Going for Broke

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and “The Coming Collapse of the Municipal Bond Market” (Aucontrarian.com, 2009)

The talk in 2013 has been of the great rotation from bonds to the U.S. stock market. This accompanies a new world record for the Russell 2000 Index (small-cap stocks). The S&P 500 has topped 1,500. It did so twice before, in 2000 and 2007. Here we are, again.

This U.S. stock market view is parochial. There are new world records wherever one looks. Flows (in 2013) into emerging-market stocks, emerging-market bonds, and real estate are raising prices and reducing yields. There are two reasons to step back from the spree. These will be taken in turn, to be followed by an excuse to go for broke.

First, asset prices have detached from reality. “There is a bubble in every market in the world,” was the proposition laid before me last week. I muttered something about gold and silver having somehow exited the ionosphere, but noting an extra 10,837 short-interest, gold contracts added to the pig pile during the week of January 21, 2013, the precious metals do not lack attention. Back to the proposition, asset prices are growing, rising, and expanding. This is a consequence of greater debt-to-output multiples. The same is true around the globe. When more debt is need to produce the same output, there is a problem. Stock, bond, and real estate prices will revert, sometime.

Second, is the often-sited stabilizing influence of liquidity. As long as it is there, the fun will last.

Caution is recommended. In the January 21, 2013, Wall Street Journal, “Money Magic: Bonds Act like Stocks,” described a late-inning investment strategy. Pension plan trustees are leveraging their bond positions because the bonds trade “in large, liquid markets, and [pension officials] say they have ample liquidity should they ever need to settle trading losses with cash.” This sounds like 2007 again. Or, 1998.

When “ample liquidity” is the rationalization for participating in detached markets, you can depend upon it: the liquidity will not be there when it is needed most. Following the Long-Term Capital Management hullabaloo in 1998, Marty Fridson, then at Merrill Lynch, etched this identity in granite: “[LTCM] forgot that in times of panic, all correlations go to one.”

Now, a reason to frolic: central banks of all stripes will not attempt to reign in the extraordinary excesses. Federal Reserve officials have made it clear they will nurture boundless spending and risk-taking. Nationalism in 2013 takes the form of unabated currency depreciation and endless money-printing (electronic crediting, for the literalists.) This will affect both real prices and asset prices. “Affect” is the selected verb, since, in an inflation, one can only play hunches of where prices will rise and fall in relation to each other.

Andy Lees (AML Macro Ltd.) wrote to clients on January 28, 2013: “One of the commentators at the conference I attended, who advises the government on international finance, said [Federal Reserve Chairman Ben] Bernanke’s aim is to achieve 4% inflation to shock the public into spending.” Stanley Fischer, Ben’s Ph.D thesis adviser, has proposed a negative 8% real rate-of-interest (for example: interest rates of zero percent and inflation of 8%). Why is the Fed chairman so tame?

He could say 4% or 400%, the result will be the same. Bernanke and Fischer have no idea what they are talking about, deficiencies on their chalkboard blot our lives with petrified Rorschach tests, one being the notion that central bankers can decide what level of inflation they will introduce. If central banks decide inflation must be stopped, they must act in a single manner: violently. The current crop will never do so, since they are chasing their tails. Money-printing operations (five years now, and doubling-down) cause lower corporate investment, fewer jobs, and a depleted GDP. The latter two are the central bankers’ ostensible goals. The only avenue to pursue their daft course is to expand money-printing operations. But, the more they pursue this course, the objectives of lower unemployment and GDP will drift farther into the mist for the very reason that central bankers are increasing unemployment and reducing real GDP by pursuing this course. Their theme song could beThe Impossible Dream.

Every couple of weeks, word spreads that the Fed is rethinking its money spree. Whatever the reason for these outbursts, the Fed will do no such thing.  “Dissension is Overrated” discussed the lost cause of any FOMC member who votes to tighten money. (A correction: “dissention” in the title, as originally written, was wrong. A fan letter followed: “in English, it’s either dissension or dissent, no hybridization permissible.” This was sent by the very strictestof constructionists, in both words and law, which raises the intriguing possibility that we are unlikely to find the latter without the former, and given the state of each: c’est tout.)

A more recent panic attack fell on the heels of a January 17, 2013, Bloomberg article: “Fed Concerned About Overheated Markets Amid Record Bond Buys.” The purported significance being the Fed would not allow markets to run amok. There was absolutely nothing in the article to support the headline. Kansas City Federal Reserve President Esther George was quoted: “We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances.” This is interesting but is consistent with the warnings George has made in the past, so there was no reason to excerpt her worries as a new-found “concern.” (Since well before George took charge, the Kansas City Fed has published Farmland Bubble Bulletins.)

Bloomberg also quoted the chairman. Ben Bernanke is “concerned.” He had recently stated the Fed must “pay very close attention to the costs and the risks” of something, or everything. Bloomberg left this for the reader to judge. A few other experts were quoted. All was dross. This was evident to anyone who read the story rather than bought or sold when the headline caused such a ruckus. Does anyone read this stuff? Oh, for a few more strict constructionists.