With revenues fading, profit margins collapsing, and only financial institutions' entire lack of transparency providing any lift in EPS, the 'great rotation' continues to provide enough cognitive dissonance to sink a boat for the asset-gatherers. The trouble, as we showed previously, is this 'rotation' is dominated by US retail investors (more specifically non-US domiciled and non-retail investors are rotating away from US equities). The US retail investor has shifted in a great-rotationary manner by the greatest amount since Feb 2000 - just as the last great bubble burst. US equities are the 3rd most over-crowded speculative long asset in the world after Crude Oil and the Brazilian Real. It seems the Fed is getting just what it wants but, just as Kyle Bass warned, "investors should be really careful doing what the central bankers want them to do."
Quantitative easing is nothing but "competitive devaluation," Kyle Bass begins this brief but wide-ranging interview; and while no central bank can explicitly expose the 'beggar thy neighbor' policy, they are well aware (and 'banking on') the fact that secondary or tertiary effects will lead to devaluing their currency. The bottom line, Bass warns, is "when the globe is at 360% credit market debt-to-GDP, there is no real way out." Furthermore, the winds of austerity have already blown (simply put no nation engaged in austerity prospectively - for the nation's betterment - they were forced by the bond markets) and with central bankers now dominant - the Krugman-esque mentality of "let's just keep going," is very much in the driver's seat since politicians now see "no consequence for fiscal profligacy." The average investor, Bass adds, "is at the mercy of the central bank puppeteers," as the Fed's policies are forcing mom-and-pop to "put their money in the wrong place at the wrong time." There will be consequences for that... there is only one way this will end... "and investors should be really careful doing what the central bankers want them to do."
With all eyes fixed on GDP and unemployment data this week (and all their revised and propagandized unreality) for more hints at if (not when) the Fed will Taper; the dismal reality that few seem willing to admit is that it is when (not if) and that the announcement of a "Taper" has nothing to do with the economy. There are three key factors driving this decision: Bernanke's bubble-blowing and bond-market-breaking legacy, the political 'clean slate' his successor needs, and, most importantly, the fear that QE will be discovered for what it is - monetization. As BoJ's Kuroda admitted last night "if QE is seen as financing debt, this could lead to rise in yields." With deficits falling, the Fed's real actions will be exposed (unless QE is tapered) and as Kyle Bass has explained before, it was out of the hands of the BOJ (or The Fed) and entirely up to market psychology.
‘Vote For Gold’
"You have to choose, as a voter, between trusting to the natural stability of gold and the natural stability and intelligence of the members of the government. And with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."
When it comes to changing the "measurement" rules in the middle of the game, nobody does it quite like Japan: in the aftermath of the Fukushima nuclear explosion, when radiation was soaring (and still is with Tritium levels just hitting a record high but who cares - Goldman partners have to earn record bonuses on the back of the irradiated island) Japan's solution was simple: double the maximum safe irradiation dosage. Done and done. Now, it is time to do the same to that other just as pesky, if somewhat less lethal indicator: inflation. Reuters reports that the Japanese government plans to adopt a different measure of inflation to the central bank's.
"China’s direct contribution to global growth is enormous, but perhaps equally as important is its role in generating growth in developed and emerging economies. A slowdown, whether significant or extreme, in the Chinese economy heralds very bad news for asset prices around the world. A growth crisis centered in Asia will further exacerbate the instability and volatility in Japan and have a devastating impact on second derivative marketplaces such as Australia, Brazil and developing markets in South East Asia. The combination of rich valuations and further threats to growth has led us to dramatically reduce risk in the portfolio and actively position ourselves to withstand the uncertainty and instability ahead"
It is easy to get the impression that the naysayers are wrong on Europe. After all the predictions of Armageddon, ten-year government bond yields for Spain and Italy fell to the 4% level, France which is retreating into old-fashioned socialism was able to borrow at about 2%, and one of the best performing bond investments has been until recently – wait for it – Greek government bonds! Admittedly, bond yields have risen from those lows, but so have they everywhere. It is clear when one stands back from all the usual euro-rhetoric that as a threat to the global financial system it is a case of panic over. Well, no. Europe has not recapitalized its banking system the way the US has (at great taxpayer expense, of course). Therefore, it is much more vulnerable. Where European governments and regulators have failed to make their banks more secure it is because they tied their strategy to growth arising from an economic recovery that has failed to materialize. The reality is that the Eurozone GDP levels are only being supported at the moment by the consumption of savings; in orther words, the consumption of personal wealth. Wealth that is not infinite; and held by those not likely to tolerate footing the bill for much longer.
Earlier we noted the rather peculiarly truthful (lack of optimistically-biased bullshit) annual report from the BIS as reading ZeroHedge-sermon-like. There is a smorgasbord of data, charts, and quotes strewn throughout the 204-page melodrama but one caught our eye. Reflecting on the fact that governments in several major economies currently benefit from historically low funding costs, and yet at the same time, rising debt levels have increased their exposure to higher interest rates, the BIS projects the dismal reality that any rise in interest rates without an equal increase in the output growth rate will further undermine fiscal sustainability. Although predicting when and how a correction in long-term rates will unfold is difficult, it is possible to examine the potential impact on the sustainability of public finances and how any normalization of rates (or Abe's success in creating 2% 'inflation' in Japan) leads the nation's debt-to-GDP ratio to explode to a surely-Krugman-mind-blowing 600% debt-to-GDP.
Kyle Bass covers three critical topics in this excellent in-depth interview before turning to a very wide-ranging and interesting Q&A session. The topics he focuses on are Central bank expansion (with a mind-numbing array of awe-full numbers to explain just where the $10 trillion of freshly created money has gone), Japan's near-term outlook ("the next 18 months in Japan will redefine the economic orthodoxy of the west"), and most importantly since, as he notes, "we are investing in things that are propped up and somewhat made up," the psychology of negative outcomes. The latter, Bass explains, is one of the most frequently discussed topics at his firm, as he points out that "denial" is extremely popular in the financial markets. Simply put, Bass explains, we do not want to admit that there is this serious (potentially perilous) outcome that disallows the world to continue on the way it has, and that is why so many people, whether self-preserving or self-dealing, miss all the warning signs and get this wrong - "it's really important to understand that people do not want to come to the [quantitatively correct but potentially catastrophic] conclusion; and that's why things are priced the way they are in the marketplace." Perhaps this sentence best sums up his realism and world view: "I would like to live in a world where it's all rainbows and unicorns and we can make Krugman the President - but intellectually it's simply dishonest."
Now that the BOJ's "interventionalism" in the capital markets is increasingly losing steam, as the soaring realized volatility in equity and bond markets squarely puts into question its credibility and its ability to enforce its core mandate (which, according to the Bank of Japan Act "states that the Bank's monetary policy should be aimed at achieving price stability, thereby contributing to the sound development of the national economy) Japan is left with one wildcard: the Government Pension Investment Fund (GPIF), which as of December 31 held some ¥111.9 trillion in assets, of which ¥67.3 trillion, or 60.1% in Japanese Government Bonds. Perhaps more importantly, the GPIF also held "just" ¥14.5 trillion in domestic stocks, or 12.9% of total, far less than the minimum allocation to bonds (current floor of 59%). It is this massive potential buying dry powder that has led to numerous hints in the press (first in Bloomberg in February, then in Reuters last week, and then in the Japanese Nikkei this morning all of which have been intended to serve as a - brief - risk-on catalyst) that a capital reallocation in the GPIF is imminent to allow for much more domestic equity buying, now that the threat of the BOJ's open-ended QE is barely sufficient to avoid a bear market crash in the Nikkei in under two weeks.
There are some problems, however.
These are not easy times for the global bond market. We’re looking at US Treasuries market (more below), and reckon this morning’s 10-yr spike to 2.23 is only the start. We could see more aggressive price declines as the curve steepens further. It’s only partly based on the better economic outlook and fears of the QE Taper. Japan banks will be among the biggest sellers due to the volatility and “death by carry”. Forget the stories Japan banks were buyers at the wides.. that’s wishful thinking from Treasury holders long and wrong on the US bond market. Unfortunately, each passing day sees the BoJ's credibility chipped away.
However, the best argument why the type of Quantitative Easing imposed by Ben Bernanke, and the associated "necessary and sufficient" condition to exit this greatest of all monetary experiments, or eventually allow Ben and Kuroda to taper QE, i.e., the "great rotation" from government bonds into stocks (because otherwise both the Fed and the BOJ will be stuck monetizing and monetizing and monetizing until one day, soon, they own all government bonds), will never work in Japan is a simple one. And quite visual...
I see this evolving story as a possible turning point. The key CB's will have gone from Offense to Defense.
In the 1940s, the Fed adopted pegging operations to protect the financial system against rising interest rates and to ensure the smooth financing of the war effort. In effect, the Fed became part of the Treasury’s debt management team; as the budget deficit hit 25% of GDP in WW2, it capped 1Y notes at 87.5bps and 30Y bonds at 2.5%. From the massive bond holdings of its domestic banks to its exploding public debt, Japan today faces a situation very similar to the US in the 1940s. When the long-term rate climbs above 2%, the BoJ will probably adopt outright measures to underpin JGB prices to prevent turmoil in the financial system and a fiscal crisis - and just as Kyle Bass noted yesterday, they are going to need a bigger boat as direct financial repression in Japan is unavoidable.
If JGB investors 'believe' as Richard Koo earlier noted, in the BoJ's new actions and Abenomics (to double the monetary base and generate inflation), then, Kyle Bass explains, a rational investor is likely to sell a portion if not all of them. The BoJ only has JPY10 trillion cushion (after the JPY60 trillion deficit) to soak up this 'rational investor paradox' selling and this is dwarfed by the holdings of JGBs in the largest Japanese banks (who are now starting to rotate away from JGBs into foreign bonds). Simply out, Bass exclaims, they are going to have make the plan even bigger... if they are to successfully contain rates. With a quadrillion JPY of JGBs out there, if a mere 5% is sold (from 'Abe'lievers) then Japan's Turbo QE is not big enough which leads to the paradoxical increase in the QQE, moar inflationary 'belief', and moar selling pressure... The BoJ has been in the market every day but 2 since April 4th trying to hold rates down (and is failing)...