Je dis que rien ne m’épouvante, je dis, hélas! que je réponds de moi; mais j’ai beau faire la vaillante, au fond du coeur, je meurs d’effroi! Seule en ce lieu sauvage, toute seule j’ai peur, mais j’ai tort d’avoir peur; vous me donnerez du courage, vous me protégerez, Seigneur!
I found the lyrics of Micaela’s song, in Bizet’s “Carmen”, particularly appropiate today. Micaela has always been my darling in the aforementioned opera. Maybe it’s just that “je ne suis que faiblesse” with French women (and no, no mails please, I’m not looking for an affair at Ashley Madison’s). The “You tube” video I have linked is, in my view, the top (or near top) soprano performance, for that particular aria. There are no live images in the video I found, but the quality of the singing (not to forget the aria itself) is superlative. I think Mireia Freni, Montserrat Caballé, or Anna Netrebko, can’t beat it -at least for this particular aria.
And now, let’s get down to business. Not before precluding some readers getting lost in translation. Micaela, in plain English, “… for all my pretense of daring, deep in my heart I’m full of fear! In this wild place, so lonely, all alone, I’m afraid. But I’m wrong being afraid …” As FDR famously stated, the only thing we have to fear, is fear itself. We should be brave and get rid of this monetary orgy ASAP. Time will put things in perspective. Inaction is a lot worse.
We are all afraid aren’t we? This is a big mess we are all in, and we know we are going to have a hard time navigating our way out of it. Deep under, whether we admit it or not (depending on your degree of Keynesianism, or self interest in preserving our job and status), we all know the monetary Princetonian-Keynesian experiment hasn’t worked. We have digged ourselves ever deeper into the proverbial hole. Mises was right all along: the only way out of an orgy of credit and easy money is taking the bitter medicine. More credit and easier money was never going to do the job.
By now, an increasing number of top strategists concede that only QE 4ever can reliquify markets again. POMO desks need urgent air support. With financial napalm. The next two charts by Societé make it very clear.
The minute we ran out of fresh daily printed USD, the reserve currency began to regain some previously lost ground (over the previous three QE’s) in forex markets. That pressured the Asian currencies, and all others with an explicit or implicit peg to the USD. Their CB issuers were forced to intervene in order to preserve their forex stability. Global reserves began their downward run with two results: an obvious reserve crunch and global liquidity reduction, as outlined above…
And a less evident direct pressure on financial prices. After all, according to the 2015 GPI report from the OMFIF, it happens to be that investments held by 400 public institutions in 162 countries add up to a value of more than 40% of global GDP. CB’s, step by step, are beginning to own the financial market. The equity portion of their portfolio is higher every day. How on earth are they going to allow it to fall? In Ken Follett’s wording, public institutional buying, together with buy backs, are the late “pillars of financial prices” (helped an assisted by nirping and printing by CBs). CBs have it best. They print money, and then go buy financial assets. Very convenient indeed.
The Norwegian Sovereign Fund, The SAFE subsidiary of the PBOC, and the GPIIF in Japan, lead the pack in absolute terms. In relative terms, Jordan-Danthine are rock stars to be considered on their own. So when the PBOC begins to dispose of reserves, we get a double whammy in stocks, bonds and -who knows- maybe even high yield spreads. If the Norwegian sovereign fund ceases to buy financial assets, and maybe begins some selling, things don’t get any better. At least, not being a CB, they don’t reduce the global monetary base.
I wouldn’t be surprised if more than one of those institutions traded pork bellies and held some contracts in their balance sheets. They are brave (imprudent) investors, but somehow too shy to bravely end the monetary orgy. A monetary tightening of 25 bps from near zero is far too much -ain’t it? No problem buying equities for the Siegel “long run” at current valuations though.
The USD funding shortage doesn’t help either. Regardless of the gradual relative weakening of the US economy pressuring the EURUSD down, the financial market is short of USD. I said it in my January post – and got the market direction wrong- but I reiterate the underlying situation. Too much debt was issued in USD in the good, low carry cost, epoch (not such a long time ago).
And the commodity and oil price disaster has destroyed Petrodollar build up, and Eurodollar accumulation. A strong dollar is equivalent to a global monetary tightening (Triffin’s dilemma revisited in a slightly different form: financial versus commercial flows). The USD still works as the reserve currency. Want some proof of the USD shortage? See side chart, courtesy of Zero Hedge.
In summary, the easy and convenient way out is QE4. More dollars, a weaker reserve currency, higher prices for risk assets, etc. What is to be done when QE4 effects fade? You guessed it, Q5. Wash, rinse, repeat. Paraphrasing with some leeway, what I shouldn’t be paraphrasing, “till kingdom come, it will be done … forever and ever, amen”.
Pity that, by now, we all know what QE4 would mean. Because we are all aware that the real economy, even with QE4, will not attain escape velocity in order to dilute debt the traditional, last twenty years, style. Fool me once, shame on you, fool me a fourth time, shame on me. I won’t take that shame. My call is that this next time, hyperinflation or stagflation are the inevitable end result of the chain reaction that will follow. Or maybe it will take QE5 to accomplish that. Let’s hope so. Hope springs eternal, with wishful thinking a close second.
And, because history only rhymes, it will be a new QE style. What’s left of the Neokeynesian tribe strives to suggest that QE failed -because money was provided to the banks. And it was not enough. It never is. So now we have to print again, with more printing presses than before and, yes, it will be QE for the people “in lieu” of the banks. How social! Real helicopter money for everybody. Won’t it be great fun!
Unfortunately, in the meantime, recession or infinitesimal growth worldwide can be taken for granted (with a deflationary bias), as confirmed by the latest data. I began to talk about recession in my mid-august post, “game over”, and all recent data seems to confirm that call. I am, as you can see, a cool, “data dependent”, economist (Oh how I luv fed speak, even if nobody knows for sure what data dependent means!).
Let’s not get carried away too soon though, and try to remain humble enough. I still remember the ECRI recessionary call in 2011-2012, crushed by Heli-Ben’s high-tech printing presses. I have come to think that’s the event where 3D printing got its ultimate boost (next QE induced bank notes would be wonderful in 3D with a Callas image).
It does look like we are, at the very least, well on our way to an end of the year or first quarter of 2016, mild recession. Even US employment, a lagging indicator in the “cleanest dirty shirt” country, is suggesting it. A recession that could evolve into a stagflationary environment further down the road. And it is a high risk game. A full blown depression could be triggered any minute, on a mistake by CB politburos, or a disturbing geopolitical event. Or we might just skip it. We are playing with fire here.
Just a couple of charts (there’s, of course, a pile of leading indicators for a recession) to show my point of view, it doesn’t make any sense to go through all of them here. Doug Short’s website is great for that. A must read for a serious business cycle look up. Hussman’s latest post also points in the same direction.
Let’s remember global trade doesn’t look great either (see ECRI chart in the last post). The Baltic dry index all but confirms the trade slowdown (and yes, notorious overcapacity as well). Lastly, this Oxford Economics indicator points firmly down as well.
Of course we can always allow for firing a couple of thousand more (not to go unnoticed is the last round of large layoff announcements), and keep them consuming with some additional entitlements and new credit. Or we can try to put a minimum salary in place (in true FDR new deal style), and ensure a couple of thousand more get laid off (Or alternatively, allow them all unemployed to migrate to Mars -I hear you don’t have to go across Hungary’s border fence to get there).
My call is that no growth of significance is in the cards, unless and until we print more (or, change the macro business model). And so, it becomes a matter of time. The Fed will not concede to QE 4ever until it is absolutely unavoidable (if they do), and will have to allow things to deteriorate gradually in the meantime. They just can’t do otherwise, and see and be seen by friends and family at their local golf course restaurant, on Sundays.
Tomorrow will be worse than today, in the foreseeable future. A long slog to a certain economic death. As Micaela said we would be wrong to be afraid, and we should try to be as happy as we possibly can -with the cards each one of us has been dealt. Time is all we’ve got in life, so we can’t just sit down, wait, and do nothing. We have to live, and we have to both trade and position our portfolio in a way that optimizes our chances of financial survival. Let me try to provide some detailed ideological means for that end.
Globally speaking, until, and unless, QE 4ever gear is engaged, all financial assets, commodities, precious metals, real estate, and commodities, are headed down (with plenty of hiccups on the way). Some have a long way to go, and some are already in late stages of their downturn (commodities). But without some extra liquidity (not just credit), prices will ebb towards fair value and under. Health warning! Don’t look below, or you might get dizzy and faint (fall) over the cliff.
It’s not the end of the world. It is only the end (or close to the end) of inflated asset prices courtesy of the maestro, Heli Ben, QE2/3, and intensive, extensive and near permanent nirping and zirping as of late. The best scenario is for prices to glide down gradually (with unavoidable significant volatility).
The implication is simple: hold cash or high quality bonds with short durations. Forget about the return on your money, and try to ensure the return of your money.
Cash.- People are beginning to realize this, and safe currency cash, in NIRP countries, is soaring. It is for no other reason, that some bright mind in the BOE has come up with this idea to ban cash. Zirping it, with the aid of inflation, or turbocharged Nirping away of bank balances, is no longer enough -it seems. Paper money is playing an increasingly relevant role, and we have to ban that. And gold -or anything that is not held through a bank account. God save … the banks! We have to make sure everybody’s money remains there.
It reminds me of the times in our history in which you had to give in all your gold to the authorities, … in order to preserve an imprecise, and unknown, but all important, “national interest”.
Much like Cristina Kirchner’s orders to her Central bank to forego whatever monetary orthodoxy might be left there (any at all?), because of a national, overwhelming, interest.
But, but … the BOE! I never thought the BOE might go full Bolivarian. I learnt my basic know how in finance in the city, a frightening long time ago, and had ever since held a great respect for the old lady. You have to live to see, life is full of surprises -they haven’t even fired the guy!
With no cash, your options are, your money being nirped away of your bank accounts, or being stripped of the market value of a substantial portion of your portfolio. Don’t worry, you will still hold the same amount of shares. Not nice, but WW II was a lot worse. Ask the Jews what they did to their wealth. Life always comes before wealth. Even with asset prices at fair value (roughly half their actual level), it will still well worth living it.
As an experienced sailor, one shot across the bow is enough for me. I plan to forget sterling for some time (at least until they get rid of maniacs at the BOE). No shorts in sterling though, Carney is said to be still sane, despite having worked for Goldman Sachs in his distant past. The worst news is that the UK is hardly the last of the pack. Look east and southeast.
Equities.- We always have to remember that correlation is not causation, something all of us, every now and then, find convenient to forget. This axiom always seems to get in the way of you trying to prove something. It’s a real nuisance. Nevertheless, let’s go through a few charts regarding the importance of the monetary base.
And of course correlation is not causation. But why then has stock picking (or sector picking, or country equity market picking) become a waste of time? CB balance sheet size and risk aversion are the name of the game (together with profit expectations).
Not much more to say here. I doubt the expansion of the ECB and BOJ balance sheets will be enough to offset the reserve destruction in EM’s. And I doubt that kind of correlation shown above comes anywhere near a healthy market. On the other side, corporate buy backs seem to be near their limits. There is no more free cash flow left to sustain them. Another engine gone faulty.
Of course, NFC’s can always issue more debt. Debt always solves the problems short term. Only a sustained increase in free cash flow would be a game changer. It would recharge buy back batteries, and improve earnings growth expectations. Regrettably, I dare say it is unlikely that free cash flow is about to surge, and increase their buy back capacity.
Short equities, save for serious USD printing again, continues to be my firm stance. Confusion will not be my epitaph, and I see a lot of confusion nowadays. Bullard’s inconsistency is spreading like a virus. Strategists swing from long to short, and viceversa, every fortnight.
Nevertheless, in this mad, mad, world, always place some stops please. It doesn’t help to be right when charged by a Central Bank, POMO driven, human herd, stampede. It’s safer to stand aside. And we will have some vicious bear market rallies, year end seasonals, or even a surprise QE4 sometime. You want to be firm, not brave.
And Commodities look as if they are influenced by global reserves as well. What do you think? It looks clear to me. Enjoy the late commodity bounce, but don’t look for sustained long term appreciation (save 4 QE4)
Bonds and HY.- Once again, it all depends on the amount of USD available. If the Fed stays the course (no printing), base rates will move down, and credit spreads will continue to widen in a risk-off environment. Curves will flatten. Ten year treasuries would be a lot higher (lower yields) if it were not for the global CB reserve contraction (Chinese selling is the paradigmatic example). With no QE4, the environment calls for lower yields and higher credit spreads over Mid-swap.
If the Fed goes for QE4ever, look for steepeners as long term benchmark rates will soar, and spreads will behave a lot better. But I still do not expect a sustainable path of reduction in credit risk spreads.
They are my favorite indicator for risk appetite. Equities are always late to the party. If we are going to see multiple expansion, it have to be preceded by HY spread compression. And I don’t see it coming.
The follow up is, that buying credit risk spreads (betting they will widen), is the way to go. In this area I have hand-picked three sovereigns: the Bund, the French OAT, and the Italian BTP. I have initiated a long position on a core (bund)-periphery spread (two thirds against the OAT, one third against the BTP).
In both environments (no printing or more USD printing), the spreads are unlikely to become much smaller. Any European jitters, world wide recession, or global credit event, and I am deep in the money. Risk reward looks great to me. My mentality is that this trade will take some time, but the risk of heavy losses is negligible at current levels, and the upside is, well, magnificent. I plan to be patient. I know the ECB would not be happy to read this -their POMO desk will shoot to kill. No nonsense, all POMOs are nervous and shoot to kill nowadays. Just look at the stop and go tactics by the Rikjsbank depreciating the SEK
Currencies.- This post is getting too long. No real news here. The euro is still a short (nearly any way you look at it, except trade balances). Economic weakness is spreading on to Europe as I write (Europe always follows the US with a lag). I love SEK vs the euro, USD or CFH. As for the dollar I really don’t know. NO QE? We will get a strong USD as the European business cycle weakens over the next couple of months. In the event of QE, all bets are off. Get rid of your USD balances, and your loose change as well.