#nothingtoseehere

The Fed firemen are also the arsonists

Jim Grant of Grant’s Interest Rate Observer has a great article pointing out the irresponsibility of the US Fed. It criticises the very conditions that made the outcomes of coronavirus way worse than had they administered sensible monetary policies decades ago. FNF Media has been saying this for years. Now we are facing long overdue nemesis. It is true of the overwhelming majority of unimaginative MMT ‘me too’ central banks.

Grant wrote,

It took a viral invasion to unmask the weakness of American finance. Distortion in the cost of credit is the not-so-remote cause of the raging fires at which the Federal Reserve continues to train its gushing liquidity hoses…But the firemen are also the arsonists. It was the Fed’s suppression of borrowing costs, and its predictable willingness to cut short Wall Street’s occasional selling squalls, that compromised the U.S. economy’s financial integrity.

FNF Media keeps on hearing tales about the failure of evil capitalism. When the actions of central banks stifle the free market from achieving price discovery, distorted capitalism will inevitably backfire.

From hereon, sharp pain will be the only effective – and quickest – way to resolve this mess. Governments need to ensure bad companies go bankrupt by rejecting bailout money to zombie companies that will just be a drag on the economy.

Instead of doling out tax dollars, the government should take equity in any business that receives money. Taxpayers deserve a return and by this methodology, it will enforce a mindset that always rejects propping up companies with failed business models. Instead of the government calling the shots, the expertise of commercial lenders should be tapped, a valid point made by Jonathan Rochford.

Unfortunately, this will cause huge short-term disruption and impact large swathes of the community but it will allow markets to clear and provide a platform for risk to be priced appropriately. It is like yanking off a Band-Aid. It stings at first but the recovery becomes far more sound, based on rational economics. Failure to do so will just lead to a protracted Frankenstein economy which will frustrate the majority.

The sad reality will be that Western governments will try to emulate Japan’s lost two decades by crawling on our belly making marginal inches forward. This is somehow seen as superior to hitting the giant “reset” button.

The only major difference being that the Japanese monoculture is experienced and better suited than any other nation to share grief. Western cultures are not remotely close to being able to tolerate such conformity. Japan is not capitalism with warts. It is socialism with beauty spots. It will pay to remember this. In the West, we will demand that others atone for our mistakes. Moral hazard will be the order of the day. This mentality must be stopped dead in its tracks.

Grant reinforced our long-held view on distorting capital markets with this,

The Fed commandeered investment values into the government’s service. It seeded bull markets in the public interest…But investment valuations don’t exist to serve a public-policy agenda. Their purpose is to allocate capital. Distort those values and you waste not only money but also timeLike a shark, credit must keep moving. Loans fall due and must be repaid or rolled over (or, in extremis, defaulted on). When the economy stops, as the world has effectively done, lenders are likely to demand the cash that not every borrower can produce.

We must not forget that post-GFC authorities have been asleep at the wheel even after the introduction of poorly thought out red tape designed to protect us.

Right before the regulators’ eyes, so many blue-chip corporations (e.g. Boeing, GE) binged on ultra-cheap debt to buy back their own shares just to chase short term performance incentives. In recent years, companies like Boeing and GE spent around $45 billion each aggressively buying back their own stock despite being in the midst of severe balance sheet deterioration. Both are trading in a state of negative equity today.

Ford Motor has a junk credit rating. GE & Boeing won’t be far behind them. Over 50% of US corporates are trading one-two notches above junk.

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The financial community has merely taken advantage of all of this short-termism. Where were the financial analysts doing forensic work on companies? All of this balance sheet deterioration was plain to see.  Why couldn’t they see the obvious long term deterioration in cash conversion cycles? How could they miss that aggregate corporate after-tax profitability has been trending sideways since 2012? Where were the biopsies? We will be witness to plenty of autopsies that were preventable.

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For Australia’s part, 28 years of unfettered economic growth has bred untold complacency. Only now will we realise the conceited arrogance of government and industry alike. One day we will realise that all of the onerous regulations dripping in ideology (e.g. climate/environment) to confound foreign investment will blow up in our faces. They will not have forgotten that Australia is an unfriendly place to conduct business.

Australia has behaved like a bloated drunk bishop looking down upon his destitute disciples climbing the stairs on hands and knees putting what is left of their pitiful savings into the collection tin. From now, the roles will be reversed at prices that will be highly unfavourable such will be our desperation. Not to mention our currency could well depreciate to a degree which makes us even more vulnerable to foreign predators. Setting our FIRB at $0 will be irrelevant if we fold to the whims of the first suitor that shows interest. The show will be on the other foot.

In press conference after press conference, we continue to be told that hibernating companies will spring back to life and it will all be a case of ‘keep calm and carry on!’We hate to sound negative here.

However, we believe that we are merely being realistic about what is to unfold. The coming depression will force us to become truly appreciative about just how well we have had it while governments have distorted our markets. Had we truly reflected on decades of prosperity instead of wailing about how life has never been worse, things might have turned out differently. We are about to get a true taste of the latter.

On reflection, some positives will come out of this tragedy because we will focus on things that matter rather than getting enmeshed in the theatre of the absurd – identity politics and the cancel culture.

Coronavirus might be a black swan event to the global economy but we have been complicit by allowing our lawmakers and regulators to play slalom with the icebergs. We all knew our overloaded ship was in danger of listing before we left the safe harbour but it was simpler to be suckered into the weather forecasts that predicted endless sunshine and eternal millponds. The engines have now stalled because the tanks are empty. We find ourselves in the middle of a pitch-black, stormy night with howling gale-force winds and a 40-foot swell. Some continue to cling on to the blind hope that the incumbent crew can bail fast enough to avoid the economy capsizing.

It will be all in vain because the ship’s crew left a tape recorder playing on a loop over the tannoy promising passengers to stay in their cabins while they secretly slipped away in the early hours on the only lifeboats available.

Central banks had one mission – create confidence. They have been complicit in the failure. They doubled down on all of the same policies that got them in trouble in the lead up to GFC. They had a simple task of telling governments to embark on structural and tax reform. Instead, they appeased their masters by endlessly cutting rates.

Never again must central banks be allowed to use QE to rescue the economy in a downturn. Central bank balance sheets should be forced to unwind all QE assets. Interest rates must be allowed to set at normalised rates which allow positive returns but avoid reckless borrowing.

While a lot of this piece might sound pessimistic we simply view it as being a realist with experience.

Pandeconomics & 32% unemployment?

Mobster Al Capone Ran a Soup Kitchen During the Great Depression ...

The Congressional Budget Office (CBO) has put forward its assessment of what the pandemic will do to the coming 2Q GDP number. It said,

  1. Gross domestic product is expected to decline by more than 7% during the second quarter. If that happened, the decline in the annualized growth rate reported by the Bureau of Economic Analysis would be about four times larger and would exceed 28%. Those declines could be much larger, however.
  2. The unemployment rate is expected to exceed 10% during the second quarter, in part reflecting the 3.3 million new unemployment insurance claims reported on March 26 and the 6.6 million new claims reported this morning. (The number of new claims was about 10 times larger this morning than it had been in any single week during the recession from 2007 to 2009.)
  3. Interest rates on 10-year Treasury notes are expected to be below 1% during the second quarter as a result of the Federal Reserve’s actions and market conditions.

That sounds pretty tame vs what the St Louis Federal Reserve has estimated.

According to the Bureau of Labor Statistics (via FRED), the civilian labour force consisted of 164.5 million people, and the unemployment rate was 3.5%. This means that there were approx 5.76 million unemployed in the U.S. in February. FRED has estimated on the back of an envelope that 47.05 million people being laid off during this period.

Summing to the initial number of unemployed in February, this resulted in a total number of unemployed persons of 52.81 million. Given the assumption of a constant labour force, this resulted in an unemployment rate of 32.1%

  1. Civilian labour force in February 2020 = 164.5 million (BLS via FRED)
  2. Unemployment rate in February 2020 = 3.5% (BLS via FRED)
  3. Unemployed persons in February 2020 = 5.76 million (#1 * #2)
  4. Workers in occupations with high risk of layoff = 66.8 million (Gascon blog post)
  5. Workers in high contact-intensive occupations = 27.3 million 
  6. Estimated layoffs in second quarter 2020 = 47.05 million (Average of #4 and #5)
  7. Unemployed persons in second quarter 2020 = 52.81 million (#3 + #6)
  8. Unemployment rate in second-quarter 2020 = 32.1% (#7 / #1)

If we backed out the more conservative figure of 27.3 million high contact occupations (#5) and added it to currently unemployed people (#3) we would get a 20% unemployment rate.

N.B. Great Depression unemployment peaked at 24.9%

Credit card delinquency in America – nothing to see here?

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Waltzing through the treasure trove of data at the St Louis Fed, this chart intrigued. It shows delinquency rates on credit cards among the smaller banks. Presumably the smaller banks have to chase less credit worthy customers because they lack the ultimate battleship marketing cannons of the bigger financial instititutions. We’re back at times worse than the highest levels seen during GFC. Among all banks, we are still away off the $40bn of delinqient credit card debts we’re back at levels higher than those before Lehman’s brought financial markets to a grinding halt.

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Add to that the step up in interest rates as well to levels we saw before the whole edifice of cards came crumbling down.

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Then why worry when the number of financial institutions looking to tighten standards on consumer lending languishes at close to zero, the types of levels we saw ahead of the market collapse? Nothing to see here?

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Meanwhile American household savings languish at 3%. Similar levels as just before GFC  melt down. Not much in the rainy day funds. So when Trump’s new economic policy advisor Larry Kudlow starts telling us to back a strong dollar and weak gold, you know exactly what to do.

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Moral hazard was supposed to be contained at the private sector level. Looks as though this time around the government is joining the party.

Fasten your seatbelts!

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The “Fasten your seatbelts” edition (March 6, 2018) of the High-Tech Strategist by Fred Hickey is best read with antidepressants or a stiff drink. To be honest I hadn’t seen a copy of this research for at least 5 years. Today I’ve read it three times hoping I haven’t missed or misread anything. It is well reasoned and well argued. I would even admit to there being confirmation bias on my side but it is compelling. Usually confirmation bias is a worrying sign although prevailing sentiment or group think, it isn’t!

Perhaps the scariest claim in his report is a survey that showed 75% of asset managers have not experienced the tech bubble collapse in 2000. So their only reference point is one where central banks manipulated the outcome in 2007/8. S&P fell around 56% peak to trough. I often like to say that an optimist is a pessimist with experience. A lot of experienced punters have quit the industry post Lehman’s collapse, hollowing out a lot of talent. That is not to disparage many of the modern day punters but it does experience is a hard teacher because one gets the test first and the lesson afterwards.

Hickey cites an interview with Paul Tudor Jones who said that the new Fed Chairman Powell has a situation not unlike “General George Custer before the battle of the Little Bighorn” (aka Custer’s Last Stand). He spoke of $1.5 trillion in US Treasuries requiring refinancing this year. CM wrote that $8.4 trillion required refinancing in 4 years. In any event, with the Fed tapering (i.e. selling their bonds) couple with China and Japan feeling less willing to step up to the plate he conservatively sees 10yr rates hit 3.75% (now 2.8%) and 30 years rise above 4.5%. Now if we tally the $65 trillion public, private and corporate (worst average credit ratings in a decade) debt load in America and overlay that with a rising interest rate market things will get nasty. Not to mention the $9 trillion shortfall in public pensions.

Perhaps the best statistic was the surge in the number of articles which contained ‘buy-the-dip’ to an all time record. Such lexicon is often used to explain away bad news. It is almost as useless as saying there were more sellers than buyers to explain away a market sell off. In any event closing one’s eyes is a strategy.

Hickey runs through the steps leading up to and during the bear market that followed the tech bubble collapse. It was utter carnage. Bell wether blue chips like Cisco fell 88% from the peak. Oracle -83%. Intel -82%. Sun Microsystems fell 96%.

To cut a long story short, assets (bonds, equities and property) are overvalued. The Bitcoin bubble and consequent collapse have stark warnings that he saw in 2000. He recommends Gold, Gold stocks (which he claims are selling at deeper discounts than the bear market bottom) Silver, index and stock put options (Apple, Tesla, NVidia & Amazon) and cash. Can’t say CM’s portfolio is too dissimilar.

As Hickey says, “fasten your seatbelts

How pathetic have people become?

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How pathetic are people’s lives that they have to take umbrage at the Prime Minister of Australia, Malcolm Turnbull enjoying a game of Aussie Rules with a cup of beer watching over his beloved granddaughter? If the PM had downed 17 pints one might question his actions but it isn’t as if the child’s parents have left grandad all alone at the game. It is harder to get more Aussie than downing some suds at a ball game. To begrudge the PM some family time with his grandchild takes some sad people with too much time on their hands. Not often I give credit to much the PM does but this is so unremarkable as to wonder how petty most of the other activists issues are.

40,000 Aussies have 6 or more investment properties

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The AFR reports that Mark Burgess, chairman of asset management firm Yarra Capital and the investment committee of industry fund HESTA said,“Two million people had investment properties in 2013 and I’m sure it’s much higher today, 40,000 had six or more.” 

It reminds me of the scene in The Big Short when Mark Baum is talking to the lap dancer about what she’ll do when mortgage rates reset  and admits she has 5 properties and a condo.

It also reminds me of a time when working in London in the early 2000s and my uncle mentioned one of his staff had nine properties. Nine. That’s what I call leverage.

Of course being on the property ladder is sort of a right of passage in Australia. The angst and wailing of first time property buyers not being able to pursue the Aussie dream is ringing louder. When the Victorian government offers 25% of the value of a home as an interest free loan or the federal government allows access to ring-fenced superannuation funds as a way of assisting them it is hard not to think that the bubble is reaching bursting point.

Unlike shares or bonds, properties aren’t liquid in a downturn. With private debt to GDP ratio of 180% and four spots in the global top 10 most expensive property markets what am I missing? Yes relentless overseas buying and a supply shortage but “affordability” exceeding 13x average income vs 7x prior to GFC doesn’t bode well.

Interesting to see another article which read,

“According to a new survey from Manulife Bank, nearly 75% of Canadian homeowners would have difficulty paying their mortgage every month if their payments increased by as little as 10%.”

I’m sure it’s nothing! I guess aliens haven’t entered the global property markets yet.