Ordinarily Grant Williams would bet the ranch on this spat being defused diplomatically and everybody leaving the negotiating table a little disgruntled (which would mean the outcome was just about perfect); but he suspects that markets have become dangerously conditioned — by one perfectly executed landing after another in recent years — to expect (and position for) the best.
As I was mulling all this over today, a good friend emailed me and asked me my thoughts on exactly this topic.
The man in question is one of the very brightest minds it is my pleasure to be able to call on for advice and counsel, and so I thought, what better way to tidy up this week's many questions than by including the culmination of our email conversation (though with the odd expletive removed and certain names changed to protect the innocent):
On 15 Mar, 2014, at 12:10 pm, Mr. Big <email@example.com> wrote:
apples to apples? ok, so why, how, what to do?
On Sat, Mar 15, 2014, at 12:26 AM, Grant Williams <firstname.lastname@example.org> wrote:
My worry is this (I'm writing about it right now):
Markets have become conditioned to Goldilocks outcomes manufactured by CBs & govts over a period of three years when EVERYTHING should have gone wrong but nothing has.
The Taper hasn't mattered (yet) because everybody believes that, if the wheels come off, the Fed will blink and crank it up again.
China's problems are starting to become too difficult to ignore. (GDP 7.7% & PMI sub-50 for a manufacturing economy? Righto. Don't even get me started on the shadow banking system, which is straining at every seam right now.)
Abenomics is just beginning to be shown up for the farce it really is — just in time for the consumption tax hike coming in a few weeks. Abe's fabled "three arrows" are not the ones everybody imagines but rather the kind of arrows with a sucker rather than a point on the end. Actually, in this case, on BOTH ends.
Putin is in a corner, and we KNOW he don't take to backin' down none.
Obama's approval is at all-time lows with midterms on the horizon, so he needs to look Presidential at home.
Draghi is trying to force the BuBa to BEG him for QE before turning the taps on, and it is crushing Europe, but he won't blink (I don't think).
The Fed meets next week and will taper another $10 bn.
That's the broad backdrop. Now, let me ask you this:
What if this next $10 bn taper is the "bang" moment when markets suddenly realize that the Fed ARE serious about continuing to wind it down? What if the latent fear over all of the above issues, combined with that next $10 bn and the words of smart guys like Seth Klarman ringing in their ears, tells managers it's "safety time"?
At some point the market factors QE at $0 if the Taper continues — and that time ISN'T after they withdraw the last $10 bn.
Above all, what if (and the marginal signs have been nagging away at me the last ten days or so) everything goes back to trading how it SHOULD, based on everything we know about markets and economics, instead of lingering in the Magical Fairydust World created by central banks since 2009?
Markets have been reacting correctly and beginning to decorrelate over the past several sessions.
Where does everything trade if a stimulus level of zero suddenly gets discounted?
I don't know EXACTLY, but I'll hazard a guess at "a ****-load lower" to kick things off.
Gold is talking loudly, so is copper. JGBs and equities are mumbling, so are bonds.
Something is happening, right now, in all the dark corners of the dance hall, and whatever that "something" is, it will NOT lead to an extension of the bull market.
Do we "crash"? I think that's the wrong question.
The right questions (I think) are these:
If a major correction begins, at what stage do they turn on the printing presses again? 10% lower? 15%? 20%?
When they DO (and it is WHEN, not IF), what happens now that the last vestige of their credibility has evaporated? A quick spike then a crash, or does the patient flatline on the bed no matter how much juice they pump into it?
I'm nervous as hell and feel a sharp disturbance in The Force. We've been here before and pulled back from the brink every time, but this time that outcome is expected again by most, and that is extremely dangerous.
Markets are most assuredly NOT ready for reality.
What say you, Wise Man?
On Sat, Mar 15, 2014, at 12:33 AM, Mr. Big <email@example.com> wrote:
EVERY new Fed chief gets a serious test. Every one. I have been trying to figure Yellen's. I know this:
A weakened/prone US, scared Russia, and nervous China is not good and not priced in.
On 15 Mar, 2014, at 12:42 pm, Grant Williams <firstname.lastname@example.org> wrote:
I've been saying for two years that nothing matters to anybody until it matters to everybody, and I have a nasty feeling that the test is this:
Suddenly, in one moment, EVERYTHING matters to everybody.
That's something even central banks won't be able to stop.
Every new Fed chair gets a test.
Burns had the run on gold that led to Nixon's closing of the window; Miller had the Oil Shock; Volcker had the inflation tiger to wrestle; Greenspan had the '87 crash; and Bernanke had the subprime crisis followed by the 2008 crash.
Now it's Yellen's turn.
After fifteen months of steady and predictable (thanks largely to the Fed's largesse and Draghi's promise to do "whatever it takes"), we are about to enter a period of extreme unpredictability right at the moment when the Fed is about to demonstrate to the markets that, yes, they really ARE serious about continuing to taper $10 bn every month.
The troubles facing the world are far, far broader than just the messy politics of Ukraine; and there is a very real chance that those troubles coalesce into one giant ball of concern that is big enough to shatter the fake sense of calm we've all been lulled into by the passage of time between crises.
If they do coalesce, I can't think of a single asset anywhere in the world that is priced correctly for such a situation.
Full Grant Williams Letter below...