March 18, 2016
By Steve Blumenthal
“So what do we do? Anything. Something. So long as we just don’t sit there. If we screw it up, start over. Try something else. If we wait until we’ve satisfied all the uncertainties, it may be too late.”
– Lee Iacocca
“This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences.”
– Henry Hazlitt, Economist
It is the fallacy of overlooking secondary consequences that is keeping me up at night. Try telling that one to your spouse. J
“Draghi and the ECB announced that they will start a series of targeted longer-term refinancing operations (TLTRO). The first will occur in June 2016. The term will be four years. The cost of this borrowing by a bank is likely to be a zero interest rate. But under certain conditions, it will be at the negative policy rate. Thus the central bank will be paying the commercial bank to borrow from it.
Imagine what would happen in the United States if the Federal Reserve structured a program so that any bank, whether Bank of America or your local community bank, were to be paid by the Fed when that bank borrowed from the Fed and used the funds to make loans to you or to buy assets in the market.” – David Kotok, Cumberland Advisors
David added, “This is a massively expanded stimulus program. It has extremely bullish implications for financial assets and for asset prices in Europe. And because of its size and lengthy term, it is a bullish force for the entire world. We expect other NIRP jurisdictions to use their version of this model. Keep a sharp eye on Japan’s next move deeper into NIRP.”
NIRP stands for Negative Interest Rate Policy. On its own it is a deflationary policy that, I believe, is ill-designed to help us exit the current excessive debt, global deflationary mess we find ourselves in.
Now look at them yo-yos that’s the way you do it
You play the guitar on the M.T.V.
That ain’t workin’ that’s the way you do it
Money for nothin’ and your chicks for free.
Dire Straits – Money For Nothing Lyrics
Banks can borrow for nothing (0%), expand their loan book by 2.5% (by the end of January 2018) and get an extra 40 bps kicker from the ECB. Get your “chicks for free”. Ok, maybe not “chicks” but certainly “money for nothing”. What they are not saying is that the banks are in trouble. Let’s hope the banks can find some qualified and motivated borrowers.
This next quote pretty much sums it all up, “In the last three years plus, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable in order to restore sustainability.” – Mohamed A. El-Erian, The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse (Random House, 2016)
What does this mean? I explained it to someone on our research team this way: It’s like you have a shoulder issue. You go to the doc and get a cortisone shot. Perfect, you feel good again. Six months go by and the pain is back. Another shot, another short-term fix. You do it again until finally the doc tells you she’s done all she can do for you. All that cortisone is really bad for your system in the long term. You need to go to a different doctor, a surgeon, who has the tools to fix the structural problem in your shoulder.
El-Erian calls it a handoff: from the Fed (injecting the juice) to our elected officials (who have the power to implement structural reform). I.e.: Individual and corporate tax reform, U.S. foreign profit dollar repatriation, grand infrastructure projects (aged bridges, natural gas pipes, highways, technology) and entitlement reform/repair (we are nearing a breaking point). Simply, policies that stimulate growth. This requires action.
The problem is that the authorities who have the ability to fix the problem don’t seem to be motivated to get to work. Power struggle gridlock. At some point, they’ll get motivated but it might take another financial crisis to wake them up. This has to happen in Europe, Japan and China as well. Debt is a mess everywhere you look.
Are global central banks nearing the “unsustainable.” No one knows for sure. Stay alert and expect the unexpected. Is ZIRP, QEs 1, 2 and 3, TARP, LTRO, NIRP and coming QE4 (helicopter money) working? Going to work? My two cents is that we have a very long way to go.
Buying government and now corporate bonds. What are we enabling? Debt has not come down. What are we messaging to corporate fiduciaries, bank prop desks, levered investors? What did low rates and no-doc mortgages do for the housing market. Keep your guard up. Stay alert and expect the unexpected.
Equity market valuations remain high and the bull market is aged. Hedge that equity exposure, broadly diversify and overweight to non-directionally dependent strategies. I continue to favor a 30/30/40 (equities, fixed income and liquid alternatives) portfolio mix and hedge that equity exposure. We can change the tilts to overweight equities and remove hedges when forward return potential is high (valuations low and attractive).
To that end, this week you’ll find a great equity market chart that shows us what the forward S&P 500 Index returns are likely to be based on the percentage of household equity ownership.
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Included in this week’s On My Radar:
- All ‘Bout That Fed, ‘Bout That Fed
- What Henry Hazlitt Can Teach Us About Inflation, by James Grant
- Charts That Matter – Forward 10-year Annualized Return 3-4% for Equities
- Trade Signals – “Aged”: The Average Bull Market Lasts 59 Months, This One is Now 84 Months Old
All ‘Bout That Fed, ‘Bout That Fed
Following are several pieces I found interesting – comments on the Fed:
Peter Boockvar, from the Lindsey Group, prior to the Fed’s Wednesday FOMC meeting wrote:
If the Fed was TRULY dependent on the data, they would be raising interest rates TODAY. The six-month job gain average is 235k, the unemployment rate is right at the Fed’s long-term forecast, the core PCE y/o/y rate gain of 1.7% is one-tenth above the Fed’s year-end forecast, the S&P 500 is just 5% from its record high, the US dollar is at the same level it was about one year ago as negative rates from the BoJ and ECB has stopped working in weakening their currencies, oil prices are up 15% from the last Fed meeting, the CRB food stuff index is at a three-month high and the Journal of Commerce index of 19 industrial materials is at a 4½-month high. Also, as the Fed likes to talk about inflation expectations, the 10-year breakeven at 1.50%, the same level it was at in August and the same spot it was at when the Fed hiked rates in December. It is not until September however that the Fed Funds futures market is 100% confident