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Former Head Of Morgan Stanley Research And Global Strategy Slams Equity Rally: "It Is As Finite As The Excess Liquidity From QE"
- Asset-Backed Securities
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David Roche, former Head Of Morgan Stanley Research And Global Strategy, and currently president of Independent Strategy shares perspectives that should be read closely by any bull who believes that there is anything else to this market rally than pure liquidity driven euphoria riding on the coattails of the Fed's Quantitative Easing program. Deconstructing one by one all the myths that make up the arsenal of every pundit who appears on CNBC to talk up their book, Roche concludes "Of course, the insider game between financial institutions and the central banks can go further. But we do not want to be a part of it because it is unsustainable. It is as finite as QE." And QE is ending in one month, at about the same time when Greece will have to bailed out as its money will finally run out. About 30 days and counting.
First, on the "V-shaped" recovery:
The US economy has to have a V-shaped recovery for the current valuations of equity, oil and commodity to hold. That will not happen for the following reasons. First, consumer income will increasingly be determined by wages, not fiscal handouts. Disposable income will fall as the handouts fade (Figure 2). Despite the manifest profligacy of the US authorities, they cannot repeat their generosity without completely blowing out the fiscal arithmetic and suffering a foreign buyers' strike for US treasuries. Household savings rates have risen only because government leverage has been transferred to households and used to heft consumer thrift. They will have to rise further and then they will become a net subtraction to consumption. The latest June figures for personal income and consumption showed the biggest fall in income in four years as government handouts fell out of the equation. The savings rate also declined.
Second, there is no need yet for corporations to invest because profits are still lousy and spare capacity is through the roof. Also, the rundown in inventories, to be followed by a restocking (which is supposed to spark an explosion in manufacturing output), will be much less powerful than anticipated because inventory to sales ratios are not lean (Figure 4). Most important, inventory cycles only spark generalised economic recoveries if they lead to job creation and increased corporate investment. Neither is likely because this is a cycle like no other.
Third, the credit machine is impaired and so is demand for credit. This is not only because there are piles of bad debts still to surface from consumers, commercial real estate and highly-leveraged corporate players. The other key reason is that the recent improvement in bank financing is down to central bank money. Wholesale debt markets are only dribbling finance into the banks. Is it really conceivable that the central banks will be able to double or triple their balance sheets to finance a credit-driven consumer recovery while the banks game the central banks to make mega profits? We doubt it.
Fourth, none of the core problems that caused the credit crisis have been addressed. Consumer leverage is worse now that it was then (Figure 7). So is bank leverage. The leverage party cannot be repeated. The savings deficit countries (the US, the UK) must see a return to thrift (which will cap consumer spending). One driver of higher household thrift in deficit-ridden countries is that households and corporations realise that the wrecked balance sheets and budgets of the government sector can only be paid for in one way, down the road — with their money.
The excess savings economies (Japan, China, Europe) are likely to go on being just that (how they invest the savings in the post-dollar standard world is another matter —and that’s bearish for the dollar. This means slow global growth.
Some simple math from Roche.
Credit crises end when the economy starts to grow without credit. Credit only expands later (Figure 9). This can happen because, in a credit contraction, the price of assets and goods and services can fall dramatically. Near 90% of the people keep their jobs and work income, so the mass of consumer purchasing power only falls by the amount of unemployment and wage decline.
Households lose about 20% of their wealth. But if the price of things (either stuff in the shops or investments) falls by more than the combined contraction of wealth and income, they have become cheaper in terms of the ability of most households to buy them. Those with money do so. They don’t borrow to buy or invest but they have the cash. Those that don’t are still busy paying down their debts. But the ‘haves’ can have enough purchasing power to move the economy off the bottom. This sort of recovery is self-sustaining. Note government has little to do with it!
If we are wrong on markets it will be because we are wrong on the economy. The markets cannot advance or stay where they are unless the economy fulfils their dreams. If we are wrong on the economy it is because the ‘natural’ recovery described above takes hold.
And a key observation:
After much flaying of our collective souls, we do not think this natural recovery will happen. The reasons are that government interference has prevented prices adjusting as they should. This holds for everything from real estate to equities and consumer products (because government continues to finance excess consumer demand.
As government solvency worsens, households will also be less willing to spend because they know they will have to bail out the government through higher taxes later. Therefore, the twin springs of the natural recovery are broken.
So what is the source of the irrational exuberance? Simple - the Fed's printing press, and the resultant cash which banks are stuck with which needs to be reinvested into risky assets.
Why are asset markets going up if it so obvious they shouldn’t be? It is too facile to say it’s all down to central banks printing money because most of that money is being hoarded in banks and not being lent onto corporations or individuals.
The secret lies elsewhere. When central banks operate ‘quantitative easing (QE)’, they buy assets outright from financial institutions to expand the money supply. Individuals are not a part of the process. And the mutual fund and ETF figures tell us they are not part of the rally either.
What happens is that the financial institutions sell their treasuries and asset-backed securities to the central bank and get cash or a deposit in return. The Fed now owns 3% of outstanding stock of US treasuries and 12% of agency (mortgage debt). In sum, that adds up to well over $1trn. [these numbers are now stale and have to be revised upward materially].The financial institutions that previously owned these assets now have cash (Figure 13). They don’t want to hold all this cash because it earns little. So they have been reallocating something of the order of $400-600bn to equities (and additional amounts to other risk assets). That is what is driving the rally in these assets. And it tallies more or less with the amount of money needed to move the market the way it has.
Individuals and even hedge funds have played a very minor role. Indeed, individuals have been ploughing their money into bonds and using their cash to pay down debt. One way we could be wrong on markets is if individuals surrender and start buying lots of stocks.
Of course, the insider game between financial institutions and the central banks can go further. But we do not want to be a part of it because it is unsustainable.
It is as finite as QE. Of course, it hurts like hell every day. But so did being a year and half early in predicting the credit crisis.
It is this precise bubble that Bernanke has promised is not happening. Yet it is, and not only in the US, but in China, whose own comparable economic situation, via the dollar peg, has doubled the dry powder available to the world's two largest central banks. Alas, it also means that just as the rally was liquidity driven on the way up, so it shall implode under its own weight. The question of course is when: As Roche notes: "Is it really conceivable that the central banks will be able to double or triple their balance sheets to finance a credit-driven consumer recovery while the banks game the central banks to make mega profits?" Well, the US already has, and it can not much more. China is already in a liquidity contraction phase, and Japan is irrelevant. Europe is finally realizing it is collapsing in a deflationary environment, so the ECB may very well be the last entity to provide liquidity. However, with the PIIGS situation reaching crisis proportions, we are confident, that very soon it will be every central bank for itself in Europe. When that happens, the scramble for the exit will be amusing, and so will be the lack of the HFT bid that we have all taken for granted for so long.
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Great piece! Explains the situation nicely. Now my only question is will QE really end on time? Or will they "go off the reservation" and build a balance sheet the likes of which not even God has seen?
It will end and he gives the reason why. Count on it. The Fed cannot act with impunity. It has to check with our mast, uh I mean our borrowers. I got my oil changed today. I was talking to the owner of the oil change place. He's independent. Bright guy. I asked him if he'd buy a Treasury bond now. He laughed. So did I.
But that's what I mean by "off the reservation" where they make a decision "We are going to buy all the paper, forever". It will melt the dollars face off, but other nations have done it before.
isn't this a good time to start another war? have those wascally terrorist do somthing and then blame it on iran or something along those lines? i think we live in very dangerous times. desparate people do desparate things. too many people are waking up too fast courtesy of the internet....it is not 1929 again..we are all wired in and we see and read about what is really going on....
Shameful,
I fully expect them to do whatever it takes to keep the Ponzi going. If that means more QE, more QE it will be. If they think something else is needed, it will be done. It is now all about perception and the game is a tight rope walk between scaring the children enough to keep them in line while keeping them excited enough to spend, spend, spend.
There is still way too much money left on the table for this scam to be declared over and done with. They've only just begun.
Now i agree that their lust for wealth they do not possess in unequaled but I'm still having problems predicting the exact action. As I see it they are walking between two chasms. To one side a hyper-inflationary depression and on the other side a total destruction of the debt system by write downs and no real (none QE) money flowing in, which will force a possibly global sovereign debt default. Now as a betting man I'm placing my bets that they will try to balance and ultimately fall on the hyper inflationary side of the coin but I have no inside information and this is just based on my limited research and more limited reasoning.
In both cases they can profit. In the inflationary event they print the money and give it to the favored players. In the deflationary event they hoard dollars and let the system burn and buy things on the cheap. Between the two I would guess for inflation as many stubborn people will not sell assets but in a hyperinflation event they can grab assets with more force. After all when you print the money you make the rules, and legal tender laws will become a nightmare ride through hell along with price/wage controls. And of historical note hyper inflation does not ruin everyone. Look at all cases and you will see that at least 1 favored class survives or in some cases prospers under the system. The military in Rome, the industry barons in Germany, the political elite in Zimbabwe. While the currency burned they did quite well.
Shameful:
i like your thought process, but you are overthinking it
the people in control are the politicians. politicians don't know anything besides getting reelected and they don't get reelected if there is a revolt within the working class, even if the money class got them elected last time.
they will always print because it keeps them in power. all they need is an excuse for the camera'a and we'll be off to the races.
if you look at the numbers, debt/gdp, M3, soveriegn debt, etc. there;s no question that much more liquidity will be required to delever the incredible IOU bubble we have today. remember that the money in a managed currency system has no intrinsic value; it is only used to do transactions that revalue assets, up or down. if more dollars are needed to keep the asset revalueing process happening, the fed's will create it. they will prevent a sharp asset revaluation by providing ample liquidity at any cost.
alot of folks on this site make the mistake of thinking of the dollar as a store of value (money) which it is not. it is a transfer medium and it is a mistake to think of it even as a temporary store of value. modern economic theory doesn't assign any weight to this as evidenced by the destruction of absolute buying power.
don't agree with it; it's just how it works right now
"alot of folks on this site make the mistake of thinking of the dollar as a store of value (money) which it is not. it is a transfer medium and it is a mistake to think of it even as a temporary store of value."
Because people can purchase "things" with "money" they think the "money" has value. But you have hit it on the head when you explain it as a transfer medium.
I try to explain to my clients in the simplest of terms that you work 8 hours and in return, you are given paper chits, pieces of paper that equal the current value society will give you for your 8 hours of work. If you dig ditches, it's at this level. If you design rocket ships, it's at that level.
The paper chit is simply the means to allow you to exchange your 8 hours of work for food, housing and the playboy channel. If you don't spend all 8/40/200 hours that day/week/month and have some left over, while you might consider it "savings" in reality it's simply unexchanged/untransferred paper chits/hours of labor that can be devalued by the entity who controls the printing press.
If things really get out of hand, you want to be given these paper chits on a daily basis because they are being destroyed faster than you can "earn" them or "spend" them or more accurately "exchange" them.
Great stuff, thanks to the two prior posters.
Ponzi's always end badly, this one is no different.
When this thing blows, its going to be the biggest ever
Financial perpetual motion is as impossible as physical Perpetual motion
Thats why I own physical
This one is a keeper and dovetails with recent completion of countertrend rally "B wave" IMO
The natural law is very simple: there were economics and financial excesses. This excesses must/will be corrected one way or another.
Unfortunately, the present approach is to preserve the past status quo with QE (or printing money) without addressing and solving the underlining ills inevitable leads to a failure. It appears that the Obama administration and the Congress have crossed Rubicon. There is no way back regardless of what Obama and/or the FED will do.
Dune fan I take it?
Will the financial landscape resemble Arrakis?
Will it take an Immortal God Emperor 3 thousand years to teach them the "there is no free lunch" lesson that their bones will not forget?
Or will it all be consumed by the Worms?
+1
Nothing new here, but Mr. Roche can word it much more eloquently than I.
BOE like the foreskin of the Fed. listen to merv this am on QE
I don't know what the market will do, but QE won't end in one month. It may take a brief respite, but Bernanke (or his successor) will continue to monetize our debt until it is "paid down" to a manageable number. That will take years, probably decades.
My own theory has always been that the Fed's involvement was never expected to stop the collapse but to slow it down. It's the difference between popping the baloon and slowly letting the air out of it. In either case, the end result is the same but one is less traumatic than the other.
controlled burn attempt to preserve incumbant structures/order - Nial Ferguson may disagree
i've been saying this for months, months, i tell ya, lol
you are right. these bankers in the know can make this thing go on for as long as they want. nobody knows when anything will actually happen.
Mr. Roche is a truth teller but most the sheep do not want the truth. The flock will be fleeced, its a given. Only question is when. Might have to break out the brandy snifter tonight.
It is good to hear the truth of what is going on explained so clearly. QE is the entire game, and the game looks like it is about to end, and so, as the prior comment says, we are let down easy into Great Depression II. I really wonder about the housing industry and where the mortgages will come from, once the Fed stops buying the agency MBSs, whereby it has singlehandedly supported housing prices and the housing market since 2008. Absent their ever-present bid . . . I am guessing the "backdoor guaranty" of Dec 24 is what they are hoping will support sales to buyers, but who, especially when there will be a hugely amply supply of USTS to buy as to which the full faith and credit guarantee is explicit. Why bother?
an extra 20 bps might solve the pension hole
The goal is not to let us down easy. The goal is to let them down easy, or more properly to give them time to finish stripping the carcass before it is tossed on the midden.
Seems a little too freshwater for my tastes.
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http://midasfinancialmarkets.blogspot.com/2010/02/ready-to-rumble.html
JP CitiSachs wants to preserve the printing press for their own purposes -savvy?
This is not new from Roach, he has more screen time on "the death of the dollar" doc then Peter Schiff does.
The central banks are all in. Ben will print to support the banks (and, of course, bankster bonuses) until the dollar is worthless and the rest of us are penniless. What other choices do the rulers' have to keep the Ponzi going? Does anyone really think the Fed will intentionally crash the markets?
They would do anything that they can do to achieve their objectives.
The one thing they have to do is keep buying US Govt bonds while pretending that mysterious others, generally presented as a brain-dead Chinese banker, are buying them.
Has Ben considered the possibility that the world will run out of electrons before he finishes creating more dollars?
Print, print, print ... until supply chain hiccup occurs ... then the music stops
"The US economy has to have a V-shaped recovery for the current valuations of equity, oil and commodity to hold."
Absolutely pitch perfect explanation!
Great article!
"Third, the credit machine is impaired and so is demand for credit. This is not only because there are piles of bad debts still to surface from consumers, commercial real estate and highly-leveraged corporate players".
and then
"Fourth, none of the core problems that caused the credit crisis have been addressed. Consumer leverage is worse now that it was then (Figure 7). So is bank leverage. The leverage party cannot be repeated".
I have preached this so much my face is blue. You can run from debt but you can't hide from debt!
And then;
"One driver of higher household thrift in deficit-ridden countries is that households and corporations realise that the wrecked balance sheets and budgets of the government sector can only be paid for in one way, down the road — with their money."
Where is the evidence of this?? This is what truly needs to happen! Why aren't the Republicans or some new Independent marching in the streets with this message???? Somebody hand that mega-phone to Schiff!!! Scream Schiff Scream! Louder!
And finally;
"Of course, the insider game between financial institutions and the central banks can go further. But we do not want to be a part of it because it is unsustainable"
Great! Just what I wanted to hear. I don't want to be a part of this either, but when will this madness end? Uncle Ben, I'm on my knees and pleading to you to let this bad debt go man, just let it go! I'm dying over here you crepe! Just let it go!
Sorry, but as much as Uncle Ben would like to continue with the QE for "as long as it takes", he is no longer calling the shots here.
China is not unconvinced that the Fed/Treasury endgame is to inflate away the debt. If China decides to hit the "sell" button HARD, Uncle Ben would be forced into a dangerously high level of QE.
At the end of the day, dollar destruction = Fed loses its franchise. This they absolutely do not want.
Ah what have they done to the purchasing power of the dollar so far? Lose franchise nothing they can run it and run it because it doesn't get revoked till Congress mans up. And waiting for that is like waiting for the hot girl at the bar to notice you, she won't. You have to man up and go in there to have any chance. Maybe $100 bread might put a spine in congress but I wouldn't hold my breath.
China owns a measely 700 billion of the debt. Hardly worth it. If they fuck with us, we fuck with them. Plain and simple. Their economy is a myth and WE allow THEM to keep pumping the propaganda. Make no mistake about who is calling shots here.
The Fed holds about 5 trillion of debt.
QE might end and it might not.
What will not end is the liability to debt holders and interest payments.
You pay or you default. There is nothing in between. To pay, the UST needs to be able to raise liquidity which means selling more debt. They're already running with Peter's money to pay Paul but Paul will want to be paid also.
End game. More liquidity is needed and the hope that Peter and Paul will keep playing even when their debt holdings become worth less and less.
I agree with all of the logic in his argument except for one thing...I believe the natural recovery will take hold. Laugh if want, but here is my simply theory:
There are two types of Americans: savers (like me) and spenders (like my wife), but as a collective, Americans are consumers at heart (my wife's ability to spend > my ability to save). The economic crisis has spawned fear in all, and has caused spenders to move to the other team, but this is a short-run phenomenon, and their innate behavioral characteristics will eventually pull them back to the dark side.
All it takes is shiny objects, especially if first possessed by the proverbial Joneses. Seriously, think about it. If all of our spenders have permanently converted to savers, then why is Nordstrom still in business (look at the stock price: JWN)? Why do iPhone sales continue to rise (same comment: AAPL)? Why did auto demand continue to improve after the cash-for-clunkers incentive ended? It's simple...the players are moving back to their respective teams! I expect this trend to continue and accelerate, especially as unemployment stabilizes and the fear of losing their job/income subsides.
Bottom line, it's easy to change your short-term actions, but it's damn near impossible to change your innate behavior. Even Boy Scouts cuss...even priests sin (although some alter boys may argue this is due to innate behavior)...even serial killers do nice things from time to time (I'm guessing)...shit, even my wife cut her spending for a whole three months back in early '09 before returning to her mission of personally rescuing the US economy.
It will happen. The 90% of those that keep their jobs will just have to pull a little extra weight in the short-term to make sure that it does.
What is the end game of the Fed just buying any and all bad securities/debt with "printed" money when a problem arises?
Hyper-inflation? Do the banks buy hard assets with their free cash for bad assets? They dont loan it, that seems for sure. Who can afford to buy assets from the banks? Seems kind of dead system whichever way they go. What does it matter if the Fed's "balance" sheet is 1, 2, 3 or 10 Trillion?
All so true.
http://www.greenfaucet.com/economy/scary-stuff-steve/43356
Just how old is this material you are quoting? It looks like it is from last summer! Which isn't to say that some of the points aren't still relevant. However, anything which is months let alone many months old should be clearly represented as said.
Somebody help me out on this....
The dollar is going where ?
And what are people going to use ?
Whose currency ?
Seriously....how can the dollar really implode.....?
......................
Here is the way it is friends....
It is all about demand and supply....
It does not matter what some bureaucrat or economist...or what anyone else thinks....
Seems to me ....somebody wants to sell more media....cause questioning....
.................................
ie Let's say the dollar goes to 25 cents....
Ok versus what ?....
...................................
Looks to me like this is a re-pricing of current assets question.....with the owners being changed around....
How much oil is going to sell at 4X the current amount ?
not even 5% of what currently sells
How many $40,000 cars are going to be sold with no credit ?
Almost none....
How much longer do you want this list to go ?
Time will tell us....
And one thing for sure....
We are going to find out....
QE may end... but still y'all will be whining till the end of your shitty days
"Of course, it hurts like hell every day. But so did being a year and half early in predicting the credit crisis."
Cassandra syndrome?)
You either print or don't print. Choice is simple, although Bernanke's newspeak kinda masks this.
In 2008, everyone thought they will provide their helicopter liquidity, but Ben let everyone down big time.
But this time, everyone is jittering, with their sweaty fingers on the 'eject' button. Which may in fact mean the music could play longer than most think.
But you never know how the Fed guys will mess things up this time.
Lies! I was just reading this morning that LPL financial says current market volatility is normal as the US economy's rebound gains momentum this year and that current price movements match the 2004 and 1994 bull market jitters...please note my sarcastic tone
But how 'bout that Baseline Scenario?
http://baselinescenario.com/2010/02/09/revised-baseline-scenario-februar...
Can the global boom return in the next few years through an emerging-markets credit bubble? I have no idea, but Bill Gross evidently thinks so:
http://www.zerohedge.com/article/just-how-ugly-sovereign-default-truth-h...
Something out of left field that is unavoidable will expose the whole scam and then there will be hell to pay.
It is just a matter of when.
CATMAN
Ben's been giving it to the economy really hard and is now going to try quantease interruptus to keep her from getting in trouble. Too late, Ben. All you've done is made a mess.
Uh, boys....I totally agree with Roche on the
unsustainability of the market ramp. That being said, this piece goes back to last September and the idiot bankers
were able to keep the ramp going through January 19.
Course, now it looks like the "lighted match" being
passed around is beginning to burn their fingers.
is the full paper available somewhere?
The headline is right out of von Mises: that fiat money creates the "appearance of prosperity".
Is there a link to the original report from Roche?
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