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.