Sa-wing Batta!

If you played, coached, or spectated little league baseball or watched Ferris Bueller’s Day Off, then you’re familiar with the age-old, friendly taunt of “Hey batta batta batta batta, sa-wing battaaaa.” During early morning Halloween hours, the Bank of Japan(BOJ) provided the treat of all Halloween-day treats for speculators around the world. They announced additional quantitative easing that set the stock markets around the world on FIYA! BOJ Governor Kuroda went and grabbed the 50oz special big-boy bat and took a monster swing at deflationary forces.

clip_image001(photo courtesy of Reuters)

What a miraculously well timed announcement on the heels of the Federal Reserve reiterating the completion of its own QE program. Of course, the Fed’s not really wrapping up just yet as it will continue to roll as opposed to liquidate the assets it has purchased over the last 5 years. The Nikkei’s intraday move was over 4%. Most of the major indexes around the world gained over a percent today thanks to the “good” news.

Japan’s central bank will be upping its bond asset purchases to $60B(all numbers in this post are in USD) a month or $730B annually. The US dollar amount will fluctuate as the Yen weakens against it, however the BOJ will keep steady at about $6.7 trillion yen a month. They claim that the move is temporary until inflation targets have been sufficiently met. Yeah, about that temporary thing? Along with the bond purchase announcement, the BOJ also stated that they’ll be buying up Japanese ETFs and REITs to the tune of almost $7 billion and $1 billion a year, respectively. That’s a lot of dough to be tossing around and my guess is that it’ll drive enough positive sentiment that from a political standpoint, nobody’s going to want to sign off on terminating the purchases. Imagine the negative perception along with a move down in animal spirits. As they say in Jersey, dey don’t want nuttin ta’doo wit dat.

Additionally, the BOJ coordinated the announcement with the Government Pension and Investment Fund of Japan (GPIF), the largest pension entity in the world, which 1 day earlier stated they would be upping their own stock purchase program. Specifically, the GPIF announced it was paring back its Japanese debt holdings from 60% of its portfolio to only 35%. An unheard of allocation choice for a pension entity considering the lack of conservatism. They might as well have said “we’re all in on stocks.” They’ll be doubling their equity exposure to 50% of the portfolio.

Rational economic thought behind these massive moves is how will the unintended consequences manifest themselves down the road? Kuroda, like all central bankers, assures the public that they can control the inflationary forces that they so desperately desire. Maybe for a little bit. Maybe forever. Recall Kyle Bass’s thesis as the BOJ is walking a fine line. At this point in the game, it’s hard not to believe that central bankers really do have everything under control. This is despite the fact that monetary and economic policies in the advanced economies have no parallels in history, and in the short-term, things seem to be working out brilliantly on a statistical basis. It is difficult not to observe all the activity while thinking that the unintended, and most probably, uncontrollable consequences will be the ultimate arbiters of the societal value behind these unprecedented steps taken by the central banks of the westernized nations.

In the meantime, enjoy the ride and the implacable rise in financial asset prices. Actually, in a November 2013 report, McKinsey stated the impact of ZIRP on asset prices is inconclusive. Specifically, they state, “…we find little evidence that ultra-low interest rate policies have boosted equity prices in the long term. In the United States, the evidence on whether action by the Federal Reserve has lifted the housing market is also unclear, because it is difficult to disaggregate the impact of these measures from other forces at work in the market.” That’s curious.

One would think logically that there would be a direct correlation between record low mortgage rates and new home purchases. Combine that with a ridiculously low WACC for the biggest financial players and Americans said hello to their new landlords, yield-starved institutional investors and astute corporate vultures. It would also be logical to assume that when an entity can borrow at 1% and buy back its own stock yielding 2.5%, that there would be positive arbitrage opportunities. The fact that those opportunities lead to reduced share counts, increase earnings, and thus drive up stock prices has no correlation to ultra-low interest rates.

D-short presents a perfect illustration of the “low-correlation” effects of ZIRP and QE on the stock market.


As I was saying, enjoy the ride. Buy every damn dip. Just buy and hold. Buy, buy, buy! In reality, I continue to think that raising cash levels due to a true lack of value across multiple sectors is prudent portfolio management. That doesn’t mean liquidate your portfolio. It just means that raising cash levels for potential bargains that avail themselves may prove more profitable than simply sitting in holdings that have already accumulated a very nice gain over the last few years. Look at the E&P’s off of oil’s slide. Myself, I don’t think we’re going to see an avalanche down to $30’s like we saw after the fall from the $150’s. Toe-dipping into the really well managed opportunities that possess prime shale or offshore acreage appears to be presenting quality value. Observe the P&C insurance players as well. They held up remarkably well in the most recent sell-off and continue to report tremendous profitability, however, in the face of a softening price cycle.

Just be careful. If you think momentum ignition and government intervention(jawbone or real) are fictional notions that don’t affect volatility, then have a look at this ZH chart.


Coming back to our little baseball reference, America was the 3rd and most valuable batter in this game of QE. Japan is hitting clean-up and protecting America’s own aggressive batting strategy. At some point, the 5th man in the lineup needs to show his power capabilities as well and drive in some runs. That 5th batter is Europe and Draghi is wielding the bat. If the game of central banks is to continue unimpeded, then he needs to put down the 36oz timber and go get his own corked 50oz bat to stave off deflationary forces in Europe. That damn German 3rd base coach keeps getting in the way though and giving the signal to sacrifice bunt.

Lastly, if you have kids, then take them to the wealthy neighborhoods to fill their bags full of candy. If you’re at home and not trick or treating, then give out the giant sized candy bars. You’ll be loved by the neighborhood children. If you’re in your 20’s and single, then go party it up with all the Halloween hotties(female or male) dressed to impress tonight…and be safe. Happy Halloween readers!

Economic Distortions

Here at, I mention Jeremy Grantham and his firm GMO quite a bit. That is for two very big reasons. Number 1, he and his firm manage in excess of $100 billion for the biggest institutional investors across the land. And number 2, he’s publicly nailed multiple bubble calls. Does he nail them to the day? Well no, but he’s been close enough and has effectively ensured his clients were positioned accordingly to mitigate the damage of the last two major stock market bubbles.

GMO came out with its most recent 7-year forecast for various asset classes and equities. It ain’t a pretty picture. These guys have consistently nailed their forecasts, especially for equities. They’re predicting negative returns essentially across the board of various sectors with pockets of relative strength in Int’l value, US high quality, and emerging markets. Observe the drilldown:


Why do you think this forecast is so negative? It may be valuations, but I think it’s because they see a major dislocation occurring within the next 7 years. This dislocation will cause most sectors to lose money over the specified time period. And of course depending how one is positioned, losses can and will be a lot worse than what is depicted in the chart. GMO will never reveal the secret sauce, so to speak, behind their methodology in determining their 7-year forecast. It’s probably safe to assume they use an amalgamation of various data inputs involving valuation, macroeconomic outlooks, interest rates, monetary trends, geopolitical trends, and so forth.

You don’t need to be able to reproduce the forecast in order to trust it. Knowing that this is how GMO perceives equity market returns going forward, one really needs to be conscious with their long-money portfolios. This is a message I have been consistently sharing over the past few articles, so let’s visit a few severe distortions that may have a major effect on equity markets within the next 7 years.

The first distortion is excess reserves maintained at the Federal Reserve. This first chart is to show how ridiculously large this number has grown to, which is now in excess of $2.4 trillion. That’s the cumulative and collected excess reserves of the banks who collude conduct business with the Federal Reserve.


Notice how before 2007, the amount was virtually zero. I realize this chart only goes back to the early 1980’s, so here’s a “Discontinued Series” chart that the Fed previously utilized to report the excess reserves. It goes back to the 1950’s and shows the same virtual zero in excess reserves as the normal course of business. That’s right, up until the Great Recession the amount of excess reserves held at the Fed was in the single digit billions. That’s basically zero. Since 2007, it has been a different story entirely.


For the uninitiated regarding excess reserves, I want to provide a relatively brief explanation. For the reader with an already good grasp, I apologize for any redundancy. The excess reserves were at virtually zero for all those decades because the Fed never paid any interest on them. Then in response to the entire financial world sitting on the precipice of obliteration, a multi-part plan was instituted in order to maintain the status quo and keep the entire system intact. The federal funds rate was dropped to zero where it has stayed, interest began to be paid by the Fed on excess reserves, and the process of quantitative easing(“QE”) was illustriously birthed.

The federal funds rate was dropped to zero so as to stimulate the economy in the face of certain deflationary doom. The book is still out on whether the US has seen true economic improvement due to ZIRP. What we do know is that savers are being heavily penalized by this policy and investors of all ilk are being forced up the risk ladder in increasingly desperate attempts for yield. The paying of interest by the Fed for excess reserves is one of the Fed’s tools for maintaining interest rates where they want them. It also just so happens to be able to provide a colossal liquidity buffer for the so called balance sheets of the participating banks i.e. Wall St.

Between the erroneously valued derivative books across the entire industry and jumbled collateral chains, the participating banks and the Fed think they’ve built an adequate buffer to potentially withstand additional impairment to balance sheets. And why shouldn’t they? They’ve got everything under control because now they can taper QE. Quantitative Easing was established to fight both fronts of the policy as a tool to reduce long-term interest rates while also stimulating the economy. Do you feel like the economy is stimulated? I know one thing for sure that has been stimulated and that’s asset prices. Take a moment to yourself and remember how this story has played out for the Weimar republic of Germany, recently in Zimbabwe, and even more recently in Venezuela.

Wondering why it matters so much that the banks keep their excess reserves at the Fed instead of productively using them within the economy? It’s because the money is essentially free. When the Fed monetizes its debt and buys assets such as MBS, it creates an asset on its own balance sheet and a corresponding liability. That liability is the excess reserves that belong to the TBTF banks who are the Fed’s main partners in facilitating QE. The banks keep those excess reserves with the Fed because why would you give away your gravy train and expose it to more unnecessary risk? The Fed pays 0.25% on excess reserves. May not seem like much, but 0.25% on $2.4 trillion equals $6 billion for the biggest banks to collect risk free in interest income.

If you were a bank CEO and knew you had derivative exposure that could single-handedly dismantle the system, would you kill the golden goose provided by the Fed? The proof is already in the pudding as the velocity of money is cratering but has had no material effect on our economy thus far. There’s no velocity of the money supply because banks aren’t lending out to businesses and households. Sure large corporations have been able to finance buy-backs and special dividends but capital expenditures have yet to reach a point of acceleration where we know some good economic tidings are bound to follow.

In the chart below, I’ve overlaid the rise of the excess reserves vs. the velocity of the M2 money supply.


If that’s not a chart yelling out for some mean-reversion, then I don’t know what is. So what are some triggers to increase velocity and why does it matter? An increase in velocity matters because that price inflation that everyone was so scared of during the beginning phases of TARP and QE, could finally begin to materialize. And this could hamstring any efforts to get the economy breathing on its own without the use of a respirator. As far as a trigger to generate velocity, it would take the Fed no longer paying interest(like they’ve almost always done) or even charging to hold excess reserves. The participating banks would immediately withdraw that $2.4 trillion in cash and put it to work. Where? Businesses and households. If those dollars hit the economy in a flood over the course of a year or two, we could see some scary jumps in asset prices that matter and not just fine art and collectible cars. Not to mention, there’s still all that cash that the mega-corporations keep parked internationally. If the US were to shift tax policy for this money and it were to be repatriated and spread around the economy, we could be talking about a doubly increase in money velocity.

The Fed knows this and you would think they wouldn’t be dumb enough to cut off their nose to spite their face but the Fed is backed into a corner. Additionally, the Fed has to answer to its political masters all while managing the world’s perception of America’s currency and economy. This is a dangerous game being played right now, as after 2008, Fed policy entered the realm of pure experimentation.

Would the Fed have maintained these policies this long, which are causing massive economic distortions, if the economy had really reached escape velocity or at least was well on its way? Let’s revisit interest rates, the second massive distortion. Gary Tanashian, with his Notes From the Rabbit Hole newsletter, provided an elegantly simple chart putting on full display the lack of efficacy of the Fed’s ZIRP policy to have any material effect on the economy. Below you’ll see the 3-month T-bill yield($IRX) overlaid against the S&P 500 index($SPX). You can see in the past 20 years that as the economy and markets picked up, the Fed would subsequently raise interest rates. That is completely normal policy and has been consistently used for decades.


But as you can see in the chart, where’s the rise in rates? The correlation of the two are generally fairly strong. Oh, so our economy is not genuinely approaching a growth level that warrants a raise in interest rates? These are the results of the great financial experiment, of which we are all a part of the double-blinded no placebo study that’s about to have a phase 3 letdown in the next year or two.

The Fed has been able to subvert a normal business cycle by reflating on demand through interest rate policy and monetary policy. That last doozie back in 2008 should have seen the destruction of several industry giants and the Fed wasn’t ready to allow that to happen in America. I get it. The pain and suffering would probably have been unspeakable and potentially worse than the Great Depression. When you combine the fact that the developed countries are so interconnected, the US didn’t want to single-handedly bring down the entire world’s economies. All that being said, the tricks to perpetrate the subversion of normal business cycle forces have been used up. You can’t drive interest rates any lower. You can’t print even more dollars and expect sufficient potency. Hence, the notion that the Fed is backed into a corner.

As far as impact to the market, I read a simple statement over at, that sums up the good fortune the Fed has had in driving up market prices in an attempt to drive the wealth effect while building animal spirits. stated, “Within the last fourteen years, there have been two major market corrections, both of which saw drops of 55% from their highs. That, or more, is the potential for what lies ahead…but next time the government is unlikely to be able to re-inflate the stock market bubble. To put into perspective how lucky (investors have been), it took 25 years for the Dow Jones to recover to its pre-crash highs after the Great Depression. Likewise, the Dow hit an intraday high of 1,000 in 1962 but never closed above 1,000 until about twenty years later.”

These distortions are what the doomsday types, Austrian economics practitioners, goldbugs, and similar minded types have been seeing and simply can’t seem to shake off. The team at GMO has never been labeled as any of those types; only true professionals’ professionals in the game of capital allocation. Below is the other chart in their 7-year forecast and it covers multiple asset classes as opposed to just equities.


The granddaddy winner for the next 7 years is timber, according to them. So forget about investing. Go cut some trees down. Chop’em up and store them in your house. Over the next 7 years that wood will have outperformed your 401k. Lame jokes aside, there are a few ways to easily make a play on timber. There are of course the biggest North American players such as Plum Creek (PCL), Weyerhaeuser (WY), Rayonier (RYN), and Potlatch (PCH). If you prefer ETF’s, there is iShares Global Timber & Forestry (WOOD) which focuses on North America and thus has significant positions in the largest players here. For more of an international flare to your timber exposure, Guggenheim offers its own Timber ETF (CUT). A cursory glance of CUT’s holdings will show that it focuses its holdings around the planet as opposed to N. America.

Since the average joe can’t simply invest in huge plots of timber like a hedge fund, endowment, or pension fund, then these are decent options to play the sector. PCL is the biggest of the N. American group and thus has a well established reputation on the street. However, friends and old colleagues will already be familiar with what is probably my favorite way to garner some timber exposure, and that is through Brookfield Asset Management. BAM! Remember though, at the end of the day these are still equities and have the potential to be pulled down with every other sector in the event of a sell-off or major dislocation.

Comparing Plum Creek to Brookfield Asset Management is not exactly an apples to apples comparison, as Brookfield is a massive asset manager focusing on real or hard assets with a portfolio approaching $200 billion. Plum Creek possesses the largest portfolio of timber acreage in N. America, so their market capitalization is justified. PCL carries a timber portfolio worth approximately $5 billion. Brookfield’s portfolio of timber acreage is significant in real terms but small compared to their entire portfolio. BAM carries approximately $4 billion worth of timber assets, and that is after selling approximately $2.5 billion worth of timber assets last year to Weyerhaeuser. BAM will monetize assets when appropriate. They don’t hold just to hold, however they’re considered some of the finest value investors in the world when it comes to real assets.

Let’s take a side by side look at long-term performance of each company since 1990. We’re using 1990 as PCL was founded in 1989, so I wanted to give it a year of operations under its belt for comparison purposes. The following chart compares the split adjusted values of each stock starting with an initial $5,000 and includes dividends but excludes the two spin-offs(BIP & BPY) from BAM.

clip_image014*Dividend data garnered from

You can see that BAM’s long-term performance speaks for itself. If you account for BIP & BPY, then to me it appears to be a no-brainer between the two for long-term exposure to timber. PCL’s dividend is vastly bigger, so if an investor needed that higher yield for whatever reason then it would make the decision of choosing between the two a little tougher. Overall though, if you want some timber exposure in combination with other world-class real assets then BAM is a heckuva way to play it.

Valuations matter. Momentum can be ridden, but in the end a stock’s price will revert to an appropriate valuation after momentum has made investors lose their collective minds. GMO’s forecast is not to be taken lightly. It’s just another recent indicator that should really make investors pause and think before allocating capital. I tend to concur with old Uncle Warren in that it’s not usually a safe bet to bet against America, so I promise that I’m not a total gloom & doomer here at These economic distortions, just a few of so many, are communicating a signal that America and really the world’s developed markets could find themselves in some pretty rough seas in the not too distant future. Invest accordingly.

Some Things Matter and Some Things Don’t In the Financial World

Whoo boy! Talk about an explosive over-reaction to the Fed tapering. The US central bank has tapered their debt monetization from $85B monthly to $75B monthly or $1.02 trillion annually to a paltry $900 billion annually. So the “one-time” TARP bail-out of $700B to save the US banking system and the US economy was so unprecedented that hard assets like precious metals, farm land, and such were driven to extreme levels. The Fed upped that number to a trillion annually and people celebrate because Bernanke has placed a Put under the market. Any threat of excessive inflation in the core CPI has been eliminated and market participants celebrate easing and tapering with virtually equal fervor.

These are truly interesting times for investors. And since it is the most wonderful time of the year, why not get a seasonal bump in equity prices too? Everyone deserves to feel wealthier. It’s the American way.

I recognize that things appear to be looking up economically in the US and since America controls the world’s reserve currency, that should positively affect the rest of the planet. GDP is slowly but surely looking up as some growth projections show anywhere from 3.5% to 4.1% for the US in 2014. Core CPI is tamed so who am I to dispute or rain on any of this optimism? All the same, I think we should visit a list of some things that just don’t seem to matter anymore in the world. We’re looking predominantly in the financial world, but we can’t avoid a couple of views on politics either. As usual, I’ll trot out some charts to help illustrate the good and bad, where applicable.

1. To get the party started, let’s start with inflation. It’s one of the touchier economic subjects out there. There are those who are of the opinion that observing the core CPI and its tame 1.2ish% is the total story. That of course ignores the following chart of growth in the CPI since the 70’s and the advent of excess credit to fund the American lifestyle.


The funny thing about core CPI is that it excludes energy and food, aside from housing, the two biggest components that hard-earned money is spent on. Additionally, hard assets and financial assets are ignored by the focus on core CPI. Hard assets(ex-precious metals) have been rising like gangbusters in 2013. Fine art, diamonds, fine watches, fine & classic cars, and farmland are all being sold for record prices. Is this asset price inflation irrelevant?

How about equity prices in 2013? Is the rocket ride across all indices simply a matter of business fundamentals? Partly. Multiple expansion? Partly. Worldwide liquidity tidal wave? Definitely. Does it really matter though? Wealth is growing…or at least the Fed thinks people will perceive their wealth to be growing and thus spend more to organically grow the economy.

The fact of the matter is that the YoY rate of change in the core CPI has been basically flat, or as neo-Keynesians and monetary sophists say, non-existent. Since monetary inflation is apparently meaningless, this means that the Fed has everything under control. If or when the need to tighten up policies to rein in any perking up cost-push inflation, the Fed will pull the appropriate levers and all will be good. That continues to be a prevailing mindset.

2. Debt monetization i.e. QE is simply overlooked as the price of doing business in growing the equity markets. As I previously noted, market participants were aghast at the sheer size of the original TARP. Now we can’t live without it, but it’s tapering. According to a Bloomberg survey of 41 economists, the median forecast is for the Fed to taper by $10B over the next 7 FOMC meetings until there is no longer any sort of QE. Do you agree? That’s a tough one to swallow. Below you can see the growth in the M2 money stock since the turn of the century.


I have read that this chart can be regarded as irrelevant for a couple of reasons. One is that the creation of this money is simply a balance sheet transaction. Federal debts are monetized, but only sit on the balance sheets of the participating banks as excess reserves. Thus, there is not the requisite rise in costs that historically accompany such transactions because those excess reserves are not being spread around. The next chart shows the velocity, or rather lack there of, in the M2 and it’s a major reason why deflationists and current believers in the status quo believe there are no or will be no repercussions for excessive debt monetization.


This chart above is leading many to believe that everything is under control. Of course, any rational follower of economics and the markets know that it will be the unintended consequences and unforeseen actions that will shift the velocity upward. And by unforeseen, I mean things that are completely foreseeable such as a shift in international confidence in the USD or a marked increase in the Renminbi for transactional settlement at the sovereign level or a significant reduction in the use of the Petro dollar for energy settlement. The current logic goes that excess reserves will be coaxed out by the banks’ greed for yield and earnings, as the spigot is eventually closed. Then the US should see some of that cost-push inflation that was so widely anticipated after 2009.

As it stands, there is a terrifically tight correlation between 10-year US Treasury yields and money velocity. Since everyone and their mother expects the fixed income market to lift the yield of Treasuries, it stands to reason that velocity will be joining the ride. Everything is always about timing, though. None the less, observe the following chart courtesy of Business Insider, via Harrell at Loomis Sayles.


3. But in the meantime, the co-policy of ZIRP which has helped to enable the efficacy of QE has destroyed what it means to traditionally and conservatively save your money. ZIRP is forcing everyone to speculate, plain and simple. Savings accounts and CD’s pay nothing. Because of that, more and more reach for yield through the dividends of the stock markets. Even the high-yield debt market continues to perform robustly and I suspect it will continue until the T-rates begin to officially rise. The lack of spread between HY and plain old Treasuries is beginning to hit what, since 1997, has traditionally been the early part of a danger zone. Observe the following chart from Bespoke.


It shows we still have some time to go before confidence erodes, but as a canary in the coal mine, a message is being provided loud and clear to those potentially stretching a little too far for yield.

4. Can anyone honestly look at official unemployment reports and not raise an eyebrow? The BLS is currently showing an unemployment rate of 7%. Fantastic! America’s well on it’s way towards full employment again. Except there’s that nagging little fact that the entire demographic of individuals who have given up looking for work are simply not labeled as unemployed and thus do not factor into the equation. So if you gave up looking for work and still don’t have a job, not to worry. You don’t qualify for unemployment benefits anymore and we won’t count you as unemployed because you’ll receive a different form of welfare. Win-win.

It’s difficult to ignore the glaring convergence between the reducing unemployment rate and the continued decline in the workforce participation rate in the US. Have a look at the chart below of workforce participation over the last 10 years, courtesy of BI, via Gunha at ISI.


The Philly Fed states that this rate is entirely caused by workers entering retirement. Obviously, retirees factor into the equation but to state that the descent, which coincides with the nadir of the Great Recession, is entirely related to retiring workers is bold. “But it’s backed by statistics! I read the report.” Yeah, sure. Ok. Statistics are never presented in such a way to influence the thinking of others.

5. Capital expenditures and the organic growth of the economy are simply not a priority for now. CapEx levels provide that behind-the-scenes, real snapshot of economic growth, and for now, CapEx is in the dumps. Businesses simply do not want to risk the capital to expand or grow sales and the work force. Instead, the current business fads are buy-backs and dividend increases. Selfishly, I’m all about the share repurchases and dividend growth in my own long-term holdings. But to use cheap capital or current cash flows for such short term benefits with little to no thought on how to build for the future seems a bit backwards to me. Getting by with less is SOP for so many corporations since 2008, but at some point CapEx will have to pick up, because SG&A can only be sliced and diced for so long to help generate earnings.

Have a look at this chart, also from BI, courtesy of Soss at Credit Suisse. It displays the ratio of business fixed investments to corporate cash flows. You can see it is still at its lowest points over the last 50 years. Corporations just don’t want to spend their money on CapEx.


Now that squiggle-pic above just depicts what corporations are willing to spend from out of their own kitty. Despite all the access to cheap capital for the corporations to borrow in order to finance the future, there isn’t a pick-up in that area for CapEx either. Observe the following chart, additionally from BI, via Chandler at Brothers Brown Harriman.


Just look at that spread on the right side of the chart. It’s very telling of the current methods being utilized to generate further corporate earnings without the CapEx investment to build a solid foundation for future earnings growth. At some point soon though, that spread will begin to converge as the US should see genuine economic progress. Companies will actually begin to invest in their future as opposed to just provide shareholder value through buy-back’s and divvy’s.

This is very important, because even though CapEx doesn’t seem to matter right now, at some point it could be a key point in the inflation argument. The scenario has the potential to play out like this: economic growth picks up and so maybe the Fed moves rates up just a quarter percent or whatever. Banks get scared that their Fed window cash machine is going to go bye-bye so they increase lending across many facets of their operations. Companies begin borrowing the still cheap capital to invest in operations and hiring actually picks up. This begins the upward shift in money velocity which should then begin to push prices upward. This is a scenario that investors will want to keep their eyes on, because it has the potential to make you a lot of money as markets grow, but it could be the mask that covers the arrival of the next financial crisis. Because we all know, nobody ever sees the next financial crisis coming.

6. Sovereign debts and sovereign solvency are issues that are front and center and yet hidden in plain sight. The numbers are simply so huge that it’s as if nobody cares anymore. Central banks are able to keep rates at or near zero percent and gin up funding on demand, so everything is under control. Unfunded liabilities are on the back burner as massive liquidity continues to be mistaken for solvency. Developed nations around the world have debt levels that are between 1:1 to 2:1 of GDP and it doesn’t matter. Here’s what matters:


7. The old banking model is dead and has been dead since the repealing of Glass-Steagall but really even earlier than that with the creation of mortgage backed securities. The so popularly and prevalently quoted old banking model was the 3-6-3 of borrow at 3% – lend at 6% – be on the golf course at 3pm. Banking pretty much used to be that simple. That’s how it should be. Banks shouldn’t be systemically risky to the entire world economy. And if the regulators around the world were actually doing their job, then these SIFI’s wouldn’t be SIFI’s. Banks now simply take in as much capital as they can and use it as collateral across the spectrum of their “sophisticated” trading operations.

Why lend to entrepreneurs or businesses in need when you can lend to sovereigns and use that asset as collateral in additional transactions in an endless chain of profit generation. The widespread acceptance of the current banking model is truly a thing to behold. Have a look at a couple of countries from over in Europe who simply appear to be clueless. This chart from BI, via Commerz Bank, shows how the Italian and Spanish banks are simply reflating their balance sheets in an attempt to stay resuscitated for as long as possible before the ECB starts monetizing like they’ve promised. Unbelievably, the entities that need access the most to that capital to help grow each respective economy is barred from access as the banks maintain their favorability to “govie” holdings.


There has been so much debt created between the sovereigns and the SIFI’s and so many derivatives are traded underneath it all to keep the illusion of solvency alive that nobody knows what’s what anymore. In a previous post last June, I expounded fairly extensively on the derivatives rife throughout the banking system. Click the link and have a read if you’re inclined. The old banking model is dead and I suspect that even after the next crisis, the system still won’t be cleansed of the systemic risk of the new banking era. If and or when a serious dislocation arrives, I’ll hold out hope for real, positive change that creates a balanced financial platform from which the world of finance, investing, banking, and economics can work. I ain’t holding my breath.

8. I don’t want to go off the deep end of a rant here after sharing what I think I are some important notions to consider in understanding some concepts behind the macro economic and financial outlook, but a couple of comments on statesmanship and justice are warranted. Civic duty in the political arena appears to be as dead as the old banking model. It really seems as if the Boomer politicians with their 60’s era non-inhaling, non-conformity or 70’s era dancing in polyester have forgotten what it means to build and develop a nation. Even the the X’ers in positions of power are infected by the commercialism they were so subjected to as youth. Both groups who control US politics seem to be consumed with consolidating and maintaining a power base, as opposed to building a nation up and maintaining an image of America as a fair, free world power. Obviously, these statements are highly generalized and that’s all I gots to say about politics.

As for justice, where is it for the bankers? Where is it for the corrupt? I realize it’s a tired question, but it’s difficult to let go. When you hear responses from Eric Holder on a slew of subjects, you just want to puke…literally. A handful of traders take the fall for the Great Recession. No banking executives are indicted in America, but during the S&L crisis going into the 90’s, hundreds of banking of executives were incarcerated and indicted for their malfeasance. Look at Iceland’s accountability of the executives from their largest banks; convicted and sentenced already. Is Iceland, an island of 300,000 people, a model of financial reform that America should be closely following? Not necessarily. That’s not the point. The point is you have a sovereign nation that held those accountable who deserved to be held accountable in the banking system. Enough about that as well.

9. The last notion on the list of things that don’t matter is volatility in the equity markets. No need to go short or hedge as you can simply go long and outperform on an absolute basis. That’s what ample liquidity across the world does. It drives up certain asset prices, and stocks are the asset du jour to be driven up by current liquidity levels in the economy. Volatility is one of those funny things though, where it doesn’t matter until it does in a very big way.

It does appear as if now may be a dangerous time to enter new positions as things seem a bit frothy, but as the liquidity continues to flow and the volatility is non-existent, it may be more imprudent to not get positioned going into the new year. At this point, hoping for a correction just to get the absolute best price on new positions may prove to be unsound. But then again, so could diving into new positions just to potentially play catch-up. For now it does appear as if the economy may begin to mend, and when combined with liquidity levels, ZIRP, and the general trend, one has to position their portfolio accordingly.

In my next post, I’d like to share a simple portfolio that may be able to take advantage of the current trends while hedging some of the correction risk; in addition to taking a contrarian stance in some of the positions. If I don’t share another post this week, have a great holidays and happy new year. And thank you so, so much for taking the time to stop by my site and having a read.