You have to start wondering if the folks around the FOMC table are actually talking to one another. Recent comments by Chairman Yellen regarding investor complacency in the face of alleged upcoming rate hikes does not seem to jibe with comments by Fed President Dudley about the recent strength in the U.S. Dollar. Perhaps the reason that investors are so ambivalent about upcoming rate hikes is because they have every reason to be. With all of the dashboard indicators arguing for a rate hike, Mr. Dudley has simply added another gauge to that dashboard. If the Fed is worried about the strength of the U.S. Dollar, they should join the queue as Japan and the EU are all in a race to debase. The ultimate winner of this race to the bottom will be hard assets with the loser being the last remaining shred of Central Bank credibility. Buy Stuff
If you did not read todays op-ed piece in the NYT by Professor Paul Krugman, it is definitely worth the read. In the piece, Professor Krugman questions the credibility of those that would even suggest that the Fed policies of the last few years are laying the ground work for higher inflation. He calls it the power of the inflation “cult”. Mr Krugman wonders why so many have adhered to a prediction that so far has failed to materialize. I won’t ruin it for you, but his general thesis is that those that would argue that endless bouts of Fed liquidity ultimately will lead to inflation are really arguing against government spending. In Professor Krugman’s view, those in the inflation camp are really opponents of social programs in disguise. As someone who never saw a government spending program he did not like, he should know. In fact, if you follow Professor Krugman’s views in the NYT, he feels quite strongly that the Fed has not gone far enough to cure everything that ails the U.S. Economy. Much like those that he criticizes, Professor Krugman constantly is pressing for more of the same, while completely ignoring the possibility of unintended consequences. Professor Krugman also fails to mention that this sea of liquidity on which the global economy currently resides has been fueled by not only the Fed, but by every other major Central Bank. As someone who puts such credence in the powers of Central Banks, one would think that Professor Krugman would at least give some deference to the possibility that they will ultimately get what they want (higher inflation).
If you were forced to listen to the circuitous ramblings of Janet Yellen yesterday,one had to be amazed at the degree of precision ascribed to the Feds various forecasts. Not only were the forecasts precise, but astoundingly they did not even make any economic sense. According to Chairman Yellen, the jobless rate is projected to fall to 5.1% by 2016 with prices also remaining stable throughout that same period. In their rosy scenario, the funds rate only rises to 150 basis points, thus further cementing negative real rates at the front end of the curve. When asked about the recent uptick in the overall price level, she dismissed this as simply noise and also downplayed the decline in unemployment as lacking substance given that the composition of these new jobs was suspect. One has to wonder at what point the capital markets will wake up to the fact that the Fed is simply a one trick pony at this stage. We had to laugh at a Bloomberg interview, post news conference, in which an analyst commented that the Fed has many options still open to it in the event of some “black swan” event. This analyst stated that they always could engage in more forward guidance if need be. We may be wrong, but if the unforeseen comes to pass(and it always does) simply stating categorically that they will do nothing for longer will probably not do the job. The reaction in the dollar, and more pointedly commodities, after this latest round of Central Bank inaction is a clear signal that the maybe the wake up call is now upon us. Buy Stuff
Much has been made about the lack of volatility, relatively speaking, across almost all parts of the capital markets. The dampening down of what would be considered normal volatility has again been laid at the feet of the command and control Central Bankers.We are not surprised however as the prevailing attitude is that low rates cure all ills, when in reality, low rates create more ills. We all should be quite attuned to the sedative effects of low interest rates on investors perceptions of real risk, if the recent crisis has taught us nothing else. Thus, when we see potentially serious geo-political flareups such as Iraq or China/Korea, any hint of serious concern is smothered quickly by the “whatever it takes” mentality inherent in all Central Bankers. However, as Bertolt Brecht said ” Because things are the way they are, things will not stay the way they are”.
I have to put us in the dumbfounded camp when it comes to the recent action in Treasuries. Yields that are scraping along the bottom, actually negative real yields if you take the most recent CPI data and a sub 2.5% Ten Year Note, would not seem to jibe with the action in Global Equity Markets. It’s hard to imagine that the equity markets and the fixed income markets both have it right. The explanation for the aforementioned Treasury rally has been laid at the feet of outright deflation, ostensibly exported from the newly submerging markets (China, Brazil, etc..). The geo-political backdrop to a global macro environment that is still based on “beggar thy neighbor” policies would argue that there is less to this deflationary argument than meets the eye. David Rosenberg of Gluskin Sheff deftly points out that the newfound global disharmony, both politically and economically, will have vast implications for forward thinking investors. Mr Rosenberg comments ” Tectonic shifts are taking place and this in turn requires a shift in strategy for anyone operating under the old paradigm of world harmony, political stability, central bank prudence and expanding global trade flows”.The tectonic shifts for which Mr Rosenberg refers are the anchors of inflation/deflation and his argument for a pre-emptive shift in portfolio composition, in our opinion (obviously), is spot on. Position yourself on the right side of the tectonic plate and Buy Stuff.
I can’t help but feel like Bill Murray in the movie Groundhog Day, whereby it appears that every day in the Capital Markets is a repeat of the day prior. Forget the new normal, or the great moderation, we are now in the midst of the Groundhog Day Market. In this nirvana, Stocks rally, bonds rally or at least stay range bound, commodities sell off and volatility across the board stays stubbornly low. Investors in this new era, would appear, like Bill Murray, to be in some kind of twilight zone where it’s not “no news is good news”, its there is no new news. Every day the background noise is the same: “Stocks are the place to be given where rates are”,” The Fed will not raise rates until…”,” Inflation is dead”,” De-flation is the greatest risk”. This world would indeed be nirvana if not for the faulty premise that underlies all of this complacency; namely that Central Bankers have it (whatever it may ultimately be) under control. What concerns us is not the occurrence of some black swan event, but rather the high level of disjointedness which will occur given the significant mis-allocation of capital across all global Capital Markets.Major dislocations in markets usually do not stem from one single “event”, but rather from the collective group -think that believes that all events are simply one-off in nature and thus can be controlled. Market dislocations occur when the macro suddenly overwhelms the micro, thus rendering simple solutions (Central Bank action) relatively ineffective. Don’t mistake sameness for safety, Buy Stuff.
The minutes from the last Fed meeting were released yesterday, and as usual, the mindless chatter was soon to follow. A great deal was made about the discussion of the continued taper and more importantly how, or if, they would shrink their $4Trillion balance sheet. Without going into details, except to tell us that rates would not normalize any time soon, the committee felt they had a sufficient number of unproven methods to either reinvest their runoff proceeds or not. Depending on growth, or employment, or inflation the Fed feels confident that rates will remain low, or not, and that they will make adequate adjustments to policy, or not, depending on whether conditions warrant. Fed speak has been reduced to the most abject level of nonsense, which everyone feels somehow compelled to comment and act on. What was classic in yesterday’s minutes was the discussion of risks whereby some Fed members felt there were potential risks out there involving financial markets, namely tight credit spreads and low levels of overall volatility possibly hinting at extreme levels of complacency. The general feeling was however that it would be” helpful to continue to explore the appropriate regulatory, supervisory and monetary policy responses to potential risks to financial stability”. In other words, stay at the party everyone, we will clean up the mess afterwards- trust us.Trust in Central Bankers at your own risk. Buy Stuff.
The obsession with spotting “bubbles” in capital markets and elsewhere seems to border on the inane. Pricing which lies outside of what would be considered normal valuations, in our opinion, do not constitute a true “bubble”. More importantly, the discussion of whether something is “bubbly” or not completely misses the point. We take much greater umbrage at the constant commentary uttered by almost all index hugging managers who state ” we know (fill in the blank asset) is probably overvalued, but where else are you going to put your money”. This relative value investing is the absolute antithesis of what true value investors practice and preach. Whether it is Rwandan debt at 7% or Greek debt at 4% or the entire junk market trading at 265 basis points over treasuries, not only have Global Central Bankers pushed everyone into the risk pool, there is now only a foot of water left in the shallow end. Risk and reward are not predicated on where Central Bankers artificially set rates, but are based categorically on what return you demand for the risk you are taking. If those returns are not adequate, you don’t play. But, Central Bankers are intent on ensuring that people continue to play, regardless of how much capital is currently being mis-allocated. Meanwhile, we are constantly being told that the ensuing backup in rates will decimate non- yielding assets such as metals and other hard assets, ironically they fail to make the same distinction with these other effectively non-yielding assets.
Anyone that has flown as of late knows the ticket inflation that has infiltrated almost every part of the traveling experience. Charges for baggage, change fees, beverage fees, overhead space fees, etc.. We have always wondered out loud how a flight to Florida from Chicago could be profitable at peak travel times for $100 round trip. Well, it turns out it wasn’t, and a Bloomberg article astutely points out the somewhat counterintuitive notion that high oil prices are actually the culprit for a turnaround in the profitability of the U.S. airline industry. In spite of fuel costs doubling over a 10 year period, airlines are on track for a record fifth consecutive year of profits. The reason for the profitability increase was that airlines not only became more lean and mean, flights were finally rationalized and thus consumers were forced to allow the airlines to charge more. However, most importantly the relatively high fuel cost made starting a new airline cost prohibitive thus finally driving bottom line growth in an otherwise unprofitable schizophrenic industry. We have to wonder if this industry example can be extrapolated into other industries where high commodity costs and low barriers to entry have led to great benefits to the consumer, but low to stagnant profit growth afforded to the producer. More stable profit growth means more stable underlying commodity demand and a compression of the amplitude of the boom/bust cycle that plagues all commodities. This type of shift would ostensibly bring smiles to Central Bankers faces everywhere.
The most recent Fed minutes came out and we were surprised to see the consternation amongst some Fed Members regarding the downward trend in medical costs. The concern was voiced in the context of a discussion on the decelerating overall price level. Some of the voting members were optimistic that wage growth momentum would be positive for inflationary pressures moving forward, but it should bother everyone that falling medical costs are a concern of those around the Fed meeting table. Correct me if I am wrong, but as I stated in our last post, the goals of monetary policy seem to have shifted towards the touchy-feely variety and as such it would seem that falling medical costs might benefit those that Chairman Yellen seems to be most worried about. Chalk this discussion up to one more example of: Be careful of what you wish for. If Central Bankers are becoming concerned, and thus forming policy decisions, based on naturally shifting price data (some go up some go down), it would seem only natural that they miss the forest for the trees. Particularly since history has proven that their forecast usually misses both the forest and the trees. Pay attention to the forest. Buy Stuff Sell Paper