By Bob Janjuah
We are trapped in some sort of horrendous Keynesian/monetarists Nightmare....
Maybe its the return of sunshine, maybe its because I have moved back into my lovely 'new' home after 6mths of renting & refurbishment, it may even be because I have accepted that my beloved Liverpool FC now needs some dramatic and radical 'surgery' if it is ever to be a real force again. Whatever it is, the net effect is that I have spent an awful lot of time 'reflecting', just thinking abt the world, watching the world 'get on with it', and listening to our policymakers and their buddies in the media, in the lobby groups and in the financial sector. My conclusion? Well, I am fast coming round to the idea that (A) I am an idiot (cue the applause!) and that (B) Kevin G may have been right all along.
First, it must be made clear that Kevin and I neither have nor 'have had' any disagreement abt the issue of sustainable REAL private sector grwth in the WEST. We don't see any. Yes, a bounce from the extreme weakness of late 08/early 09 was to be fully expected. In fact the 2 of us were cheerleading this view way back in early 09 - and were being criticized for this view. Kevin's work also made clear that one 5%+ GDP data point, driven by inventory, was certain - he thgt it would be Q3 09 but it ended up being in Q4. However, we both have felt and feel that the prvte sector is in the middle of a long multi-yr period of balance sheet repair, and that the questions re sustainable real 'growth' could/can only be answered once we strip out and/or see the abatement/absence of UNSUSTAINABLE government largesse/bailouts/handouts etc. To us, once you strip away the policymaker and his period of peak effectiveness, where we are now much closer to the end rather than the beginning, what is left to take grwth forward is not very much at all.
When calling myself an idiot and suggesting that Kevin may have been right all along, I refer of course to the key themes I have been talking abt for nearly a year now: Sovereign Creditworthiness; and The Great Battle between Voluntary Austerity & Deflation, vs Involuntary Austerity, Inflation/Stagflation, Serial Bailouts, Debt & Debasement. I do not intend to go thru a repeat/rehash of these themes - see my previous comments for that. What is important is this: After the disaster of the 18/24mths culminating in March 09, which nearly saw a complete collapse in the global financial system and the global economy on the precipice of utter multi-yr depression, I had, STUPIDLY it now seems, assumed that policymakers and alike would (A) learn lessons, (B) get serious abt reform and regulation, and (C) not do anything to repeat the primary mistakes that lead to the said disaster. Namely too much debt, too many global imbalances, too much moral hazard, and the belief that the only good economic policies are the ones that encourage and promote reckless spending, reckless leverage, and which view reckless asset bubbles as symbols of success.
I had assumed, after doing what it took in late 08 and early 09 to avoid global depression and systemic financial system collapse, that policymakers & their buddies would see the light and realise that the only path to long term success for the problem economies (US, UK, most of Europe, Japan, etc) would be a period of Austerity, Balance Sheet repair, Deflation, Real Structural Economic reform and Serious Financial System/Accounting regulation/reform. This path is NOT the easy path near term, but it is the ONLY path for ensuring the long term health and success of the problem economies, as well as ultimately the ONLY path which will both successfully iron out the grotesque global imbalances and help ensure the long term success of the global economy.
SADLY, during my period of reflection, I have come round to the view that we have missed this golden opportunity. What instead I am seeing is a desperate attempt to re-write history ('there was no bubble', 'rates too low for too long had nothing to do with it', 'it's all just the fault of a bunch of greedy traders', etc etc) AND at the same time it is clear global policymakers and their buddies, whilst jaw-boning us abt 'exit' and 'austerity/fiscal repair', simply do NOT mean what they are saying - in other worlds, they are talking 'responsibly' but are acting IMHO in a reckless and irresponsible manner. And in my book actions ALWAYS speaker far more clearly and far louder than (cheap) talk.
As part of this self-reflection I have thgt a lot abt the old truism, which is as true now as it has always been, that MV = PY. That, in essence, the level of high powered 'money' multiplied by money velocity equates to nominal growth. In particular I have reflected upon the post-07 multiple factor increase in high powered money at the Fed and others, the observation that the V of M IS returning, and in particular I am now clear that the Fed et al have no interest in, and would find it almost impossible anyway, to successfully and PRUDENTLY calibrate its 'reduction' of M as V picks up. In fact, it seems clear from recent action that the Fed et al will prefer to keep M too high for too long, in the course of which we will see bubbles and Ponzis which will make the 08 unwind seem like a walk in the park. Folks will dispute the 'pick-up in V' part of this discussion. But ask yourself this - are you more or less WILLING, and more or less ABLE, to borrow money personally now vs 12mths ago. The answer is obvious and clear I think, certainly on ABILITY, and arguably so on WILLINGNESS.
Of course I have also been thinking abt the argument that we in the West have excess capital, human and non-human, which means we cannot have an inflation problem. I think this may all be utter rubbish. Why? Well it seems clear that, (for example) in the US, Capacity Utilisation rates, the levels of long-term unemployment (both standalone & as a % of total unemployment) and CPI inflation are ALL not only closely linked, but also the l-t trend in the US is clear. Namely that the peaks in Cap Ut rates required to give (say) 5% annualised headline CPI in the US have been on a declining trend since the 70s, AND the labour market in the US is far less efficient than it used to be (a function of the US becoming a service sector economy and a 'skilled labour' economy over a 40yr period where the investment in school education has been sharply declining). All of which means that perhaps, whilst there is excess labour, it is the wrong type of labour based on required skills/education. And whilst Cap Ut at 73% may imply lots of excess capital stock overhang, perhaps economist have underestimated the scrappage cycle and the levels of obsolete but not yet scrapped capital stock. We may only be 2 Cap Ut points away from a serious inflation problem, not 7! Also, in the context of labour, lets not forget that President Obama, and esp. folks like Reid and Pelosi are clearly very keen to EUROPEAN-NISE the US labour/benefits/welfare state system. ALREADY, the current administration has made it far more attractive than 2 - let alone 20! - years ago to be a long term unemployed person thru increased benefits etc. The US is catching the European disease and something that was and is again a big problem in the UK also - that it is, for many folks who lack the required skills/education, far more attractive to be 'permanently' unemployed and on benefits, rather than working in unskilled jobs.
The Greece bail-out, the goings on at the IMF involving the huge build-up of 'new bail-out' reserves, and all the talk in the UK abt fiscal repair based on fantasyland 'efficiency gains' are the latest evidence that policymakers EVERYWHERE have no appetite to be brave, to be strong and to do the right thing. It seems that it is clearly too painful to do anything else. Instead, policymakers EVERYWHERE seem to have decided that the only way out of the hole is MORE DEBT, MORE DEBASEMENT, MORE BAILOUTS, ugly INFLATION and/or even uglier STAGFLATION, FAKE AUSTERITY, ZERO STRUCTURAL ECONOMIC REFORM, & MINIMAL REGULATORY REFORM.
We are trapped in some horrendous Keynesian/monetarist nightmare, where policymakers, aided/abetted/advised by their buddies in the media, in the lobbyist cabal and in financial system, have YET AGAIN decided to go down the route which merely delays the problem/pushes it down the road, but which virtually guarantees that when the NEXT bubble collapses (I assume it will be the Global Government Debt/Bond Bubble and/or the Global Fiat Money/Paper Money/FX Bubble), there is NO pleasant way back.
When this next bubble collapses, those of us living/working in these problem economies will realise, too late of course, that WE are the new emerging markets. And no, I don't mean the next China, instead my reference is to Argentina back in the late 90s/early 00s!.
So if (as it seems to me) - even though we are agreed on the weak sustainable grwth outlook for the UK US Japan & Europe - that I WAS wrong and that Kevin is right on Austerity and the Reflation Trade, that policymakers will simply keep on behaving recklessly by loading on more debt and blowing more and bigger bubbles until the point of market and/or taxpayer revulsion, then this has some very clear 'asset allocation', and other, implications:
1 - Paul Volcker - it seems to me you were used by President Obama as a tool of political convenience post-Massachusetts. It seems to me that there is no real policymaker will to implement genuine reform/regulation - the lobbyists and the financial sector's players seem to have taken care of that. As you are one of my heroes, can I please suggest that you tell the President to find another tool, and please go enjoy your well earned retirement away from the beast that is Washington.
2 - Reform/regulation is all the chatter post SEC/Goldman. I have no view on this specific issue at all, but I do see this whole issue as having a broader side-effect - it serves Washington as a smokescreen against that chrge that prgress on real reform and regulation has been at a pace that would embarrass a snail on sedatives. As the policymakers in the West have clearly decided that MORE debt and MORE bubbles are the only way forward, whereby wealth is transferred from those who have been prudent and saved, to those that have been reckless and who have levered up and speculated, via inflation, then we should not be at all surprised at the lack of zeal on the issue of reform and regulation.
3 - Citizens of Germany, Finland etc - Oh Dear! You have, IMHO, been sold-out by your leaders domestically and at the European level. All your hard won wealth, success and competitiveness is now, it seems, going to be used as a CASH COW to bail-out countries that had decided to go down the easy money/debt/don't pay any taxes route. Is this what you really signed up for when the European project was being put together (assuming you had a choice!!). You should feel deeply disappointed in (and perhaps even disgusted by) your policymakers as you, your wealth, your competitiveness and your successes have been SOLD OUT for the sake of bailing out a country which historically has been a serial defaulter. Be prepared for the next guy coming cap in hand.
4 - For me, if I am right abt what I have written so far I have, long term, ABSOLUTELY NIL desire to own any EUROS or to own any BUNDS....why own BUNDS when you may as well own Greek Govvies - same risk, big pick up!?!?!!?...This is what the EURO and EUROZONE has become - the Greek bailout ensures that everyone in the club will be 'dumbed down' to the level of Greece. A truly sad day for Germany/Northern Europe.
5 - On this, it seems that the market is going to wait for Greece to actually get some IMF/EU cash into its coffers before it is convinced. Once this cash turns up, certainly 'out to 3yr debt' - the bit covered by the IMF/EU - looks likely to rally. How long it rallies for and how far is a moot point. I think it is virtually certain that Greece will not be able to deliver on its fiscal promises and therefore what this all really comes down to is 'at what point does the German electorate and domestic leaders other than Merkel say 'No Mas''. Nobody knows for sure. But to me the biggest nonsense around is that the whole EUROZONE project will fail if Greece is NOT bailed out and allowed to default. On the contrary, the failure of the EUROZONE is GUARANTEED if Germany 'opts' out. And the credibility of the EUROZONE would be GREATLY ENHANCED if Greece were allowed to default/restructure. After all, membership of ANY club only has value if the club rules are adhered to. Any club that does not enforces its own rules and which instead 'forgives' (BAILS OUT!) those who knowingly and repeatedly break these rules is, frankly, a JOKE and an embarrassment and not a club worth joining UNLESS you are looking for handouts/'arb-ing' the club (and its rules).
6 - More generally, it is clear to me that in the UK, US, EUROZONE (x-periph!!) & JAPAN, owning govvies is a total disaster on anything other than on a short term trading horizon. The global policy solution to the Credit Crisis is now clearly MORE DEBT, MORE FX DEBASEMENT, MORE BAILOUTS and MORE INFLATION, so why own any govvies other than for trading purposes. The same applies to the currencies/fiat money of these 'blocs'. I think the next big trend in govvie mrkts in the UK US EUROZONE is to expect bear flatteners - the shrt end of curves will wear all the inflation repricing risk, whereas very long (10yr+) maturities will do relatively better. I think we could see 2yr US UK EUROZONE out by 200bps over the next 6/9mths, with 10yrs out by perhaps 'only' (!!) 50/100bps. The bigger risk is parallel shifts higher in yield curves across the curve. Urgh!
7 - On bonds, and whilst the real underlying prvte sector trend is one of deflation, policymakers have decided this is undesirable and therefore INFLATION is their sole motive. They also feel they can, over the long term, fool the investor community into believing their 'talk' of exit and into believing that some uber-narrow and 'convenient' measure of inflation is enough to fool us all into to think that there is no inflation risk. Thus they can carry on debasing and adding debt ad nauseam. All fine of course until inflation becomes TOO OBVIOUS to deny. At that point - and this may be mths/qtrs off - this game ends horribly badly with deflation the end trend, but not before a horrible inflation/stagflation spike. And at which point we will all again see the exploded bubble we have (again!) been part of, wittingly or not. When this bubble bursts, I really do think 08 will look like a picnic. I will also be curious to see who the scapegoat is next time, as clearly policymakers will not of course accept their central role. After all they have a 'great' track record on this issue.
8 - My loathing of paper 'assets' out of these economies also applies to credit and equity. Clearly however some excess credit spread provides some inflation offset/protection - esp. in HY and distressed, and in equity land there is also some inflation protection, up to a point. So net net I can see SOME reasons to hold such risky assets - after all, the WHOLE POINT of Western policymaker 'policy' is to blow up these speculative bubbles, with total disregard for both the fundamentals and for the inevitable consequences of exploding bubbles. HOWEVER, once the inflation genie really takes hold - and it may be some mths/qtrs away - risky assets like credit and equity will get crushed too. Our work last yr told us the sweet spot for equities re CPI in the US was between abt 1.5% (headline annualised) and 3.5% - a very narrow window!!
9 - IF I am going to be forced to own paper assets I want to focus on quality, on global big caps (debt & equity), and on strong balance sheet developing economy stks, where the focus should be on DOMESTIC grwth/growing domestic demand.
10 - What I really want to own in a world of reckless policy, debasement, more debt, inflation etc, are PHYSICAL ASSETS like Gold, Oil and PRIME PROPERTY. I can see GOLD @$2k/oz in the next yr or so, Oil north of $100, and when I say Prime, I really mean SUPER PRIME - location and quality are key.
I still hope, for the sake of the long term, that I am wrong and that Voluntary Austerity and Deflation will be enacted sooner rather than (too) late(r) in the problem economies. However, it is clear that over the last 6/9 mths I have let my view and vision get coloured. I let my HOPES (for Voluntary Austerity) and my still total BELIEF that this is the only way forward for long term success, colour my judgement. I have been blind to the reality - that our leaders and their buddies care little abt the long term and that all that seems to matter to them are short-term 'fixes', short-term popularity gains, more bubbles and more debt, whatever the consequences for inflation/stagflation and fiat money. We seem to be stuck in an era where policymakers only understand more debt, more deficits, & more debasement. This IS gonna come back and savage (forget 'bite') us real hard unless our policymakers turn abruptly towards Voluntary Austerity/Deflation. As I've said before, we do NOT have the luxury of time here - it is simply not feasible to continue on the current policy paths for much more than a few qtrs. We do NOT HAVE years. And the longer we wait, the worse the unwind will be.
All of the above is of course a longer term focus. In the shorter term, more trading focus:
As per my last cmmt of over 6wks ago, S&P has rallied and is in spitting distance of my 1220 target. I think we can see 1220 over the next few days, BUT I would now - tactically - be reducing risk. Why? Well firstly because we have had lots of 'good' news over the last 2mths, esp. around grwth & Greece (yes, good news!..or aren't bailouts good news anymore?!?!), but also because I think that over the next few weeks bond yields are going to breakout into a higher trading range (say 4.25% 10yr UST yield +/- 20bps) as we collectively realise that reflation is the only game in town - whatever the consequences!! For me the initial breakout will be enough to knock up to 10% off global stocks over and May, which in turn shud set up the next bubblicious buying oppo.
Bottom line though re the trading outlook is that the BULLISH call from early March has abt run its course with upside S&P price targets pretty much hit - 1220 should be hit in the next few days but I think this is the tail of the rally from the 1040 early Feb lows. From here, over the next mth/6 weeks, the trading theme is MORE BEARISH with higher bond yields and S&P off by maybe 10%, say from 1120 to very low 1100s.