It seems that everywhere you look in the financial media these days there is persistent hype about artificial intelligence (AI) and the companies developing it. Right alongside this great investment boom is doom and gloom about the future value of bonds. Oil, too, is frequently covered for two reasons, the inability of oil futures prices—which seem suspiciously low—to reflect the long-term effects of what is happening in the Persian Gulf and the high prices of refined products such as gasoline and diesel where the real squeeze seems to be right now.
It's hard to resist the constant din of such news in order to arrive at an independent assessment. But that is precisely what we should strive to do in the face of what seems like the overwhelming consensus. However, I am not writing to give you financial advice which often requires precise timing to be of much value. In the financial markets—as I have learned again and again—being early is almost always the equivalent of being wrong. What I hope to do is to help you understand the financial news better. First, let me declare that I have no financial interest in anything mentioned in this piece lest you think I am "talking my book."
To be a contrarian with a long view requires a lot of mental armor as near-term events almost always contradict your prognostications. Trends in financial markets tend to go on longer than any skeptic can conceive. As famed economist John Maynard Keynes is quoted as saying, "Markets can remain irrational longer than you can remain solvent." Taking the long view, not surprisingly, requires not only patience but also fortitude.
It turns out that one of the best indicators for contrarians like me are covers of The Economist magazine which historically have signaled an important inflection point in the market highlighted. This is not because the magazine's editors believe an inflection point is near. On the contrary, they believe the trend is intact and will persist for much longer, if not indefinitely. But history suggests that when the conventional wisdom has penetrated the editorial offices of The Economist and specifically those in charge of covers, that wisdom is about to be proved obsolete.
My favorite example is the March 6, 1999 cover of The Economist which shows two oil workers covered in crude oil which is gushing upwards from a valve they are desperately trying to close. The headline is "Drowning in oil." At the time the spot price for the world benchmark Brent Crude, that is, the price for immediate delivery, was hovering around $10 per barrel. This is after Brent Crude registered the unfathomably (by today's standards) low price of $9.44 per barrel during the second week of the previous December. The markets really were drowning in oil.
What's more is that The Economist suggested in the same edition that prices might settle around $5 per barrel given the incentive of producers to produce more to generate sufficient income to meet their obligations and given the presumed surfeit of oil available to be exploited.
As it turns out, that edition very closely marked the nadir of oil prices which by the second week of March 2000 had reached $30 per barrel and were on their way to over $140 per barrel by mid-2008, the all-time top. (Prices never did decline to the aforementioned $5 per barrel.)
And so, much more recently The Economist opined about the direction of bond prices. (For anyone who doesn't keep track of such things, bonds are simply financial instruments that allow you to lend money to a government or corporation at a specified interest rate with a promise to repay what you originally lent by a specific date. For example, a 10-year bond will be repaid in 10 years.) The magazine believes a government bond crisis is in the offing, something it announced on its cover on October 8. Interest rates have catapulted worldwide from historic lows meaning governments now have to pay much more to borrow. To understand what this means to bondholders, that is, those lending to governments, you need to do a little math. If you buy a bond for $1,000 which pays 2.5 percent interest for 5 years, you almost certainly will not be able to sell that bond to someone else for what you paid if interest rates go up.
Let's assume that interest rates have risen to 5 percent. An investor can now buy a $1,000 bond directly from the government and get 5 percent in interest per year ($50), twice what your bond pays ($25). Since your bond pays interest that is only half of what any investor can now get by buying from the government directly, if you want to sell, you'll have to discount the price of your bond considerably. You'd have to sell your bond for half of what you bought it for to match the interest payments on the new 5-percent bonds. (I'm simplifying the situation a bit to make the example easy to understand.) Those bonds pay $50 in interest per year and yours only pay $25, so an investor would need two of your bonds to equal the $50 in interest which means that investor will only offer you $500 for your bond. The $25 per year interest now equals 5 percent for the new owner.
In its cover piece The Economist is offering a double warning, one for governments and their citizens and one for investors. High interests rates tend to slow down the economy while making it more expensive for governments to pay interest on their debt. Investors become gun-shy about investing in government bonds if they believe interest rates will shoot up undermining the value of the bonds—which in turn forces governments to offer higher interest payments to attract bond buyers. This can become a vicious circle that threatens a loss of confidence in the government and its currency.
I'm inclined to think that because this looming crisis has hit the front cover of The Economist that it will shortly dissipate and interest rates will head down pushing bond prices up. (Reversing my example above, a 5 percent bond fetches a much higher price when new bonds only yield 2.5 percent.) The likely cause of this reversal will be an economic recession that shrinks economic activity thereby lowering the demand for credit and thus reducing its price, that is, the interest rate charged. I'm not prophesying the kind of bull market in bonds that lasted 40 years from 1980 to 2020 and took the 30-year U.S. treasury bond from nearly 15 percent down to 1 percent during the COVID pandemic. But I do think a medium-term reversal might be in the offing.
What might cause that recession? Now we circle back to AI. The AI industry is in what is almost certainly a financial bubble. The bubble will inevitably burst one day bringing down stock prices and investment in the economy. Another thing pushing down on the economy: high oil prices and the prices of oil products such as gasoline and diesel. I happen to think the resulting recession will be worse than 2008. Back then high oil prices also played an important part in creating the financial crash.
The financial headlines today do, in fact, presage tomorrow, just not in the way most people think. They often signal an important top or bottom in the prevailing trend, which is just the opposite of what those headlines are saying or implying. I'm reminded of Stein's Law, the amusingly obvious observation made by economist Herbert Stein: "If something cannot go on forever, it will stop." It's easy to forget that in the frenzy that is now gripping world markets which are in thrall to the AI industry's hype machine.
P. S. For a short tour of magazine covers that got it wrong while inadvertantly giving fodder to the contrarian readers, see this summary.
Kurt Cobb is a freelance writer and communications consultant who writes frequently about energy and environment. His work has appeared in The Christian Science Monitor, Resilience, Common Dreams, Naked Capitalism, Le Monde Diplomatique, Oilprice.com, OilVoice, TalkMarkets, Investing.com, Business Insider and many other places. He is the author of an oil-themed novel entitled Prelude and has a widely followed blog called Resource Insights. He can be contacted at kurtcobb2001@yahoo.com.
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