I like Chinese proverbs (like the one above). They can be incisive. In an atmosphere of widespread confusion, long, convoluted, and incongruous explanations, are the predominant reasoning today for all that’s going on. Most of the narratives are lies, but some well intentioned commentary simply reflects the fact that the author doesn’t know what he’s talking about.
While some Governments (like Rajoy’s in Spain) say the worst is over, and others say crude pricing and European Q.E. will recreate an equity investors paradise, Janet Yellen is reported to be quietly expressing her concern about the international situation. Soros briskly labels markets as “hellish”. Some countries are backdating currency puts targeted for those caught indebted in CHF after the swissie’s price realignment (Eastern Europe).
Others, like “professor” Abe (I am anticipating a Nobel prize in economics for him – just to follow the Krugman gaffe) are rejoicing in the crude repricing effects for their economies. Some are desperate, rising rates outrageously, only to bring them down again weeks later (the Russian Central Bank). Venezuela’s Maduro (and his unfortunate fellow citizens) are close to suicide, literally imploring the OPEC to cut production.
It feels like Central Banks are losing their grip on the world economy further. In my view, the process began in November, with all those disorderly comments by the different members of the FOMC -just because the S&P had gone below 1900. It has been an ongoing development. The event flow conspicuously shows they are gradually losing control.
I have shown my surprise during more than a few of the different episodes of this GFC, when financials took a turn towards the entirely unexpected (to me). Like when Q-Eternity was born in mid 2012. I was overwhelmed by that decision. Or the “whatever it takes” wording by super-Mario. Both I didn’t expect. But, honestly, none of the seemingly extraordinary events taking place this January has taken me by surprise.
The last couple of years have enabled some clear thinking by lots of unbiased analysts like me. The narrative was, and is clear, however insane. All you need is a decent intellect, and the necessary emotional distance to value what’s going on in the world financial battlefield (a real battlefield, as currency wars extend to creditor-debtor wars, tax wars and others). As the famous Swiss psychiatrist Carl Jung once said: “in all disorder, there is a secret order”. Things may look complex, but there is always an understandable explanation for everything. And it ought to be a short one if you don’t want it to sound “chinese”.
The explanation for all of this remains unchanged. We are extending and pretending -in an ever agonizing time frame- the durability of a massive “free credit, free printing, all leverage” financial orgy that took place beginning roughly (I am sorry for the coincidence) when the “maestro” took over the FED in 1987. In fact, I see no real, substantial changes in the global financial village, since my last post.
Crude’s carnage, Copper’s, Iron Ore’s, or the Baltic dry index rock bottom prices, provide some incentives for thinking. Why didn’t central Banks control these deflationary disruptions? Weren’t they in control?
The SNB’s remarkable defeat is the first of many to come. Blocking ATM use for a day is not precisely what an efficient central Bank should be engaged in. Hi Jordan, Danthine, what about giving resignation a thought!
The deflationary global spiral, or super-Mario’s last hurray (he wants to double his ratio of assets to GDP), are additional landmarks in the trip to the global financial system day of reckoning.
Von Mises crudely advised us of this inevitable outcome more than fifty years ago. We are following the expected course, faster at times, and desperately slowly during some very long periods (like QE3), but nothing has changed much.
I acknowledge I am very late for this post. Denial never helps in life. You can only transform, or be transformed, by what you accept. That goes for everything, not just for being late (Central Bankers please read that again). I admit to having made some very serious money this month (read the last couple of posts to know why), and I have been busy cashing in my profits, whilst relaxing and self-indulging in the meantime. You have to enjoy life when you can. I am late, because I have been living the “dolce vita”. Short explanation equals no lie. I apologize for the delay. I will have to reduce my posts to a maximum of two per month from now on. I need time.
Intelligence needs emotion to be useful to both yourself, and others. Similarly, money needs life to make sense. Now that my intelligence (“with a little help from my friends” at the SNB) made money, I needed life (plain living), and emotions, to enjoy it. And I also needed a breather in order to think clearly again. You can’t think clearly when you are counting the loot. Yes, the loot -somebody trading the EURCHF lost the money I made. They listened to Jordan, I did not. Normally, you can’t tell a central banker from a politician or a liar (maybe the only difference is they are more “keynesian” or, worse still, “Krugmanite”). The swissie’s peg break up was a phenomenal victory for us naysayers, but it is already in the past. Sometimes, David does beat Goliath. I will make sure that some of this is included in my biography. Unlike the King Crimson members (¿remember the band?), I don’t want confusion to be my epitaph. Right or wrong, clean, straightforward ideas, and the resilience to live accordingly.
Last November I wrote a post called “Debt sustainability and/or inequality will end the show”. I have read it over and over again, and I still stand by every word! To make it short, I said and I reiterate now, that inflation will not kill the beast (the money and credit bubble). In fact we are having it the other way around. We have deflation expanding. And, surprisingly enough, for most who read everyday bank financial reports, that is not a bad thing “per se” (deflation hurts the bubble, the banks, and debt sustainability, but not the real economy).
As I said in November, neither will interest rates hikes (if they are ever brought back up by some Central Bank) end the show. I also thought, and still think, that money printing will persevere. Central Banks will rotate to share the effort in the same way as a breakaway group of cyclists in the “Tour de France”. It was Mario’s turn to lead the pack and he stood up to the challenge. They really have no other options left. They will print till they die. Printing presses will be moved around to help prop up shipping prices, but the the printing environment will prevail. Not “for ever and ever, amen” though. The US will be reluctant to print again. I found these remarks by Plosser particularly inspiring. He is getting it right, despite being a central banker !!!! The US seems to have had enough of the QE recipe.
Stein would say: if something can´t go on for ever it will stop. Something will have to put an end to this. So it will have to be debt sustainability, and/or inequality that pulls the trick. The Greeks are focusing on both, but primarily fighting the debt sustainability issue. They got the concept right. See what Tsipras had to say in an open letter to German Citizens. A must read. Their debt reasoning is faultless (other issues like minimum salaries, or a larger public sector, are an entirely different point). Unfortunately, notwithstanding their honest arguments, there is no way out for them on the debt affair. They have to fight for a fair deal, but creditors cannot concede, and Tsipras knows it. It will have to be extend and pretend (extending debt maturity fifty years at a near zero nominal rate), or a total breakup.
All this posturing and bargaining between Schauble and Greece is not mainly about money (Greek debt is peanuts in the global picture), or austerity (the message for the masses). It is about letting go of the assumption that debt parked in world balance sheets is payable, and not a fictitious asset. It they get a relevant haircut, following Tsipras’s flawless reasoning, it is the endgame for the actual set up. The only solution available, if you want to extend and pretend debt sustainability, is extending maturities indefinitely with zero yield (equivalent to a haircut in fact). But that does not solve growth (debt overhang is still there, preventing aggregate demand healthy growth). And it is nevertheless a lousy situation for creditors, because they will then have to engage in debt restructuring negotiations with Italy, Spain, Portugal and the likes. A bad outcome in any event. If the debt sustainability popular perception goes, the system will sink immediately.
Inequality has become a regular media matter during the last couple of months. About time. The news is that Obama is trying to walk “the long and winding road” back to reasonable equality in the US. He knows he won’t make it, but it makes sense to at least give it a try. His plead is mostly political and ethical, but it is not something urgent in the US. Inequality is an advanced neoplasia in poor countries. It is awful in the US, but poverty levels are still endurable by society. Syriza would not get a 10% vote in the US right now. Maybe in two or three years time. Who knows where we will all be in two or three years time. Civilization will look different for sure.
Inequality will probably upset things more on an international country to country basis (Islamic terror, Putin’s last stand, and/or all kinds of international violence), than on an internal, same country, inequality front. Saudi kings can remain relaxed on this front. At least for the meantime.
Unless some terrorist group manages to nuke a top occidental city, I think debt sustainability will be the driver of the meltdown.
So I think (please underline think) I know the catalyst for the end: debt sustainability. At least I made my choice. Actually whether the catalyst is the perception of debt sustainability, or a surge of violence relevant enough to upset the financial environment, the result is going to be equally unpalatable. But unavoidable anyway. We can only postpone the inevitable, but we have to assume that an inequality or debt sustainability driven break-ups are unpredictable moments. We have to be aware of their risk, but we cannot pin point them.
We knew the Swissie peg was unfeasible, but didn’t know when it would break. It came as a surprise, but it was a sure thing. We knew the EURUSD at 1,40 was unsustainable, but did not know when printers would be transferred from the US to Frankfurt. Now we know they will be all set and ready to start in March (conveniently after Greek negotiations).
We know a 0.25 yield for the JGB will be something to talk about decades from now, but we don’t know how long it’s going to last. We know European QE will produce an even worse result than its predecessors, but we don’t know for how long masses will remain enamoured of the concept. We know Greece can’t pay, but we do not know when politicians will have to admit it. We know growth will not be reignited by printing money again, but we still hope for a decent 2015 and better 2016 (with some crude price help).
¡Don’t we know a lot of things! I just miss one answer: ¿when? So we have to take the “fight the SNB battle” approach that has served me so well. Wait and be patient. One day we will cash in on our patience. It now yields a lot more than most government bonds.
Regrettably, we have to park our money in some asset category while we pamper and wait. Few assets qualify for that role today.
- I sold all my CHF in the three days after the peg broke (leveraged forwards first, and then all my CHF cash). There is a price for everything. That includes safe assets, and parity in the EURCHF looks like an excessive price to me. Above 1.06 (1.06 to 1.10 range) I would gradually deploy some small non-leveraged money back into swissies. Not below that level though.
- I increased my SEK holdings. Still not leveraged (not above 100% of my total financial assets) but decent size. The Swedes are begining to talk down their currency, and when those comments come after a 15% plus depreciation against the euro or USD, it always generates (inside me) some complacency on the validity of the trade. They are talking “QE”, and even claiming they are a commodity currency! (in Davos). Talk about jawboning south, a currency’s value. The currency was richly valued below 8.50 to the euro, and they had to bring it down. But there is a limit to begging your neighbor. They won’t get away with much more of that. I doubt we shall see it depreciate further than 9.50 against the euro.
- I still hold close to two thirds of my global portfolio in USD. Dropped my leverage at 1.26 after a nice run of 10% in the EURUSD cross. Of course I am not happy that I did that in November, but there is a time for leverage and a time for “cash only”. I still see parity with the euro as a tangible possibility, but I will not commit to that “all in”. I will increase my USDEUR shorts above the 1.13 level (long the USD), but with a well defined limit of 100% of my assets.
- I am not ready yet to hold JPY in my portfolio. But I increasingly do not think it is a one way bet against the yen either. Yen shorts are not for me, particularly at current levels. The country is bankrupt, but yen counterparts are not a lot better off. From a trading perspective I think it may be time to trade some yen strength, but with a short term, low volume, fast trade profile. I don’t want to hold long term yen just yet.
Aggregate demand is still the holy grail of economics. Currency wars will keep redistributing it. Some will be pushed back into Europe next year, and the US and Japan will have to foot the bill. Until the next episode of easy money takes place somewhere else. And so on and so forth. Solid aggregate demand will only come back after a huge debt-write-down, or a debt-jubilee (or a combination of both). They are similar procedures but debt jubilees are on a “per capita” basis, whilst write-downs only affect creditors and debtors involved. My God, they already knew that in Mesopotamia thousands of years ago! We had forgotten.
Nothing new to report on the bond side. I can be boring and stubborn. I still think trying to enhance your return via credit risk is like siding with Jordan’s currency positions. ¡Foolish! No credit risk, when debt sustainability is a concept at stake. Write downs will reverberate everywhere. Keep your money as safe from insolvency as you possibly can. Corporate bonds can be safer than governments’.
In the meantime, you cannot short bonds (not even US treasuries) knowing the Wicksellian interest rate is negative in most currencies. A common mistake by otherwise smart people. They learnt that the hard way in the 10y USD treasury, or in the widowmaker JGB trade. They are tempting trades, but it is clearly too early to think an interest rate normalization (a normal yield curve). We should not forget the world is still awash with Central Bank liquidity. Welcome to the club of humble, often caught wrong, traders. Timing is everything, just ask me: I am always early.
On the other side, you have to refrain from shorting bonds for now, but you cannot overstay your “long duration” investments. In the event of an unexpected black swan, losses will be preposterous when yields normalize. And they will not normalize gradually. It will be like shouting “fire” in a crowded pub.
So you have to endure, and put up with NIRP or ZIRP -where possible as it still is in USD or SEK. Zero looks great nowadays. I know it’s really awful, but alternative choices don’t make sense. Duration yield pick ups (with care) you can do, but no credit risk yield enhancement. Not a pretty landscape for serious investors who want to emphasize the return of their capital. Even Soros says it is a hellish environment for investing.
Timing the top is still the name of the game in equity markets. You can play the “overweight Europe, underweight US equity markets trade”, but it is crowded there. And I hate relativity. Buying a lame duck you are not a lot better off than buying one on it’s last leg. I will opt for healthy “chicken”. Not a brave conduct, and it doesn’t taste as good, but it is a lot more useful for financial survival. Sometimes you have to be a coward.
I have no idea of how long this last hurray atmosphere -courtesy of the ECB – is going to last. If a Grexit materializes QE might never take off! I keep on trying to short the S&P 500 minis, but also keep on being stopped out for moderate but recurring, and above all, discouraging, losses. I have a big size short implemented again this last week. Most readers know by now, that valuations are incredibly stretched. Investors are just playing games with relative prices (superior yield of stocks to bonds), and or the power of additional liquidity to deviate prices even further away from fair values.
Let’s think as if valuations were already correct. Even if that was the case, when all this nonsense is over, and balance sheet debt values become realistic, somebody will have to pay for entitlements. And it will not be the impoverished citizens. Corporations will be forced to pick up the tab. It’s fair, and it is the only way to support a minimal entitlement level that we need to prevent real, and not only economic war.
Equity repricing will come. It is not only a question of reversion to the mean (that will bring profit share of GDP down by at least three hundred bps globally). It is also a relocation of entitlement expenses via taxation. A disaster in equities is near -in spite of European and Japanese QE. Keep trying to time the top, with stops. Do not despair. It will be well rewarded when it is finally in place.
So it is zero equity (beta) risk. It you want to take some alpha it’s OK with me (if you can find it in today’s bloated price context), but be sure to cover your beta at least partially. Actual valuations are extremely dangerous. I mean inordinately dangerous. Financially life threatening.
Let’s do our best everyday, accept ZIRP or even NIRP, and reward will come. Like it did for us SNB fighters. Financial survival will be a superb outcome once debt destruction is over. We need excellence, together with luck, to come out unscathed.