Central Banks

Things in the 'economy' must be good - investors are nearing their most levered long to US equities ever. As Sean Corrigan notes, Net Margin (defined as NYSE Margin Debt minus Mutual Fund Liquid Assets) is within a hair of its all-time record high and relative to the March 2000 peak in the Wilshire 5000 (broadest US equity market cap), we are rapidly approaching 'peak' exuberance levels. Indicatively this should make sense since the market is at all time highs, but it is so because of central banks, not because of individual investors. So why would the investors themselves be just as stretched as the global central banks, and how does this leverage upon leverage unwind in the end?

One possibility for the markets to reverse has always been some grand event but another is just the economic deterioration that wears away at the markets as current levels cannot be rationally supported. It is not just the Law of Diminishing Returns which is coming into play as the central banks create more money but the effects on the consumer of seriously declining available cash to be used to purchase goods and services.  We have been subject to a massive amount of monetary printing and an unconscionable manipulation of data but the affects of reality cannot be ignored forever because reality forces the consequences as the fantasy gives way over time.

The overnight macroeconomic news started early with China where the second, HSBC Manufacturing PMI declined from 51.6 to 50.4, below estimates of 50.5, yet another signal of a slowdown in the country (where one can argue the collapse in copper prices is having a far greater impact), and where the Composite closed down 0.17% after its Mayday holiday. China wasn't the only one: India dropped to 51.0 from 52.0 in March, and Taiwan dipped to 50.7 from 51.2, offset however by the bounce in South Korean PMI from 52.0 to 52.6, the best in two years (a number set to tumble as Abenomics steal SK's export thunder). The focus then shifted to Europe, where virtually everyone was once again in contraction mode, as German Mfg PMI declined from 49.0 to 48.1, the lowest since December, if a slight beat to expectations (while VDMA industry body said March Machine orders dropped 15% Y/Y so little optimism on the horizon), France rose modestly to 44.4 from already depressed levels of 44.0, Spain PMI also rose from 44.2 to 44.7, Italy PMI at 45.5 from 44.5, Poland at 46.9 from 48.0, a 45-month low. At least Greece seems to be doing "better" with the Mfg PMI "rising" to 45.0 from 42.1. Across the reports, the biggest decline was in input prices following the recent clobbering in commodities, which in turn is translating into price deflation.

Over a year ago, we first explained what one of the key terminal problems affecting the modern financial system is: namely the increasing scarcity and disappearance of money-good assets ("safe" or otherwise) which due to the way "modern" finance is structured, where a set universe of assets forms what is known as "high-quality collateral" backstopping trillions of rehypothecated shadow liabilities all of which have negligible margin requirements (and thus provide virtually unlimited leverage) until times turn rough and there is a scramble for collateral, has become perhaps the most critical, and missing, lynchpin of financial stability. Not surprisingly, recent attempts to replenish assets (read collateral) backing shadow money, most recently via attempted Basel III regulations, failed miserably as it became clear it would be impossible to procure the just $1-$2.5 trillion in collateral needed according to regulatory requirements. The reason why this is a big problem is that as the Matt Zames-headed Treasury Borrowing Advisory Committee (TBAC) showed today as part of the appendix to the quarterly refunding presentation, total demand for "High Qualty Collateral" (HQC) would and could be as high as $11.2 trillion under stressed market conditions.

Stanley Fischer, who cost his central bank a lot of money with his ill-timed bet to invest billions of the Bank of Israel's foreign  currency reserves on names such as Apple last year, has demonstrated that Einstein's definition of insanity is alive and well when it comes to central-planners, has just decided to double down on stocks. Alas, this is not a joke. Bloomberg reports that "The Bank of Israel plans to almost double equity holdings by the end of the year after falling bond yields prompted the central bank to invest in European shares for the first time. The bank will increase its stock holdings to as much as 6 percent of foreign-exchange reserves, or about $4.5 billion, from 3 percent at the end of 2012, according to Yossi Saadon, a Bank of Israel spokesman. Investments in shares rose to about 4.5 percent of assets in the first four months of 2013 as the institution made a “small allocation” to European equities in addition to its U.S. funds, he said." Well, if the BOI's investment in AAPL was the beginning of the end for that company, one can start shorting Europe - an academic Keynesian just called the top.

At the very crux of the financial crisis, former Fed governor Kevin Warsh notes, "experimental extreme monetary policy," had the "right risk-reward", but, he warns, in this excellent (and somewhat chilling) discussion at the Milken Institute, "we left a financial crisis more than for years ago." and since then the Fed has "over-promised and under-delivered." The Fed has "enabled" Washington to do nothing, since the politicians expect the same "rabbit out of the hat" rescue that occurred in the darkest days of the financial crisis. This means no growth strategies ("the mix of policies has to be right") will occur. Since the financial crisis, Washington has done its level best to focus on GDP in the next quarter, or perhaps the election, and precious little beyond that short-term horizon. Warsh concludes, "There Is No Plan B." The Fed has fewer degrees of freedom and the rest of Washington is not coming to the rescue; and furthermore "the ability of a central bank, exclusively, without the rest of Washington doing any bit of the task, to turn an economy from a modest recovery to a robust one is an experiment that is untested - and will not prove to be successful."

The highlights from Bill Gross' monthly letter: "The past decade has proved that houses were merely homes and not ATM machines. They were not “good as money.” Likewise, the Fed’s modern day liquid wealth creations such as bonds and stocks may suffer a similar fate at a future bubbled price whether it be 1.50% for a 10-year Treasury or Dow 16,000.... if there are no spending cuts or asset price write-offs, then it’s hard to see how deficits and outstanding debt as a percentage of GDP can ever be reduced....  Current policies come with a cost even as they act to magically float asset prices higher, making many of them to appear “good as money”. And the take away: "PIMCO’s advice is to continue to participate in an obviously central-bank-generated bubble but to gradually reduce risk positions in 2013 and perhaps beyond. While this Outlook has indeed claimed that Treasuries are money good but not “good money,” they are better than the alternative (cash) as long as central banks and dollar reserve countries (China, Japan) continue to participate....a bond and equity investor can choose to play with historically high risk to principal or quit the game and earn nothing."

People always stop and stare at traffic accidents (no matter how minor) and arguing couples (no matter how unattractive); ConvergEx's Nick Colas has the same problem with the ever-moribund CBOE VIX Index, even though it’s essentially the exact opposite of the proverbial train wreck.  Even with the zombie-like march higher for US stocks, surely the uncertain state of the world would demand more than a 13-handle VIX?  Well, it doesn’t; and Nick offers up some off-the-beaten track explanations for why “13” isn’t the right answer.  Implied volatility should either be higher or…  (gulp)… much lower.  The biggest overlooked factor for both directions: the role of technology in society and commerce.

With today's cap-arb market frenzy focused on the latest development out of Cupertino, where Tim Cook moments ago announced that Apple's Goldman-syndicated bond issue would be $17 billion, the biggest ever for a corporate issuer (basically representing a circular cash flow stream where hedge funds give AAPL cash, so that AAPL cash pay them cash in return), some are wondering: is locking in a sub-4% yield for 30 years the best idea for a company which may not exist long before that? And with the stock recently having crushed the Apple collective, plunging 40% from its all time highs in a few short months, leaving many bottom and momentum-chasing hopefuls explaining just how they get to throw good monopoly money after bad monopoly money time after time, some are looking at alternative means of expressing their affection for the computer/cell phone/tablet company preferably coupled with a juicy ROI. One such suggestion comes from Germany's Auction Team Breker, which last November made news for selling an original 1976 Apple I computer for the world record price of $640,000 (€492,000). Considering the Apple I originally sold for $666.66 in 1976, this represents a jawdropping CAGR of 20%+ over 37 years, a return which trounces virtually every other asset's return over the same time horizon, or most other time horizons.  On 25 May 2013 collectors, capital appreciation chasers and Apple-aficionados will have the chance to buy another of the 6 surviving Apple I computers still in working order. Expected price $260,000-$400,000.

The weakness in economic data (not to be confused with the centrally-planned anachronism known as the "markets") started overnight when despite a surge in Japanese consumer spending (up 5.2% on expectations of 1.6%, the most in nine years) by those with access to the stock market and mostly of the "richer" variety, did not quite jive with a miss in retail sales, which actually missed estimates of dropping "only" -0.8%, instead declining -1.4%. As the FT reported what we said five months ago, "Four-fifths of Japanese households have never held any securities, and 88 per cent have never invested in a mutual fund, according to a survey last year by the Japan Securities Dealers Association." In other words any transient strength will be on the back of the Japanese "1%" - those where the "wealth effect" has had an impact and whose stock gains have offset the impact of non-core inflation. In other words, once the Yen's impact on the Nikkei225 tapers off (which means the USDJPY stops soaring), that will be it for even the transitory effects of Abenomics. Confirming this was Japanese Industrial production which also missed, rising by only 0.2%, on expectations of a 0.4% increase. But the biggest news of the night was European inflation data: the April Eurozone CPI reading at 1.2% on expectations of a 1.6% number, and down from 1.7%, which has now pretty much convinced all the analysts that a 25 bps cut in the ECB refi rate, if not deposit, is now merely a formality and will be announced following a unanimous decision.

Wishful thinking now runs so thick and deep across the USA that our hopes for a credible future are being drowned in a tidal wave of yellow smiley-face stories recklessly issued by institutions that ought to know better. A case in point is the Charles C. Mann’s tragically dumb cover story in the current Atlantic magazine - “We Will Never Run Out of Oil” - setting out in great detail the entire panoply of techno-narcissistic “solutions” to our energy predicament. Another case in point was senior financial writer Joe Nocera’s moronic op-ed in last week’s New York Times beating the drum for American “energy independence.” You could call these two examples mendacious if it weren’t so predictable that a desperate society would do everything possible to defend its sunk costs, including the making up of fairy tales to justify its wishes.

We recently asked:"are there really unpredictable market shocks or are investors paid not to care? To us, all signs point towards the next currency reset. We think monetary authorities are compulsively destroying the current global monetary system; they simply have no choice if they are to keep it afloat in the short term." With Bernanke not attending Jackson Hole, we think the choice for next Fed Chair may have profound economic implications, and that it would not require expertise in econometric modeling, credit policy management, and maintaining the public perception of economic stability. We think the next Fed Chairman will oversee a conversion of the global monetary regime. Neither growth nor austerity nor gloom of night will stay these currencies from their appointed devaluations. Bank balance sheets must be preserved; ergo sufficient inflation must be manufactured. We think the dull but persistent economic malaise amid increasingly aggressive monetary intervention policies will soon engender fear among the not-so-great washed – net savers. We think all should question whether we are 100% wrong. If not, then prudence dictates some allocation to properly held precious metals. (Presently, it is less than 1% of all global pensions.)

In the past months and right after implementing Quantitative Easing Unlimited Edition, the Fed began surfacing the idea that an exit strategy is at the door. With the latest releases of weak activity data worldwide, the idea was put back in the closet. However, a few analysts have already discussed the implications of the smoothest of all exit strategies: An exit without asset sales; a buy & hold exit. We have no doubt that as soon as allowed, the idea will resurface again. Underlying all official discussions is the notion that an exit strategy is a “stock”, rather than a flow problem, that the Fed can make decisions independently of the fiscal situation of the US and that international coordination can be ignored. This is logically inconsistent as we address below...

Capitalism may have bested communism a few decades ago, but exactly how our economic system allocates society’s scarce resources is now undergoing its first serious transformation since the NYSE’s founding fathers met under the buttonwood tree in 1792.  Technology, complexity and speed have already transformed how stocks trade; but As ConvergEx's Nick Colas notes, the real question now is what role these forces will play in long-term capital formation and allocation.  Rookie mistakes like the Twitter hack flash crash might be easy to deride, but make no mistake, Colas reminds us: the changes that started with high frequency and algorithmic trading are just the first step to an entirely different process of determining stock prices.  The only serious challenge this metamorphosis will likely face is a notable crash of the still-developing system and resultant regulation back to more strictly human-based processes.

Over the years, Jim O'Neill, former Chairman of GSAM, rose to fame for pegging the BRIC acronym (no such luck for the guy who came up with the far more applicable and accurate PIIGS, or STUPIDS, monikers, but that's neither here nor there). O'Neill was correct in suggesting, about a decade ago, that the rise of the middle class in these countries and their purchasing power would prove to be a major driving force in the world economy. O'Neill was wrong in his conclusion as to what the ultimate driver of said purchasing power would be: as it has become all too clear with the entire world drowning in debt (and recently China), it was pure and simply debt. O'Neill was horribly wrong after the Great Financial Crisis when he suggested that it would be the BRIC nation that would push the world out of depression. To the contrary, not only is the world not out of depression as the fourth consecutive year of deteriorating economic data confirms (long since disconnected with the actual capital markets), but it is the wanton money (and bad debt) creation by the central banks of the developed world (as every instance of easing by China has led to an immediate surge of inflation in the domestic market) that has so far allowed the day of reckoning, and waterfall debt liquidations, to take place (and certainly don't look at the stock index performance of China, Brazil, India or Russia). Despite his errors, he has been a good chap having taken much of the abuse piled upon him here at Zero Hedge somewhat stoically, as well as a fervent ManU supporter, certainly at least somewhat of a redeeming quality. Attached please find his final, farewell letter as Chairman of the Goldman Asset Management division, as he moves on to less tentacular pastures.