I was writing my own piece on this topic for my next blog post, but Barron’s said it for me this week (from Barron's Daily Round-up, November 27, 2009):
"…unemployment officially is 10.2% and 17.5% when those who can't find full-time work or have stopped looking are counted. Meantime, despite the Fed's massive easing of monetary policy, credit continues to tighten, as its most recent survey of lending officers showed.
"But with liquidity shut off from the real economy, it has flowed into asset markets and into the so-called carry trade -- borrowing at the near-zero interest rate resulting from the Fed's federal-funds target of 0-0.25% to invest in anything else that provides a higher return. And with the dollar losing value steadily against foreign currencies, it has literally paid to borrow to invest in anything else, with the key exception of the Japanese yen. Since it became cheaper to borrow in dollars than yen, greenbacks have become the key funding currency for carry trades.
"The cracks have not been all papered over from the output from government printing presses in the U.S. and elsewhere. While that liquidity did stanch the bleeding that followed last year's crisis, it also helped levitate U.S. equity markets nearly 60% from their lows. And the riskier the asset, the greater the gains, from small-cap stocks to junk bonds to emerging markets.
"But those trillions have not cured the underlying debt deflation at the root of the economic crisis. In past cycles, the reliquefication by central banks could be counted on to pump-prime the economy. Borrowing and lending would resume after having been restrained by tight monetary policy, and a new cycle would start.
"After the bursting of the debt bubble, the process isn't working. It may have stoked a speculative binge in commodities, currencies and risky securities, but the real economy continues to labor.
"As it does, grandiose projects such as Dubai World collapse under the weight of their huge debts. Risk, previously suppressed successfully by policy actions, begins to increase.
"That, in turn, forces the curtailment of risk positions, from hedge funds to Wall Street proprietary trading desks. Hedging costs rise, forcing further reductions of positions in a vicious circle. As year-end approaches, the willingness to hold risk positions is reduced still further, exacerbating the process."
I could not have said it better myself. And combine all of that with the fact that many people expect capital gains tax rates to be higher in 2010 than in 2009, and you could see a lot of profit taking between now and year-end. That could make for an ugly December for the stock, corporate bond, and commodities markets, but probably means that Treasuries and the dollar will surprise on the upside (where else can the money go?). Of course, as I have said many times before, logic can tell us with some comfort level what will eventually happen, but predicting the timing of this or any other market movement is nearly impossible. Still, it looks prudent to trim risk-asset positions here, and it's tempting to take that money I was saving up for Vegas next month and bet on the dollar and Treasuries for the rest of the year...
Sunday, November 29, 2009
Wednesday, November 18, 2009
20-20
Hindsight’s a bitch. I was cleaning out my (overcrowded) Outlook folders and came across an old email from my friend Jayson at 10:53 p.m. on March 10, 2009. In hindsight, we now know that the prior day’s close of 676.53 for the S&P500 on March 9 turned out to be the nadir of the bear market. The next day (the 10th) the S&P jumped over 6% on good news from Citibank, and Jayson’s email to me that night said “So is the bull back?” In all of my infinite wisdom, I responded to him with the following (this will prove once and for all that I am not doing this blog to impress anyone with my market-timing skills):
Is the bear dead? Maybe – at the very least the market had gotten insanely oversold and needed a bounce. In the bigger picture:
BULLISH: Copper prices have turned up noticeably over the past seven days. It is not a big move yet, but if it continues that is very bullish. Note that copper prices turned up a week before yesterday’s stock market bump.
BEARISH: Economic news is still 100% bad (e.g. UTX news, WSJ p. B1). I do not count C’s announcement yesterday of operating profit in February as good economic news. They borrow from the fed at about 0% and lend at much greater than 0%. A monkey can make an operating profit in those conditions – they will still show a loss this quarter after marks and reserves. The fact that the market moved up so big on this silly news just shows how oversold the market was. Also bearish last week was increasing LIBOR and widening spreads in the debt markets.
BOTTOM LINE: It doesn’t feel over to me. It is hard for me to believe that such a ridiculous piece of “news” as Vikram Pandit’s remarks at Citi marked the end of the bear market. On the other hand, copper has been a very good indicator of market bottoms in the past, and if it keeps moving up then I will have to concede that the bear is probably dead. Also, if auto sales stabilize or turn up in March then that would also be very bullish (note they will report a huge drop vs. prior year’s March – the key is what happens to the seasonally adjusted annualized run-rate in March 09 vs. Feb. 09). Also watch for any other glimmers of economic good news.
So what have I learned from this? Two things: First, I should not have doubted copper. As I discussed below in my post “Anatomy of the Bear” on March 4, copper prices turning up marked the bottom of all four great bear markets of the 20th century, and so far it is one-for-one in the 21st century (and I’ll give Jayson credit for being one-for-one for at least asking the question at the right time). Second, and perhaps more important, this is yet another reminder of knowing what we don’t know. Bear market bottoms occur when everyone is sure it has farther to go. It is worth remembering that the same applies to bull market tops.
Is the bear dead? Maybe – at the very least the market had gotten insanely oversold and needed a bounce. In the bigger picture:
BULLISH: Copper prices have turned up noticeably over the past seven days. It is not a big move yet, but if it continues that is very bullish. Note that copper prices turned up a week before yesterday’s stock market bump.
BEARISH: Economic news is still 100% bad (e.g. UTX news, WSJ p. B1). I do not count C’s announcement yesterday of operating profit in February as good economic news. They borrow from the fed at about 0% and lend at much greater than 0%. A monkey can make an operating profit in those conditions – they will still show a loss this quarter after marks and reserves. The fact that the market moved up so big on this silly news just shows how oversold the market was. Also bearish last week was increasing LIBOR and widening spreads in the debt markets.
BOTTOM LINE: It doesn’t feel over to me. It is hard for me to believe that such a ridiculous piece of “news” as Vikram Pandit’s remarks at Citi marked the end of the bear market. On the other hand, copper has been a very good indicator of market bottoms in the past, and if it keeps moving up then I will have to concede that the bear is probably dead. Also, if auto sales stabilize or turn up in March then that would also be very bullish (note they will report a huge drop vs. prior year’s March – the key is what happens to the seasonally adjusted annualized run-rate in March 09 vs. Feb. 09). Also watch for any other glimmers of economic good news.
So what have I learned from this? Two things: First, I should not have doubted copper. As I discussed below in my post “Anatomy of the Bear” on March 4, copper prices turning up marked the bottom of all four great bear markets of the 20th century, and so far it is one-for-one in the 21st century (and I’ll give Jayson credit for being one-for-one for at least asking the question at the right time). Second, and perhaps more important, this is yet another reminder of knowing what we don’t know. Bear market bottoms occur when everyone is sure it has farther to go. It is worth remembering that the same applies to bull market tops.
Thursday, November 5, 2009
Easy Money
Earlier this week, after hearing and reading a variety of pundits opine about when the Fed will raise rates, I wrote a draft of a piece that remarked that (IMHO) long before the Fed decides to raise the much-watched and oft-discussed Fed Funds Rate they will likely begin shrinking their balance sheet, which exploded last fall from $900 billion or so (which had been remarkably steady for many many months) to over $2.2 trillion in a matter of two months. While I still think that will be the case, the Fed’s statement yesterday makes it very clear that the Fed has no intention of doing any of this any time soon. They plan to keep buying securities (mainly debt securities such as Agency bonds) and keep interest rates low, low, low.
Also yesterday there was an article in the WSJ titled “Fears of a New Bubble as Cash Pours In.” The title pretty much tells it all, but here is one example: “Asian stock prices are shooting up, in part due to low interest rates in the U.S. Investors looking for higher yields are borrowing in U.S. dollars and then pouring that money ‘into countries that are growing more rapidly,’ said Stephen Cecchetti, chief economist at the Bank for International Settlements, the central banks' central bank, which warned early of the last asset bubble and is beginning to do so again.”
Judging from both the WSJ article and the Fed’s policy statement it appears that policy makers can’t connect these dots, so I will state the obvious. Since the mid-1990’s, central banks around the world (led by our own Federal Reserve) have followed the decades-old dogma that as long as inflation is subdued they can keep interest rates very low to drive economic growth. The problem is that they look at CPI and PPI as the only measures of inflation. Modern economic theory was developed during a time when excess liquidity flowed into the hands of producers and consumers who bought intermediate and consumer goods with the excess money and drove up prices, creating inflation in the PPI and CPI. When the central banks saw this inflation, they knew it was time to tighten monetary policy. But it doesn’t work that way any more.
Since the mid-1990’s, the excess liquidity still flowed into the hands of producers and consumers, but they no longer used it to buy products as measured in the PPI and the CPI. Instead, they invested in assets – stocks (late 90’s), real estate (early-mid 2000’s), oil and gas (mid-late 2000’s), treasury bonds (last year), or gold (now) – or they just leave cash on the corporate balance sheet. Part of the switch from products to assets has been due to the baby boomers planning for their upcoming retirement, while part has been due to competition from low-cost foreign producers (China) keeping product prices so low that it both prohibits domestic producers from raising prices and also disincents them from making more products. As a result, there has been massive investment in and inflation of assets, but the Fed doesn’t consider that “inflation” because the CPI and PPI only reflect product inflation, not asset inflation. Therefore, the Fed and the other central banks around the world will continue to keep rates low and monetary policy loose for the foreseeable future.
But eventually that will change, and one of two things will happen. One possibility is that the Fed and other central banks wise-up at some point and tighten monetary policy. This would likely deflate all sorts of bubbles, from gold to Asian real estate, and would also adversely affect less “bubbly” assets like stocks and domestic real estate. In the long run this would be healthy, because it would finally ring the excess leverage out of the system (that almost happened a year ago, but the Fed was so effective at reflating that it never really happened).
The other possibility is that the Fed continues to let excess liquidity feed these various asset bubbles. Many people predict that this will lead to horrible inflation, and that is probably true for a while at least, but asset bubbles typically eventually end differently. Usually they end by deflating quickly and violently in a somewhat deflationary manner. Perhaps the bond market will (finally) start demanding higher yields, forcing interest rates up in spite of the Fed’s free-money policy, or perhaps some other event will have the effect of yelling “fire” in the crowded theater. But I would expect that one way or another, after perhaps a period of bad inflation, we will still end up (eventually) back with a deflationary contraction that sends almost all asset prices downward.
This makes for an incredibly difficult investment environment. On the one hand, we could see another “bust” next year, while on the other we could have an inflationary easy-money party for many years before the bust. When the inevitable deflationary contraction finally comes then the clear winner for investment portfolios will be Treasuries, but if you buy them today you risk getting killed by several years of easy-money inflation that erodes their value. If instead you plan for inflation by buying risk assets set to capitalize on easy money, then that will backfire badly if the Fed wakes up and tightens any time soon. And if you are looking to me (or anyone else) for the magic answer then you will be disappointed. As I have said before, the best we can do is to know that we don’t know, which in this case means try and plan for both.
Also yesterday there was an article in the WSJ titled “Fears of a New Bubble as Cash Pours In.” The title pretty much tells it all, but here is one example: “Asian stock prices are shooting up, in part due to low interest rates in the U.S. Investors looking for higher yields are borrowing in U.S. dollars and then pouring that money ‘into countries that are growing more rapidly,’ said Stephen Cecchetti, chief economist at the Bank for International Settlements, the central banks' central bank, which warned early of the last asset bubble and is beginning to do so again.”
Judging from both the WSJ article and the Fed’s policy statement it appears that policy makers can’t connect these dots, so I will state the obvious. Since the mid-1990’s, central banks around the world (led by our own Federal Reserve) have followed the decades-old dogma that as long as inflation is subdued they can keep interest rates very low to drive economic growth. The problem is that they look at CPI and PPI as the only measures of inflation. Modern economic theory was developed during a time when excess liquidity flowed into the hands of producers and consumers who bought intermediate and consumer goods with the excess money and drove up prices, creating inflation in the PPI and CPI. When the central banks saw this inflation, they knew it was time to tighten monetary policy. But it doesn’t work that way any more.
Since the mid-1990’s, the excess liquidity still flowed into the hands of producers and consumers, but they no longer used it to buy products as measured in the PPI and the CPI. Instead, they invested in assets – stocks (late 90’s), real estate (early-mid 2000’s), oil and gas (mid-late 2000’s), treasury bonds (last year), or gold (now) – or they just leave cash on the corporate balance sheet. Part of the switch from products to assets has been due to the baby boomers planning for their upcoming retirement, while part has been due to competition from low-cost foreign producers (China) keeping product prices so low that it both prohibits domestic producers from raising prices and also disincents them from making more products. As a result, there has been massive investment in and inflation of assets, but the Fed doesn’t consider that “inflation” because the CPI and PPI only reflect product inflation, not asset inflation. Therefore, the Fed and the other central banks around the world will continue to keep rates low and monetary policy loose for the foreseeable future.
But eventually that will change, and one of two things will happen. One possibility is that the Fed and other central banks wise-up at some point and tighten monetary policy. This would likely deflate all sorts of bubbles, from gold to Asian real estate, and would also adversely affect less “bubbly” assets like stocks and domestic real estate. In the long run this would be healthy, because it would finally ring the excess leverage out of the system (that almost happened a year ago, but the Fed was so effective at reflating that it never really happened).
The other possibility is that the Fed continues to let excess liquidity feed these various asset bubbles. Many people predict that this will lead to horrible inflation, and that is probably true for a while at least, but asset bubbles typically eventually end differently. Usually they end by deflating quickly and violently in a somewhat deflationary manner. Perhaps the bond market will (finally) start demanding higher yields, forcing interest rates up in spite of the Fed’s free-money policy, or perhaps some other event will have the effect of yelling “fire” in the crowded theater. But I would expect that one way or another, after perhaps a period of bad inflation, we will still end up (eventually) back with a deflationary contraction that sends almost all asset prices downward.
This makes for an incredibly difficult investment environment. On the one hand, we could see another “bust” next year, while on the other we could have an inflationary easy-money party for many years before the bust. When the inevitable deflationary contraction finally comes then the clear winner for investment portfolios will be Treasuries, but if you buy them today you risk getting killed by several years of easy-money inflation that erodes their value. If instead you plan for inflation by buying risk assets set to capitalize on easy money, then that will backfire badly if the Fed wakes up and tightens any time soon. And if you are looking to me (or anyone else) for the magic answer then you will be disappointed. As I have said before, the best we can do is to know that we don’t know, which in this case means try and plan for both.
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