“Here’s when US equity and bond markets will change direction,” Cali Money Man grumbled a few days ago. He is a wealth manager and has been on the job at brokerage firms and large banks through three phenomenal crashes. Unlike others, he hasn’t forgotten the craziness that led up to them.
“When investors come to fear the next Fed-talk, that’s when markets will change direction,” he said. “Now they bid up risk in advance on confidence – and afterwards on reassurance – that ZIRP will continue. But eventually they’ll focus on the start and pace of tightening. Fed-speak will assume an aura of bad news.”
And on Wednesday, there was some Fed-speak. As the minutes from the Fed’s July 29-30 policy-setting meeting were published, investors hit the sell button, just a smidgen, then changed their minds, but not much. The Dow and S&P 500 ended the day up, the Nasdaq slipped. The reaction seemed uncertain, jittery, frazzled, but finally unconcerned.
All eyes have been on the Fed for years. By now nothing else matters. And the minutes had a nasty message buried inside: the Fed was seriously debating [5] if it should raise interest rates sooner.
Many participants noted that if convergence toward the objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.
“Many participants.” No longer just a couple of hawks! And QE is practically history. It confirmed Fed Chair Janet Yellen’s quickly brushed-off warning in July to Congress; and it confirmed what other Fed governors have said recently: rate hikes might come sooner and be quicker than anticipated.
Alas, it took the market only about 30 minutes to decide that the FOMC minutes were backward looking and hence irrelevant. What mattered now was what would be said at the big shindig in Jackson Hole. When Yellen speaks on Friday, the pundits will vivisect her oracular pronouncements and read in between the lines to ignore what they don’t like and put in bold italics any hint that ZIRP would last forever, that in fact, the Fed couldn’t ever raise interest rates.
That’s what powers the market. Fundamentals have been obviated by the Fed.
“I was on a conference call with a group of portfolio managers,” Cali Money Man said today. “Their mood was resigned capitulation to the trend, going fully invested in order to survive. Low-risk assets pay nothing. They’re negative to clients after fees. And even worse after inflation. Yet these ‘low risk’ assets, such as high-grade bonds, face almost certain losses.”
Almost certain losses: that’s how low-risk assets are being defined today. The Fed’s new world is dripping with ironies.
ZIRP and QE, in effect since December 2008, have succeeded in creating a world where fundamentals have been surgically separated from valuations, where “low risk” assets produce almost certain losses, and where everyone has to pile into high-risk bets just to overcome fees and inflation, with a good chance of losing a big part of the investment down the road.
And these “principal-agent dynamics,” as Cali Money Man calls them, boil down to one hyper-ironic strategy: take on risk to survive. That strategy, when multiplied by a million times around the world, drives markets even higher.
“The bull move has lasted so long – despite weak macro fundamentals, despite its mysterious origins – that nobody can see its end,” he said. “We’re like observers on June 24, 1812, watching Napoleon’s Grand Army march off to Russia, with its victory certain.”
And so, one after the other, portfolio managers who have been bearish based on how they saw the fundamentals and other factors capitulate; they can no longer believe their former views. “This is the essence of a one-sided market,” Cali Money Man said. “Oddly, the third one of our generation.”
But one-sided markets invariably tip over. It’s just a question of when. And how violently. Cali Money Man added pensively: “I wonder how many of us will be at our desks four years from now.”
But not everyone is bullish on US securities. The report by the US Treasury – released on Friday when everyone was on vacation or getting ready to head out of town, and when no one was supposed to pay attention – was a zinger: US net capital outflows soared to $153.5 billion, the largest ever recorded. Read…. Foreigners Dump Record Amount of US Securities, But Who the Heck Is Still Buying? [6]