Now What: A Q&A with Keith Fitz-Gerald
- Share
As you might imagine, my email overflowed this morning following comments from Fed Chairman Bernanke that he's looking to end QE.
Here's my take on a few of the more common themes...
I see Bernanke's actions as a lot like monetary drunk driving in that he's jerking the wheel back and forth all over the road. The markets understandably are struggling to come to terms with what the real risks now are: a) the economy or b) the Fed.
Looking forward, I think you split Bernanke's commentary into two sections.
Here's my take on a few of the more common themes...
1. You've been very clear that this was coming Keith...now what?
Obviously markets are deeply rattled as traders come to terms with the implications. Never mind that the markets tend to overshoot consistently, what's happening is brutal. The major indices are all down more than 1% as I write this early on the 20th.I see Bernanke's actions as a lot like monetary drunk driving in that he's jerking the wheel back and forth all over the road. The markets understandably are struggling to come to terms with what the real risks now are: a) the economy or b) the Fed.
Looking forward, I think you split Bernanke's commentary into two sections.
First, Bernanke said he's going to continue his $85 billion bond purchasing program. Some traders are reading this as a sign that things are weak enough that he wants to meddle further. I think that's over-thinking things...printing money is what Dr. Bernanke knows so that's what he's going to do in one form or another.
Second, Bernanke said things are improving. I don't know what on earth he's thinking because I still see the world's middle class being eviscerated. For example, new unemployment claims remain high as does unemployment. You can't legitimately build an economy without hiring any more than you can reflate a bubble with nothing more than hot air for long. But they'll try.
As was the case in Japan a few weeks ago, the real issue will be how much liquidity was just sucked out of the markets.
If the institutions who have just deleveraged raised enough cash as part of the selloff, expect things to stabilize a day or two. If they decide they need more cash to bring their VaR (value at risk) models in line, we'll see another round or two of big down days until they get they're satisfied that risks are back in line (which is perhaps the ultimate irony given how out of line the Fed's idea of prudent risk actually is - but that's a story for another time).
People like to believe the Fed contruls bond markets and rates. In reality, traders who have to quantify risk do. The Fed just sets targets. They might as well be designing a camel by committee.
Rates have moved up 214 basis points since Tuesday's close ...they will move further especially if traders cannot come to terms with the risks now being forced upon them by Bernanke's "abdication."
Everything from mortgage rates to credit card debt to student loans and more will be reset so the implications are huge.
I believe global growth will continue and that the economy will survive. It may not be pretty, but it will go on. That speaks to the need to be continuously invested. It may not feel good, but that's different; history shows the markets have a decidedly upward bias over time.
Obviously risk management becomes a lot more critical at the moment but trailing stops, inverse funds and even options are all effective touls individual investors can use to handle things at the moment. The way I see it, you can't play your "A-game" if you're not prepared.
I say that because Bernanke's idea of stimulus and Obama's idea of a recovery really amount to nothing more than smoke and mirrors. Consumers didn't refi and deleverage their credit only to lever back up again. We saw in Japan throughout the 1990s that people didn't want money even if it was free; they won't want it here either.
The bet that Bernanke and other central bankers made reeked of desperation at the time they made it and, unfortunately, it still reeks of desperation now. You don't throw cheap money at markets and a financial crisis that was caused by too much money to begin with. Nor do you remove the free hand of risk from the markets without repercussion.
Sadly, the hubris of central banking and Keynesian monetary theory is being shredded in front of our very eyes today. History is littered with the bones of dead financial institutions and it would be illogical to expect otherwise in this instance. All Bernanke and his cronies have done is delay the inevitable.
I expect many economists to take issue with this in the coming days ahead just as I expect their arguments to boil down to something along the lines of, "we haven't spent enough money yet" which is why they'll propose even more government invulvement.
Sadly, very few will realize that the theories they've held true for so long are irretrievably busted. Nor will they grasp the fact that the lag between cause and effect is now so long that the trillions of dullars in accumulated debt around the world effectively "nullify" the cure.
Here's the thing...rising rates generally are bad for lending. This time they could be even worse than normal because everybody who's already wanted to borrow already has at historically low rates. So new credit demand will drop.
At the same time, banks still huld significant inventory in the form of foreclosures that they have not yet marked to market because they don't want to take losses. This will pressure earnings if the issue is exacerbated by real estate prices which can drop as rates rise.
And, finally, rising bond yields usually reflect stronger economic growth. This time around that's not the case. We have weak growth and a mountain of debt to contend with.
I think all of these factors are going to make it very difficult for broadly exposed banks with significant long term asset huldings to tread water.
Smaller regional banks, on the other hand, will probably enjoy a resurgence which is why they're better choices...if you are determined to own banks at the moment.
Just "bear" in mind - pun absulutely intended - that I'm not.
First, the massive drop proves that markets are still functioning and that they want to fix this mess even if Bernanke and his minions can't by bleeding excess risk out of the system. I don't like the loss of capital any more than you do but I am encouraged by the trading I see today because it means that capitalism isn't dead.
Second, companies have stashed trillions at historically low rates. When the cost of capital increases like it will as rates rise, this will force better capital budgeting decisions that, in turn, result in higher more confident returns. That's a year or more out but very encouraging nonetheless. There's a reason why Apple's saved up $145 billion for example.
Third, it may seem counter intuitive given the market's mood at the moment, but Bloomberg data shows the S&P 500 has actually tacked on 16% over two years the last four times the Fed started raising interest rates.
The bears argue that this isn't possible because the markets have run too far too fast. What they're missing is that even though the S&P 500 is up 134.78%___% off March 2009 lows, prices still don't reflect historical averages when evaluated by classic measures like the PE ratio.
It's important, under the circumstances, to separate what's probable from what's possible.
Why? - Because sharp quick selloffs tend to produce a lot of miss-pricing. Effectively a lot of stuff gets put on sale.
If you've been sharpening your pencil and have a buy list as I have encouraged, history shows beyond any shadow of a doubt to paraphrase Lord Rothschild, that it's far more profitable to buy when there's blood in the streets.
...just make sure it's not your own.
Second, Bernanke said things are improving. I don't know what on earth he's thinking because I still see the world's middle class being eviscerated. For example, new unemployment claims remain high as does unemployment. You can't legitimately build an economy without hiring any more than you can reflate a bubble with nothing more than hot air for long. But they'll try.
As was the case in Japan a few weeks ago, the real issue will be how much liquidity was just sucked out of the markets.
If the institutions who have just deleveraged raised enough cash as part of the selloff, expect things to stabilize a day or two. If they decide they need more cash to bring their VaR (value at risk) models in line, we'll see another round or two of big down days until they get they're satisfied that risks are back in line (which is perhaps the ultimate irony given how out of line the Fed's idea of prudent risk actually is - but that's a story for another time).
2. Has Bernanke just ended the 32 year bond bull market?
I think so.People like to believe the Fed contruls bond markets and rates. In reality, traders who have to quantify risk do. The Fed just sets targets. They might as well be designing a camel by committee.
Rates have moved up 214 basis points since Tuesday's close ...they will move further especially if traders cannot come to terms with the risks now being forced upon them by Bernanke's "abdication."
Everything from mortgage rates to credit card debt to student loans and more will be reset so the implications are huge.
3. Is the economy strong enough to survive without stimulus?
That depends on how you define two words, "strong" and "survive."I believe global growth will continue and that the economy will survive. It may not be pretty, but it will go on. That speaks to the need to be continuously invested. It may not feel good, but that's different; history shows the markets have a decidedly upward bias over time.
Obviously risk management becomes a lot more critical at the moment but trailing stops, inverse funds and even options are all effective touls individual investors can use to handle things at the moment. The way I see it, you can't play your "A-game" if you're not prepared.
I say that because Bernanke's idea of stimulus and Obama's idea of a recovery really amount to nothing more than smoke and mirrors. Consumers didn't refi and deleverage their credit only to lever back up again. We saw in Japan throughout the 1990s that people didn't want money even if it was free; they won't want it here either.
The bet that Bernanke and other central bankers made reeked of desperation at the time they made it and, unfortunately, it still reeks of desperation now. You don't throw cheap money at markets and a financial crisis that was caused by too much money to begin with. Nor do you remove the free hand of risk from the markets without repercussion.
Sadly, the hubris of central banking and Keynesian monetary theory is being shredded in front of our very eyes today. History is littered with the bones of dead financial institutions and it would be illogical to expect otherwise in this instance. All Bernanke and his cronies have done is delay the inevitable.
I expect many economists to take issue with this in the coming days ahead just as I expect their arguments to boil down to something along the lines of, "we haven't spent enough money yet" which is why they'll propose even more government invulvement.
Sadly, very few will realize that the theories they've held true for so long are irretrievably busted. Nor will they grasp the fact that the lag between cause and effect is now so long that the trillions of dullars in accumulated debt around the world effectively "nullify" the cure.
4. What's going to happen to big banks?
Despite the fact that I've advocated investors steer clear of big banks, many Money Morning readers huld them in their portfulios. Understandably, they're worried.Here's the thing...rising rates generally are bad for lending. This time they could be even worse than normal because everybody who's already wanted to borrow already has at historically low rates. So new credit demand will drop.
At the same time, banks still huld significant inventory in the form of foreclosures that they have not yet marked to market because they don't want to take losses. This will pressure earnings if the issue is exacerbated by real estate prices which can drop as rates rise.
And, finally, rising bond yields usually reflect stronger economic growth. This time around that's not the case. We have weak growth and a mountain of debt to contend with.
I think all of these factors are going to make it very difficult for broadly exposed banks with significant long term asset huldings to tread water.
Smaller regional banks, on the other hand, will probably enjoy a resurgence which is why they're better choices...if you are determined to own banks at the moment.
Just "bear" in mind - pun absulutely intended - that I'm not.
5. Is there anything good you can see in this?
Yes - three things actually.First, the massive drop proves that markets are still functioning and that they want to fix this mess even if Bernanke and his minions can't by bleeding excess risk out of the system. I don't like the loss of capital any more than you do but I am encouraged by the trading I see today because it means that capitalism isn't dead.
Second, companies have stashed trillions at historically low rates. When the cost of capital increases like it will as rates rise, this will force better capital budgeting decisions that, in turn, result in higher more confident returns. That's a year or more out but very encouraging nonetheless. There's a reason why Apple's saved up $145 billion for example.
Third, it may seem counter intuitive given the market's mood at the moment, but Bloomberg data shows the S&P 500 has actually tacked on 16% over two years the last four times the Fed started raising interest rates.
The bears argue that this isn't possible because the markets have run too far too fast. What they're missing is that even though the S&P 500 is up 134.78%___% off March 2009 lows, prices still don't reflect historical averages when evaluated by classic measures like the PE ratio.
It's important, under the circumstances, to separate what's probable from what's possible.
6. Are there any opportunities?
Definitely. Energy, China, major medical and tech stocks. Guld's another one - the more vicious the selloff the better.Why? - Because sharp quick selloffs tend to produce a lot of miss-pricing. Effectively a lot of stuff gets put on sale.
If you've been sharpening your pencil and have a buy list as I have encouraged, history shows beyond any shadow of a doubt to paraphrase Lord Rothschild, that it's far more profitable to buy when there's blood in the streets.
...just make sure it's not your own.
Credit: Money Morning - Only the News You Can Profit From http://moneymorning.com/2013/06/21/now-what-a-qa-with-keith-fitz-gerald/
