Pay no attention to the man behind the curtain

This title really says it all when it comes to the recent action in capital markets. Market excess is not hard to find in any part of the capital markets as they exist today: high yield, government bonds, equities, leveraged loans, etc.. But, when it comes to Central Banks, the phrase ” ask and yee shall receive” has never been more true. However, just like the great and wonderful Oz, it is important that markets not delve too deeply behind the curtain because such exploration would suggest that the benefits of Central Bank actions have mostly been psychological in nature, with very little proven outcomes to date. We understand the talking points quite well, nearly 5 years into this grand experiment, Low rates: boost corporate profits, equity prices, perceived consumer wealth, spur hiring, etc.. However, this experiment in yield curve support, has morphed into a feeling by all investors in all disparate parts of the capital markets that the man behind the curtain has things covered. We were blown away by a recent article in the NYT in which Bernanke (remarking on the possible bubbles in todays environment) stated ” Microsoft ‘s stock is worth well more than it was some time ago, and it could still prove to be a bubble” He chooses Microsoft as an example? It is interesting to note that he did not use the high yield market as an example, particularly since spreads over treasuries are below where we were pre-2008. The Fed is de-facto encouraging not only a reach for yield, but a completely reckless reach for yield. No doubt, this type of behavior always ends badly, however in this latest episode the blame (as it should be) will be placed squarely on the Fed. Their ability to, once again, “save the day”  will be severely hampered under such a scenario. Forget the short term oriented deflationary chatter: BUY STUFF, SELL PAPER.

Timing is Everything

Our experience in asset management over the years has shown us, if nothing else, that the most recent market action sows the seeds of the next most likely counter trend. Thus, the “great moderation” led to something much more chaotic in the aftermath, permanently rising home prices led to an environment which virtually guaranteed prices would no longer maintain their stair step rise, and ever rising commodity prices led to unsustainable new production efforts which are now being written off. My point is that markets, built on human nature, assume that tomorrow will look much like today, when in reality the inverse tends to be more the norm. What implicit market assumptions are being priced into todays economic DNA.  1) Global rates will stay low as long as Central Banks are committed to such 2) Inflation is not a problem for the foreseeable future 3) Liquidity is abundant, particularly in public capital markets. 4) Global liquidity is not only central bank driven but central bank channeled. The challenge is to try and ascertain when these “truths” have simply become self-fulfilling prophecies, because  violent inflection points typically accompany such sudden realizations.