‘Most of the [macro] economic theory is actually misguided .. They got on the wrong path about a hundred years ago by assuming that the economy was like a machine. .. relatively simple, understandable and controllable and the underlying reality is, its not.’
– Dr. William White, November 20, 2018 (Context:
(Story) – ‘Inter-temporal smoothing’, social disharmony)
'The BIS failed to consider a highly likely answer: On August 15, 1971, President Richard Nixon officially closed the gold window.''This BIS question caught my eye:
"Why has the amplitude of financial cycles grown since the early 1980s, raising their importance for economic activity? The reasons are not yet fully understood, but arguably changes in policy regimes may be partly responsible."The BIS failed to consider a highly likely answer: On August 15, 1971, President Richard Nixon officially closed the gold window.'
- Mike "Mish" Shedlock,
BIS Fears "Bulge of BBB Debt" and "Financial Cycle" Default Waves, December 19, 2018 (
Gold)
'Recessions reset the system. Weak companies default, pricing power for the strong is corrected, and a new expansion cycle begins. Zero interest rate policy has enabled record high debt. Excessive leverage is the telltale sign.''I believe we hit a short-term fear bottom but our initial starting conditions have hardly improved. I pointed that out in Wednesday’s “
Trade Signals– Record Extreme Pessimism, Expect a Rally” citing investor pessimism reached the lowest since 1995 and lower than anytime during the Great Financial Crisis. This is as extreme as it gets. Expect a rally. And we may rally for several months. However, I don’t think we are out of the woods as the economic expansion is now 115 months old (2009 through December 2018), the second longest in history. In comparison, the longest expansion lasted 120 months (1991-2001), the expansion post the great Tech bubble lasted 80 months, and the average for more than 100 years is 40 months. All expansion cycles end with a recession. This one is aged and odds favor a 2019 recession. Keep an eye on the recession indicators posted in
Trade Signals each week. Currently, there is no immediate sign of a recession.
Recessions reset the system. Weak companies default, pricing power for the strong is corrected, and a new expansion cycle begins. Zero interest rate policy has enabled record high debt. Excessive leverage is the telltale sign.
I’m on record saying the coming opportunity in high yield and other areas of distressed debt will be epic. But “distress” won’t appear until liquidity is yanked from the system. I believe we are in the early innings of the yank. Add to the risk pile near-record high valuations, near-record high individual investor exposure (as a percentage of their household wealth) to stocks (“all in” as the say), record corporate share buybacks largely behind us, and central bankers pulling the punch bowl away. For an investment advisor to not be risk focused at this stage in the cycle is imprudent. A bear market has begun though I don’t believe we are anywhere near a Sir John Templeton “buy” moment. That remains ahead and it likely presents in the next recession. Always does.
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I sure hope your holidays have been wonderful. Grandma Pat joined us for a week and, boy, did we enjoy her company. Somehow she has the Sir John Templeton gene. She reads my piece each week and asks for my advice but I just tell her to keep doing what she’s doing. The Christmas dinner table discussions were lively. Powell firing a knuckleball at Trump and Treasury Secretary Steve Mnuchin yelling fire (unknowingly or knowingly) on the most illiquid day of the year… well, you just can’t make this up. I told the family it’s going to get even bumpier in 2019. Buckle up. Our risk management processes are working, to which I’m grateful. I hope yours are as well!'
- Steve Blumenthal,
A History of Early Stage Bear Markets, December 28, 2018
'They have been using these models to forecast future market actions and the economy for decades, and they are about 0 for 300 in being right. It is statistically impossible to be that bad unless your models/assumptions are fundamentally flawed, which they are. Their underlying economic theories manifestly don’t work. Because they have no politically and academically acceptable theories to substitute, they are slaves to their own mal-education..''Powell and the Federal Open Market Committee listen to extremely smart PhDs from all the best schools with their fabulous multi-algorithmic models, which prove that you could raise rates and reduce the balance sheet at the same time with no problems.
Bluntly, those smart people (many of whom are actually quite brilliant, and I’m sure they are nice people, and their kids and dogs love them) mistakenly trust models based on past performance, and even worse (much, unbelievably, really badly, worse, which I can’t emphasize enough!) on monetary theory that is clearly, evidently, badly, manifestly wrong.
They have been using these models to forecast future market actions and the economy for decades, and they are about 0 for 300 in being right. It is statistically impossible to be that bad unless your models/assumptions are fundamentally flawed, which they are. Their underlying economic theories manifestly don’t work. Because they have no politically and academically acceptable theories to substitute, they are slaves to their own mal-education. They think this makes them smarter than the markets. I can’t say it any stronger than that. I have actually been in the room when someone was aggressively (I use that word precisely, as it is the correct word for that particular conversation) remonstrating a Federal Reserve economist about said models. He went so far as to say that the best thing that Powell could do would be to fire all those PhDs and ignore their models.
As you might imagine, the Fed economist was not happy with that analysis. The veins in his neck were popping, he was red faced and his voice was raised. Having known him for 10 years, I was rather shocked. He is actually a rather mild-mannered guy. But this clearly got his goat.
Now, here’s the shocking thing… and the lesson that I learned, which was burned into my brain. He asked a very simple question, (neck veins popping): “You can’t take away a model without replacing it with another model. What model will you replace it with?” The interlocutor, who is perhaps the best observer of the bond markets I know, stammered a little bit and then forcefully said, “You can’t actually model the future,” or something to that effect. (This was back when I was drinking, it was later in the evening and more than a few bottles of wine may have been involved. As you might guess, like me, he was not a fan of models. And it was the nature of this gathering to disagree with each other late at night…)
Personal sidebar: my day job for the last almost 30 years has been to look at money managers, who usually have a model that looks at past performance and projects it into the future. Every hypothetical performance model I have ever seen looked absolutely awesome. I can’t say that I’ve seen a thousand of them, but it is not an exaggeration to say that I’ve seen more than a few hundred… well, maybe many hundreds. And then I have observed the performance of those models after I have seen them. Bluntly, it makes me skeptical of all models—including the ones that I build myself.'
- John Mauldin (
Source, December 28, 2018)
'..things often prove even worse than I expect.''Progressively more reckless central bank measures over the past decade have been necessary to promote the perception of ample and sustainable Liquidity. But with Crisis Dynamics having recently afflicted the “Core,” it is difficult for me not to see a Liquidity environment fundamentally altered. Confidence has taken a significant hit. I believe the leveraged speculating community has been impaired, with outflows and general risk aversion ensuring ongoing de-risking/deleveraging. Similarly, with confidence in “passive” (stock, fixed-income, international) ETF strategies now badly shaken, it's difficult to envisage a return to booming industry inflows. And with derivatives players stung by abrupt market losses and a spike in volatility (option premiums), I expect we’ve passed a critical inflection point in the pricing and availability of market protection.
The backdrop points to an inhospitable Liquidity backdrop. Serious market structural issues have bubbled to the surface, issues market participants either haven’t appreciated or simply believed would be readily rectify by central banks before confidence was impacted. The orientation of powerful financial flows has been upset. Hedging and derivatives markets have dislocated. The great fallacy of “moneyness” for risky stocks, bonds and derivatives is being laid bare.
Importantly, I view speculative Credit as the marginal source of global Liquidity. I believe a historic Bubble in securities and derivatives-related Credit has been pierced. This Bubble was fueled by years of zero/negative rates and Trillions of central bank "money". As we saw this week, bear market rallies tend to be ferocious. And when a short squeeze and unwind of hedges is in play, surging prices will spur hope that the sell-off has run its course and that Liquidity has returned to the markets.
It’s just not going to be that simple. Global markets face serious structural issues years and decades in the making. Hopefully markets can avoid crashes and make necessary adjustments over an extended period of time. For a while now, I’ve feared a scenario where illiquidity becomes a systemic global issue. From closely analyzing previous booms and bust episodes, things often prove even worse than I expect.'
- Doug Noland,
Thoughts on Liquidity, December 29, 2018
'This bubble, widely referred to as the "everything bubble" is really an artifact of a junk bond market fueled by increasingly ignorant Fed policy since 2009.''In the US, 15% of the companies in the S&P 1500 are Zombie corporations. The Zombie attribute applies to firms that are unable to cover debt servicing costs from current profits over an extended period.'
..
This bubble, widely referred to as the "everything bubble" is really an artifact of a junk bond market fueled by increasingly ignorant Fed policy since 2009.'
..
There are many investment grade bond funds that will either have to break their agreements or dump up to $3.15 trillion of debt if there are significant debt downgrades, and there will be.
This will spill over into equities in a major way.
Don't be fooled by these stock market rallies. Bonds are due for a huge repricing event and stocks will follow in a major way.'
- Mike "Mish" Shedlock,
Suddenly There's No Appetite for Bond Deals as Spreads Widen, December 28, 2018
'Expect a credit collapse in 2019.'
- Mike "Mish" Shedlock,
Market Gives Finger Formation to Fed's Dot Plot Take, December 28, 2018
Context Hallmark of an Economic Ponzi SchemeHistory is Clear, Central Banks Fail to Assure Economic StabilityConceived in Disgrace: The 350th Anniversary of the Creation of the Bank of Sweden'..over time, debt stops stimulating growth..' - '..The mother of all bubbles exists and it is in the debt markets..'Too Late To Matter: Fed-Sponsored Economic Bust Coming No Matter What, December 19, 2018
Q3 2018, THE Cycle PeakWhat occured on Wednesday was an unprecendented buying panic unlike anything I've ever seen before..''..the inanity of monetary policy today..'What’s Wrong With the 2 Percent Inflation Target - By Paul Volcker'World faces wave of epic debt defaults, fears central bank veteran''I have posited that the global Bubble has been pierced at the "Periphery,"..''When the next recession arrives, they’re not going to know what hit them.''A global crisis in the current backdrop would make 2008 seem like a walk in the park.''..unsound "money" and Credit back in 2008 appears pristine in comparison.''..the Bubble .. it is decidedly global .. So long as confidence holds at the "core" and speculation runs unabated..''..each bursting Bubble is to be reflated by a more formidable Bubble inflation.''Eurozone countries face massive amounts of debt coming due in the 2018–2020 period..''..the long-run negative effects of debt eventually outweigh their short-term positive effects..''The ongoing "global government finance Bubble" is unique in history.''..a replay of the reckless U.S. mortgage Credit episode, only on a much grander global scale.''..to envisage a global crisis beyond the scope of 2008/09..''..to not be an endless source of easy credit and bail-outs..'Can we try capitalism? Real capitalism - By Stanley Druckenmiller'..the higher the level of debt the greater the restraint on economic growth.''Ten-years of ultra-loose global finance destroyed discipline - by borrowers and lenders alike.''..government and central bank-related risk distortions are fundamental to self-reinforcing Bubble inflation and resulting deep structural maladjustment.'How Business Owners Take Cues From Interest Rates - By Frank Shostak(Banking Reform - English/Dutch) '..a truly stable financial and monetary system for the twenty-first century..'