Via Mark J. Grant, author of Out of the Box,
A Moment's Notice
“In each age men of genius undertake the ascent. From below, the world follows them with their eyes. These men go up the mountain, enter the clouds, disappear, reappear, People watch them, mark them. They walk by the side of precipices. They daringly pursue their road. See them aloft, see them in the distance; they are but black specks. On they go. The road is uneven, its difficulties constant. At each step a wall, at each step a trap. As they rise the cold increases. They must make their ladder, cut the ice and walk on it, hewing the steps in haste. A storm is raging. Nevertheless they go forward in their madness. The air becomes difficult to breath. The abyss yawns below them. Some fall. Others stop and retrace their steps; there is a sad weariness. The bold ones continue. They are eyed by the eagles; the lightning plays about them: the hurricane is furious. No matter, they persevere.”
The present is a time when things are in great confusion. We are creating money from nothing and yet enjoying the fruits of their labors. The economies in Europe and in Japan and America are worsening and yet yields for their sovereign debt are barely off all-time lows. The stock markets of the world, following the 2008/2009 financial crisis, are back at new highs. All of this has taken place because the world’s central banks, acting in concert, have pumped enough small pieces of paper into the fire to keep it burning long into the night and so all of the markets on the planet have been stoked with fuel. The blaze has burned brightly and while others have enjoyed their success in equities; beginning last spring I suggested the more conservative approach of long corporate bonds where compression has been a huge winner and, according to most indexes, the strategy has outperformed the stock markets while maintaining the relative security of senior debt. So much for the arcane science of Wizardry.
“Though this be madness, yet there is method in it.”
-William Shakespeare, Hamlet
The manna continues to flow from heaven, the central banks’ balance sheets balloon, everything is postponed, everything is delayed, more money is tossed upon the table, the politicians in America and in Europe dither, no one wants to confront the real problems, more money is thrown about and those with intelligence wonder when it will all end. There is a sinking feeling to be found in the boardrooms of a number of large money managers that all of this central bank flotation of the world cannot go on forever without consequences. When the fundamentals of the markets are out of line with their performance then history teaches us that at some point rational behavior will cause a correction. What concerns me the most, quite frankly, is that the plastic envelope has been stretched so thin by the outpouring of manufactured money that when the prick comes, the black swan arrives to be noticed, that the rubber band will snap with an alarming amount of elasticity.
“Logical consequences are the scarecrows of fools and the beacons of wise men.”
It was just five years ago when the world learned a rather harsh lesson. It was a lesson that cost Americans 36% of their wealth. It was a lesson that spewed what capital that was left into the bond markets and evaporated the capital available for equities. It was caused by “easy money” manufactured by the banks and it met its Waterloo when it became clear that mortgages and mortgage securitizations could not be paid. The dawning realization caused a downdraft that sunk many a ship while making fortunes for the ones hauling the right tack. Hindsight proclaimed that we should have seen it and foresight now proclaims that we shall meet our Master again soon. The difference in then and now is that the banks created the problem and this time it is the central banks that have created the problem and while some may argue that the central banks can print indefinitely, and perhaps they can, it is not without consequence when it occurs.
“Sooner or later everyone sits down to a banquet of consequences.”
-Robert Louis Stevenson
So the next crisis, the sovereign debt crisis, will occur when some country’s debt cannot be paid and when some funding country refuses to accept the bill for their own citizens. The yield on anyone’s debt, first dismissed by the EU as unfair and now heralded as a sign that things are improving, is little more than a charade of masks. The yields have fallen because of the free-flowing paper that must be parked somewhere. Yet whether the yield is 4.00% or 7.00% if the principal cannot be re-paid then the coupon is of little consequence. In each of the troubled nations in Europe there is grave doubt in my mind if their debts can be serviced even as they add more debt to their woodpile. You can consider Greece, Portugal, Ireland, Spain or Italy and reach the same conclusion about any of them. Most can fund for the moment because of the capital available but when the gimmickry has run its course then woe to those left holding this bag of tricks. It is a very dangerous game of musical chairs in my opinion.
The distinction, of course, is that the banks can’t print money and the central banks certainly can but the other side of this coin has not changed and that is that the debtors still must pay their bills. To date the ability of the creditors to pay has been earmarked, perhaps pockmarked, by the ECB and the EU handing out money, in one form or another, to the debtors so they can meet their obligations but as the situations in Spain and Italy deteriorate then the size of the capital that will be needed will press the ability of the financial sound nations in Europe to cope with the sheer mass of the solution that will be demanded.
The correct bet of last year was certainly on the side of the central banks but the correct bet of this year may soon turn out to be on the side of the consequences of their actions. There is no sheet of paper, no matter how thin, without two sides; no coin without a heads and a tails and no action, as Newton correctly remarked, without a reaction.
Each strategy has consequences and bad strategies may have lethal consequences. Keep playing for now but when the turn comes or the black swan lands be prepared to abandon ship upon a moment’s notice. That is my counsel.