Jim Bianco Warns "Investors Should Be Careful What They Wish For"

Authored by Christoph Gisiger via Finanz und Wirtschaft,

Wall Street is rattled. This week, the long-running stock rally turned into a rout. On Monday, the Dow Jones suffered its largest one-day decline since the summer of 2011. After stocks came out roaring at the beginning of the year, investors now are facing a lackluster performance for 2018. For Jim Bianco, the sudden plunge is a sign that financial markets are finally showing concern about inflation. The influential market strategist from Chicago thinks that a return of inflation could force central banks to accelerate their exit strategy and that the basic relationship between stocks and bonds will change once again.

Mr. Bianco, financial markets have been thrown into turmoil. What is going on?

For the first time in the post crisis area the markets are finally showing concern about a return of inflation. This is something that we talked about and speculated about for a long time, but it never became an issue until now. The catalyst to this sell-off was last week’s employment report which showed that wages were up 2.9% in January, the fastest pace since June 2009.

Why are investors so concerned about that?

The reason the market is worried about inflation has to do with central bank activity. Central banks and especially the Federal Reserve have put out the idea that it could take up to ten years for them to unfold their unconventional measures. For instance, the Fed said that it might get its balance sheet back to normal in 2026. But built into this was the assumption that there would not be anything like inflation that would come along and force the Fed to move in a different pace. So now, if inflation materializes it forces central banks to move a lot faster.

Why is that a problem for financial markets?

I’m of the opinion that all central bank stimulus is fungible. Whether it’s the European Central Bank, the Bank of Japan or the Federal Reserve: it doesn’t matter who does it as long as stimulus is added. If you add up their balance sheets, they have accumulated an all-time high of 16.4 trillion dollars. So even though the Fed has raised rates five times and is expected to reduce its balance sheet, collectively the central banks are the easiest they have ever been right now. But if there is an inflation fear coming, it forces the hand of the two easiest central banks: the ECB and the BoJ. What will they do about it in response? Do they start to taper faster? Do they start to reverse? These are the questions that are the heart of what’s bothering the financial markets right now.

Since the financial crisis, economists predicted time and again that inflation was just around the corner, but it never happened. What’s different this time?

The models that are saying inflation is returning in 2018 probably said the same thing in 2017, 2015, 2011 and many other times. Yet, it never materialized. Part of the explanation why inflation never materialized might be the Amazon effect: the internet is making things much more efficient and that has been holding down prices. But what’s different now, is that the market is taking it seriously. The market did not take it seriously in 2017, 2015 or 2011 when we thought inflation might return. It’s the market that pushed the yield on ten year treasuries up to 2.85% and that sent the Dow down 4,6% on Monday. But the most telling thing to me is the reversal of some of these correlations in the market.

What do you mean by that?

The correlation between stock market volatility and inflation expectations has been negative for a decade, meaning that when inflation expectations went up, volatility would go down and vice versa. But now, we’re on the verge of that correlation becoming positive for the first time since the financial crisis, meaning that as inflation expectations go up so does volatility.

Why is that so important?

This could be a return to the way that markets used to trade in the 1980s and 1990s. During that time, we traded with an inflation mindset: whenever we thought that inflation is coming back, up went interest rates and down went stocks. On the other hand, whenever we were relieved that there was no inflation, down went interest rates and up went stocks.

And how used markets to trade in the recent past?

Since 2000 we’ve traded with a deflation mindset: our biggest fear was deflation. When we thought that deflation was coming back, down went interest rates and – since deflation is bad for stocks – down went stocks. In contrast to that, when we were relieved that deflation was not a problem up went interest rates and up went stocks.

What does it mean when these correlations are changing once again?

People still think that’s the way we’re supposed trade right now. But if we’re transitioning to an inflation mindset like in the 1980s and 1990s, higher interest rates mean inflation which is bad for stocks – and add to that a set of central banks that are completely unprepared for a return of inflation because they’re in such an easy position right now.

Another remarkable development is the weakening of the US Dollar. How does the Dollar weakness fit into the whole picture?

I think it’s a confirmation of this reversal. I would argue that just like the correlation between volatility and inflation expectations has been turning up for the last year, the Dollar has been turning down. Behind both of those developments has been a concern about inflation. I think that’s been the primary driver. Look at it this way: Why would the Dollar be weakening with the strong economy? With the tax reform? And with everything else that has been going on with stronger interest rates? The Dollar shouldn’t be weakening unless you worry about inflation. That’s why the Dollar could be one of those warning signs we misjudged and tried to tie it to politics. But the Dollar maybe has been one of those things that are telling you inflation is coming.

So what’s next for the bond market? Is there a specific technical level which investors should watch out for?

On the ten year treasury note it was 2.63% from last year. We broke it last week and you saw the market sell off quite a bit. At this point, you now have to go with the 2014 high of 3.05% which is one of the highest levels in the post crisis era. If we take that out that would be a very big concern. We’re only around twenty-five basis points away from that level so we’re in a very weak technical position right now. Ultimately, if you’re a stock investor, what you would need to stop the route would be interest rates to stabilize and maybe even have a rally in bonds to signify that the market is saying: “maybe we overdid this inflation thing”.  Something like that happened on Monday after the Dow briefly went down nearly 1600 points during the trading session.

During this great bull market, it has always been rewarding for equity investors to buy such dips. Is this still a smart thing to do now?

The buy-the-dip-strategy worked because what never ever materialized during any of these dips was inflation. But if inflation returns, I think that jeopardizes the whole buy the dip mentality. So far, you had central banks that elevated markets and they have never been forced to really think about accelerating their exit because you never had inflation. So every dip has been a buy. But if central banks have to deal with inflation and have to accelerate their exit than a buying the dip mentality could really be a problem.

What’s your general take on the state of the stock market?

Stocks had a huge run. January has been the 15th straight month without a decline. Also, the Dow Jones went 404 consecutive trading days without experiencing a 5% correction. This week’s losses in stocks brought this streak to an end. The only time the Dow lasted longer without undergoing a 5% correction was the 437 trading days ending September 7, 1959. So if you understand that this has been the second longest run of this kind in the history of the Dow, you should understand that we might get into a period like we were in 2015 or in 2011 when we had several months of choppy to sideways markets with a lot of volatility. Gone is that period where the market never corrected and only went up.

So what should investors do now?

If we’re in an inflation environment in which both bonds and stocks struggle the whole risk parity trade is going to be problematic. It’s going to be very difficult to find a place that is going to perform well. This could be like the 1980s and 1990s: when markets went down, everything else went down as well, even investments like gold. So you really have to be careful in this environment.


Oldguy05 Wed, 02/07/2018 - 17:30 Permalink

I'd be very happy if gold goes down.

I don't have a truck but the Yaris has a good amount of trunk space.

(That lil car, with studded tires beat the 4x4 I had in the snow....awesome little snowmobile!)

Come to think about it, My 95 Mercedes has a good sized trunk as well.

Don Sunset Wed, 02/07/2018 - 17:32 Permalink

Thee Orange Joolius, of Thee Wharton School of Thee UPENN, a well known stable genius to himself, will be lampooned throughout all history over his voluntary assumption of the soon-to-be mother of all economic collapses.

all-priced-in Oldguy05 Wed, 02/07/2018 - 19:55 Permalink

Google the legislation that created social security - and all additional legislation added to it -


Start reading - every time you see the word "entitlement" put a check mark on a piece of paper


When you get to 25 check marks maybe you will have figured it out -


The people writing the legislation called it a fucking entitlement - how the is it not one?



In reply to by Oldguy05

laser Wed, 02/07/2018 - 17:40 Permalink

Calling for inflation is like calling a large bad dog. It doesn't come. And when it does, it knocks you down on the front porch and runs into the house and tears up the furniture.

Al Huxley Wed, 02/07/2018 - 17:41 Permalink

At this point, if Jim's suggesting I should be hoping the risk-free capital gains should continue for the rich pricks who own the country, because otherwise it will be bad for all of us, I say 'bring it'.  I'll choke down dog-food and live in a cardboard box on the street if it means some pain for the sociopaths in charge of this system.

itstippy Wed, 02/07/2018 - 17:56 Permalink

Conventional wisdom is that inflation is good for people who are in debt, because they repay their debt with devalued money.  Many economists have said that the U.S. can "inflate away" its debt.

Unfortunately, inflation only works as a way to reduce debt burden IF YOU ARE IN THE PROCESS OF REPAYING THE DEBT, AND THE DEBT IS AT A FIXED INTEREST RATE.  At that point yes, you are repaying with "cheaper" dollars than the ones you borrowed.  People with 30-years fixed rate mortgages benefit from inflation.

The U.S. Government is NOT in the process of repaying its debt.  Far from it.  They roll over existing debt when it matures, paying whatever the new interest rate is.  They also borrow somewhere around $1T per year in new debt.  If inflation were to take off, and Treasury yields climb, and the Central Banks tighten, the U.S. Treasury is in a world of hurt.  So is Japan, every nation in the Eurozone, and the U.K.  

Oldguy05 itstippy Wed, 02/07/2018 - 18:08 Permalink

If it wasn't for never again having a balanced budget, It Would be a good thing. Rolling over old debt to a lesser interest rate isn't a bad plan. The bad part is continually taking on new debt. But....in this day and age money is created by debt. We have sooo screwed ourselves! Thanks Fed guys! I'd say goys, but their not.

In reply to by itstippy

itstippy Oldguy05 Wed, 02/07/2018 - 18:34 Permalink

They will be rolling over the debt at higher interest rates if inflation takes hold.  During inflationary times debt buyers demand higher returns for their capital, including U.S. Treasuries.  Inflation only helps if your debt is at a fixed rate and you are paying it off.  You do not refinance debt in inflationary environment because interest rates go up.

In reply to by Oldguy05

Truth Eater Wed, 02/07/2018 - 18:28 Permalink

Gisiger thinks the market controls the bond rates.  Huh?  NOBODY with half a brain is buying bonds now.  NOBODY!  So, who is?  The damned central banks!!  Who do you think has been floating stocks and bonds for the last 8 years?  So when bonds drop and rates go up, it is because the FED is holding back.


btw- they should never have tampered with the free market because now it is so far out of reality, this junky starts to see bugs under his skin if you say no pump today.

Let it Go Wed, 02/07/2018 - 19:52 Permalink

Albert Einstein developed the general theory of relativity which remains one of the two pillars of modern physics alongside quantum mechanics. Often we find the qualities of relativity extend to other parts of our lives and the universe as well such as economics.

This is important because we exist in a world where the state of real value is always dependent on, or determined by a commodity or an item's relationship to something else such as supply or demand. The material world of tangible items by its nature has been far more restrained in its growth, in short, the amount of tangible goods has not matched the growth of paper assets. More on why this is so important in the article below.

 http://Economic Relativity In Relationship To Currencies.html