The "Toxic Mix For Risk-Assets" In A Post-Taper World

Tyler Durden's picture

From Guy Haselmann of ScotiaBank


Markets have been unwelcoming and volatile since Janet Yellen’s swearing-in ceremony on Monday morning.  She should not take it personally as market agita is the result of a confluence of factors.  Certainly, the FOMC deserves a large portion of the blame as years of ‘pedal to the metal’ strategy demolished the ability of the Fed to know what the market’s reaction function would be once they eased off the accelerator.  Few should be surprised that there were a number of risk-seeking investors who were waiting for ‘tapering’ as the catalyst to reduce risk and to remove capital from a few EM countries.

To be fair, some of the troubles that have arisen in EM countries are isolated country-specific problems, but few should dispute that capital outflows have occurred due to ‘tapering’; thus, exacerbating their challenges.  

A quick reminder is in order.  One main goal of the extraordinary measures of Fed policies (QE and ZIRP) was to lift asset prices. In this regard, the Fed was successful as the S&P rose 160% above its 2009 low (from 676 to 1848).  The S&P is also coming off of a 32% year and posted double digit gains in 4 of the last 5 years.  Credit spreads have had an equally impressive surge.  Junk bond yields (oops, they are called ‘high-yield’) have declined more than 1500 basis points from 2009 spread levels.

Despite recent market weakness, the S&P is only 5.2% below all-time high prices; yet, investor worry seems quite substantial.  Part of the reason is due to the speed of the descent (5%+ in three weeks).  However, the magnitude (not speed) of the decline is quite small given the enormous gains in recent years; and therefore, it will not prevent the Fed from continuing its tapering path. 

The drop in the 10 year yield to 2.65% should actually provide further encouragement and cover for further QE withdrawal.  The hurdle to ‘taper the taper’ (i.e. pause) is exceptionally high.

There is only one way that the lofty asset price levels could have been maintained and that was for enough economic growth to be generated in order for the economic fundamentals to justify the prices.  For too long, investors have given the Fed the benefit of the doubt that its policies would be able to achieve this outcome; consequently, they loaded-up on risk assets.  They believed that if the economy should falter, the Fed would merely react by staying accommodative until economic activity improved.  The ‘Fed put’, clearly, resulted in wide-spread moral hazard and investor complacency.  

The shift to ‘tapering’ when the global economy appears under strain now leaves investors in a quandary.  The fact that investors have begun to question the effectiveness of further asset purchases and whether much more can be provided without causing financial instability has roiled investor mindsets. The most recent Fed Minutes have unveiled these as valid concerns.   The impact of ‘tapering’ along with the challenges exposed in China (Trust securities), Japan (Abenomics and imported energy costs), and EM countries (capital outflows and interest rate hikes) are forming a toxic mix for risk-assets.

The toxic brew, after several years of double digit portfolio gains, means that prudent investors and portfolio managers are well-advised to reduce risk (and stop justifying out-sized risk exposures by ‘fear of missing the upside’).

Risk positions have accumulated over several years, therefore three weeks of volatility (and the resulting minor correction) witnessed recently are probably only a small fraction (and indication) of what is yet to come. 

Poor market liquidity will likely intensify capital flows and force transactions at sub-optimal prices. The most liquid instruments will start to command higher liquidity premiums.  Should global challenges deteriorate further or contagion advance, a meaningful reduction in growth and inflationary expectations are likely to arise.  This potential scenario may (be necessary to) propel Treasury prices higher and through the 2.5% yield on the 10-year note.

“Every closed eye is not sleeping and every open eye is not seeing”.

      – Bill Cosby

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DoChenRollingBearing's picture

Bearing Guy knows about rolling bearings for cars.  But, I like gold, and to a degree silver and platinum.  

I still have some stocks and bonds, but I have sold so much for nearly twenty years that I do not want to sell more (in case I am wrong, and I have been wrong many times).

The Simple Safety Strategy:

1) Physical gold

2) Physical CA$H


From there you can add ammo, stocks & bonds, real estate, survival preps, etc.

disabledvet's picture

besides natural gas the best asset for the past six months has been the dollar.

Haven't been able to say that certainly since the 90's but really not since the early 1980's.

the PTB will do everything in their power to keeps those yield spreads from compressing.

I think they thought they had the "winner" with Taper...both in surprising the market with it and with finally able to get around the problem of all this "asset revaluation" by creating a huge asset inflation in China and a massive consumption boom over there.

Instead you've got a problem of "rebound" as the Chinese who already have the bulk of all dollars in existence right now start hoarding them in anticipation of "something stupid."

If Japan follows China into the USA production boom you could really see some huge inventory builds in the USA...something which is very growth positive as anything sitting on the shelf is actually a liability (in the business sense...not in the accounting sense) not an asset.

"It doesn't become an asset until the sale is made." Until then the product is in fact worth NOTHING.

NOTaREALmerican's picture

So, there aren't really any "investors", just people gambling on the Fed.

Huh.     Where did this word "investor" come from?

Winston Churchill's picture

Greek mythology.

'A long term investment is a short term one ,

gone wrong' , Rockerfeller.

disabledvet's picture

"what should investors do now that your oil monopoly has been broken up by the Government Mr. Rockefeller?"


Rainman's picture

The speed of loss and magnitude is equal to the pace of insitutional divestment ....the first in the lifeboat theory as I recall .

Flying Wombat's picture

Gold will make a come-back this year.  It's called a "risk asset" for now.  But that will change to its historical role as "safe haven."  Each week, we get more positive news, like the below.

Indian Government to Loosen Stranglehold on Gold in March?

disabledvet's picture

we've had five years of fleeing to the safe haven of liquidity...not gold.

in many ways this makes gold more valuable not less actually.
but price might not move much from here for a long time.

jonjon831983's picture

Guess what's going to happen?  When next taper is done the world will be beggin for some lovin from Yellin.

Bruno de Landevoisin's picture

February 5th, 2014, Note to the Federal Reserve: 


Dear Janet;


If I may be so forward, as a concerned permanent resident of the United States of America, it is with great consternation that I feel compelled to write you the following distressing note.


Purposely degrading this Nation's hard earned reserve currency status, which was so honorably passed on to you by previous generations who built this great country from the ground up through their virtuous and industrious blood, sweat and tears, only to then implement a disgraceful monetary policy that deliberately steals from future unborn generations in order to facilitate living standards beyond our means, so as to sustain an unearned, undeserved and unprincipled culture of grotesque illegitimate debt financed over-consumption, can only be characterized as a deplorable unconscionable abomination of Biblical proportion.


Respectfully yours,


Le Baron Bruno Camille Soucanye de Landevoisin

satoshi911's picture

Taper is a word for fools

Where is this taper?

There is only fiat-to-the moon, FIAT-INFINITE

By taper you mean FED will quit buying $85 billion a month of US debt, who the fucking hell is going to buy it if the FED doesn't?

Oh, I see they'll force folks to cash out their IRA's and move 401k money into T-bills & T-bonds? Perhaps but is there really that much left?

People have been pulling out thier 401's and IRA's since 2006 to eat,... sure the gubmint gets 10% tax on that early pull-out, how much is really left?

Can the gubmint raise interest rates to get the world to crawl back to investing in US-TREAS? Probably not.


Oh and then a few days ago FABER told you all to buy T-Paper,... funny its sounds a lot like toilet-paper. Maybe that is why ZH we get FABER everyday to get 'investors' to pay uncle-sams debt.


There will be NO fucking TAPER, only FIAT-TO INFINITY.

The EM is imploding same as everything else, people are selling everything to get money to live, we're in a DEPRESSION worldwide.

I hate this talk 'TAPER' and it effects the world, and the FED controls GOLD, ... the USA prints USD via the FED trillions all in secret and bails everybody off, from ISrael ( bank of israel ) to Europe, to CHINA. The FED is now paying all US-DEBT bill's as the US Congress is largely a dysfunctional puppet show.


Yep, keeping talk about TAPER for what?