Last week we heard from Nomura's bearded bear as Bob Janjuah restated his less-then-optimistic scenario for the global economy. Today his partner-in-crime, Kevin Gaynor, takes on the bullish consensus cognoscenti's three mutually supportive themes in his usual skeptical manner. While he respects the market's potential view that fundamentals, flow, valuation, and sentiment seem aligned for meaningful outperformance, it seems actual positioning does not reflect this (yet). Taking on each of the three bullish threads (EM policy shift as inflation slows, ECB has done and will do more QE, and US decoupling), the strategist teases out the reality and what is priced in as he does not see this as the March-2009-equivalent 'big-one' in rerisking (warranting concerns on chasing here).
Update summary added.
Just a headline on Reuters, citing Medley Global Advisors:
- FED WOULD CURTAIL ASSET BUYING IF COMPELLING EVIDENCE OUTPUT GAP CLOSING QUICKER THAN EXPECTED
Is the Warsh-Hoenig-Plosser-Fisher-Kocherlakota mutiny about to go nuclear? We will bring you the report if we see it.
Could it be that the fundamental economic indicator that is gospel not only to Goldman Sachs, but to Ben Bernanke in estimating and determining monetary policy, the output gap, provides a flawed reading of the economy? As a reminder, Ben Bernanke has repeatedly expressed little regard for either commodity inflation or US dollar exchange as having an impact on overall US inflation. As Askari and Hochain state: "according to [Bernanke's] theory, inflation was related only to the output gap. As long as the output gap was negative, that is, if actual gross domestic product was below potential GDP, the economy was at no risk of inflation. Hence, he argued that the central bank had to adopt an aggressive money policy until the output gap closed. Such is the policy prescription from what is called the Taylor Rule or the Phillips Curve. Because potential GDP is not a measured macroeconomic variable, it can be estimated in millions of ways. There are, therefore, millions of ways for estimating an output gap, making the concept difficult to use as a policy tool." The problem with these millions of estimations, is that especially courtesy of the Greenspan created bubble over the past 20 years, the American economy is, ironically, not a true representation of itself. And thus, the output gap estimates need to be normalized for a "bubble free" GDP environment. It is precisely this issue that none other than the St. Louis Fed addresses in its latest paper: "Has the Recent Real Estate Bubble Biased the Output Gap?" The conclusion is startling: based on a production function output gap normalization (an approach "based on a relation between available productive inputs (such as capital and labor), their current utilization rates, and aggregate production"), Bernanke could be fatally wrong about the economy's "capacity for inflation" courtesy of the CBO's overestimated output gap, and that his loose monetary policy could end up being a disastrous precursor to rampant (and not distant) hyperinflation, due to his blatant avoidance of simple logic when interpreting the economic output gap.
"Over the full ten-year period, we now see the deficit cumulating to $10½trn, up from $9trn previously." - Goldman Sachs