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Axel Merk Warns "Investors Are In For A Rude Awakening"
Submitted by Axel Merk via Merk Investments,
Will she raise or will she not? As financial markets focus on whether we will see a Fed rate hike this week, investors may be in for a rude awakening.
Why do we care about the Fed?
We care about the Federal Reserve (Fed) because it controls short-term interest rates and the underlying money supply that’s available to the banking system. What the Fed does with these controls has implications to the credit (the ease and cost of borrowing money) that is available to the broader economy (for corporate loans, household mortgages, etc.).
What is the Fed’s job?
Most central banks have a single mandate to keep inflation low and stable. The Fed, under former Fed Chair Bernanke’s leadership, has adopted an explicit 2% inflation target. In addition, Congress bestowed upon the Fed the mandate to maximize employment. And, because it appears so convenient for Congress to outsource seemingly everything to the Fed, it now has the responsibility to also provide financial stability.
What has the Fed achieved?
In our assessment, the Fed has achieved one thing: they have compressed risk premia. What? What about inflation, employment, financial stability, and what the heck does it mean, “the Fed has compressed risk premia?”
We focus on risk premia because, in our view it’s the only obvious achievement of the Fed, but it also has profound implications for investors. Wikipedia defines risk premium as follows:
- ... a risk premium is the minimum amount of money by which the expected return on a risky asset must exceed the known return on a risk-free asset in order to induce an individual to hold the risky asset rather than the risk-free asset.
Let’s try this again: when risk premia are compressed, risky assets are not expected to provide much additional return compared to a "risk-free" asset. This is noticeable, for example, in the low yield spread between junk bonds and U.S. Treasuries (i.e. the risk premium).
Central banks around the world have attempted to stimulate their economies through lowering short-term interest rates and engaging in “quantitative easing,” with the goal of making it easier and cheaper for corporations and households to borrow and spend money (the source of economic growth according to theory followed by many academics and policy makers). This theory is questionable at best and there may always be unintended consequences. Lower interest rates have lead to yield chasing in riskier assets and provided justification for high equity valuations on the back of a low discount rate in fundamental models. Meanwhile, there may be relatively little borrowing for purposes of productive projects that create goods and services with real underlying consumer demand.
While default risk may arguably be lower when borrowing costs are rather low, it also means bad businesses survive when the economy as a whole might be better off with employees working for more productive enterprises instead. In this context, economist Murray Rothbard has quoted former German Reichsbank President Schacht as saying, "Don't give me a low [interest] rate. Give me a true rate. Give me a true rate, and then I shall know how to keep my house in order."
Why should investors care?
Investors need to care because the above is just a proxy for all risky assets, including what is sometimes referred to the ultimate risk asset, the stock market.
All else equal, economic theory suggests that when volatility (risk premia) is lower, asset prices are higher. Investors are more willing to pay for an asset when the future appears less uncertain. As volatility increases, for whatever reason, asset prices should tend adjust lower to provide the higher expected future return needed to compensate the investor for the increased risk level.
Stock prices were rising on the backdrop of low volatility. Such an environment, in our assessment, fosters complacency: investors have been lured, courtesy of the Fed, to buy the stock market.
The trouble is that risky assets are, well, still risky. So while central bankers can mask risk, they cannot eliminate it.
As a result, our analysis suggests many investors may be holding assets that are riskier than they think.
Where we are
The Fed’s hope was that the economy would be on sound enough footing by now, so that the ‘extraordinary accommodation’ can be removed. Alas, hope is not a plan.
In our assessment, the Fed has tried to boost economic growth through asset price inflation. While we don’t think printing money creates jobs in the long-run, it does impact various sectors of the economy and, well, asset prices. Housing, for example, is affected by monetary policy: as home prices rise, fewer home-owners are “under water” in their mortgage (there are more implications, such as rather hot housing markets in places such as San Francisco).
Relevant to this discussion, though, is that if asset prices were to deflate, there might be higher headwinds to economic growth than had asset prices not previously been artificially boosted. And that’s exactly where we are: in our analysis, the reason the markets are so nervous about a rate hike is because it signals a shift towards rising risk premia. As the Fed is trying to engineer an exit, risky assets, from junk bonds to stocks, warrant a higher risk premium. In our analysis, all else equal, we don’t even need a Fed “exit:” even a perceived Fed exit warrants higher volatility and, with it, lower asset prices.
Where we may be heading
Think about it: we have investors that have enjoyed years of bull market; investors that have been told to “buy the dip;” investors that have invested in the markets under the faulty assumption that the markets are a low risk endeavor. Now let volatility spike for any reason - blame the Chinese if you wish - and our assessment is that an increasing number will say: “I didn’t sign up for this. I didn’t know investing in the market is risky.”
Differently said, rather then the glass being half full, it may be half empty. Rather than buy the dips, investors may now sell the rallies. Investors may scramble to preserve their paper profits. It will take a while for most investors to embrace this new regime, but we believe the tide may well have shifted.
So will we get a rate hike?
It doesn’t matter. What matters is what the Federal Reserve Open Market Committee (FOMC) has been arguing since the spring of 2014 in their Minutes:
- The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.
To us, this is a promise to be "behind the curve," i.e. to be late in raising rates. The Fed will try to keep rates lower than the Fed itself ‘views as normal.’ Presumably, it will try to avoid risk premia to blow out too much too quickly. Maybe they’ll succeed, but I would not want to bet my house on it.
What should investors do?
Just as with every bubble that has been built, investors have been most reluctant to take chips off the table when times were good. We urge all investors to have a close look at whether they are comfortable with the risk profile of their portfolio. Based on our discussions with both retail and professional investors we believe many are over-exposed to risky assets. We don’t expect everyone to do what I did in early August, which is to actually go short the market (please read: Coming Out - As a Bear!), but we urge everyone to do some serious stress testing on his or her portfolio.
Which asset classes do we think will outperform?
In August, any trade that appeared to have worked, went into reverse. In fact, one could argue there is no such thing as a risk free asset anymore, and given that risky assets were in decline, most investors lost money. It’s one reason why looking at alternative strategies, such long/short strategies (in currencies, equities or otherwise) might be worth considering.
The so-called "flight to safety" did not benefit the greenback; instead, the euro surged on days when U.S. equities plunged. While the media was highlighting how some emerging market currencies plunged, the greenback was down versus all major currencies on numerous days when the S&P was down sharply. We are not suggesting that the euro, or any one currency, will necessarily, be the bastion of strength. Instead, what’s been happening is that investors had been piling in to the same trades, such as “the dollar must rally because the U.S. has the cleaner shirt, will raise rates, because ...” well, a good trade works even better with leverage; except that when "risk is off," i.e. when the pessimists take over, de-leveraging is the mode du jour. As such, all those out of favor investors are suddenly outperforming.
In our assessment, different asset classes adjust at different speeds. The currency markets, when it comes to free-floating currencies at least, adjust faster than equity markets. In the equity market, we expect downward pressure to persist for an extended period until public sentiment is firmly in bearish territory (this may take months, more likely years).
And just before anyone thinks that bonds must do well when equities do poorly, remember that both have at times risen simultaneously; as such, it’s perfectly possible for both stocks and bonds to decline.
What about gold? Gold in the long-run has a near zero correlation to equities. It’s out of favor with many investors and if we are right, the Fed will intentionally be “behind the curve.” The reason for the Fed intentionally being late, by the way, has to do with the credit bust with 2008: Bernanke used to argue that when faced with a credit bust, one of the biggest policy mistakes would be to raise rates too early. Our interpretation: the Fed wants to err on the side of inflation. Add to that that we think that neither the U.S., the Eurozone, nor Japan can afford positive real interest rates in a decade from now, and we think investors should evaluate whether gold may add valuable diversification to their portfolio.
I would like to caution, though, that I once had a discussion with an FOMC member who told me the scenario above is unrealistic because it wouldn’t provide a stable equilibrium. My response was: I never said it would be stable!
Years earlier, I talked to a former high-ranking FOMC member who had retired a few months before. I mentioned to him my concern that the increasing debt in the system would make the FOMC less flexible, as small moves would have an amplified impact. He also brushed off my concern, suggesting the Fed could always fine-tune its policy. We may have seen some of this “fine tuning” in recent weeks, with Fed officials stepping away from rate hiking plans whenever the markets throw a tantrum.
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Rude awakening
Is yellen going to strip?
Noooooooooooooooooooooooooooooooooooooooooooo
The purpose of a rate ike at this juncture is not to restore normality but to cause chaos in nations where the USA does not have control so as to bring the whole world to heel.
I agree. I think this is all about the preception they are defending the dollar against the Yuan or the EM. They will raise and it will crush commodities and EM currencies even futher. The talking heads will blame China and if it continues we are likely to see war. That is the real goal.
Not to mention the fact that many of TPTB want the economy to shrink, while the stock market rises and money supply increases.
They've promised reductions in 'greenhouse gases' (utter bullshit) which can only be done through economic shrinkage. They need the stock market to rise to provide the illusion that 401Ks and pension funds are stable and secure. Again, it's perception--even if one will not be able to survive upon retirement, it doesn't matter if the respective account has lots of digits. As a pissed-off retiree, whom do you blame if your multi-million dollar retirement doesn't buy anything? So long as it's 'not them' they could give a shit. Lastly, these sociopaths have worked their asses off to create 200+trillion in unfunded liabilities (that they won't deny--it's probalby more like 500 trillion). They need an economy with at least 600 or 700 trillion from which they can leach (a quadrillion would be even better--who'll notice 500 trillion taken from a quadrillion?).
"Yellen is going to strip"
Thanx for putting THAT vision in my head.
Damn you man. Damn you straight to HELL!
That's disgusting! Who wants to see her circumcised cock swinging around?
I like the way he talks about markets as if one exists.
I don't like his accent.
Vee haf vays off making you talk...
One lie replaced with another.
.25 x 0 = ?
...or .25 / 0?
Knock, knock. Who's there? Nineteen. Nineteen who? 1937.
Paul Hardcastle - Nineteen
https://www.youtube.com/watch?v=b3LdMAqUMnM
Haven't got a 1930 like depression yet though
Yes, a rate hike is required to kick off the mother of all defaults. And until we get rid of the debt overhang, the world economy simply cannot grow. Bring. It. On.
LOL! Almost. You really think that growth can continue forever and ever in a biosphere with finite resources?
Tell us another fairytale and good luck with that!
But yes, let the truly insolvent fucks and worthless fucks go to the guillotine already!
using metrics in economics and applying mathamatical formulas to quantify all aspects of the economy has been a major and far reaching disaster. none worse, perhaps with the exception of unemployment and inflation, than the totally fraudulent metric "GDP". youll notice in von mises' magnum opus human action that there is not a single formula.
were it not for the measurement of the ambiguous "GDP", we would not be so concerned with growth.
We sure as hell would be concerned with growth.
Expansion is what is required by our monetary system.
That is why inflation of 2% is "stable prices" and everyone and their mother talks about growth.
Fraction reserve currency requires expansion (exponential) to function.
No growth=no currency system.
That is why sustainability is a no go right out of the gate.
pods
i was speaking more of an ideal world in which we would be operating under a sound monetary system. my problem with using economic metrics for everything is that it takes the focus off of real problems and gives huge power to the international banking cartel by allowing them to manipulate the numbers without end. we start from a false monetary system, then apply a metric system based on false logic to justify that monetary system, while also making those metrics esoteric enough that the average person simply stops paying attention or freezes up when such metrics are mentioned. that way the economy can be absolute shit, with obvious signs to anyone with eyes, and yet your average person will still say, well GDP is up and unemployment is down so things must be good.
Are you implying that reality exists without accounting?
Blasphemy! Burn him!
Growth is an organic function that always has its limits, generally in a self regulating cycle. Growth as an economic theme is one that is derived through artificial means, principally through deliberate inflation that is subsidized by debt. By creating inflation, people are incentivized to purchase sooner than later to beat the curve, which in the short run has positive results, much as cash for clunkers did.
The problem with artificial stimulus is sustainability. Inevitably front running inflation consumes future earnings and productivity which, if the front running is to continue, demands debt to sustain....which creates another layer of unsustainability. We managed to exist in a time when growth was slower but we were not forced to "invest" as the only means of protecting our wealth due to deliberate devaluation of our money....but that wasn't good enough.
The cold turkey from this addiction to stimulus is going to be a bitch.
Look at all the metrics of the economy a central bank is supposed to control and fix. What a friggin joke.
Good Lord. The "markets" have already priced in a quarter point move, and the "strong dollar" rally has already tightend for the fed. The fed can, and probably will, hike tomorrow, but I still maintain my position that we will never see fed funds above 1%. Any move the fed makes is purely to benefit the bankers and to continue the illusion that all is well with the world.
Sure seems that way. The only way the funds rate goes above 1% is if things are already spiraling out of control.
The reason I believe the Fed will raise rates .25% is because my credit union has already raised its interest rates by the same amount in anticipation, which I believe, that the Fed will do the same.
The fed will never raise interest rates . . . ever. The next move is more liquidity, QE or outright purchases of S&P's. We are following the Japanese playbook, all central banks and the politicians care about is the stock markets, fuck the peeps, they can eat shit and die.
A Jew has ALWAYS been the head of the Fed. That alone should tell you how illigit and illegal the Fed is!
Unfortunately, this is too inconvenient of a fact. It really begs some serious questions - particularly regarding Israel, Saudi, etc. Perhaps some serious use of rope and lamp posts too.
I guess if you don't count Hamlin, Harding, Crissinger, Young, Black, Eccles, McCabe, Martin, Miller, Volker...
Check out Volker.
Crank this shit up to eleven Mr. Yellen!
Lets get this rate no rate ordeal over! It has been going on for toooooooo long!
5 basis points.
Rate hike = Barbarous relic = Hilarious :)
What about interest rates? Can we now call them 'pet numbers'?
What good is an interest rate? You can't eat it, you can't drink it!
I firmly hold that a .........Wait..... Holy shit.., what could Gartman do to the rate hike!?
It's obvious they don't eat burgers, eggs, chicken, or cheese at the Fed. I own a machine shop. I know that if I recalibrate all the calipers in the building I can surreptitiously get the boys to meet any specification I want.
The good news for me is that I'm not an investor - I've been in cash for months. Make a trade, take a small gain, return to cash immediately. At any given moment, there's a 60% chance I'm 100% cash.
Fine tune = We'll be OK if we make all the deck chairs face east.
That way we won't see it coming from Europe?
All the other children are looking on in fear and confusion. One kid is laughing his ass off behind Janet. What's up with that?
Crap cartoon. Those shoes are far too elegant. Yellin' wears size 2 triple wide Yenta pumps.
http://www.qupidshoes.com/Qupid-Women-Pump-YENTA-01-p/yenta-01.htm
Wrong. Yellen wears jackboots with pointy toes for kicking American workers when we're down.
I would have thought black riding boots, with 6" spurs.
FOMC Decision:
We will neither raise nor lower interest rates. We will instead disband the Fed. You are on your own now.
wait is that Ax Merkel or Axel Merk?
Axle Foley...
What's an investor? I know other terms such as manipulators, riggers, fixers, front runners, fraudsters, ponzi schemers, inside traders, spoofers, scammers, front men, bagmen, market makers, interventionists, plunge protectors, rehypothecators and Corzined...Who is this Investor and what do they do? There are no markets to invest in...right?
They invest in politicians.
The investor is a mythical creature first mentioned in texts written by Pliny the Elder around 70 BCE. Some scholars think there might have been investors in prehistoric times that later became extinct. They point to gamblers as degenerate forms of investor, but there is no evidence for a taxonomic connection. Probably investors and productive investments never did exist but our deep and continued need to believe such a thing possible keeps the myth alive.
Riddle me this Mr. Merk:
Say volatility remains very LOW, but stock prices FALL at a steady 2% rate over the next 5 or 10 years. The market is much less "risky" by the academic definition, but investors are far worse off.
Volatility is NOT risk. Loss of real purchasing power over time is risk.
Why do we care about the Fed?
We care about the Federal Reserve (Fed) because it controls short-term interest rates and the underlying money supply that’s available to the banking system.
In a properly managed Medium of Exchange (MOE), INTEREST collections must exactly equal DEFAULTs to deliver zero INFLATION. The operative relation is:
INFLATION = DEFAULT - INTEREST = zero
In a proper MOE process, the supply and demand for money (a promise to complete a trade) are in perpetual perfect balance. It's the nature of all trades.
What has the Fed achieved?
In our assessment, the Fed has achieved one thing: they have compressed risk premia. What? What about inflation, employment, financial stability, and what the heck does it mean, “the Fed has compressed risk premia?”
The Fed has achieved many things. Among them are (1) Enormous income to it's owners and (2) Sustenance of government largess.
INFLATION: Should be zero. Fed shoots for 2%. Fed delivers 4% on average for 100 years
EMPLOYMENT: Of no concern to a properly managed MOE process
FINANCIAL STABILITY: Of no concern, but automatic, to a properly managed MOE process
COMPRESSED RISK PREMIA: In a properly managed MOE process there is zero risk to all parties. DEFAULTs are exactly equal to INTEREST collections ... all the time ... everywhere. It's an actuarial process like underwriting insurance risk. Reliable traders enjoy zero INTEREST load. Deadbeat traders are ostracized by INTEREST collections driven by their propensity to DEFAULT. Their INTEREST load is so high they cannot deliver on any trading promises. They are driven from the marketplace in a perfectly natural fashion.
Why should investors care?
Investors need to care because the above is just a proxy for all risky assets, including what is sometimes referred to the ultimate risk asset, the stock market.
Investors thrive on the uncertainty caused by improper MOE management. They thrive on the false premise that capital must back all trading promises. With a properly managed MOE process, money never loses value. The time value of money is 0%. That makes all DCF calculations mute. With a properly managed MOE process, investors would have to find honest productive work.
Where we are
The Fed’s hope was that the economy would be on sound enough footing by now, so that the ‘extraordinary accommodation’ can be removed. Alas, hope is not a plan.
Proper management of any MOE process is purely "objective". Hope is not involved. The process "guarantees" a free and ample supply of money. Supply and demand for money are in perpetual perfect balance. There is zero INTEREST load on reliable traders. Deadbeat traders (like all governments that roll over their non-delivered trading promises) are ostracized. Money is known for what it is ... "a promise to complete a trade" and never loses value. No backing of money is required in a proper MOE process. A proper MOE process cannot be manipulated. A proper MOE process exhibits no cascading effect in the face of a DEFAULT. Rather it exhibits a gentle negative feedback effect with immediate balancing INTEREST collections. The process is perfectly stable. There is "no business cycle".
It's really pretty simple folks. We need to fire the Fed and install a properly managed MOE process.
Cost? Virtually zero!!! Profit from operation? Absolutely zero!!!
Bitcoin $229
Perhaps it is time to consider a larger frame of reference. Why does the Government wish to change (or not change) rates in this geo-political/financial climate? What will happen internationally to U.S. interests if the interest rates a)remain the same; b)increase by a small amount (.25%);c) increase by a moderate amount (.5%) or d)increase by a large amount (1%)?
We might get a 1% solution to really deal with a USD that is too strong relative to other currencies such as the Yuan which is getting weaker. Would a higher interest rate cause a slightly less overvalued USD? Should we 'punish' China by encouraging manufacturing in the U.S.A.?
You cannot yet reduce to below zero although it has happened in some spaces where markets dictate. So you raise to give yourself flexibility to kick the cans down the road later. You wash the bood from your hands should interest rate rise cause some asset classes to tank and say its unintended consequence. You first raise interest rate than choose the metrics (eg GDP growth) to amplify and silence or jiggle other unsupportive metrics (eg inflation). Let's not get serious just a voodoo dance.