Global Macro Trading Journal
- Thread starter Daal
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In general I agree and it's difficult to identify an exact frontier where the "real" effects are separated from the psychological. I start from a few premises, some or all of which could of course be incorrect:
The first is that monetary interventions 'work' because they inflate the money supply - either by lower rates, or direct expansion through QE (I prefer to use Austrian TMS, see http://blogs.forbes.com/michaelpollaro/austrian-money-supply/ ). Something like Operation Twist or proposed SQE, if they don't increase monetary inflation, might have a psych-related effect on asset prices but none at all in the real economy, and even the asset-price effect should be limited and very transitory.
The second is that underlying conditions justify much lower prices for risk assets. Excessive debt is a drag on potential growth, malinvestments are everywhere and monetary interventions only increase this problem. Risk assets are significantly overvalued relative to historical norms. Monetary inflation increases prices somewhere but the exact effects depend on prevailing psychology (for instance current interventions have boosted stock prices but not housing, which is what the government really wants to see go up). It doesn't have to be stocks or risk assets at all, but present psychology is such that this is where we see the most dramatic effects.
Third, to the extent that asset prices are inflating and these assets are tied to some kind of valuation or cash-flow fundamental, mean reversion is inevitable. The tendency will be for each round of inflation to generate a proportionally lower and lower impact on asset prices, requiring steadily greater interventions to maintain the lofty valuation. The cycles also increase in frequency. Eventually you'll reach a point where the effect reaches zero - this is also the point where "inflation expectations" start to become "unanchored" in the language of the Fed. Supply of money begins to overwhelm demand, consumer prices and PMs (gold especially) start to absorb the entire inflationary effect. Stocks may rise or fall in nominal terms but either way are mean-reverting in real (inflation- or earnings-adjusted) terms.
The process of reduced marginal returns for money inflation is in my view already becoming visible. In 2006-7 it only took a slowing of TMS growth to 1-2% yoy to trigger a massive credit crunch, deflation scare and liquidity crisis a year or two later, the 'growth scare' in 2011 was against TMS growth declining to a still-high 10% yoy. QE2 managed to reverse the decline in year-on-year TMS growth by March or April of 2011; the macro data appears to have lagged by about 6 months, so we saw growth fears peak in the summer and fall but stabilization in the winter.
Note that as of January US TMS2 was back below that 10% annualized level, though still quite high year-on-year.
The next couple of quarters ought to be very interesting; if I had to guess (and it's really just a guess) I'd say SPX will consolidate at approximately these levels while the economy should pick up through at least the summer, with another crisis wave striking no later than the fall. The improvement might only be visible though once the data is fully revised; ironically the data in MoM comparisons could start to disappoint earlier if some of the recent releases were stronger than reality, due to reporting or measurement errors.
Actual results will be very instructive re: if anything I said above has any validity.
I would be surprised, in 2010 and 2011 stocks halted their advance pretty much immediately once the easing programs tailed off. The past week actually has the look of a final blow-offy move to me, if SPX loses the 3/14 low I'll be looking at it as a rangebound market (for now still a steady uptrend).
I agree with your extended thoughts on principle, but remain agnostic on timing. Fundamentals are like oscillators -- overbought can get insanely overbought, oversold can get insanely oversold, and the wait for mean reversion can be painful...
These "ugly goldilocks" conditions feel like they could persist for a while, and this latest push actually came AFTER Bernanke made noises about taking the punch bowl away (the day gold got whacked 5%).
In terms of exposure we're liking shippers, drillers, natty producers -- look at SEA, OIH, FCG today. That's not bearish action.. it's complacent "the world is ok" breakout action in which debasing policies drive paper asset valuations while PMs, the stuff of no yield, get kicked to the curb.
Also, the major 2010 and 2011 dislocations were a product of macro events -- 2010 Greece (I think?) and 2011 debt ceiling freak-out (worrying that Repubs would sabotage the government) -- but what's the near-term driver here for such a blow-up? They're always out there, but hard to see one...
Portugal, Spain, and China come to mind. The market even appears to realize Portugal is headed for trouble as their yields are the only ones in the EMU which didn't decline the last few months.
The central thesis being tested here is that a free lunch is available - central banks can cause stock indices to rise at a 45-degree angle forever, regardless of valuations, and without any obviously negative side-effects. It has never been the case in the past, otherwise SPX wouldn't have gone sideways for eleven years. I don't think they'll be successful but we can sure make a go of extracting plenty of excess returns from the interim volatility...
The blow up will come the way it always come, one day people will look at the same headlines that are hitting every day and will interpret as bad and because the market will be down, the media will report things as being bad. People's experience is that things have changed dramatically but its partially an illusion, its the mood that changed.
If you look at Europe, if you strip out the 'good news' that derive from market prices going up(like Italian bonds), its the same shithole still, portugal deficits getting worse, etc. But people are focusing on the good side and that kind feeds on itself(through market prices creating more news, better moods etc)
At some point it reverses. Back in August 2011 after the downgrade, almost no one could see how on earth equities would rise ever again. Remember the NYT 'is this 2008 again?', it all a sentiment cycle, the news matter but not as much as people think
Except, to continue playing devil's advocate, the bulls argue it's not about CB support, but rather solid earnings and a creeping U.S. recovery, plus stocks as a better inflation hedge than the alternatives (when inflation is mild at least).
Portugal and Spain are the defaults that cried wolf, and China has been on the edge of its crash seat for a while now... as has Japan -- what is it for Japan now, 20 years?
Agree there are no free lunches, but there is also the question of who pays and how.
It is not implausible to me, for example, to imagine a scenario in which the poor and indebted middle class are the ones that pay through the nose for bad CB policies -- in the form of stealth inflation and real wage erosion -- even as paper assets stay elevated for years.
The "who pays the piper" argument is tricky because there are many backdoor ways for the piper to potentially get paid. One of those ways is to perpetually screw an underclass that doesn't understand what's happening -- what all those nominal Dow points actually cost in real purchasing power loss.
Another counter to the free lunch challenge is the Minsky paradigm: The idea that stability begets instability and central bankers like their volatility all at once. This argument says CBs will pay bigtime, but not for a while yet, i.e. continued irrational optimism, on into crack-up boom, on into 2008 redux or even worse...
And so, again, it comes down to timing. Unlike those who take a while to turn the ship, I'm happy to change in an instant. For now though the free lunch crowd is toasting Big Ben.