Quantitative Easing

The investment thesis for gold has never been limited to popular relationships, such as CPI-type inflation, financial meltdown or political instability. We prefer to focus on the irretrievable gap between financial assets (claims on future output) and productive output (GDP). In essence, the most compelling reason to own gold is that financial assets have lost their underpinnings to sustainable productive output.

In a somewhat shocking admission of its own un-omnipotence, or perhaps more of a C.Y.A. moment for the inevitable mean-reversion to reality, Reuters reports that San Francisco Fed President John Williams said Friday that low neutral interest rates are a warning sign of possible changes in the U.S. economy that the central bank does not fully understand. With Japan having been there for decades, and the rest of the developed world there for 6 years, suddenly, just weeks away from what The Fed would like the market to believe is the first rate hike in almost a decade, Williams decides now it is the time to admit the central planners might be missing a factor (and carefully demands better fiscal policy).

On January 6, 2004, Senator Charles Schumer and I challenged the erroneous idea that jobs offshoring was free trade in a New York Times op-ed. Our article so astounded economists that within a few days Schumer and I were summoned to a Brookings Institution conference in Washington, DC, to explain our heresy. In the nationally televised conference, I declared that the consequence of jobs offshoring would be that the US would be a Third World country in 20 years. That was 11 years ago, and the US is on course to descend to Third World status before the remaining 9 years of my prediction have expired. The evidence is everywhere.

“It wasn't raining when Noah built the ark.”

Americans are increasingly likely to respond positively to a placebo in a drug trial – more so than other nationalities. That’s the upshot of a recently published academic paper that looked at 84 clinical trials for pain medication done between 1990 and 2013. These findings, while bad for drug researchers, does shed some light on our favorite topic: behavioral finance. Trust and confidence makes placebos work, and those attributes also play a role in the societal effectiveness of central banks. That’s what makes the Fed’s eventual move to higher rates so difficult; even if zero interest rates are more placebo than actual medicine, markets believe they work to support asset prices.

For years, a rather pointless argument has been ongoing amongst economists - that of inflation vs. deflation.

"... if you look at what is supporting equity prices - how much of that support is coming from real economic activity versus from using stock buybacks, using cash on balance sheet for stock buybacks, or mergers and acquisitions, to reduced competition in the marketplace. These are the sort of stories that if there were a small increase in interest rates, you would temper some of that frothiness. Eliminating the incentive to engage in that kind of activity seems to me to be a good idea... There would be a proportion of the population that would have less capital gains - but they’ve been enjoying very big capital gains, and it is a narrow segment of the population."

To the extent the Federal Reserve decides to increase interest rates, it should be apparent that such a move would be inconsistent with their prior actions. In fact, it may likely be a desperate effort to re-load the monetary policy gun as opposed to a signal of domestic economic strength. Not only is this a departure from the past, this would lead many to question the Fed’s motives. It is worth keeping in mind that blind trust and confidence in the Fed has propelled many markets much higher than fundamentals justify. The bottom line is that NIM and the Taylor Rule-adjusted curve are both flashing warning signs of economic recession, while the traditional yield curve signal is waving the all clear flag.

"The nightmare for the Riksbank board is maybe something like this: they are gathered in the south of Sweden, looking out over the Baltic Sea, when they see a giant wave of money coming in from the euro zone and try to fight it with a hose."

"The end of QE mattered" admits BofAML, adding that "the impact was not replaced by BoJ or ECB dollars." It is this new 'hostile' investment backdrop as liquidity cheer swings to illiquidity fear (and two years of non-stop "pain trades") that has faith in the big three bull beliefs fading fast. October's "pain trade" has been a broad-based rally in all risk assets, but there are a number of factors preventing BofAML getting more bullish now that risk has surged.

"It could simply be 1998/99 all over again. After all, a “speculative blow-off” in asset prices is one logical conclusion to a world dominated by central bank liquidity, technological disruption & wealth inequality. What worked back then? What rose from the rubble of 1998? How would one position for one final melt-up on Wall Street..."

"My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy.”

• China's central bank cuts rates for sixth time since November (Reuters)
• Global stocks hit two-month high on dovish Draghi message (Reuters)
• $6.5 Billion in Energy Writedowns and We're Just Getting Started (BBG)
• Alphabet, formerly Google, sets share buyback, shares jump (Reuters)
• Hurricane Patricia, Stronger Than Katrina, Nears Mexico (BBG)
• TVA Cleared to Start First New U.S. Nuclear Power Plant in Nearly 20 Years (WSJ)

After yesterday's dramatic late day market rout catalyzed by the tumble in the biotech sector in general, and Valeant in particular, and foreseen in its entirety by Gartman who went bullish just hours before, this morning US equity futures and European stocks have recouped some losses on the recursive, and traditional, hope that Mario Draghi will say something to push risk higher when he speaks in 2 hours at the ECB's press conference in Malta. And yet, just like Yellen a month ago, Draghi faces the paradox of reflexivity that after years of being ignored, is the "new thing" in town: how does he intervene and demonstrate he is readier than ever to set up stimulus, without panicking investors over euro area’s health.

Global Capitalism is trapped in its own Prisoner’s Dilemma; fourty four years after the end of the Bretton Woods System global central banks have manipulated the cost of risk in a competition of devaluation leading to a dangerous build up in debt and leverage, lower risk premiums, income disparity, and greater probability of tail events on both sides of the return distribution. Truth is being suppressed by the tools of money. Market behavior has now fully adapted to the expectation of pre-emptive central bank action to crisis creating a dangerous self-reflexivity and moral hazard. Volatility markets are warped in this new reality routinely exhibiting schizophrenic behavior. The tremendous growth of the short volatility complex across all assets, combined with self-reflexive investment strategies, are creating a dangerous ‘shadow convexity’ that will fuel the next hyper-crash.