by Louis Navellier

July 13, 2021

The best news last week was the continuing decline in global bond yields, including the 10-year Treasury rate falling below 1.4% last Tuesday. The European Central Bank (ECB) on Thursday announced that it would tolerate up to 2% annual inflation over the “medium term,” in an attempt to rekindle growth there. Essentially, the ECB signaled that easy money will continue to be available. (Italy is now led by Prime Minister Mario Draghi, who was once head of the ECB and is a pioneer of Modern Monetary Theory).

Countries that have over-printed money have effectively caused that money to be worthless in places like Venezuela and Zimbabwe. That’s why there is real fear that endless money printing could cause currency devaluation. Germany still remembers its hyperinflation from 1923, when some money was hauled in wheelbarrows, just to buy normal food items. This painful hyperinflation episode caused subsequent German central bankers to become ultra-conservative, so I am eagerly awaiting any response from the Bundesbank regarding the ECB’s loose money policies. So far, Germany is withholding any criticism.

In America, the $64,000 question now is: Why are Treasury bond yields continuing to decline as inflation heats up? As I mentioned on Fox Business recently, there are several theories. One is that strong demand for corporate bonds is pushing Treasury bond yields lower. Another theory says that the negative interest rate environment in Europe is boosting demand for U.S. debt, since the U.S. offers positive returns. The third (and most outlandish) theory is that the Fed has embraced Modern Monetary Theory (MMT) and is engineering negative yields so that the cost of servicing the rising U.S. Treasury debt will start to shrink!

Believe it or not, all three of these theories are valid. All three have some merit.

If and when the Fed decides to raise key short-term interest rates, I don’t think they will be able to raise rates by much, since the federal debt has risen to $30 trillion. Even now, with low rates, the cost of paying interest on the federal government’s huge debt now exceeds the Defense Department’s annual budget!

The rest of the world is watching America. Increasingly, it looks like they expect the U.S. to embrace MMT and eventually offer negative Treasury yields. Already the yields on the TIPS (Treasury Inflation Protected Securities) are in negative territory, as this Wall Street Journal table demonstrates. (Look under the “yield” column and you will see that all TIPS from here to 2030 offer at least -1.0% negative yield).

Another example of the worthlessness of holding bonds for income or growth in America is that even “junk bond” yields have now fallen below the Consumer Price Index (CPI) for the first time in history, according to research by Bespoke Investment Group. It’s a strange world we live in when both junk bonds and Treasury bonds have negative “real” yields (after inflation). As a result, I am convinced that Treasury yields will be following their European peers and eventually offer negative nominal yields as well.

For now, it looks certain that neither Fed Chairman Jerome Powell nor Treasury Secretary Janet Yellen will try to constrain the money supply with significantly higher interest rates that might impede economic growth. It seems like Secretary Yellen, the Fed, and the Biden Administration all embrace the “free lunch” promises of MMT, so, just like the late 1990s, we are in a perfect environment for growth stocks!

The Economic News Remains “Mixed” Enough to Keep the Fed Accommodative

The economic news last week was mixed. On Tuesday, the Institute of Supply Management (ISM) announced that its non-manufacturing (service) index slipped to 60.1 in June, down from a robust all-time high of 64 in May. Since any reading above 50 signals expansion, the June ISM service index is still positive, and all 16 of the service industries surveyed reported an expansion.

Global trade is resuming, as the Commerce Department reported that imports rose 1.3% to $277.3 billion in May, and exports rose 0.6% to $206 billion. The bad news is that imports grew faster, which means the trade deficit surged to over $71 billion, which tends to put a drag on GDP projections for last quarter.

Crude oil and lumber led the surge in imports, while pharmaceuticals and food led exports. Naturally, since Covid-19 vaccines are badly needed in Latin America and other parts of the world, pharmaceutical exports should remain strong. However, a growing drought out West is expected to hinder food exports.

When consumers are spending up a storm, imports tend to rise, so the trade deficit could grow further. I should add that the Atlanta Fed’s GDPNow estimate is currently forecasting the second-quarter GDP to come in at an annual pace of 7.9%, up a tick from its previous annual estimate of 7.8%.

On Thursday, the Labor Department reported that new weekly unemployment claims rose to 373,000 in the latest week, compared to a revised 371,000 in the previous week. Continuing unemployment claims declined to 3.339 million in the latest week vs. a revised 3.484 million in the previous week. Economists were expecting those two data points to come in at 350,000 and 3.35 million, respectively, so this week’s unemployment claims were higher than expected, while continuing claims came in a bit better.

All of this just means that the Fed will likely remain accommodative, since lower unemployment is the Fed’s primary goal and 6.8 million jobs have not yet been restored since the pandemic commenced.

In another cause for caution, the worldwide Covid death toll has now reached four million and many countries, like Australia, Japan, and South America, are worried about new variants, like the Lambda variant that first appeared in Peru. Australia canceled its Formula One race last week and Japan declared a state of emergency and banned all fans from the Summer Olympics. All I can say is that we are fortunate that a majority of Americans have been vaccinated and our economy is striving to return to normal.

Is “Commission-Free” Investing Really Free?

The word “free” is supposedly the most potent word in advertising. Many online retailers offer “free delivery” but the cost of delivery is added into the price of the product. The desire for a “free lunch” is the basic idea behind Modern Monetary Theory – the belief that a big government can print nearly unlimited amounts of money, then give it away and never have to pay the piper via inflation or high interest charges.

On Wall Street, the free offer “hook” is “commission-free” investing. Robinhood has made investing popular for millions of investors, especially first-timers who like to trade a lot and pay zero commissions. So how does Robinhood – or similar brokerage firms – make money while charging no commissions?

The answer is “Payment for Order Flow” (PFOF), whereby Citadel kicks back some of the bid/ask spread to an originating broker dealer. With Robinhood, 81% of its first-quarter revenue was derived from PFOF, especially from traded options and themed ETFs, which can have much wider spreads than most stocks.

Gary Gensler, the new Chairman of the SEC, is reportedly wary of PFOF, so the SEC is in the process of reviewing PFOF and may propose some changes that may be subject to public comments before any new rules go into effect. Interestingly, PFOF has existed for decades, but with the Citadel algorithms taking over Wall Street, plus the boom in ETFs – which puts another bid/ask spread onto securities with existing bid/ask spreads – Wall Street firms have effectively figured out how to “double dip” via the ETF industry.

Our friends at Bespoke have documented how some of the most popular ETFs, like SPY & QQQ, actually lose money for investors who bought these popular ETFs at the opening and sold them at the close every day since their inception. This important Bespoke research proves that ETFs are not designed to be traded actively, since their bid/ask spreads can be cost-prohibitive, especially during fast market conditions.

Typically, ETF spreads are “tight” at the market opening and closing, but they can widen dramatically during the middle of the trading day. I know all this because I had my own ETF a while ago and was shocked that according to Morningstar, the average buy/sell spread on my now-defunct ETF was 3.54%. (I should add that I was never compensated in any way from my ETF, which was sold to Oppenheimer. However, had I been a broker dealer, I could have received a PFOF from the bid/ask spread.)

Most investors have no idea that ETFs have a sizable bid/ask spread on top of the underlying spreads on the securities they hold, which effectively allows broker/dealers to “double dip.” The popular “theme” ETFs, such as those that specialize in ESG, cannabis, robotics, etc., are notorious for their super-wide spreads that can be incredibly lucrative for some broker dealers. It is impossible for me to be a fan of any ETFs that are fleecing investors on bid/ask spreads, so I cannot say anything positive about funds like the ARK ETFs, since they have a high investor turnover. Someone is making a lot of money off investors.

I should add that I have been warning investors about ETF spreads for many years. One example is: “Are Your Clients at Risk of Being ‘Fleeced’ When You Buy and Sell ETFs” (reprinted in AdvisorHub, April 6, 2018), or you can download any one of our White Papers on ETFs at our website, namely:

  • The Evolution and Mutation of ETF Sharks
  • Sharks, High Frequency and ETFs
  • A Second Part of the Chessboard Problem (or “Wild West” ETF Pricing)

In the end, I applaud the SEC for investigating PFOF, but I expect they may not be able to stop a practice that has existed for decades. However, perhaps the SEC can at least mandate a big warning label, like the one for cigarettes, to warn investors that they could get “fleeced” on ETF spreads.

All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

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What Do Bonds Know That Stocks Don’t?

Sector Spotlight by Jason Bodner
I Beat the Odds – in a Most Unwelcome Manner

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Louis Navellier

Louis Navellier is Founder, Chairman of the Board, Chief Investment Officer and Chief Compliance Officer of Navellier & Associates, Inc., located in Reno, Nevada. With decades of experience translating what had been purely academic techniques into real market applications, he believes that disciplined, quantitative analysis can select stocks that will significantly outperform the overall market. All content in this “A Look Ahead” section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.

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