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Freedom for Catalonia.

“An unjust law is itself a species of violence. Arrest for its breach is more so.” 

One has a moral responsibility to disobey unjust laws.” 

Mahatma Gandhi / Martin Luther King Jr.

We Catalans want to vote -and break free as well. No decent state can impose its sovereignty on citizens that reject it. At the very least, people have to be able to vote with their feet. The principle of self-determination is a cornerstone of international law. Recently it has been watered down to avoid quests for state shattering independence. But it is still the applicable international, and fair, law. We have a human right to vote out.

I am not a nationalist at heart. Not a Catalonian, Spanish or even a European nationalist for that matter. But, just like the Brits did, I hope we place dignity and freedom above convenience and comfort. I favor free trade, and a global world, but from a perspective different to the one that has been used since WW II. Upsizing is wrong. We need smaller units in the future. Smaller Sovereigns and smaller Corporations. Small is beautiful, and “small” is what we should target as a critical methodology to clean up this global mess. My linked thoughts are dated October 2014 -long before this Catalonian independence issue climaxed.

Brits opted out of bigness and bureaucracy. We Catalans are about to choose out of hubris and financial repression. They yearly take away between five and seven percent of our GDP -final figures depending on who does the math. Unsustainable for any country or community when using IMF criteria (and uncommon sense). Greeks were unable to dispose of their debt servitude at their time, and the cost of their public debt is well below that level. But others (or even the Greeks later on) will follow. You can count on that. Is Italeave (the euro) next?

When I read that we have to punish Britain or Catalonia for opting or wanting out, it reminds me of some sage advice my father gave me when I was young. Capitalism and Communism could both be right, but both have intrinsic problems -he said. The difference between them is that in the former they have to keep immigrants out, while communists have to build walls to keep their people inside. What is your choice?

If the EEC or Spain had done their homework correctly, nobody would be voting out. Even if somebody did, it would not be an ominous precedent but a happy “good riddance to bad rubbish” reaction by the rest. We should always read the symptoms and causes, not the consequences. Killing messengers and dissidents might be emotionally rewarding but makes little, if any, sense. We criminalize “leavers” and forget the people and reasons that make us leave: they are the root of the problem.

Freedom never comes cheap. The establishment always refuses to concede when it affects their wallet or their power. As is always the case, Spaniards despise us but want to stymie our departure. Is it due to to the psychological proximity of love and hate, or is it just shameless selfishness?

Hopefully, we will vote our freedom soon. Economic and social problems will follow -but it pays to put as much distance as possible with Spanish hubris, disdain, and blatant inefficiency. A short-term pain for a long-term gain. Divorce is hopelessly messy. Ask Theresa May.


 

Something’s gotta give

“State meddling has successfully stabilized China’s US$7 trillion stock market by curbing volatility and steering valuations to rational levels.”

China Securities Regulatory Commission. (via zero hedge)

 

Everything is under control. We are entitled to timeless prosperity. Perpetual money printing. Never-ending bullish markets. Infinite credit … Perhaps!

Regardless, when I read the previously quoted official statement, I corroborate not only how dumb the regulators are at times, but more worryingly, how deeply complacent. Not only The Donald brags about his stock market success. Yellen assures us that a new financial crisis is nearly impossible in our lifetimes. Draghi continues to be infinitely pleased with himself and exudes confidence when he talks. They pat each other on the back. Our Gods are feeling good about themselves. Interesting.

Even the people at the Chinese POMO desks are claiming victory. This last statement caught me off guard. You have to be particularly stupid to boast about your proficiency at market manipulation. And these are the great Central Bankers and regulators that will supposedly save the world? One thing I am sure of is that humanity will need a merciful God when this breaks!

In financial markets, as in life, everything only lasts so long. Eternity is, as Kafka said, a long time (surtout vers la fin) and is only applicable to heavenly concepts, Muslim faith or the Buddhist nirvana. To be honest, I even doubt that. According to ordinary mortals like Minsky (and uncommon sense), financial stability breeds instability. Whatever the sell-side or the bulls say, stability and growth cannot be forever extrapolated into the future. At some point, reality rears its ugly head. I’m going to elaborate on the most relevant issue of them all. What catalyst will put an end to this egregious bubble?

Answering that question implies a lengthy reply. First of all, I think we have to exclude some relevant potential factors -borrowing a clinical approach to diagnosing the precise pathology of an ailing patient. You engage in successive diagnostic tests to help discard possibilities -until you focus on the right disease or infection. Hey, I feel like Dr. House!

For starters, I think the traditional catalyst is out. It has always been inflationary pressures that urged rates up, slowed activity, lifted default rates and finally induced a recession when the long end of the curve collapsed and inverted. A bearish steepening and spread increase, followed by a bullish flattening. Things change: we have to rule out inflation as the catalyst for anything nowadays. If a near doubling of petrol prices in a context of synchronized global GDP growth was unable to generate inflation and AHE growth this year, what’s going to get the job done?

Inflation and maybe hyperinflation might very well be the outcome after CBs throw the kitchen sink at the next recession -or financial market collapse. But it will not be the catalyst for anything. A chronically shabby aggregate demand will preclude an unfortunate inflationary behavior acting as the detonator for the next crisis. Inflationary threats will move rates and currency crosses, and maybe alter the social landscape -but are unlikely to bust this bubble.

As usual, some caveats apply. We can’t write-off inflation entirely. I am just excluding the kind of inflation that would pressure CBs to raise rates significantly.

Underground inflation, the one that kills families without showing up too badly in macro data, is alive and well. Think tuition, health care and the other concepts featured in the chart. Similar trends apply outside the US. And it bears remembering that even mild inflation is not without consequences, particularly in a context of stagnant wages. It relentlessly tears up the social fabric of our peaceful coexistence.

Stagnant wages I said. I am understating the problem. Wages are a disaster. Employable workers (reasonably skilled labor excluding drug addicts) are in short supply -and have been for some time. Amazingly though,  it hasn’t moved wage costs upwards. The labor market is increasingly oligopolistic (employers have the upper hand), and secularly weak aggregate demand doesn’t give companies much leeway on the matter.

A second pathology to be ruled out is the traditional, rate hike induced, market bust. CB’s see an overheating and hike rates, even before inflationary pressures (unlikely but possible). The Fed is at it right now, and some pundits worry about the timing. It is not the best of times to lift rates, but I think interest rates will not kill the beast either. No matter how clear they voice their intent to raise rates, remember that any increases have been tagged as “data (market) dependent.”

The market knows that full well -and that is the reason for always confronting Fed dot plots. Market dependency means that they will reverse course if markets tank. That behavior not only backs equity prices but is also vigilant of the steepness and levels of the interest rate curve. It is unlikely that they would tighten enough to generate a sustainable market tantrum. Even if there is a policy error (something likely at some stage), they will bail themselves out lowering rates fast and activating POMO desks.

Third, monetary aggregates are not likely to precipitate a downfall. We all know the Fed is going to take some chips off the table (reduce its balance sheet). Regrettably, they also say that it is all subject to the state of the economy, meaning in reality, that it all depends on how much the market can handle. It makes sense to think that QT will deflate asset prices because QE inflated them. That was indeed my initial line of thinking. But politburos at CBs are not dumb. They will fine tune the withdrawal of liquidity and stop it whenever needed. And they will manipulate prices if they think they must, to prevent any negative wealth effects. I doubt QT will have a long life.

Even if aggregate credit growth stalls on its own, they still control the money supply. We play by their rules, and they manage liquidity (very unfair, I know). Even if they surprisingly opted for fair play from now on, we have to presume they are not stupid enough to prick the bubble because of their own doing.

 

If we leave inflation, a disruptive rate rise, or quantitative tightening out, we are left with only three areas of risk:

 

1.- Debt related risks. China and Europe are the likely candidates for the role played by subprime mortgages in 2007. Student, auto loans or state o municipal bankruptcies are not systemic enough to tilt the apple cart. Ponzi debt can be found everywhere, but China and the European periphery are the weakest real credit scores (forget market manipulated pricing and implied risk measures). High yield and credit-spreads also merit a careful follow-up. It is always the weakest link in the chain that breaks first.

Italy is the obvious candidate but, not to forget, credit spreads are priced for a lot more than perfection. The chart below has gone viral. See the Real Vision version using a “Credit Strategist” chart. 

2.- Geopolitical and social risks. We are all increasingly angry with each other, and social and political tensions keep mounting. War of some kind is no longer a questionable call. Civil unrest and systematic terrorism are already integrated into our life style. Trump and Brexit are sideshows. The tensions between nationalists and globalists are widespread and in reality nothing but the intellectual friction area between the haves and the have-nots. The real underlying battle is wealth distribution.

The particular black swan event to come is unidentifiable in advance but is fast decoloring from black to gray. We don’t know what, where, or when, yet we cannot feign surprise when the next major incident takes place. The substrate of social tensions is volcanic. It’s hard to price tail risks, but it is imperative to do so as they inch towards the center of the distribution -and are becoming relevant enough in number and substance. Zero is the market pricing right now -and it is not difficult to certify that it is wrong. Dangerously wrong.

3. A recession is a given sooner or later. Even without social tensions and within stable markets, it is essential to remember that the business cycle has not been repealed forever. Growth will become elusive at some point. Under the weight of an aging cycle, or the accumulated debt pile sapping growth, and or because of ridiculous productivity figures due to malinvestment and insufficient educational levels (in a context of low population growth). Who knows. But before eternity takes over what’s left of us, even our post-GFC lackluster growth is going to stop.

There’s a fair chance it could come very soon. China should not engage in a new macro boost similar to the 2016 credit surge, once the Communist party meeting this fall is over. But it is a wild card to consider given past decisions. The US is cooling even if I have to admit to some contradictory figures. Some macro aggregates are suggesting a recession might be immediate. A Trumpian reaction of some kind has to be factored in, and it’s not an easy one to anticipate because it won’t be very rational.

Anyway, Real Value-added data doesn’t look good. It measures the economy from the supply side and is a rarely used approach. Nonetheless, it seems a reasonable indicator of an impending recession. Carmaggedon is also there to help (with a significant contribution of autos to US GDP helping make it a relevant happening). Savings have plunged, and consumer credit growth is firmly on the rise again. Do we never learn?

But it could very well be that the recession has to wait till 2018 or even later. Anyway, when it happens, it’s 100% curtains for the bubble. And it is the most likely bubble killer. Just to avoid repeating the same things ad nauseam, I will give you Paul Brodsky’s narrative on why a recession ends it all (emphasis mine).

“Consider that wealth is no longer created from production, but rather from financial pricing models and credit creation, credit that must increase at a parabolic pace and can never be extinguished without substantial output contraction and rising unemployment. (…)

Central bank purchases and government investment have been fabricating output growth and asset gains. Central banks now hold about $19 trillion in assets on their balance sheets, up from almost zero in 2008, and are now 20 percent owners of global assets. (…)

Stocks, bonds and real estate collateralize each other while output growth makes it possible to service debt. (…)

The problem is that there are too few dollars for each claim on dollars (credit). The credit that collateralizes equity cannot be repaid and, if output declines, cannot be serviced without more credit. Equity and credit prices will fall (deflate) in tandem as debt service and repayment declines, unless more dollars are created and floated to asset holders. (…)

The current imbalance separating credit (claims on money) from money itself suggests a doubling, tripling or even quadrupling of the money supply in float (yes, 100, 200 or 300 percent monetary inflation directed towards financial markets). This implies nominal asset prices could rise, but not nearly as much as the purchasing power value of the currency they are denominated in would fall.

We doubt all the new money could be distributed to the investor class and then reinvested back into financial markets, and so we think it is highly likely that nominal equity and debt prices will fall markedly in the future, though we cannot know from what level.

In the meantime …

Last February I wrote that the USD was key .. and got it all wrong. I said:

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.

I nailed the causality, but despite being aware of the key role of the USD, I got the USD prognosis wrong. The USD depreciated strongly in all pairs (particularly in the EURUSD cross), and consequently, it all went risk-on: equities, currencies, credit spreads, rates, etc. To a stratospheric degree. I have to try again. I was right in linking dollar strength with risk-off, but I made a big mistake because it failed to materialize. Will the dollar recover some strength in the near term?

As I said in February, it is challenging to get the USD right. Technicals suggest that the USD’s demise has been greatly exaggerated. No other than Kit Juckes (Societé Generale), a famous euro bull that proposes a three-year target of 1,30 for the eurusd cross, admits to overdone moves. Capital flows (eurusd vs. capital flows), interest rate differentials (eurusd vs. real yields) and peripheral spreads (eurusd versus bund/bono spread) are the three technical criteria he follows most. Here are his three charts on the issue. They speak for themselves.

 

I entirely agree with his take on the short term/technical situation. His reading on the eurusd rate has been excellent. Long term he is a dollar bear against the euro. Again, all things equal I reluctantly tend to agree. My fundamental discrepancy is that all things will not continue to be equal because the European recovery has been based exclusively on QE and a cheap euro. The periphery is heavily indebted and reliant on capital from abroad. If QE goes, and the euro recovers fair value, the periphery will take it on the chin. That is my reasoning for remaining a long term euro bear. Euro appreciation is unsustainable because it undermines the very reasons that support it.

But please take all of this with a grain of salt. Trump wants a weaker dollar, and bubble preservation requires an easy dollar. Politics will play a relevant role, and it’s hard to anticipate which way things will roll. I’d rather bet the ranch on a Chinese bust next winter, or the fact that the periphery will not survive in a strong euro, post-European-QE world. That, I am 100% sure of. The periphery is an unfixable mess if the ECB does not subsidize the south with new credit, low rates, and a weak euro.

Bond trading is not easier. Not foreseeing a spurt in growth and much less so, stable and healthy growth with associated inflation, it is clear that I am not a bond bear. I do think bonds are also in a bubble. Maybe a more pronounced bubble than equities. But the risk of a flight to safety stampede, and my conviction of meager growth at best (a recession cannot be that far out), effectively impede long bond shorts. Bubbly prices also make me uneasy going long duration. I am caught between a rock and a hard place. Just can’t touch bonds with a reasonable degree of conviction.

If you take a look at the next chart, it shows that low rates can be with us for a long time. Zero credit risk rates (if that concept continues to exist in the future once a couple of sovereigns go under) will remain low for at least the next decade. That is of course unless CBs do something foolish (incrementally stupid) and start a hyperinflationary period as a reaction to the next recession or market fall out.

Equities are the perennial TINA choice I have wrongly eschewed for years now. I am running out of patience (and money) but will still wait for a repricing. It’s tough because now I find myself siding with the billionaire bears club way below the minimum wealth level to join it. Not the best place to be because they have deep pockets and can afford to be wrong (I can’t). But that’s how it turned out -and I’m not going to change my point of view because I ain’t rich enough.

Stan Druckenmiller (May 4th at the Ira Sohn Conference): “Get out of the stock market.”

George Soros (June 9th, as reported in the Wall Street Journal): “The billionaire hedge fund founder and philanthropist recently directed a series of big, bearish investments, according to people close to the matter.”

Carl Icahn (June 9th, on CNBC): “I don’t think you can have (near) zero interest rates for much longer without having these bubbles explode on you” while also saying it’s difficult to assess when exactly that might occur.

Jeff Gundlach (last Friday, in an interview with Reuters): “Sell everything. Nothing here looks good.”

Bill Gross (in his monthly investment letter, released last week): “I don’t like bonds. I don’t like most stocks. I don’t like private equity.”

Nick Colas. Convergex (via ZeroHedge August 2017).

La morte a Venezia.

“A crash occurs because the market has entered an unstable phase, and any small disturbance or process may have triggered the instability. Think of a ruler held up vertically on your finger: This very unstable position will lead eventually to its collapse, as a result of a small (or an absence of adequate) motion of your hand or due to any tiny whiff of air. The collapse is fundamentally due to the unstable position; the instantaneous cause of the collapse is secondary.”

Didier Sornette. Expert at mathematical modeling of periodically collapsing bubbles. (Hat tip: Hussman, Mauldin)

 

“Framed as a financial decision problem, one faces a choice between two scenarios:

1) A small probability of losing all of your money all at once at an undisclosed time in the future.

2) A high probability of gradually losing small amounts over an indefinitely long period of time, keeping in mind that persistent small losses over an indefinite time period could lead to large cumulative losses.”

Aleksandar Kocic. Deutsche Bank derivatives strategist.

I loved “Death in Venice.” Visconti had always appealed to me, but this motion picture was a masterpiece. Characterized by most critics like a movie on homosexuality, to my mind, it is rather a film on the inevitability of physical decay and death. It could very well be an epilog to Hamlet, where both ideas regularly recur in most of the imagery. Whatever we do, decay and death are, like in the delightful pop song, right “there” waiting for you.

More importantly, Death in Venice is a rumination on the weaknesses of mankind -and how vice at times, or just benign neglect towards our conduct, gradually take over many of us (if not all) as we age. And a stunning portrait of the decline and subsequent fall of the then bourgeoisie. Their contribution to society was already waning. For some proof just take a look at the ladies loitering along the Venice Lido with their parasols.

All establishments see an end to their period of dominance. Nobility passed the baton to the bourgeoisie who in turn ceded their power to modern politicians. They finally gave in to the economic establishment represented by banks and multinationals. In the last twist of events, post the GFC, our central bankers are the new deities in town, promoted and conditioned to serve that very establishment. They are living their last days in paradise. History always rhymes.

Life is a business that inevitably ends up filing for bankruptcy. The film overtly transmits that it is the very nature of life that leads to death. But the reality of an end to everything, including long economic cycles, or social models, is sometimes adequately turbocharged by extraordinary events. It is the onset of a cholera epidemic that enhances the perception of decay and death in the film -much like CB largesse and Keynesian ideological support has added grandeur to the debt overhang caused by the profligacy of consumers, sovereigns, and corporates.

Moral standards are always relaxed in periods of social or economic decline. I have absolutely nothing against Gustav von Aschenbach’s (the main character) sexual orientation. But, gay or hetero, it is certainly inappropriate to lavishly consent in sexual desire for a naive young male or female. Your first feeling is that of repudiation. But then, the musical score, identified as the result of his work as a composer (in the original novel the main character is a writer), re-conciliates us with Von Aschenbach. If Mahler’s Adagietto is the result of his work, then maybe we can consent to some moral depravation. Aschenbach is a great artist!

Furthermore, what I like most about the film (music and photography are not to be quickly forgotten either) is the convoluted acceptance of his moral sloppiness and, together with it, the acceptance of his last days as a human being. He has surrendered in life. Some of us wish to die with our boots clean, but not few give up the fight well before that. We should all fight the desire to let go. We should all die with our boots clean. But that is an impossible feat for human kind as a whole. It takes too much courage for the ordinary mortal.

Von Aschenbach has given up fighting and lives his last days -perfectly dressed according to his social status- compelling himself to live his somewhat superficial life style to succeed with Tadzio. He extends and pretends until the very end, attempting in vain a near impossible feat (a relationship with Tadzio). CBs are trying to go further into debt to dilute our global debt pile. Their chances of success are strikingly similar if you read Paul Singer. Do you believe in miracles?

In an unforgettable scene, Aschenbach’s hairdresser applies a generous coat of mascara, and some lipstick, to try to rejuvenate him -and succeeds for a time (same as money printing can make things look better for a while). A perfect description of letting oneself go while appearing not to.

If you have ten minutes to spend, do enjoy this long trailer of the film as a divertissement, while listening to the beautiful melody of Aschenbach’s (in reality Mahler’s fifth symphony) Adagietto.

The developed world is acting very much like Von Aschenbach. We know we are an old society on the verge of substantial change. We are aware that some of our problems are insoluble in the short run. We know inequality is metastatic cancer, and we know that increased debt adds to already morbid obesity. We know we are in the midst of a financial cholera epidemic, but we are tired and feel that we need or even deserve some solace. Kicking the can forward helps. But we need more than that.

Any consolation. Drugs, sex, and rock and roll … or money printing and orgiastic spending like there is no tomorrow -all represented jointly in the film by the fantasies with Tadzio. We know a relationship with Tadzio (or more Keynesian spending) is not the answer to boredom, depression, and senectitude. Who cares; we are tired of the GFC and need an easy way out.

We might not crave for sex with a youngster (hopefully), but we let ourselves go regarding money printing, debt, market manipulation, and bubble blowing. Very much like Venetians were aware of Cholera in 1911, we know this CB Keynesian/Phillips Curve model is going to kill us -but we know we are going to die anyway. So why fight?

The outcome is, don’t we all know, not flirting with Tadzio, but financial genocide once the scam is over. That does not deter us from engaging in wishful thinking while living the Venetian “dolce vita.” If we are going to die, let it be fully indebted and invested. People are not that stupid; they are aware of the inevitability of a bust but, very much like a terminal cancer patient, don’t want to talk about it.

We just want to live whatever might be left. Most are aware by now of the fraudulent nature of current financial markets and the subsequent stratospheric pricing. Nevertheless, that doesn’t impede complacency or neglect to adapt to prominent risks. Recent market moves can be easily dubbed as vicious and nonsensical.

European Bank prices are a case in point -if you look at their efficiency ratios, real NPLs, capital structure (most holders of tier 1 or tier 2 securities are blissfully unaware of the risks involved) or balance sheet sovereign risks. Other absurdities abound. Like Covenant light being the new standard for bonds!

But, of late we got a fresh momentum move to ponder. Let’s comment on the EURUSD rate -it shows the most intense rally in decades. I understand that the dollar was too strong, still, a twelve per cent repricing in six months is far too rich. Ultimately the catalyst was Draghi publicly suggesting that the ECB would tolerate EUR appreciation (the famous eyebrow lifting statement in his press conference). Now, please consider the following facts:

  • We have similar GDP growth in both areas (for the first time in nearly a decade, the Eurozone can match US growth). Not for long. The growth prognosis is being altered as I write by the appreciation of the trade weighted euro. Currency crosses are the dominant factor for growth in a secularly mediocre aggregate demand scenario. We are transferring growth from Europe to the US just as we did the other way around with the EURUSD move from 1,14 to 1,04.
  • A 200+ bps differential in two-year rates and 175 bps in the ten-year. The 5-year rate for Bunds is still negative! Core inflation is similar. Unless the USD depreciates 2% yearly, it pays to hold dollars instead of euros. And you have no peripheral risk (I doubt you can count California’s secessionist ideals as a risk).
  • Europe is printing euros to the tune of 60 billion per month, building the largest CB balance sheet in the world. In the meantime and the US monetary base has been stable for three years now and the FOMC is trying to shrink it. There is an international USD shortage. Euros abound. Supply and demand analysis suggests USD strength save for a significant repositioning (like now).
  • Europe sports the highest entitlement contingencies in the world (with a share of 24% of global GDP, Europe pays out nearly 60% of total global entitlements). No wonder we have an immigration problem!. Even with equivalent debt to GDP ratios, Europe is a lot worse off (entitlement contingencies are staggering), and immigration is a serious, pervasive problem for our intensely “welfared” Europe.
  • And yes, we have a great balance-of-payments, if entire attributable to our northern neighbors -while the south rejects or at least indefinitely postpones economic reform enjoying the ECB monetary largesse and fiscal profligacy in the meantime. Internal and external commercial disequilibrium are chronic, and no improvement is to be expected with actual policies. Bickering between the north and the south will continue for years to come.

Keeping things simple, and with the benefit of hindsight, it is all clear to me. The Donald wanted a stronger euro and a stronger yuan; he twisted enough arms around the world to get both. That’s all folks, think about the efficacy of some Trumpian intimidating handshakes and forget the narratives meant to explain the move. He won the battle, but bullying other countries ain’t going to make America great again. Sadly, that’s what he is best at -and likes to do most. He sees it as bargaining. With a Sicilian flavor, it must be. The fact is that a simple and subtle sales tax would have protected America efficiently against unfair trade practices. No need to make “friends” in Europe or China.

Thank God I saw that train coming, held no unnecessary dollars, and hedged my bond dollar exposure to a degree. I wish I had hedged entirely, but the extent of the landslide (sorry, price slide!) has managed to surprise me again. Momentous moves are becoming not only unpredictable but ubiquitous. This move needs to consolidate but it might continue up to the 1,21 level or more. Yet it is sowing the seeds of its own destruction. If growth stalls in the periphery and that is only a matter of time, we will get a severe down move in the EURUSD again!

Why fight? Why not buy the euro and play the CBs hand and the market momentum! Forget the looming sovereign bankruptcies in the south. Yes, I’d love to consider that thinking inappropriate. But I can’t. It makes some sense to me. Maybe more sense than my investment principles. What’s the use of financial virtue when financial vice gives you the best deals? Sex and hopium come cheap and require minimal effort! Let’s indulge. What if we try the next 500 shades of Grey?

Kocic’s options.-

When you consider that investors need the return, that they have seen dissidents like me chopped into pieces, that CB are thoroughly in control, and that there is no other option left (TINA), you have to understand that, like Von Aschenbach, they reluctantly let themselves go. Kocic’s first option is the choice for most: assuming a low probability of being wiped out -but dancing while the music is still playing. They have been right up to know. Why not for the next year or two? Just load up on a couple of ETFs and hope for the best. Don’t forget your mascara and lipstick before you go, you want to look good at all times -and enjoy sex with Tadzio while it lasts!

I don’t know of anybody who has fully embraced the second option quoted above. Losing money slowly is very painful. It comes close to a Chinese torture. And you never know how long this orgy is going to last. It is discouraging, to say the least. We could have ten years to go!

Most investors try positioning their portfolios along the blurred line between the two options. It makes sense for its practicality but adds little conceptual value. Eclectic solutions sometimes add a new flaw to the ideological extremes they are trying to bridge.

I have tried a third alternative strategy, and it worked nicely since the GFC. Until it didn’t. I tried to game the CBs and did well for a decade -with only 2013 in the red. That is until I unknowingly stepped into a widow maker trade: shorting euro zone banks. I got massacred.

I know that European banks are still a recommendation by some analysts. I just think they do not know what they are talking about. It is not about their P&L account but their balance sheet and their shareholder structure. I don’t care if they make more money for a year or two! But nobody wants to look that deep. This year’s business is a lot better, the curve is steepening a bit, and Europe is out of the woods for good, or so they say. Wishful thinking is prevalent nowadays. God save the Queen!

So I lost big. In fact, it had to happen sometime. You cannot anxiously trade for your return every single year -without participating in the risk party with a stable beta exposure to risk- and expect not to be caught on the wrong foot at some point. Your problem is that wanting to avoid playing the CB game, either you trade markets for a living or you remain out -with a sluggish portfolio and close to inexistent yield. There are no good options left for dissidents!

The trillion dollar question is how long this goes on for. Bubbles always end with a bust -but this time might be different. This bubble has the market vigilantes none of the previous ones had. CBs existed in 2008 and 2000 but were hardly aware of the market risks involved. Market intervention by CBs was rare. Manipulation non-existent.

This time is different. The market scam is very well protected by a praetorian guard of POMO desks at major CBs. I do not see how they are going to lose control unless a recession puts them belly-up. And they can work to prevent excessive economic weakness printing some more, or even stimulating credit growth as needed. Playing against the CBs increasingly looks like a lose-lose proposition in the short run.

Hussman brilliantly summarizes it in the chart above. We are in a log-periodic Bubble with a finite-time singularity ahead. I just can’t see why the singularity is going to take place August 2017 -or any other date for that matter. We are left in the dark and have to patiently wait.

However fed up with this situation, I find myself unable to suggest a viable solution. Most likely it follows that physical decay is becoming a personal reality as well. You can see I don’t try to hide I am feeling “down” right now. But at least I don’t use lipstick or yearn for sex with Tadzio as an escape from my dreary financial day to day existence.

Okay, enough negativism for today. To end on a higher note, let me get my initial philosophical thread back. Believe it or not, this was initially meant to be a frivolous post to be read at the beach. I hope you enjoy it.

 

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). Continue reading

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

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

The future ain’t what it used to be

To use Bob Dylan’s legendary lyrics, for better or worse, “the times they are A-changin”. Just in case you hadn’t noticed: Central Banks do not want to change. But you can’t stop the species’ evolution, and holding on to an obsolete model is not a viable strategy. They ought to know better.

Let’s forget Central Banks for a while. When talking about embracing the future, citing Cinderella has become a classic. Had she walked back to recover her shoe, she wouldn’t have married the prince. To all appearances, she did best not looking back. That is, provided she wanted to become a princess, because, in fact, she never asked for a prince -but a more mundane night off (and a dress). Any doubts? Read the story once again!

That goes a long way to corroborate that we never know what’s next, and, even if we did, we might be unable to single out the best available option, or the one that will work best for us. The world is now moving really fast, and my perception is that tectonic social and economic moves are accelerating. An unfortunate outcome indeed, because I don’t like where we are heading (nobody should), and because the speed of events inevitably unleashes some unwanted bad vibes. We all like to move at a more leisurely pace, particularly when facing deep and unpredictable social and economic changes. And we all feel the fear of change as well, even though, as Roosevelt once said, the only thing we should fear is fear itself.

Life is like cycling, to keep our balance, we have to keep moving. It takes courage to do so because, in times of change, moving can be jeopardous. Trading markets today generates feelings similar to sailing on a reach, flying our maximum size asymmetric spinnaker, on a thirty-knot breeze. Exhilarating, and, of course, great fun -but emotionally tiring if it goes on for long.

Constant adrenaline shots are unhealthy, and if you’re not careful, following very tiring days, you end up sleeping on your toes as well. Asian markets provide their fair share of trepidation. We get sparse moments of rest, even in these stalemated markets. No matter the reassuring establishment messages, we are all aware of the precarious state of both our global social contract, and global business model -low implied volatilities, and CB controlled markets do not fool our inner traders.

The result is we humans trade less, a lot less. Trading volume in equities came off a time ago, and bond and currency volumes are taking a beating as well. Only cyber traders subsist, they do not suffer angst, and they do not need a full night’s sleep. To CB delight, we, independent money managers and individuals, are trading less and less in this hazardous environment, and that facilitates rigging operations. Banks are not that happy about it.

It does look as if CBs are still in control. So, in the midst of this precarious, uneasy calm, it comes as a surprise to see more and more global strategists at core establishment banks changing sides ostensibly, and making sure everybody makes a note of it. Bank of America, JPM, Citi, and belatedly even establishment darling Goldman Sachs, are signaling a clear risk-reward imbalance for equity investing. They are flagging risks the traditional way: “small upside, large downside perspective for equity investments”. No VaR nonsense this time around (we all know implied probability inputs are POMO desk massaged figures). The result is that smart money ebbs out of equities in the US, for 14 consecutive weeks, and even buybacks are weakening.

Hard to believe, the reality is that, amazingly enough, prices haven’t budged, even as recession probabilities mount, and FOMC members put rate hikes back on the table. POMO desk price control is doing fine. Nothing comes for free though. As a downside for extend-and-pretenders, market intervention is taking place more and more in the open. Above certain levels of intervention, stealth techniques are no longer possible. We now see what looks like a direct intervention on a nearly daily basis. You know the adage: if it looks like a duck, swims like a duck, and quacks like a duck, it is probably a duck. The S&P 500 is rigged!

I think the FOMC’s actual policy stance was implicitly exposed by some Williams (San Francisco Fed) comments on the risks of a market plunge because of policy normalization. They are trying to put interest hikes on the table again while controlling market moves exhaustively. They probably think that if they can handle the initial headline impact, as a market mover, everything will be OK. To me, this is wishful thinking again. Market pricing follows valuation rules that are only invalidated when monetary aggregate variation takes a front seat. It is thus an impossible feat to maintain a pricing level related to previous printing and ZIRP levels, once these are gone. If the headlines do not move the market, market players will, only later on. Markets, like water, always end up finding a way forward. They only need time. Continue reading

Stalemated markets open a period of uneasy calm.

The last market move to reprice risk assets has been effectively stalemated by Central Banks. It does look as if they opted for the best choice available to them (in their own perverse logic). To be sure, back in February things were not looking pretty for extend-and-pretenders. So they met (at the G20 meeting in February, or elsewhere), and decided to intervene. Listed companies, with anxious executives, worried about the value of their options, and most banks, were glad to cooperate. The result was a new iteration in the recent series of resounding victories in financial markets -led by CB’s and establishment forces. Repricing risk was, once again, adjourned “sine die”. Long live POMO desks, and associates!

As I see it, politburos at CBs became apprehensive about the late, marked deterioration in global macroeconomic data. Unsurprisingly, they scented the chance that the market rout might become the last nail in the recession coffin. They are for certain, well aware of the fact that this last economic cycle, that began in the aftermath of the GFC, is already long in the tooth. And yes, they jumped the gun. I must say I expected better emotional control. Actually, I don’t think they spent a minute to brood over the option of changing course in the aftermath of a staggering credit and money base increase that had produced no substantial, meaningful result in the real economy. They confirmed that they get done fast with that kind of reasoning. No sweating over the real efficacy of their policies. No roadmap. Just survival techniques of the highest level. That amounts to no less than preserving the legacy bubbles of the Bernanke era. Continue reading