactics and commanders, the same as kinetic warfare. In financial warfare, the leading commander is the secretary of the Treasury. The weapons include account freezes, sanctions and financial blacklisting of certain individuals and companies.

The financial warfare equivalent of an H-bomb is a complete ban from the U.S. dollar payments system. The U.S. dollar represents 60% of global reserves, 80% of global payments and almost 100% of global oil sales. Cutting off any party from U.S. dollars is like cutting off the oxygen from a patient in intensive care. They won’t last long.

That is exactly what U.S. Secretary of the Treasury Steve Mnuchin threatened to do to China on Sept. 12. He threatened to cut off China’s access to the U.S. dollar payments system if China does not rigorously enforce new U.N. sanctions on North Korea as a means to deter North Korea from pursuing its nuclear weapons and missile development.

The problem is that North Korea will not be deterred. It’s in “breakout” mode, which means it is dashing for the finish line of a nuclear-capable ICBM arsenal. North Korea is not trying to hide its efforts beyond normal operational security, and it’s not using the weapons as a bargaining chip for sanctions relief or other economic benefits.

North Korea could have those with a phone call to the U.S. in exchange for stopping its programs and allowing reasonable inspections. They have not picked up the phone. They are hitting the “launch” button.

Likewise, China will not enforce the sanctions beyond superficial compliance. They certainly will not go to the lengths the U.S. expects.

China fears a destabilized North Korea that could be reunified on South Korean and U.S. terms. China fears a flood of North Korean refugees entering China. And China views the entire North Korean situation as a U.S. problem, not a Chinese problem (Russia views it the same way).

A war between the U.S. and North Korea is not the worst result for China because it bleeds the U.S., Japan and South Korea, who are rivals for dominance in East Asia. Finally, Chinese behavior is governed by “face.”

By the U.S. Treasury making such a public declaration, China cannot back down without losing face. In an age of rising Chinese power, China will not lose face.

But here’s the thing:

Cutting China out of U.S. dollar payments means a selective default on U.S. Treasury debt.

China has over $1 trillion of U.S. government securities in its reserve position. Those securities are paid at maturity and rolled over through the U.S. dollar payments system run by the U.S. Treasury with the Federal Reserve as fiscal agent. If China is denied access, then China’s Treasury securities portfolio is effectively frozen.

China is relying on those liquid dollar reserves both to bail out its insolvent banking system and to defend its currency. The implications of freezing China out of dollar payments are almost incomprehensible.

So the path is set.

North Korea is going for the weapons. The U.S. will not allow North Korea to get them. The U.S. is relying on Chinese help, which will not be forthcoming. The end result is a shooting war with North Korea and a financial war with China.

Investors should move now to lighten equity exposure, establish selective short equity positions and increase allocations to safe-haven assets such as U.S. 10-year notes, gold, silver and cash.

This war is coming in six–eight months. The time to make your financial moves is now — before it’s too late.

Regards,

Jim Rickards
for The Daily Reckoning

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