What makes Yellen so confident in her ability to tighten without disruption?

The latest fad in CentralBankville is market manipulation. It has been the inescapable follow up to a long string of increasingly stimulative monetary policies. Easy money can be traced all the way back to the maestro’s nomination. He began with low rates, then came QE (BOE), even more QE (FED), please take it up to extreme QE (ECB, BOJ), introduce negative nominal rates (Riksbank), then profoundly negative rates (SNB), add some yield curve control (BOJ), and all while increasingly tilting towards “forward guidance” policies. Outright manipulation was, in retrospect, the next obvious step in the Central Bank’s conspicuous seizure of power in the global village. 

Why do I say manipulation? Because it is clear to me that the only difference between intervention and manipulation is communication. CB’s have been increasing their market intervention for the last two decades. So far so good, even if I doubt it’s a healthy habit if we want to continue to pretend that markets ensure the optimum allocation of resources. But post the GFC, and led by Bernanke, they have increasingly switched over to price manipulation.

Only the BOJ continues to intervene in the open as opposed to manipulating. If they want to keep the long bond yield low, they tell market players to expect unlimited buying by the BOJ at a certain level. If they want to support equities, they go on the tape to affirm they are buying ETFs. The rest, with a special mention for Bernanke (reluctantly, his successor as well), and Draghi, have fully embraced the dark side of the force.

Sure enough, manipulation is now a methodology applied regularly at most Central Banks. It gives them a feeling of control, and they are in control! They are pleased with their success. It does help to keep other players in the dark and confuse them with price and volume signals that they perceive as market generated -when they are in fact CB cooked.

All clear then? Nope. In the long run, it ain’t going to cut it either. Manipulation has never been a viable long term strategy, and this time is not different. Manipulation is only feasible at critical turning points, in a context of very easy money. At some point, when easy money ebbs, manipulation will fail, and it is hardly reassuring to see that Yellen is oblivious to the fate that awaits us.

Undisputably though, manipulation is working, for now, therefore helping Yellen, Draghi, Kuroda, and Co feel safe. It is a foolproof medium term strategy -when simultaneously implemented by coordinated Central Banks in the right liquidity environment. And it can wreak havoc within the ranks of the dissidents. Let me disclose that I got severely hit by the surreptitious short squeeze in European Banks post the Italian and Spanish bank bankruptcies of the month of June. I had a very strong short in the Euro Stoxx bank index and was stopped out two weeks ago for the second time in a row this year.

In truth, nothing new under the sun. Preemptive strikes against the possible generation of negative momentum in any of the financial or economic variables they target had already become the norm. I knew they did that in the Eurex market for sovereign bond spreads -but was unaware of the extended scope of their manipulative interventions. They manipulate not only rates but also equities, gold or even commodities when required -with timely and stealthy interventions. Even bank share prices are a target now! POMO desks are all over the place and preemptively strike against possible systemic risks when denoted by price moves of critical assets.

They do it for a substantial reason. Interventions are suddenly not enough if investors are aware of them. They would point their finger at inconsistencies in pricing. So CBs come up with a plausible narrative for a forced market move -and make sure it is attributed to market forces. In this way, they manipulate the variables that they think are essential to generate a guide for investors. They use market price manipulation to induce momentum following thus guiding investors in the “right”, extend and pretend direction. Press narratives make me laugh heartily.

I am near certain that coordinated manipulation is one of the taboo (nobody dares touch the subject) causes of the low VIX numbers. Low realized volatility influences implied volatility in the pricing structure -if sustained long enough. Of late implied volatility, however low, is still above realized volatility! Not to mention the most likely direct manipulation of the VIX that takes place when required. Pavlovian instincts are alive and well, and investors respond instantly to guidance and its enforcement by POMO desks when needed. Manipulated, powerful market moves show the way. The quest for yield ensures the crowd’s approval. Think on your own at your peril. I can attest to that.

I have no doubts that monetary largesse warrants the long term bullish bias in equity markets, but, regardless of the underlying trend, I have never seen a succession of bullish turnarounds (against all technicals) in such reiterated, almost standard fashion. Some major, vertical turnarounds take place when the volume and price activity have signaled a strong down move in most of the time frames. I have been trading global markets for a long, long time; I know what I am talking about! POMO desks prevent any breaks before they could near a systemic risk qualification. BTFDippers are happy to cooperate. ETFs do not leave the party. Stop busting and “fear of missing out” finish the job. POMOs end up making lots of money. Our money. It is a criminal conduct.

Manipulation is also the ultimate cause for the ridiculous pricing of Euro zone banks. I stumbled into a new widow-maker trade and was inevitably stopped out. Not that the situation for European Bank shareholders is not dire. Most of their shares are held by customers that have been told that what they are holding is a near risk-free product. It is vital that they remain oblivious to the risks of their holdings or else an investor stampede would ensue. The ECB can not afford that to happen. Mario is doing whatever it takes once again. I understand the ECB’s concern, but the end never justifies the means.

It is not manipulation that provides the overall bullish impulse. Liquidity and the quest for yield take care of that. Both provide the necessary bullish support for the success of manipulative activity that surged post the first 1Q2016 financial market scare. But even in a bullish market, we should have ups and downs; not everybody is that complacent. The problem is no “downs” are allowed to happen. The Yellen put is “at the market” and is permanently rolled over regardless of the price.

It doesn’t cost them money (they make it back manipulating prices), and they play the game in size. CB balance sheets have infinite elasticity when needed. With the additional help of ETF induced reduction in the total price-sensitive free float, their interventions are more and more meaningful. CBs are now firmly in control of the downside. They even think there will never be another financial crisis in our lifetime -forgetting the need for incrementally accommodative monetary policy to keep things stable. Yellen’s assuredness is eerily reminiscent of Keynes’ assertion of confidence back in 1927.

Pity the upside is another matter and has them worried enough. You cannot control everything -fooling everybody all the time. By now investors are exultant and play happily to the BTFD script -but refuse to take a more cautious stance in their asset allocation. Central Bankers are surprised by market froth. They completely forgot that it is always difficult to put the genie back in the bottle -particularly if you suppress downside risk for years.

As for their increasingly erratic guidance, the truth is they have us all confused -and their reputation is further tarnished by recent events showing that they have lost control of the upside in equities and High Yield. As the bubble soars, macro managers and global strategists are all at a loss when trying to understand Janet Yellen’s latest flip-flopped statements. Consequently, we have all been whipsawed to some extent (that is, of course, unless someone has played by the rules and stuck to a long only, trust the Fed, investment strategy). It is my worst year ever.

How do you blend the following Yellen conceptual contradictory statements into a coherent narrative? Let’s synthesize a couple of them:

  • We will probably never have another financial crisis in our lifetimes. Has she joined the Irving Fisher- John Maynard Keynes school of predictions?
  • QT (quantitative tightening) will be a peaceful process. Something akin to watching the paint dry. Wow! Best wishful thinking in town.
  • Weakness in economic growth and inflation figures is only transitory and should not affect the interest rate hike calendar or the QT schedule. Of late, she has tempered that view.
  • Valuations are probably on the high side and implicitly allowing for some “minor” financial stability concerns. Only on the high side? Really?
  • The QT process should start relatively soon (meaning September in Fed-speak). Got you, Janet. But is it going to last? Will it be market dependent?
  • The Wicksellian rate of interest is very near current levels and (implicitly) requires few additional rate hikes. Good guess! Sure of that or the precise NAIRU level as well?

Believe it or not, she said all of that in the last two months. When trying to make sense of it, I feel like I am working to decipher Egyptian hieroglyphs. Finally, I think I have a comprehensive view that fits it all in nicely. Let me explain is what I think she and the core members of the FOMC mean:

  1. We have had low or nonexistent interest rates for too long, and side effects are killing us. We want out of the NIRP and ZIRP business asap. We also need a cushion to use in the next recession when it inevitably comes. Some of us (Yellen and Fisher) would also love to leave positive real interest rates without a market bust before we quit (next year). Oh my God, please help us out of this corner we have painted ourselves into. Low rates cannot go on forever!
  2. Because I cannot even hint at admitting the detrimental side effects of low rates (Yellen), I have to base rate increases in perceived economic strength, and I have to sell the idea that the economy is doing fine -regardless of the disappointing figures in the data from March onwards. Whenever I see strength ain’t good enough and lose confidence in the ability to raise rates repeatedly without real or financial economy disruption, I will come back to being concerned not about a recession but about not having enough inflation. What worries me (Yellen) though, is being able to get out of low rates, and stop the bubble without busting it -or the economy.
  3. We are terribly scared about equity valuations, high yield spreads, VIX levels, commercial estate valuations and perspectives, unstoppable stock markets worldwide, house price levels and lease prices. We are aware of the risks involved where we sit now. But we cannot voice our concerns -or talk bubbles even in conditional mode.
  4. We think taking out some excess reserves (QT) might be more useful to stop the bubble than some additional rate hikes. And probably also less disruptive to the real economy. The financial bubble is the problem, but we can always pull back if we see too many cracks. We will adapt QT as it goes, if needed, monitoring markets carefully.  We will engage in market manipulation when necessary, and feel confident we have done well at that in the past. On a positive note, we are comforted by the fact that the real economy is unlikely to be affected by QT (it wasn’t directly affected by QE either) unless something breaks in the financial world. Manipulative guidance should help make sure QT is an orderly process.
  5. The potential growth of the economy has been severely hampered by the demographic and productivity expectations (of course they do not think they have also contributed to lower our growth potential). Debt levels are breathtaking: no way we can raise rates that much more. The rate level we can achieve is not high enough to stop the bubble. We have no alternative but to take some chips (sorry, money) of the table. At this stage, QT is a must do.
  6.  A strong dollar is not as good as it seems (Trump) but a very weak USD doesn’t help either. We need tighter financial conditions in the least disruptive manner. No interest in a weaker dollar anymore (but let’s make sure The Donald doesn’t get to know this). At some point though we will have to make a stand. Where?

Where do we go from here?

I think they are trying to take money out of the system and raise rates. CBs are now aware of the need to end easy money, or as they put it, normalize monetary policy. They will decrease stimulus as rapidly as they dare to, but keep an eye on both financial markets and the underlying economy.

If the markets or the economy tank, they will cease tightening, or even reverse course. It is too late in the game to change their strategy -however wrong they are beginning to understand it is. If only the market falls, manipulation and more base money or credit will most likely control the damage. But if it is the economy that takes a nose dive all bets are off.

Success at market manipulation makes them confident that they can handle market volatility and prevent any serious downside. They know ETF volume is dumb money that will only sell if frightened enough to do so. They will try to break asset bubble dynamics, get rates up a little bit higher, and make sure that they do not induce a market event or a recession.

The real economy is the variable they do not control entirely. Printing and pushing credit aggregates has helped the economy short term but they haven’t fixed anything structural. They know it. Every new massive intervention has added a new layer to the global debt overhang. Debt matters and at some point, it will sink the ship. The real economy will be the final arbiter of our fate.

Accordingly, I think we have to wait for an end of this artificially extended business cycle and sell only on real economic weakness. Financial market weakness will be aborted quickly with the same recipes they are using now. If this is a financial play, the game is rigged in their favor. More money and credit and lots of coordinated manipulation in a context of a mass of investors starved for yield make their success a sure thing.

I will take advantage of the time in between to lick my wounds and wait for the kill. Until the real economy breaks, they are the dark side of the force and still in control. I have learned that lesson the hard way. In the end, the real economy will implode crushed by the debt pile, the disastrous aggregate demand (inequality and wages will impede any improvement there), and the revolt of the have-nots. It is only a matter of time.

Timing is always the problem. Growth keeps slowing, and it is an ongoing process once the brutal 2016 stimulus has worn off. Only the BOJ and the ECB continue to prime the pump. But we should not expect financial markets to front run that event. Rather, capital markets might be late to react to a deteriorating real economy because it will take a severe jolt in confidence to erase the Pavlovian mentality now embedded into most fund managers.

I have been too greedy, and CB’s found my back. I’m short of ammo now, and I have to make the next/my last shot at shorting this bubble, count. In the meantime, I am standing aside and bidding my time, as I press myself to remember that this summer of 2017 is irreplaceable -and I can already feel it slipping through my fingers. Let’s make the best of it while we wait for the CB orchestrated, global financial genocide, to take place.

Holding-your-nose, or bidding-your-time. Pick your poison.

How long can this last...  After all, valuations are hugely stretched by any measure you can think of; there’s no disputing that. Not even the most steadfast bull could make a case that today’s market is cheap in some way. But does that matter? …

And that’s the thing; fundamentally, I think our market is absurdly priced. There are bubbles everywhere, … (but) extreme valuations can persist for a long time before something finally spooks investors into heading for the exits. And I’m not disputing that this is likely to happen at some point but I am saying that shorting the market or sitting in cash for years to wait for it is imprudent. …

Indeed, at this point, I’m not entirely sure what would actually bring about a sell-off and that is why, despite my bearishness on the fundamentals, I’m still in the hold-your-nose-and-buy camp.

Josh Arnold. Seeking Alpha (Emphasis mine)


“I’m having a hard time with this market because I can see what a powerfully stable social equilibrium is being established around this transformation of capital markets into a political utility. I’m having a hard time with it because, like any powerfully stable social equilibrium, to be truly successful in that world you must give yourself over to that world. You must embrace that world in your heart of hearts. …

I can’t do it. I can’t embrace the machines and the vol selling and the ETF parade and the central bankers’ “communication policy”. So I’m NOT happy. I’m 20+ pounds overweight. I don’t sleep well. I DON’T trust the Fed, much less love them, and I never will. …

So here’s my question. How do you survive, both physically and metaphysically, in a market you don’t trust but where you must act as if you do? How do you pass? How do you reconcile the actions and beliefs necessary to be successful in this market with the experiences and training of a lifetime that tell you NOT to act this way and believe in all this?

Accommodation to the Hollow Market is a miserable experience for discretionary stock pickers (and the same is true for any security selectors, whether it’s bonds or commodities or currencies or whatever), and the higher your fee structure the more miserable it is, which is why hedge funds have been particularly hard hit. Why is accommodation so difficult? Because the point of discretionary stock picking is taking independent, idiosyncratic risk. …

For the past eight years, whenever you’ve stuck your neck out with idiosyncratic risk sufficient to differentiate yourself and move the needle, more often than not you’ve been slapped around brutally for your trouble. So you stop doing that. … you effectively lock in your underperformance and pray for the Old Gods to return and unleash their mighty wrath on global equity markets. Of course, you’ll be down 50% of the market in The Storm, just like you were in 2008, but hey … at least that would give you a reason to come into the office. Anything but this. …

Ben Hunt. Epsilon Theory (Emphasis mine)

Don’t we all (particularly us males) love to think we are smarter than the rest of the pack? We elaborate sophisticated reasonings for the most pressing issues at hand. And we do well at that. If we had to judge market players’ expertise according to their capacity to construct and replace narratives as needed, then the EMH would be indeed viable. Sadly though, players’ capacity for narrative cannot be inferred and transferred to data or conceptual analysis’ efficacy.

We need more profound and unbiased analysis, less narrative, and an effort to keep things simple. Sometimes they are. Like today. Three decades of easy credit, easy money, and permanent ultra low to hard negative real interest rates have generated something really ugly. Now dubbed the “everything bubble”, it is also known as the mother of all bubbles (Saddam-speak), the big fat ugly bubble (The Donald), a permanently high plateau for stock prices (I. Fischer), or … you name it. The result is, in plain wording, a scary, extremely dangerous price environment for investable assets.

And we asset managers have to live with that. Unfortunately for us, this extreme environment begs some very tough heads-or-tails decisions of the kind I really hate. In such a bubbly environment, only four relevant asset allocation decisions matter. That is of course if he/she can afford to decide because passive managers cannot. And most active managers can’t either because of that frequently forgotten concept called career risk.

But if you can decide, you have to take a stance on these four issues. Very much like Josh Arnold and Ben Hunt, all of us active independent asset managers have to pick our poison. The good, safe options dissipated in a central bank deceptive nebulous long ago (not to be confused by the technological cloud where things are supposed to be safely kept).

  • First of all, we need to answer a primary question. Will we be able to reflate ourselves out of debt (explicit debt and off the books entitlement contingencies), without a bust?
  • Second: if the previous answer is a positive one, we must take a warm attitude towards risk. But, if it is negative, should we stand-aside-and-wait (with a more or less active bearish stance), or should we “hold-our-nose” and “buy-and-hold” for as long as we dare?
  • Third: if we think the credit bubble will not burst, or if we decide to hold our nose and go long equities anyway, should we opt for active or passive management?
  • Fourth: In order to obtain some additional return on top of the negligible level of risk-free rates, is it best to overweight bonds (currency, credit or duration risk), or stocks (beta, alpha, or both)?

I have already answered the first question many times over. Sorry for tooting my own horn, but I’ve been proved right up to now. Nobody knows what the future will bring, but I am confident that GDP growth will not bail us out.

My only doubt is if it is possible that, faced with a round of global debt defaults, CBs will manage to activate goods and services inflation, as opposed to asset inflation (see Goldman Sachs chart underneath) -and dilute our debt. I think it is unlikely that they would manage to induce a controlled amount of inflation and sustain it long enough. The odds are stacked against such accuracy, and some episodes of hyperinflation would be unavoidable. But there would be no bust and rare defaults. Inflation and debtors are BFF.

High inflation with bouts of hyperinflation, if achieved, would be no final solution to our woes, but … who cares! Nobody seems to care about long term fundamentals anymore. We are all buying time. In fact, life is all about that. Maybe we should use this mantra and apply it to economics and investments. It would be very Keynesian: the long term doesn’t matter because we are all dead.

Investors are still die hard Keynesians -or maybe they have just switched over to a new discipline: surf-investing. Only today counts. If they can buy USD denominated, one hundred year maturity, unsecured Argentinian bonds, then we are not looking for final solutions -but rather trying to kick the can down the road as far as it will go.

Yes, the Argentinian bond issue went three times oversubscribed, and I doubt anybody thinks that it will be honored at face value in 2117. Investors pick up the yield and feel comforted by the fact that recovering the principal will be somebody else’s problem. It sure will. When you see things like that, there’s that gut feeling that the end has to be near!

The second question is a difficult one to answer. I can’t share his reasoning, but maybe Josh Arnold’s decision to hold his nose and buy (top quote), is appropriate, to use Janet Yellen’s preferred vocabulary. She always finds her opinions appropriate. I find them dumb even though you have to credit her with a lot less hubris than her predecessor. As for me, I just hate to hold my nose … because I can’t hum. Humming and whistling along is essential to my happiness.

Seriously now. I just can’t sleep properly holding Amazon at 150 times earnings or Tesla at infinite times earnings. Hey, I have nothing against infinite -when in it is not referred to an investment valuation ratio. Infinite wisdom or infinite happiness would be great! But I digress, don’t get me wrong about those companies: both are truly exceptional even if I doubt the survival of the latter. Nonetheless, there is a reasonable, sustainable valuation for everything even if it doesn’t show in the market. We should always remember that price is what you pay but “value” is all you get. Momentum is only transient value: timing is everything. You have to remember that if you hold Tesla. At least Amazon has a sound business model with decent entry barriers (to put it mildly). Tesla will have to compete with the large automakers!

This issue is a tough call. I got it wrong until now. For nearly ten years I could have profited from the most obscene bubble in the history of humanity and I did not. Thankfully I made money elsewhere (bonds and currencies). Nevertheless, you have to update your stance every now and then. I do it constantly, but my stand today continues to be “no”. No way I am going to hold my nose and hold equities at these valuation levels and current debt reset risks. Yes, I am aware that there is a residual risk that CBs might get themselves out of trouble reducing the debt pile with no disruption. I will undertake that tail risk.

Why do I think we will not dilute debt with growth or inflation? Well, I explained that in my last post. My reasoning could be flawed, but I am confident that I got this one right. It is another issue altogether if this can be prolonged for another decade. I would have said no to that one a mere five years ago. Facts have made me change my mind, or at least doubt my timing.

Not that I can see this going on for long, but I also lack an immediate catalyst for an abrupt end to this fantasy. It follows that I have to be cautious because I got hit this year by the joint effect of the Chinese 2016 credit boom and the ECB-BOJ massive monetization. The lesson? You never know how much more printing and “crediting” we can take on board before we go under. Sometimes you have to be a coward and preserve some firepower. This might still go on for some time, but I doubt it. My female side tells me the end is not far off.

The third question is an easy answer. In this context, if I wanted to hold equities significantly I would go for passive management. Sorry colleagues! With stratospheric valuations, I do not think stock picking adds a lot of value. I love stock picking myself, even if I am now focused on macro and global strategy. My background is not quant oriented but that of a discretionary trader and investor. And I think stock selection it is the way to go in normal market conditions. But these are not standard fare markets. I even doubt they can be labeled as markets to a full extent anymore.

I would not go passive in my bond selection, but holding equities is a different matter. With equities, your beta is going to be 80% of your performance, and the universe of stocks to invest keeps falling as the “winner takes all” economic model takes its toll on most sectors. If I want to hold US banks, I would go for a sector ETF and remain as liquid as possible in this highly unstable global environment. The same strategy is valid for utilities or consumer staples to name another two sectors. Unless you are a picker in very specific sectors like Biotech or start-ups, stratospheric valuations make active returns at best indistinguishable from passive returns.

What about beta neutral and alpha only (balanced long-short or long alpha index hedged)?Current markets do not offer a pricing efficiency that can generate reliable alpha. And any alpha to be found is infinitesimal compared to the beta risk of your portfolio. Tinkering with your alpha while hedging your beta is not attractive because there is not a lot of upside and hedges would not be all that reliable in a global reset. And long-short strategies have been crucified by position crowding and CB induced stop busting.

I hope all of that changes soon, but for the time being it is all about knowing the exposure you are willing to underwrite in the everything bubble. Forget the subtleties and get the big picture right, or else you will not survive the implosion of the era of the central banker -when it comes if it ever comes (my faith in a return to sanity in global markets wanes and ebbs away daily).

Lastly a few thought on bonds? Sticking to the US (European sovereign spreads are not market spreads at all thanks to the ECB), fifty percent of the market says pricing is bubbly, and another fifty strongly suggest that the lows in ten-year yields are yet to come. The market was ultra short ten and thirty-year Treasuries in January and then flipped to the other side in May. Lots of money was lost in slippage and stops. All that money is in broker or ETF’s pockets now. We, active managers, are close to extinction. I can’t take comfort in the fact that my grandchildren will see a wax prototype of myself and colleagues in a museum, a couple of decades from now. I hate wax figures!

In the short run, I still take sides with the Ice Age hypothesis, but not without some caveats. A substantial part of our unemployed has become unemployable. Our low-skilled segment of the global workforce (a growing segment) is rapidly becoming obsolete. How do you introduce this concept into the NAIRU calculation? Not that I ever thought that you could nail NAIRU with a reasonable degree of accuracy. I think the Fed is getting one thing right: they have to tighten and reduce their balance sheet. Better late than never.

  • Employable worker slack is very tight, and the real cost of living, if you use reasonable weightings for shelter, healthcare or education, is soaring. No wage inflation to be seen just yet (I confess to being surprised) but …
  • And financial instability is atrocious despite, or maybe because of, ultra-low VIX readings and low spreads. They have to tighten financial conditions asap.

In the long run, it all depends on the attitude of CBs when they have to pick their poison. At some point, they will have to print to death, regardless of hyperinflation or whatever, or sit back and accept the global debt reset. Minskian Ponzi debt levels are a larger portion of global debt with every day that passes. In a global default wave, you get rid of all Ponzi debt and then some. I am not sure that CBs would accept that without going Bolivarian. I would only hold very long durations in futures, and then, with conveniently placed stops. Cash markets could become very illiquid if the market smells something remotely Bolivarian.

I said I would not accept passive investment in bonds because credit risk is the one I would like to monitor very closely. I could accept the risk embedded in the run of the mill duration of bond ETFs, and even their currency denomination risk. But credit risk is something to remain particularly active about. Some sovereigns are highly unlikely to survive.

All in all, this is getting more and more difficult. In two weeks time, I will comment on the USD, the yuan, and some trades. Something more specific. For today, the same as in my last post, I had to stress the big picture options. You just have to get them right. And I have to keep this post short. I am leaving tomorrow for an important Mediterranean regatta. I plan to enjoy myself: life is oh so wonderful that you can never get enough of it!


The post-Keynesian paradise (hell): few viable options left.

Time always provides the final judgment on an issue. To quote Cameron Crowe, it is always “time” that puts things in proper perspective. It took humanity an unspecified amount of time to know the Mona Lisa was superb. In just a few decades we learned that María Callas was as close to unique as you can get in real life. But, regrettably, it took almost a century for most economists to realize that Keynesianism (monetary and fiscal policy) was not the solution. It was the core problem, to begin with.

A debt overhang was not going to be solved with more debt, however profusely lubricated with monetary aggregate largesse. Even back in 2008, it was crystal clear that it would only make things worse. It sure did. We bought ourselves some time (one decade), but at what cost? Much like in the perfect storm we find ourselves in the wrong place at the wrong time. Never mind the extraordinary debt pile. While postponing the day of reckoning we have synchronized a couple of worldwide social and economic trends that seriously endanger a peaceful future for our species.

Well-known facts first. A huge and relentless money and credit boom that began when Nixon closed the Gold window has taken our credit and monetary aggregates to unthinkable dimensions. Despite the CB engineered delay, we face the inevitable bust of the cycle -according to Mises. Okay, I know not few think that the Mises outcome can be avoided, but even the optimists concede some difficulty when trying to achieve just that. I will give you a couple of charts to illustrate the point. The first one is courtesy of the McKinsey Global Institute -the figures are largely worse two years later, particularly in China. Global Nominal GDP is 78 trillion for 2017. Do you really think we can we dilute this debt pile with no bust?

The second chart shows the monetary base growth implemented by the three main CBs since 2008. Staggering. BOJ and ECB are increasing their balance sheet in 2017 by a further two trillion! We are monetizing more than 7% of European GDP per year yet we are delighted to find out that we are achieving 1.5 to 2% growth at best. Does that sound like remotely sustainable to you?

Are you missing the PBOC’s assets in the previous chart? It is not relevant to include the PBOC in global monetary base growth. The PBOC has resorted primarily to credit growth instead of base money growth because they control the banking sector. Sex is taking place behind not fully closed doors, in the Total Social Financing variable. Quarterly figures are breathtaking (chart: Zerohedge).Nevertheless, you pay a price for everything, even in China. Liquidity constraints at financial institutions have become serious by now, and the need to handle them is one of the reasons to “de facto” suppress free market pricing for the USDCNH. They need their USD reserves to provide some credible backing to the amount of renminbi they have to print to keep their financial system alive.

The next chart (hat tip: Kevin Muir) shows that monetary base growth keeps accelerating, demonstrating that this is not a stable macroeconomic model. We need incremental amounts of new money to remain afloat.

Let’s not become too fixated on debt. Sadly, the obvious debt overhang is no longer our sole relevant concern. Things have deteriorated sharply in the last decade. Social trends and CB policies have bought time at the cost of fostering major impediments to growth, the traditional recipe in order to dilute excess debt creation. It is difficult to grow yourself out of debt past a certain point. It is impossible to do so after ten years of disastrous neglect of the supply side -favoring instead financial market speculation. The reflationary trade is dead in the water and I have been saying so for months. I am betting the farm on that. Growth will not put a blanket over our accumulated credit excesses this time around. Why? We have messed up our supply side. Growth is a simple matter. It depends on the number of hours worked, and productivity increases. The number of hours worked depends on the working-age population growth. Productivity has two drivers: education and CAPEX.

A multiplicity of reasons suggests population growth is a non-starter in the developed countries. And we do not want to take on some people from the underdeveloped world to fill the void. It won’t be easy to change that because we need more than the addition of new souls to the production process. We need “educated souls”, and it would help if they were spiritually educated as well. I don’t care the underlying religion or lack of it, provided the ethic code shows some consistency. No way we can achieve those educational standards soon enough.

Productivity will not fare much better in the short term. The CB orchestrated money flood, and financial repression has lured savers to play the “everything bubble” -destroying CAPEX expenditure and, consequentially, productivity growth.

Money has been diverted from the real economy to fuel credit and financial market excess. Zero rates have grossly added to discounted cash flow values simultaneously providing “faux” valuation support (the Fed model is a sophism), and animal spirit backing for all the speculative activity taking place. In the meantime, our supply side barely invests to cover depreciation of our current capital infrastructure. With insufficient CAPEX, and decreasing standards of education, productivity is a mess, and it will also take a long time to fix that. US figures are unnerving. It’s just as bad, or even worse, elsewhere.

Our supply side is hardly ready to take a leap forward. It shows some serious additional flaws. Zero and negative interest rates have endangered the stability of corporations in the US, taking the ratio of corporate debt to EBITDA to historic heights. Much less so in Europe and Japan, but China is another leveraged corporate monster. And our global supply side has maneuvered successfully to avoid taxation and convert competitive markets into oligopolistic structures. In most sectors, the winner takes it all, creating a spiral of increasingly oligopolistic global markets. The “FAAMGs” are the paradigmatic example. Nothing that can’t be fixed if we want to (the establishment does not), but this is not a supply side that can spring to efficient, widespread growth instantaneously.

At this point in history, we are fast running out of luck. There seems to be no limit to our woes. Robotics is endangering a meaningful percentage of our global workforce, adding to the problem of unemployment, and the increasingly inefficient distribution of wealth. It will be difficult to build a solid aggregate demand if we cannot put most people to work and pay them reasonable salaries. By raising the complexity of jobs that are left for humans (the rest will be taken over by robots or software), technology is compounding our educational problem. We not only need to recover previous educational levels. We have to increase them markedly, and steadily, over the next decade or more.

Lastly, the population is growing older as we combine falling natality with the extension of life expectancy. The population dependency ratio deteriorates as I write -and this is a secular trend. That does not bode well for entitlement pressures, never mind the undeliverable promises that have been sold by our politicians to the masses. Even if we had no accumulated debt, entitlement promises and pensions were a chimera. Add debt and life expectancy expenses (medical and pension costs) to the problem, and there are very few viable options left. A lot less than in 2008.

In fact, whatever growth we have been able to squeeze out of the system since 2008 has always been based on debt, money printing, or currency devaluation. Healthy, productivity-driven growth has only been found in a few small countries.

We have already shown the consequences of printing and growing debt aggregates. Devaluation of currencies is another traditional way to grow. But, globally speaking it is a zero sum game. You can devalue your currency against the rest, but not everybody can devalue at the same time. Some countries can opt for this, but it will never be a global solution to what has become a pervasive planetary problem: growth!

Think about it. We have simply been shifting growth around with currency market moves. A strong yen transferred growth abroad. A weaker yen took it back to Japan. Euro weakness last year stimulated the euro area and euro strength will sap growth if kept up.The Chinese would love to devalue if allowed to, Trump wants a weak dollar, Swiss and Swedes want weak currencies, the Bank of Canada allows bubbles to form when trying to keep rates low to protect the Loonie, New Zealand tries desperately to temper Kiwi appreciation. The minute the problem is global, currency devaluation is out of the question for most. We will not collectively devalue our way to growth either.

Sooner or later things will have to change … big! It is thus crucial to find out faster than the rest what road we are going to take -as these problems explode and provoke a new era for society and financial investments. It is not difficult to envisage the problems we are up against. It is near impossible to know what the CBs will do when pressured by future events, or the calendar of such events. Yet therein lies the reward in financial terms. We won’t get paid for outlining the problems. But we can make a killing if we are the first to guess what our establishment will do when confronted with reality. There is also great value in pinpointing the time more precisely. An unlikely feat unless luck helps.

What can CBs and governments possibly do? Well, let’s start by looking into what they are actually doing right now.

Muddle through: Austerity and Financial Repression.

From a macro-financial perspective, initially, I don’t care much if austerity is imposed reducing government expenses or increasing taxes. Of course, I have a view, but I think the relevant issue is to assume or not that millennials will accept to pay for our excess, either diminishing public services or allowing for a higher taxation that does not provide them with additional services.

In the long run, I am positive that the new generations will revolt against paying for our excesses. They don’t hold most of the financial assets endangered by a global reset. It is in their interest to bust the system and write off debt -and as a side effect they will devalue real estate prices and enable access to ownership of their homes. They cannot afford them now. Healthcare and educational costs are also pressuring them. At some stage, they are going to say enough is enough.

Austerity comes together with financial repression. We have done this in the past, in the aftermath of WW II. Investors help dilute debt if CBs impose negative or barely positive real rates on debt. It takes a long time but it can dilute debt significantly if maintained. It also helps public perception of the sustainability of a high debt load.

It is morally repugnant. Money is transferred from prudent savers to people and institutions that overspent or overindebted themselves. Old people are affected most because it impacts the return on the accumulated savings of a lifetime. Sublime unfairness!

But it works, at least for some time. The main problem is not just the moral underpinnings of such strategy,  but the significant side effects we explained in previous paragraphs. Zero rates destroy propensity to save, generate asset bubbles, bankrupt insurance companies, and pension funds if kept for too long, decrease CAPEX feeding bubbly speculation instead, augment wealth concentration, stimulate further leverage etc etc. Low rates are unsustainable in the long run, particularly in economies that need substantial CAPEX investments due to the complexity of the installed productive capacity on the supply side. If kept low for too long, productivity stalls, creative destruction subsides (no cleaning up of economic zombies) and growth languishes.

The key issue is: can you perpetuate austerity and financial repression? The answer could very well be yes. Acknowledged, you can’t be sure of anything nowadays, regardless of the fact that even CBs themselves see obvious stability risks (ECB chart released last month shows it clearly). Yet my own view is that, before long, the have-nots will denounce austerity. Even if that doesn’t happen, over time, financial repression will stymie our residual growth potential, taking the global economy to a standstill and a global recession. It’ll be curtains for markets after that. When that happens, if it happens, is anybody’s call.

The nuclear option: Debt defaults.

A plain global default of the unserviceable levels of debt is the free market’s choice. Most active independent Asset Managers are desperate to get there. Put me on that list. No matter how painful, we need to move ahead, and the sooner the better for the new generations. Defaulting is not something to look forward to, but the alternative options are even less palatable. Governments should print only what’s needed to protect bank deposits “strictu sensu”. All other financial assets should teach their holders the true meaning of risk and fake valuations. We ought to leave moral hazard behind before we engage in a new economic model that precludes credit and monetary induced growth.

Understandably, CB’s try to prevent this outcome. It was a long time ago that central banking was an honest profession. Bernanke is still arguing that he did the right things in spite of assuring in 2008 that subprime risks were “contained”. Amazingly he kept the job for another seven long years.

The Zimbabwean way. Currency debasement using inflation.

This is the traditional method to destroy debt. You can still opt to inflate away your debts. But you have to generate inflation in the real economy for that end. And go ask Mario, Janet, or Kuroda-san, it ain’t easy. Somehow the money is always finding its way into physical or financial assets. Even if you succeed at stoking inflation, you have a new problem: keeping long-term rates low (you can anchor short-term rates, but to anchor long-term rates as inflation grows, you need some kind of permanent QE).

If inflation becomes the preferred option and it takes hold, you want to convert your money to equities and physical assets fast enough. An inflationary environment is the only way to prevent a stock market bust. All shorts would be exterminated.

The existence of this option is what makes things so difficult for a fund manager. Equities are grossly overpriced but would be the asset of choice in an inflationary scare. We just had one. And you never know what CBs might do. It CBs fail to generate inflation, intentionally or not, debt defaults are forthcoming and prices could be cut in half. If they succeed, equities will soar as the asset that best protects you in that environment. An extreme binary option between both tails of the normal distribution. Buying index puts and calls makes a lot of sense, particularly with current levels of implied volatility. Only the difficulty of the timing puts me off.

Tough times ahead -but you have to believe in humanity.

We have painted ourselves into a corner with no easy way out. However, the choices that will be made greatly condition the optimal investment strategy. Impossible to know well in advance. I will do my best, but can’t help a feeling of despair when I think about what we are up to. Preserving wealth in this context is a vast undertaking. When faced with something we don’t know, and can’t possibly know for certain, you have to remember Mark Twain’s prescient advice. It ain’t what you know, but what you think you know, but don’t, that will get you into trouble.

Remaining humble and adaptable is key to surviving this future, Mauldin denominated, “Global Reset”. While we wait we can lift our spirits remembering some of the highlights of the human species. If Donizetti and Pavarotti could write and sing this piece, there is at some point a bright future for us. I always run out of tears when listening to it.

The crux of the matter

“Every time the economy stops slowing or contracting, people seem to become irrationally hopeful that means something truly radical and positive even though all experience since 2007 has demonstrated that there actually is no rational basis for that hope. The road to Japanification is surely paved with so much disbelief. It’s completely understandable in a sense since it has been almost eight years of all the “experts” constantly claiming that things were definitely going to get better.”

Jeffrey P. Snider

So much for the Hopium apex of H1 2017. Hope has never been a viable investment strategy, and if you base ten investment decisions on hope, on average you are going to turn out as a loser. But if you do it just once, maybe you can pull it off. Not because hope helped your chances of success (it sure didn’t), but because what you were hoping for just happened.

So right now, this is a binary risk. Like tossing a coin for heads or tails. After ten years extending and pretending (in fact a couple more if you take into account some pre-GFC central bank practices), we are about to find out which side of the intellectual divide of our economics profession got it right. Can we reignite a credit cycle without cleaning up the previous excess, or is it correct to state that Japanification is our course, and no sustainable recovery can take place in this context?

Everything I read or hear points to a state of mind where investors have decided that the time has come for an economic take off after the crisis. This must be it, everybody thinks. Yeah, lots of risks looming, but experience has taught them that BTFD is the thing to do. Central Banks will prevail. And it has unsurprisingly become a self-fulfilling, self-reinforcing, prophecy. Investors keep on buying the tiniest dip in spite of nuclear war threats, or even a couple of FOMC members coming out “en masse” to suggest that the time has come for the Fed to shrink its balance sheet. Nothing can stop this train.

Monetary Policy started this last tranche of the bubble (the “everything bubble”) when credit growth flopped in 2007. Ironically, this last 2017 bull market blow off comes at a time when monetary policy is being accepted as nearly exhausted everywhere. Isolated and pretentious as they are, even CB politburo members have begun to realize the long-term dangers of shoring up monetary and credit aggregates. Not only The Fed openly suggests it is going to reduce its balance sheet, but the Dutch parliament gives Draghi a warm welcome with a beautiful tulip -to remind him of one of the best bubbles of all times. Very subtle. I’ve got more examples, but I feel these two suffice. Confidence in monetary policy has declined markedly, at least in academia.

Continue reading

On “hopium” and the delusions of crowds.


“Religion is the sigh of the oppressed creature, the heart of a heartless world, and the soul of soulless conditions. It is the opium of the people.”

Karl Marx

In a world with scant, if any, religious feelings left, hope is the establishment’s spurious replacement. In the well known Marxist quote above, you just have to change the term “religion” and read “hope” instead. The wise but controversial adage is still valid today. The establishment and CB politburos have been using Hope & Opium to kick the ball forward -for a seemingly endless decade. So far so good, but it pays to remember that hope never was, and will never be, a viable investment strategy.

It’s bad for morale to discredit hope, and I am aware of the high probability of being ignored as the automatic defense mechanisms for “cognitive dissonance” immediately pop up. If you need the yield or the return (ROI), financially you just have to be  “all in”. Most investors are additionally even selling some volatility to enhance their returns, regardless of being aware of assuming undue financial risks. It is all understandable. If I need the return, TINA is my criteria of choice (load up with equities, sell volatility). And if I were all in, I would hate to read my posts. Nevertheless, take a close look at the next chart. It shows the exuberant levels of risk in the system and gives me the shivers.

It could all well be the result of a new era. And, according to Heli-Ben debt doesn’t matter (LOL). Apparently, valuation doesn’t either (low rates are thought to provide a waiver that protects them from valuation excesses). But, at least, let’s look at financial valuations in relative terms (compared to physical assets) in the next chart. Sobering, ain’t it?

Finally, I can’t resist talking valuation in absolute terms, if only for a short overview. The Schiller CAPE confirms all our fears (see for yourselves online). So do charts on market cap related to gross value added, or price to revenues ratios -and all others that do not use “estimated future adjusted earnings” and current rates. That applies to most markets, Japan being the exception.

But complacency is soothing, and its appeal is difficult to resist when investors feel that they hold a CB put covering their back. No wonder everybody and their dog is short the VIX, and markets are rallying on little more than hopium. I have no words. I can do no better than Paul Brodsky at summarizing what’s going on.

“Rising markets, an unwillingness to acknowledge fat tails (unlikely knowns), and the inability to model Black Swans (unknown unknowns) have concentrated popular wealth into a narrowly distributed range of highly vulnerable assets and investment strategies. … 

We cannot help but conclude that asset prices are generally rising due mostly to inertia, in spite of unreason, and that the most likely outcome will be something unexpected and disappointing. …

 A socialized market framework with implicitly guaranteed perpetual positive returns for all must fail. … Helping to close unsustainable distortions is the only way capitalism can survive. Capitalism without failure is like Catholicism without hell.” Continue reading

It’s not “the Donald”. It’s “the dollar”, stupid.

Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries’ demand for reserve currencies.

On the one hand, the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities. On the other hand, they cannot pursue different domestic and international objectives at the same time. (…)

The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists.”

 Governor Zhou, People’s Bank of China, 23 March 2009 (emphasis mine)

Most pundits are unaware of the relevance of the USD at this point in time. They’d rather skip the point. I listen to frequent complaints on the “unpredictability” of currency prices. Maybe, just being naughty here, the underlying reason is that trading the majors, ie USD/JPY or EUR/USD, is tantamount to singular trading capabilities for most. I honestly find currencies more predictable than equities, but a host of market players prefer to engage in stock trading with a long only bias. We have to bear in mind the extraordinary behavioral biases that have been engendered by decades of easy money -and it’s certainly addictive to go long with a Greenspan kinda put to cover your back.

Unfortunately, notwithstanding the difficulty of getting the dollar right, at this stage, it is a must. It is “the dollar” (and not “the Donald”) that will be the main driver of global financial market developments for the next couple of months -and even well after we transition into a new global economic regime.

In order to understand “the dollar”, we must understand the history of the International Monetary system (IMS), all the way from the Bretton Woods accord, where the USD was granted prime reserve currency status, to the Nixon letdown, and, finally, the Global Financial Crisis. And no, I am not forgetting the 1985 Plaza accord in between but it is hardly relevant from a structural point of view.

Please bear with me for some background. The role of the dollar as the primary reserve currency begins at the BW summit, and it is essential to understand why the newly bred system was flawed from the very moment of its inception. Continue reading

Lost in translation.

The more things change, the more they stay the same.

Gary Lineker synthesized the essentials of soccer in a memorable if somewhat simplistic quote. “Football is a simple game. Twenty-two men chase a ball for ninety minutes, and at the end, the Germans always win.”

When it comes to finance, the same postulate applies. Politicians, and Politburo members (read central bankers), or us fund managers and analysts of all kinds, come and go, but “Government Sachs” is the permanent result. As the French (Karr) would put it, “plus ça change plus c’est la meme chose”.

Trump is a teenage-minded social disruptor, not an economic game changer. Trumponomics, or reflation, are nothing new and are not going to be all that different. Expectations with Obama were even higher, and the economic result at the time was … more Government Sachs (with the Obamacare disaster as a poisoned heritage)! Trumpist honeymooners, please come back down to earth. Deflation or reflation, more QE, yield curve control, infrastructure spending, or some helicopter money, hardly matter -in the neglected long run.

No president can change deep secular trends. Like global warming, debt overhang, growth to debt increased dependency, the factual bankruptcy of not few sovereigns, aging society, technology-based job destruction, the deteriorated educational level of the workforce, or unfeasible promised entitlements. On these issues, Government Sachs people argue that the glass is half full. I won’t argue about it -it is not a worthwhile contribution to engage in estimating the degree of fullness or emptiness.

Half full or half empty, these issues are serious stuff. Changing the unnerving, deep structural trends, takes commitment, hard work, a couple of decades, and it sure implies turning things upside down. This US President and his Government Sachs team are certainly not interested in turning this “winner takes it all” economic model upside down. They want to remain on top. They are a club of smart, self-serving billionaires!

So, what’s all the market fuss about?

I talked about all those 2016 liquidity enhanced financial price swings in my last post, and I stated that the narrative follows the facts. I still think so. Let me add something else: behavioral economics runs the show today. The success of the ongoing (quasi aeternal) Central Bank put, and constant risk suppression by hyperactive POMO desks, has finally modified the behavior of economic agents. They feel that risk has effectively been outsourced to Draghi, Yellen, Kuroda, and Co. Consequentially, and for as long as we are in a context of negligible yields for IG bonds and Sovereigns, speculation with term premiums and equity will remain rampant. There is no alternative parking for the smart money, so the show must go on. We will bet the ranch on every twist and turn in whatever narrative “du jour“.

Sadly, it follows that liquidity pumped swings, fabricated credit booms (like the PBOC turbocharged credit boom in 2016), and outright POMO manipulation, have all but taken me to being “lost in translation”. So far, I still know where I want to go, but I wonder where and when the next surprising/unexpected move is going to flare up. Short term handling of the fund’s NAV has become exhausting -you never know what’s going to hit you next. Sometimes you are unable to find out what hit you last!

Market price swings are getting worse, and even more unpredictable. And it’s not a question of just being humble and looking up what somebody else has to say -in order to find the lost thread in your narrative. I do that daily, and, unfortunate as it is, I can see that I am not alone in my musings and contradictions. The latest “pissing” contest between Gundlach, Gross, and Minerd, on the TA limit needed to declare the end of the bull market in Treasuries, is a case in point. When it Is all about how to use the ruler to define your trades, it is an ominous sign for us all. With all respect to classic TA (I use it as a tactical discipline), rulers are becoming much too prominent. I crave for substance. Continue reading

The Keynesians, the Pavlovians, and other tribes.

Staunch Austrian Economists argue that a known quote, attributed to Milton Friedman in 1965, was taken out of context. For most, he signed in for Keynesianism when he coined the phrase “We are all Keynesians now”. Well, maybe he did. But such enthusiasm does not jibe with the fact that, three years later, he felt the need to fine tune his views on the issue. He then stated that what he really meant was that “We all use the Keynesian language and apparatus; (but) … none of us any longer accepts the initial Keynesian conclusions.”

That goes a long way to prove that Keynesianism’s obsolescence has roots in the very distant past!  Fifty years ago, a key economist like Milton Friedman felt the urge to distance himself from the “Keynesian initial conclusions”. Not that he was a stand-alone dissenter. For that matter, Von Hayek had used much stronger words to underline the major economic shortcomings of Keynesianism. “Bon-Vivantism” or “Shortermism” might have been a more accurate depiction of the discipline’s content.

Unsurprisingly, it was only the initial, tweetable quote, that remained in the minds of the economists of the time. Fast forward to 1971, and Richard Nixon wasn’t in the mood for subtleties at the time. Reportedly talking off camera, he told an ABC news reporter “he had also become a Keynesian in economics”. Off camera, or not, he was just talking his book. He had no choice but to officially embrace Keynesianism, and the leeway provided by the indiscriminate use of monetary and fiscal indulgence it supported. Sure enough, six months later he suspended the USD convertibility into gold, effectively defaulting on the gold peg of the, from then on, reserve fiat currency of the global economy.

Regardless of the need to cut the peg short at the time (defaulting in full was the only other option), nobody in the Austrian School of Economics can pardon the fact that he failed to anchor the currency to some other alternative peg (I stand for a peg of the monetary base to “Gross Output”, with a 2% flexibility band on each side). From then on, money printing was to be unlimited in nature and relied exclusively on the collective decision of the FOMC, and that of the other Politburos.  Keynesianism provided a free entry into the wilderness of limitless public deficits, ever expanding debt levels, boundless CB balance sheets, and manipulated interest rates.

Taking his cue from that doctrine, Ben Bernanke pondered the merits of the modern technology called “printing press”, together with the use of helicopters to spread out the money. That infamous speech earned him the deserved nickname of “Heli-Ben” -and a long tenure as the chair of the Federal Reserve. From then on, the world has been run on the premise of full conversion to the Keynesian religion.

A couple of decades later, and we all ought to be enthusiastic Keynesian converts by now. If Nixon had no other choice at the time, just think about what our real options are, today! Even if we wished to abandon the Keynesian discipline we have long gone way past the point of no return. We are truly stuck.

  • Piles of debt effectively impede moving forward, or even backward, with fiscal or monetary recipes, for much longer.
  • Outrageous inequality has been enabled by financial repression (punishing savers to enrich investors in the top wealth tier), and fostered by the availability of ever cheaper debt, with the aim of subsidizing faltering aggregate demand. Obviously, technological change hasn’t helped either. Ditto for educational levels, nearly everywhere. Top chart with the daunting wealth pyramid, courtesy of Gordon Long.
  • Supply side neglect has rendered a substantial part of our goods and services produce, obsolete, or environmentally unsustainable.
  • Keynesian public spending has bloated government sectors to more than 50% of GDP in some countries. European Labor Unions think it is not enough!
  • Unlimited liquidity has generated bubbles and inefficient pricing in most markets.
  • Zero financial costs for borrowing has favored a gearing up of most non-financial conglomerates, and a desperate search for yield (read return) by most investors -at all costs.

Yet we keep switching from monetary to fiscal Keynesian policies, suggesting escape velocity came real close with QE, or, of late, suggesting that fiscal reflation would solve the previously described pathology of our global economy business model. An endless continuum of policy mistakes. For how long? Continue reading

Trumpocalypse Now?

Perception might be the reality in your retina, and the only relevant factor when working to push the ballot count in your favor. But in real life, sooner or later, it is reality that inevitably prevails. That goes for economics as well, regardless of the easy fixes offered by Trump’s economic program, and others. Our present global economic reality is, at best, worrisome -and with a sad prognosis for the next couple of years (or more). That is a fact that can be perceived in many different ways. Make it opposite ways if you wish. But a fact after all.

In this world of relative beliefs, and prevalent wishful and/or politically correct thinking, finding the truth should still be the underlying quest. Learning the (economic) truth takes time and effort because it is complex and difficult to fully grasp and comprehend. It is so tiring, that we have come to accept that there is an infinite amount of truths for the same fact -depending on the color of the lenses of the viewer. Can’t find the underlying truth? Don’t stress out. Relative values have long faded absolute ones. Most think there are different truths depending on the eye of the observer. Nobody wants to find the naked truth anymore. It might be sobering, and it is not worth the effort involved. Or is it?

Bearing this in mind, we have to take the recent Trump event with a grain of salt. Here comes “the Donald”, now Mr. President, stating the obvious to all (by now): that monetary policy with its reiterated tools of financial repression, and abundant printing and lending, was not the way to go (Of late, Theresa May apparently also got that message as well). The issue is, for both, and for the rest of us, that despair and depression (of the economic kind) are not a great alternative to Keynesian wishful thinking. Nobody dares mention them.

Thankfully, “the Donald” and team have thought up something “new” in order to inject some badly needed optimism. A good old bricks and mortar revival conveniently sprinkled with some fresh lending. That ought to help him pull it off!  After all, he knows both sectors well, his life has always been full of bricks and mortar, and debt -lots of it. I wonder why prolific Paul Krugman hadn’t thought it up beforehand (maybe too many vested interests in the Keynesian priesthood monetary cause).

yogi-berra-quote-its-deja-vu-all-over-againWe live interesting times. Hence, it was unsurprising to see a post-election healthy bid for Caterpillar and the Banks, while Alphabet, Amazon, and Microsoft were sold with disdain. The Dow up big, and the Nasdaq down correspondingly. Animal spirits are all over the place once again, because brick and mortar spending will save the day. Hip Hip Hooray!

Inadvertently, we are getting used to all this nonsense. A couple of months ago, just after Brexit, it was the promise of infinite NIRP and helicopter money taking equity markets to a new, if marginal, top. Now, it is the reflationary program that will allow the present economic cycle to endure. Only our species can be stupid enough to move from fiscal to monetary policy and then back again, reiterating the same mistakes “ad nauseam”. Whatever they do, they never try to fix the supply side. See (above) what infamous Yogi Berra had to say for situations of the sort. It always pays to smile when facing such a serious issue for mankind, particularly when high doses of Prozac are the only alternative. Continue reading

A Botox high for makeup heavy financial prices.

We live in a finite world. Finite land, finite water, and resources, and a finite life. But sometimes our patience is stretched out to infinity -or close to it. We, financial experts, and ordinary fishermen, both share the need for patience. It comes as a tough achievement, because, as Franz Kafka once suggested, long waits (he mentioned eternity) can be exasperating, “surtout vers la fin“.

Ever since Alan Greenspan started to use his monetary tool box in order to conduct and conform market behavior (October 1987), valuation has mattered less and less, and financial markets have been morphing into casinos. Monetary aggregate levels and their growth, interest rate suppression (financial repression, and the consequential quest for yield), and the Fed’s valuation model (based on the infamous “ERP”) have fully taken a front seat. It’s now been nearly a decade since these three drivers for financial pricing became the only game in town.

It is indeed a brave new world. The world where equity prices can float comfortably above the 2.3 times price to sales ratio level (US), and while at it, brush off any inconvenient events. Like Brexit, a two-year negative growth spell in profits, or an increase in the debt/EBITDA ratio for NFC’s, that ought to affect the WACC seriously, and valuation correspondingly. Impressive -to say the least.

And it does look like a Fisherian permanently high plateau at first sight. Monetary policy tools have successfully suppressed volatility, driven markets the CB’s way, and helped improve consumer confidence. Yet, stubbornly, I still don’t buy the idea that you can indulge in ordinary “long-only” asset management, in this seemingly placid environment. Financial markets are the shakiest house of cards I can remember in 30+ years of trading.

Fortunately or not, depending on your point of view, all actions come at a cost, and nothing lasts forever. After years of monetary abuse, out in the open for everybody else to see, the true nature of the so-called “monetary policy tools” has been revealed. The essence of the much fantasized and overhyped, CB monetary toolbox, is, after all, a cosmetic kitfed-tool-box, with lots of lipstick, mascara, eye shadow, or rouge. The functional, basic health of the underlying financial system, or the economy, is unaffected by all those skin creams, lipstick, and even Botox of late.

I find it remarkable that CB’s got away so easily, doing no more than plain cosmetic manipulation, for so long -as mesmerized investors watched in awe what CB’s were apparently able to do. They did well at deceit, and their success has provided them with an invincibility aura that has kept them alive against all odds. In the meantime, we feast on supply side neglect. Nobody wants to streamline and update our productive capacities, Schumpeterian creative destruction costs votes. Votes are, literally, all that counts in politics.

Needless to say, I have been gradually running out of patience. Thankfully, not out of other people’s money. Not that past results protect you for long. We all have to remain humble, or else the market will do it for us. No, no problem with humility to report, but I am running real short of patience by now. Still some more left, but not much. I can’t wait to move on to a new phase in the solution of our global economic problems. One in which the use of Botox is forbidden. One in which I can cease to represent the Perma bear script. I’m fed up with the role. It’s boring!

We might be very close to the end. Witchcraft is “out”, as soon as the general public gets acquainted with the underlying bag of tricks. Sooner or later, somebody finds out there is no magic in what they are doing. Investors are currently dawning on the fact that Central Bankers are not the “magic people” they themselves think they are. Playing their missionary role, in the Common Knowledge game, becomes a lot more complicated from then onward.  Go ask Janet.

What has changed in financial markets over the last couple of months? Two things. First, Investor perception of Central Bank’s capability to keep these Botox treated markets looking pretty enough. Second, the degree of conviction of Keynesian priests in the efficacy of what they are doing.

Nothing else has changed substantially -hey, I think I know what you’re thinking now. What about debt and leverage? Well, sadly, the underlying health of the financial system is largely irrelevant for as long as we have the CB’s back. In the meantime, debt has, of course, kept growing exponentially, and the global economy looks anything but healthy. Everybody knows that! Still, being more of the same, this perception is not really a game changer. We got used to talking debt in trillions, and it hardly bothers us anymore. Continue reading

A subtle, self-restrained, change of heart.

Regarding eternity, it is my conviction that nothing; not even love, hope, or faith, springs eternal. Neither does life. Thankfully, there is an expiration date for all of us. Emotions, hopes, and beliefs are, more frequently than not, faded at some point. To all appearances, our Central Bank deities are also impaired by this human weakness. The very same year the 1975’s have begun to sing about it, most Central Banker’s, discreetly and dispassionately, have, all of a sudden, had A change of heart. About time! As Unamuno (famous Spanish essayist) once stated, a man has the permanent right to contradict himself. Good to know that, because it might come in handy soon enough!

Following up on that sudden change of heart, please don’t make too much of it. It’s not an abandonment of their firm beliefs in Keynesian utopia, and it is circumscribed to some specific, but highly relevant, matters. Like…. Well, amazingly enough, it is related to the merits and efficacy of “nirping” and “printing” ourselves all the way to financial disaster.

Most Central Bankers had a nightmare this summer, and the Kalecki path to monetary destruction was clearly exposed to them in a dream. It was a MLK kind of dream, vivid and clear -they are now scared to death. Of late, I can see the fear in the whites of their eyes -as they inevitably question their deeply held faith that the Bernanke policy mix would save the world. Bad for them, but, I will concede, it comforts me deeply. Apparently, insanity, unlike stupidity, does have some limits after all.

Not that the dream couldn’t have come earlier. It was crystal clear to anybody who wanted to see what was going on. In fact, it took ages. To prove the assertion, I am reproducing three great charts, courtesy of Tad Rivelle at TCW, John Hussman, and Jeffrey Sneider. They all summarize what the FOMC members have done over the last 25+ years (Greenspan, Bernanke and Yellen tenure).091916-tradingsecrets-01

wmc160919aabook-sept-2016-inefficiency-net-worth-to-spendingTake your time working on them. It is their simplicity that makes them so valuable. They are further explained at TCW’s, Hussman’s, and Alhambra’s websites. It is pretty obvious that there is no way to leave this party unscathed. To add insult to injury, the amount of global leverage (next chart) puts us, worldwide, in absolute terms, well past the Minsky moment. Stability, as he said, generates instability, as Ponzi debt takes over productive debt. At some point, leverage goes past the amount of income needed to service the debt. Then, the credit boom stalls and asset markets and the economy crash. Negative interest rates postpone this, but at the cost of suppressing productivity increases -because Schumpeterian creative destruction comes to a standstill. Hyman P. Minsky was a visionary. He saw, decades ago, what reality is only confirming right now.leverageglobal-zh

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Confusion Reigns Supreme.

It has been an awfully hot summer in Spain. I did well enough (you can always do better) while sail racing intensely with my team, and, sadly, it’s time to engage in something more substantial. Not that I really crave for substance at this “Prozac” time of the year. I love the pleasures inherent to my bourgeois way of life that, save for my adrenaline generating sail racing, and abundant brainstorming, blend nicely with “easy economics”. So let me disclose my current emotional bias in favor of the Welfare States, Easy money, Easy credit, Liestatistics, Hail Mary passes, NIRPs, QEs, and bubbles of all kinds. They all increase the apparent NAV of our accumulated wealth. Next step is hugging good old Heli-Ben -and I’m real close to that right now.

No, I am not drunk! But I’m not serious anyway. This summer has further eroded my year to date return, as the sovereign spreads -and all others- collapsed to mind-numbing figures (considering the underlying fundamentals). I underestimated the quest for yield, and CB resolve, once again. On top of that, and confirming the fact that bad news rarely travel on their own, the Fed managed to contain and reverse, USD appreciation -that didn’t help.  My new updated return YTD is only 3% by now. When you are not happy, it helps to laugh at yourself -and anything that moves as well.

For an insight of the logic of these moves, I cherry picked two charts, on the fundamentals of the Italian Sovereign spread.20160713_italy_07d2b89a7-57ae-4550-8ddd-498409cc7bbc

And another two, related to the consistency of the USD weakness of late. Of course, in the new CB economic textbook, an upswing in the Ted spread is a clear precursor of an imminent dollar depreciation (excess dollars around?!!!). Am I being too sarcastic for my own good?8-TED-spreadABOOK-August-2016-TIC-TED Continue reading