Archive - Sep 13, 2013 - Story

It’s always a good sign for an empire’s fortunes when the commander in chief of the armed forces completely loses the confidence and trust of the troops.

To say that bonds are under pressure would be an understatement. Over the last few months, sentiment about fixed income has flipped dramatically: from a favored investment destination that is deemed to benefit from exceptional support from central banks, to an asset class experiencing large outflows, negative returns and reduced standing as an anchor of a well-diversified asset allocation. Similar to prior periods, history will regard the ongoing phase of dislocations in the bond market as a transitional period of adjustment triggered by changing expectations about policy, the economy and asset preferences – all of which have been significantly turbocharged by a set of temporary and ultimately reversible technical factors. By contrast, history is unlikely to record a change in the important role that fixed income plays over time in prudent asset allocations and diversified investment portfolios – in generating returns, reducing volatility and lowering the risk of severe capital loss. Understanding well what created this change is critical to how investors may think about the future.

Despite Hank Paulson's recent re-emergence basking in the glory of his miracle, the 'too-big-to-fail' problem is bigger and more prone to fail than ever before (M&A dominance, capital cost advantages, major AFS loss potential and huge reliance on repo funding). The following excellent infographic from The FT succinctly summarises the reasons why banks failed last time... and what lessons - if any - we have learnt...

Faber begins by noting that "a deflationary bust, whenever it may happen (tomorrow or 10 years), is inevitable; and is the opposite of an increase in prices from inflation." Of course, it is the central banks' response to even the fears of that bust (e.g. whether it washes around the world - from EM to DM) that will turn an asset-deflationary bust into a hyperinflationary collapse in fiat currencies; and focused on the long-term, 'Gloom, Boom, & Doom Report's' Marc Faber looks at how to preserve wealth through this as he ranges from the obsolescence risk of equities to the political risk of real estate and banking risks of cash and deposits. Faber reflects on various lessons from the past (hyperinflations, wars, banking crises) and geographies as he moves from asset class to asset class highlighting the pros and cons of each. Preferring a mix of gold and diversified real estate (and not government bonds), Faber warns investors to be highly skeptical of anyone who believes they can forecast what is going to happen over the next 5-10 years.

Still believe in humans buying and selling stocks, influencing the machinations of broad-based equity valuations based on their aggregate (rational, frictionless, technical, fundamental, and infinitely liquid) beliefs... then what the f**k is this?

Until six days before Lehman Brothers collapsed five years ago, the ratings agency Standard & Poor’s maintained the firm’s investment-grade rating of “A.” Moody’s waited even longer, downgrading Lehman one business day before it collapsed. How could reputable ratings agencies – and investment banks – misjudge things so badly? Regulators, bankers, and ratings agencies bear much of the blame for the crisis. But the near-meltdown was not so much a failure of capitalism as it was a failure of contemporary economic models’ understanding of the role and functioning of financial markets – and, more broadly, instability – in capitalist economies. Yet the mainstream of the economics profession insists that such mechanistic models retain validity.

While we await Obama's response to the Putin NYT op-ed from Wednesday night, the "pen-pal by proxy" pissing contest just got a new contender: the Tea Party's own, and current Heritage foundation president, Jim DeMint. And while DeMint's thesis is certainly admirable, namely that America is exceptional, his argument is that this is due to the... limited power of government!? Jim, and the NSA probably had the same question ahead of us when it was intercepting this letter as it was being transmitted in TCP/IP space and then saved among a plethora of cloud servers, we wonder: wasn't the point to refute Putin, not admit he is correct?

"The Bank of England now has the ability to take the froth out of future housing market booms, without having to resort to interest rate increases," is the way the UK's realtor association explains their demand that the BoE limit national house price growth to 5% a year. While they would benefit from short-term gains, it seems the Royal Institution of Chartered Surveyors (RICS) sees the dangers of another unsustainable housing boom outweigh them. As The FT reports, RICS adds, "this cap would send a clear and simple statement to the public and the banking sector, managing expectations as to how much future house prices are going to rise. We believe firmly anchored house price expectations would limit excessive risk taking and, as a result, limit an unsustainable rise in debt." Or will it merely lead to further financial engineering and leverage?

On a day when the CBOE was struggling to disseminate data, exchanges proclaiming self-help against one another, weekly expirations and an AAPL share price well below early week pin-risk levels, it makes perfect sense that it would be a VIX-sparked momentum ignition algo that would lift a super-low-volume day in US stocks from perfectly at VWAP to close at their highs (banging them 0.25% higher in the last 3 minutes of the day)... all we can say is WTF...

"A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money ."

- Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, November 21, 2002

What do you do when there are some of the biggest and most catalyzing events in recent years waiting just around the corner? Why you buy stocks of course with both hands and feet... The Dow gained around 3% on the week - its best since the first week of January - outperforming its higher-beta peers (as AAPL lost over 6% for its 3rd worst week of the year). This was the lowest non-holiday week volume of the year. It seems weak retail sales and a collapse in confidence also spurred buying (and yet more short-covering: Shorts +0.5%, RUT +0.17%) and the opposite-world of QE rules the day/week (until next week perhaps). Bonds rallied (best week in 4 months), the USD dropped its most in a month, and VIX had its biggest weekly drop in 6 weeks. Gold and Silver were clubbed like baby-seals this week until lunchtime today - when they started to surge green on the day.

The American public is "just too darn stupid to get it." That is the message that CNBC's Rick Santelli hears from the mainstream media when discussing polls that suggest US citizens are against a rise in the debt ceiling. Perhaps, as he exclaims, "we should only poll the Harvard and Princeton professors," since they have such a good grasp of reality. But, it is the "giant leap of faith" that the Fed can really move unemployment and keep the economy humming along to support the level of equities that has the Chicagoan irate. Congress - listen up - he explodes, "70% of Americans oppose raising the debt ceiling, and 55% oppose it even if it means default." With the mid-terms not so far away, Santelli warns, "Americans know exactly what they want and they are not getting it from the current Congress."

Just how will your great-grandchildren preserve their wealth - or are they stockpiling condoms and gasoline now?

Financial circles in Hong Kong are buzzing today on the new Goldman Sachs projection that gold may drop below $1,000 an ounce. The central thess: since the US economy is out of the woods, there’s no longer a need for gold as a risk hedge. But as one senior-level manager at a major investment bank noted, "Nobody knows what the f**k is going on..." However, this mentality entirely misses the point of precious metals. When the hopes and dreams of the entire global financial system rest on the lies of politicians, the whims of central bankers, and the mountains of debt they have all accumulated, things could turn on a dime... tomorrow. Gold is an insurance policy. It’s a form of money that you might never need to use. But should that need ever arise, you’ll be so much better off for owning it.