Dear Fed,
Macro Man speaks to a lot of well-informed, knowledgable punters. Many of you (collectively on the FOMC) know some of these very people. They are smart, and they spend a lot of time analyzing you and trying to understand your way of thinking.
And last night, after you changed this:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period
to this:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period
the interpretation of this group of well-informed observers ranged from "as dovish as it could be" to "man, that's pretty hawkish."
Please. I know Greenspan once said that if his meaning was clear, you hadn't understood him properly. But where did that get us? Seriously, one shouldn't need to employ a literary theorist to figure out what you're saying. Ditch the stupid word games and speak clearly. Compared to A students like the RBNZ:
In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010
and the Bank of Canada:
Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target
you collectively get a big fat F for your essay.
Sincerely, Macro Man
Given the opacity of the Fed's communication strategy (in terms of using blunt phrases to convey very nuanced shifts), is it any wonder that the market's reaction was as schizophrenic as it was?
And given that schizophrenia, is it any wonder that a "signal" trader like Macro Man is struggling amongst all the noise? Taking an introspective step backwards last night, Macro Man concluded that one of his primary problems is that he is reacting to short term price swings, rather than anticipating. The problem with reacting is two-fold: conviction is necessarily lower than it would be with a well-thought out macro view, and the lack of serial correlation leads to a lot of top-and-tailing. Macro Man has had enough.
Anyhow, the primary feature of the Fed's semiotic parlour game was the introduction to conditionality to the "extended period" clause. The first two conditions- the output gap and actual inflation- would not appear to merit tightening for the foreseeable future. The third- inflation expectations- could prove to be a bit more problematic, though 10 year breakevens are still below their pre-crisis levels. Still, the recent normalization is striking!
QE or not QE? That is the question. Whether 'tis nobler in the mind to suffer the slings and arrows of outrageous banking, or to take arms against a sea of troubles, and buy Gilts to end them?
-Hamlet's Soliloquy, by theBard of Avon Swerve of Lomard Street
The highlight of the day today will be the Bank of England's policy announcement at noon local time. An extension of QE has been widely bandied about in the press, particularly in the wake of the recent GDP shocker. Ex-MPC'er David Blanchflower certainly favours more; at this juncture there appears to be little firm consensus, however, with some shops calling for nowt and others calling for £50 bio more gilt buying, plus a cut in the reserve deposit rate. If the latter were enacted, one would presume that sterling would get trashed.
Whether the Bank should do more QE is, of course, another question: the GDP figures scream "yes!", but more forward looking indicators suggest a more positive trajectory for the economy.
Either way, there should be some fireworks. And let's not forget Jean-Claude, ostensibly relegated to the role of bit-part actor in this week's drama, but always capable of stealing the show at his press conference. Needless to say, Macro Man isn't getting his hopes up for a spot of plain speaking there.....
Macro Man speaks to a lot of well-informed, knowledgable punters. Many of you (collectively on the FOMC) know some of these very people. They are smart, and they spend a lot of time analyzing you and trying to understand your way of thinking.
And last night, after you changed this:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period
to this:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period
the interpretation of this group of well-informed observers ranged from "as dovish as it could be" to "man, that's pretty hawkish."
Please. I know Greenspan once said that if his meaning was clear, you hadn't understood him properly. But where did that get us? Seriously, one shouldn't need to employ a literary theorist to figure out what you're saying. Ditch the stupid word games and speak clearly. Compared to A students like the RBNZ:
In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010
and the Bank of Canada:
Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target
you collectively get a big fat F for your essay.
Sincerely, Macro Man
Given the opacity of the Fed's communication strategy (in terms of using blunt phrases to convey very nuanced shifts), is it any wonder that the market's reaction was as schizophrenic as it was?
And given that schizophrenia, is it any wonder that a "signal" trader like Macro Man is struggling amongst all the noise? Taking an introspective step backwards last night, Macro Man concluded that one of his primary problems is that he is reacting to short term price swings, rather than anticipating. The problem with reacting is two-fold: conviction is necessarily lower than it would be with a well-thought out macro view, and the lack of serial correlation leads to a lot of top-and-tailing. Macro Man has had enough.Anyhow, the primary feature of the Fed's semiotic parlour game was the introduction to conditionality to the "extended period" clause. The first two conditions- the output gap and actual inflation- would not appear to merit tightening for the foreseeable future. The third- inflation expectations- could prove to be a bit more problematic, though 10 year breakevens are still below their pre-crisis levels. Still, the recent normalization is striking!
QE or not QE? That is the question. Whether 'tis nobler in the mind to suffer the slings and arrows of outrageous banking, or to take arms against a sea of troubles, and buy Gilts to end them?-Hamlet's Soliloquy, by the
The highlight of the day today will be the Bank of England's policy announcement at noon local time. An extension of QE has been widely bandied about in the press, particularly in the wake of the recent GDP shocker. Ex-MPC'er David Blanchflower certainly favours more; at this juncture there appears to be little firm consensus, however, with some shops calling for nowt and others calling for £50 bio more gilt buying, plus a cut in the reserve deposit rate. If the latter were enacted, one would presume that sterling would get trashed.
Whether the Bank should do more QE is, of course, another question: the GDP figures scream "yes!", but more forward looking indicators suggest a more positive trajectory for the economy.
Either way, there should be some fireworks. And let's not forget Jean-Claude, ostensibly relegated to the role of bit-part actor in this week's drama, but always capable of stealing the show at his press conference. Needless to say, Macro Man isn't getting his hopes up for a spot of plain speaking there.....
64 comments
Click here for commentsMM - what's with the lines through everything ?
ReplyDangling strikethrough tag no doubt, after "Bard of Avon Swerve of Lomard Street"
ReplyViz pre-emption vs reaction, I think that's the range bound paradigm we're in. A lot of equities in EM are still trending for the most part but chasing breakouts one way or another has been pretty painful outside of gold.
ReplyIt is a lot more like we are all waiting for something, FWIW I'm just building positions that I like on a longer "signal" basis when it gets to my level. It requires a patience bordering on disengagement.
"It requires a patience bordering on disengagement."
ReplyExactly so. I read the 1st book by Edward Rutherfurd a little while ago and have now lined up the rest to read.At a 1000 pages per book that will disengage me nicely.Until I get a decent counter trend move to make it worth my while I have taken the wallet out of play and I'll leave those who like it to whip each other to death.
"Whether the Bank should do more QE is, of course, another question: the GDP figures scream "yes!","
ReplyNo, I say, just let GDP fall for while and stop worrying about it. Governments spending printed or borrowed money isn't going to improve anything.
Strikethorugh sorted!
ReplyMaybe I can offer my own interpretation of the Fed statement. "We're committed to sticking with this ZIRP and QE because we'd look stupid if we stopped them now and the stock market collapsed. We hope and pray that the economy starts getting better soon because we've got no other options and if appears that we are helpless then someone in Washington will blame us and try to cut in on our turf. We need to look busy, so we'll alter a few words and make it look like we're thinking hard about this."
Reply"By the way, we have all of these Treasuries we bought to keep the price up. Can you buy some of them from us? The nice men who sold them to said they were liquid. . ."
Nemo, MM, agreed. Other than gold, there's still a pronounced lack of alternatives where to put your money, so you might as well leave it wherever it is. Disengagement, as in do nothing but watch. Avoid the treadmill. All I can say with conviction is that long term the dollar is toast, and the jury is still out which other currencies will be toast as well. That's probably not a well-thought out macro view, but maybe it's all one needs to know ATM.
ReplyFunny: my word verification captcha is 'money'. Is this a good omen?
"But What Do I Know" got the Fed right. Also, remember, the academics are in charge, and they like to explain. Here they were explaining what "economic conditions" they were referring to were inflation-related, not unemployment-related.
ReplyThey are trying to persuade the markets they may become more hawkish. Does this mean that they will become more hawkish, or that they think they will need verbal cover for new dovish actions?
LB's interpretation of the Fed statement:
Reply"We're committed to sticking with this ZIRP policy because we've seen the employment report and the revisions and they are lousy. Now get out there and sell down this absurd stock market rally right now - we have all of these Treasuries we bought to keep the price up, and we are selling more next week so we think you should buy some of them from us".
This only works until it doesn't.
On LB's prediction of a weak US employment report Friday, I don't know what Friday will hold, but after that we'll go into an extended period of unexpectedly good weekly claims reports and unexpectedly bad monthly non-farm payrolls.
ReplyThe reason is that we are entering a season of normally heavy job losses but heavy hiring. With payrolls already sliced to the bone, firing will be below normal through the winter, and seasonal adjustment will make it look better than it is. Meanwhile, hiring off the unemployment rolls is running only 54% of normal in my latest 4-wk moving average, and exceptionally poor hiring will keep overall employment low and the unemployment rising.
So, upside surprises on weekly claims are starting already, but downside surprises on monthly NFP will begin in next month's reports.
Forgive me for some bullish pratter, but I'm beginning to wonder if we might see a bit of a shocking jobs number this week, given the strength in ISM manufacturing employment and other anecdotal signs of improvement.
ReplyAlso if you look at a chart of initial claims, it looks at a lot more like the mid 70s or the early 80s than the last two recessions.
Agreed with PJ's diagnosis. The problem is not in manufacturing right now - US small business is on life support, can't rollover debt and even those who are doing OK just won't hire with the uncertainty about taxes and health care costs - many are still laying off workers or closing down. I won't be convinced of an employment recovery until hours worked and temp employment finally start to show signs of life.
ReplyAnd that LB, is why I'm short RTY. Until those Senior Loan Officer surveys start looking okish those small companies have no access to credit and can't invest or grow.
Replyjust look at todays productivity numbers or ULC. Big business being aided by weak dollar but agreed NFIB survey and small businesses bumping along bottom.
Replyyest fed announced 25bn less in agencies. today mpc did 25bn less in gilts, riksbank increased rate on funding to banks and ECB 1Y LTRO is history .
rate of increase of money supply is decreasing should be negative for risky assets but that seems slow to evolve.
can't figure out what happens to curve but that implies a flattening esp if payrolls weak tho traesuries and gilts hold less value thamn bunds and acgbs.
Pardon my stating the obvious, but if MM's TIP breakevens on 10y TIPs and 5yX5y charts are even close to correct (and they agree with the ones I made)... two things are pretty obvious:
Reply(1) the market is clearly not pricing in rampant inflation
(2) Equally clear, the market is not pricing in deflation either
Number 2 is rather important, since the rally in nominal treasuries is supposedly based on the notion that we will have deflation at least for a few years.
If TIP b/e spreads are (almost) back to pre-crisis levels, one might expect nominal rates to be also... that means 10y and 30y rates should be bouncing around 4.75% ?? (all else equal)
All else is not equal though -- Bernanke's bad policies have crushed real (after inflation) yields and eliminated ALL incentives to save -- aka build capital. Without capital, the economy is not going to grow except via accounting shams
Now the price of QE becomes apparent
US equities are flying after government reports showed dramatic increases in productivity...
ReplyThousands of workers were laid off, unemployment rose from 6% to almost 10%, while sales are done out of existing (depleting) inventory. At least until those workers start unemployment and we run out of inventory -- but that's a problem for next year.
So if the markets think this productivity increase is a good thing, maybe we should lay off ALL the workers in the world.
Imagine the productivity we would get from that!
The Fed statement tells us under what conditions they will start thinking about tightening. They clearly state we are watching this and this and this, and all of those things, as PJ points out, are not employment related. I think this is helpful information.
ReplyIt is nice that RBNZ says they will stay put until the second half of 2010 and that Bank of Canada says until the end of Q2. Now they have to stick to that for eight months or else they face the long term consequences of a loss of credibility. These statements seem a bit careless. A lot can happen in a week, let alone, eight months and staying put may not be the right thing to do. The Fed cannot afford to be so casual.
I would say "resource utilization" means employment.
ReplySeems to me you have to be pretty biased going in to come up with a hawkish interpretation.
Makes me wonder what they're afraid of, but ADP doesn't point to jobs. I think it's still the financials and a Texas-sized plate of turds.
MM, they should get D- instead of F 'cause they showed up and made some effort.
ReplyIf we learned anything from Greenspan's Follies (we learned, not Alan G), it is this:
Reply1) excessively easy money policies sometimes show up in rampant consumer cost inflation, but other times they show up in over priced financial assets (aka bubbles)
2) Bubbles are pleasant in the short run, especially if you pretend not to see them
3) the cost of cleaning them up afterward is HUGE, unless you retire and stick some hapless academic with the problem
Bernanke's message is pretty clear: he is a cornered animal and reacting in a panic. He absolutely must raise rates to head off the asset bubbles he is creating as we speak. At the same time, he absolutely cannot raise rates because of unemployment.
Bernanke must raise rates. Bernanke must keep rates low.
Bernanke is between a rock and a hard place, and he is hoping against all odds that the clueless wonders that inhabit Wall Street will understand this and help him out.
The banks, being insolvent, are in no position to help anyone else keep their head above water. Drowning victims do not think rationally -- they are known to grab onto the heads of lifeguards and push the lifeguard underwater in a fruitless attempt to keep themselves alive a few minutes longer. Banks are doing exactly that, calling for never ending steep yield curves to keep their heads above water one more month. They don't consider the long term consequences of their actions.
The G-7 needs real leadership -- historically that came from the USA, but the current batch really isn't up to the task and we all know it.
ZURICH (Dow Jones)--Adecco SA (ADEN.VX) Thursday reported a better-than-expected third quarter net profit as the world's largest temporary employment firm benefited from a pick-up in demand for blue-collar workers in the U.S. and France.
ReplyThe result raised hopes that global employment markets could slowly recover after months of persistent weakness that has catapulted jobless rates to record levels and has triggered concerns that hiring will remain low even as the global economy moves out of recession.
....
"We are very pleased with the evolution of the market (in the U.S. and France)...and our cost-cut efforts", said Chief Executive Patrick de Maeseneire, adding that the improving market trend has continued into October.
The company said demand has risen for the temporary placement of industrial workers in the U.S. and France, Adecco's two key markets that generate more than half of the company's annual revenue.
In the U.S., sectors such as car manufacturing, transport and telecommunications increased hiring, Adecco said, noting that the pick-up was marked in the South as well as in the Mid-West.
temp jobs? in car manufacturing?
ReplyThe green shoots are real -- and they are weeds
Ian, interesting data, and thanks for the balanced point of view. We have to weigh manufacturing improvements against state/local govt furloughs, pay cuts and layoffs and a flat retail and RE/finance sector. Stalemate for the time being?
ReplyPM looking sloppy. Could be that this India/IMF purchase has attracted too much attention in the short term.
ReplyOn a related topic, lawsuit has been filed against the infamous Cash4Gold operation. From a press report:
"The class action suit was filed for consumers who claimed that their jewelry was either lost in transit to Cash4Gold or that their checks were systematically mailed too late to request the return of their jewelry during the stated return policy period if the jewelry was received."
IMF would do well to pick up a few of those employees.
LB, no worries. I just see so much on the case for a jobless recovery around blogosphere that I have tried to look for stuff on the other side to balance out my view. In markets you are paid to look around corners, etc...As you say, the proof is the pudding.
ReplyI think Buffet's biggest single purchase ever is a telling sign.
ReplyHe didn't buy US Treasuries (as might make sense if he saw deflation), he actually sold the zero coupon treasuries he had in his PA last year.
Buffet bought a railroad -- which as the
FT pointed out is a rather defensive bet. Its one that is unlikely to grow much, but also one unlikely to contract -- but it will throw off lots of cashflow.
Buffet could have bought Ford for the same price as BNI. GM's market cap (if you can call it that) is less than the M&A fees Buffet will have to pay.
Railroads do fine with no economic growth at all. Of course one can ask, do we actually NEED economic growth, and have we had any REAL economic growth (as apart from dollar devaluation) in a long time? Sometimes it's a good idea to question one's beliefs.
ReplyDebating LB has been somewhat unrewarding, but I don't have "patience bordering on disengagement" so I'll bite:
ReplyNo, we haven't had REAL growth (beyond USD devaluation and uneconomic leverage) since Eisenhower was President (maybe longer than that, but WW2 gums up things).
But for those still clinging to the idea that US Treasuries are "risk free" and represent "safety" in times of stress -- you had better hope we get some real economic growth in the future.
Someone has to pay, in real terms, for all the debt that has been accumulated. If that doesn't happen, some precocious little child is going to yell out that the emperor has no clothes and you are all holding a bunch of 1970s certificates of confiscation.
But someone does have to pay for all these spendthrifts -- and speaking as a US taxpayer I am all to happy that the someone is increasingly likely to be Chinese or Middle Eastern. I have nothing against either group -- but I would rather it be them than me.
If they are foolish enough to lend Uncle Sam money at 3% when long term inflation / dollar devaluation is 3.5% -- well, we all know what happens to fools and their money.
Many traders read that last line and are now smirking and thinking they will be smart enough to get out before the mortgage house of cards collapses -- everybody thinks they are smarter than everyone else and they will be able to exit just in the knick of time.
I may not like Buffet, but I can't argue with his success. I have to invest for real growth (after taxes and inflation) or I am out a job
I am not a gold bug any more than Paul Tudor Jones is ... but as he says there is a time and place for everything.
ReplyIndia yesterday chose to put their reserves into gold, not US certificates of confiscation. Its a small amount in the grand scheme of things, but after 30 some odd years of central banks being net sellers of gold / accumulating IOUs from the US government -- its a big change at the margin
Wotcher Gary, thought that might get you going. Look, Gazza me old china, LB is not married to Treasuries, just dating for now. Rest assured that we will see signs of distress in lower-quality credit and equity turds before Ts go down the plug hole.
ReplyOn another note, LB thought this was an excellent time to add some gamma, and did so. As for the much-maligned certificates (COC - per Gazza) nice rally in the middle of the curve today, eh?
Gold bug profit taking tomorrow, anyone?
LB: It boils down to a question of size and investment horizon. If you are just punting around really small / liquid bets on short term trades -- that is speculation, not investment. If your investment committee allows a little "alpha generation" trade account on the side, great.
ReplyBut if you are responsible for investing many billions -- you are forced to make longer term, fundamentally oriented bets.
There is no way to defease a pension with a 6% assumed return (3.5% inflation + 2.5% real) with bonds that pay half that amount. Treasury bonds are about as risky to me as non-agency mortgages. If I put 10% in Treasuries getting (ahem) 3%, I need a similar amount in something yielding 9% to have any chance of meeting never mind beating my liabilities.
BTW, 6% is Buffet's number, most companies are assuming 7-8%. Given the G-7 is demographically pretty old, I am using pensions as an example investment need.
Wall Street doesn't like to think more than a couple days ahead -- which is how it got itself insolvent. If you think a year or two out -- 3% Treasuries are guaranteed losing trades unless you know a low risk way to get 9% yields.
Wall Street is trading the certainty of 3% returns today for the certainty that portfolios will not meet obligations tomorrow.
I wouldn't want to be on the receiving ends of those obligations when tomorrow comes around
Gazza, the central thesis of bear market investing is to avoid losses - return of capital. It's all the reaching for extra yield by the pension fund guys that scares me, in fact, about the present market, and this is why a second meltdown is possible.
ReplyThe LB game plan, based on the Japanese playbook, has been to sit tight in low-risk assets in the core portfolio and then to take (hopefully) well-timed shots in the risk arena when the odds are extremely favorable. Keeping an eye on the 10y yield v. dividend yield of SPX has been a useful metric, and no losses in 2007 or 2008 tells its own story. Your 5-yr return or 2-yr moving average says more about your investing than what you did last week.
LB - pensions have stated liabilities, which are based on whatever assumed portfolio returns. For most, that liability is at least 6% (most are still 7-8%).
ReplyCalling this a "reach for yield" is pretty naive. A more accurate term would be "failure to live within our means". If you want to assume a lower TRR, companies have to make much bigger annual contributions, and thus EPS would be lower. We have to pay the piper one way or the other -- just a question of how.
If you want to argue pensions should assume "more reasonable" TRRs, great. But you will have to embed much lower EPS forecasts going forward.
No, it doesn't matter if we all switch to defined contribution plans or 401Ks instead of defined benefits -- that's all accounting flim flam. The real underlying economic liability is the same, regardless of the legal vehicle used to defease it.
There are three choices:
1) Savings must be MUCH higher,
2) returns must be MUCH higher,
3) there will be defaults in the future
As for your claim to have no losses in 2007-8? You would have to have been almost all in cash, in which case you were making the mother of all bets on a collapse.
Any real investment committee would have fired such a portfolio manager in 2007, long before the collapse came.
P.S. If you are following "the Japanese game plan", with your imaginary investment committee that lets you go 100% into cash for two years, you should be honest with our fellow blog readers and point out that Japanese corporations "solved" their pension problems by firing workers and dumping the liabilities on the taxpayers. In other words: they defaulted. They called it something else for political spin reasons, but they defaulted.
ReplyMrs Wantanabee started trading forex, because Tokyo's former "banking professionals" were clearly unable to satisfy her needs (double entendre intended)
Gary, my dear chap, you really should learn more about bonds, in general. Once upon a time funds had balanced portfolios, and were able to diversify between stocks, bonds and commodities. On seeing the imminent crash about to unfold, LB unloaded stocks and HY bonds. By sitting mainly in 2y and 5y Ts last fall, and then putting a few toes out in the spring as credit and stocks bottomed, LB was able to avoid the misfortunes that befell many others.
ReplyThe Japanese playbook means that one will invest based on expectations of BoJ-like interventions, resulting in Japanese-style outcomes. It doesn't mean that one approves of the BoJ or Fed actions.
LB -- you are obviously not running a big institutional portfolio
ReplyGary - a lot of big institutional portfolios are going to get creamed before this is over by trying to reach for 8-9% in a deflationary environment, while the better hedge funds and long-short funds will do quite well. You really have to think outside the box, this is not the 90s (well, maybe the Japanese 90s). The type of thinking you portray will ruin many unfortunate investors and retirees and bankrupt a number of cities, states and institutions along the way.
ReplyLB - a tiny little hedge fund is simply not going to be able to handle the amount of savings the US has now (which most people agree is not enough to fund retirements)
ReplyIts great that you plan to live in a guarded castle somewhere -- but in your selfish style, you forgot the masses have votes and they know where your castle is.
In the real world, a pension might decide to port some alpha to your little fund (if it really exists). But somebody still needs to manage the core holdings.
If you have ever traded something more than your PA -- you would know that no real manager could sell several billion in equities and shift into 2y to 5y Treasuries without causing a serious mess
Real macro hedge funds top out around USD $10 billion AUM -- and those are the really really big ones. Even "super stars" like Robertson and Soros ran into problems when they tried to run $15 billion.
Whatever their merits, macro hedge funds need extreme liquidity and are not scalable beyond USD $10 billion.
If you were a real PM or even a real hedge fund guy, you would know that
Gary, your posts are revealing of an endemic problem in the money management industry. Heaven help the "masses" if they place their trust in managers who are convinced they can make 8-9% every year. The model is broken and people need to scale down their lofty expectations, not to mention take responsibility.
ReplyAnyway, it's been a most enjoyable exchange, Gary, as always, but LB simply must repair to his guarded castle and bring down the drawbridge before the masses discover his locale and storm the portcullis. Cheers!
Gary - I don't understand your argument. You seem to have a correct diagnosis of the problem:
Reply"There are three choices:
1) Savings must be MUCH higher,
2) returns must be MUCH higher,
3) there will be defaults in the future"
The key is that returns CANNOT be much higher. Returns can at best track nominal GDP over any lengthy period of time. Moreover, during deleveraging returns are worse than nominal GDP growth (just as they are better during credit expansions). Now, in a zero-inflation environment with deleveraging, the best returns anyone can reasonably expect are 3-4%. Probably less.
In such an environment, the yield hogs are bound to be disappointed. Pension managers pile in to risk assets with a nominal yield that meets their fund assumptions but will get only an actual return of 3-4%. So the answer is (3), there will be defaults. Or maybe (1) savings will be much higher, but then we will have lower growth and lower stock prices. However, governments are doing their best to drive down savings, forcing us toward (3) -- bubbles followed by defaults.
Isn't this environment similar to what Japan has oscillated between -- sharp rises in risk assets followed by equal size declines, as sentiment and performance oscillate?
So don't your premises imply LB's conclusions?
I really resent being continuously misquoted...
ReplyI do not know any fund assuming 8-9% returns. I think LB should go back, read again, and stop acting like a half-wit CNBC reporter.
I wrote that many funds assume 7-8%, which is a HUGE difference over time. I quoted Buffet's suggestion of 6% as a reasonable long term assumption (not every year)
The problem pensions face with bonds is the reinvestment risk that is embedded in YTM calculations. If you bought bonds at 5% YTM, that yield assumed you reinvested all coupons at 5% -- not at sub 3%. Actual yields, factoring in sub 3% reinvestment rates and lower compounding, won't even come close
Even if society postpones the retirement age 10yrs to age 75 (good luck with that), defeasing these liabilities at current Treasury rates is mathematically impossible.
This means Treasury bonds are NOT risk free to US investors... Non US investors simply have to ask if 2-3% yields will overcome a USD decline rate of 3.5% (long term inflation)
Japan started with a lot more savings and a lot older population (closer to death = less savings needed). The US population needs about 15 years more savings on average, but we are starting with a lot less. If US savings rates go to 10% and retirement money earns 6% -- a lot of elderly people will still outlive their money.
Trying to do it at sub 3% yields? There is no retirement age at which that will work. Hence, US Treasury bonds are VERY VERY risky to real money investors
PJ -- leftback has some basic literacy problems. He misquotes all the time.
ReplyYou wrote: "Now, in a zero-inflation environment with deleveraging, the best returns anyone can reasonably expect are 3-4%. Probably less."
zero inflation is your assumption, and it is not supported by history or by TIP b/e rates (see MM's post).
Deleveraging has nothing to do with real returns, only accounting returns. Leveraging up amounts to shifting cashflows across time.
You then wrote: "savings will be much higher, but then we will have lower growth"
Again, history does not support your views. In fact, higher savings rates tend to permit higher growth rates over long time periods. Forcing people to spend money they don't have just makes people indebted -- and its fraudulent to call this "growth"
I would agree that assets (including Treasuries) are priced way too high given pitiful savings rates and an aging population.
Either retirement will need to be delayed by decades -- or else asset prices (in real terms) will come way down.
Claiming that US Treasuries are "risk free" is fraudulent unless / until the retirement age is set to 85 or so (and rises over time).
That was my claim -- US Treasuries are not risk free
Thanks, PJ, appreciate that assistance there, having been forced to take shelter and man the ramparts against battering rams. Now, suitably refreshed with a cup of mead from the castle cellar ....
ReplyGary, we are in a whole new world. You have never seen this before and you can't get your head around it. The old asset allocation models will not work. Pension funds and university endowments are full of managers who can't think their way out of a paper bag and they are going to take excessive risk and some will fail. It really is going to go pear-shaped in a big big way starting next year, or even earlier and some people are going to go broke.
Those who do not learn the lessons of history are destined to repeat them, and some people may well become destitute in the process. Debt deflation is a serious business. If you study Japan and the 1930s you have some chance of getting through this thing intact. The fundamental problem is that very very few people in the US have the mental equipment to think this thing through. Didn't you learn anything at all last year?
Oh yeah, I keep forgetting the favorite quote of Wall Street:
Reply"This time is going to be different"
I have a real portfolio to manage, and I have already wasted too much time blogging with a newbie
The LB-Gary contretemps is reflective of the discussions going on in many places & in the market (except from the sell-side folks who call me); will it be US-style recovery of Japanese-style non-recovery.
ReplyAs for pension funds; it's not a surprise that the Japanese were the initial (and later very big) buyers of 'market-neutral' strategies in the 90s (and early '00s).
Gary - it's BROKEN - so the future probably will involve a series of extravagant and entertaining zig-zag excursions up and down in equities and commodities, driven by bursts of QE, while ZIRP remains in effect for a surprisingly long time.
ReplyMeanwhile, the savings rate will rise a lot and US buying of Ts will increase as foreign demand wanes. The most profitable path would therefore be to sit tight most of the time and take a punt on risk assets only when the QE cycle is ON, retreating when the cycle QE is turned OFF. The cycles may be quite long - 6-9 months, for example.
This is pretty much what we talk about every week with MM's kind permission. Risk-ON (HY, AUD, SPX) or Risk-OFF (USD, JPY, US Ts). Not that hard to understand now, is it?
O.M.I.NYC ... Geithner is trying to engineer a Japan type situation, but his days as Treasury secretary are numbered
ReplyPublicly, Obama can say whatever he wants. In private, I know his advisers are telling him the mantra of "penalize the prudent to reward the irresponsible" is what caused the routing in Tuesday's election.
No one liked that policy when it was Bush's, and no one likes it now.
Japan kept that cr@p going because of its corrupt LDP politics -- it had nothing to do with economics or deflation or whatever other CNBC spin.
If Japan had a credible alternative to the LDP, the "lost decades" would have been shorter.
The rest of Asia, after the 1990s implosion, took their lumps, closed bad banks and moved on. Same thing the USA used to do before Greenspan.
US voters made it pretty clear on Tuesday that change will be coming to America or else it will be coming to incumbents (both parties).
Before next year's elections, Obama needs a fall boy, and Geithner's name is already near the top of the list (probably already penciled in for execution at dawn if my sources are right).
Bernanke has already been re-appointed and it would be difficult to reverse course now. He has also been much less supportive of the "punish the prudent, reward the elite" policy.
Unless you think Obama is going to fall on his sword hari kari style like so many LDP Japanese premiers -- Geithner will soon be thrown to the wolves.
The stagnant LDP's debt binge to prop up the status quo is what caused Japan's lost decade. US voters just said that won't be tolerated here
it's (hara-kiri) - a form of seppuku, or ritual suicide.
ReplyLet's hope it doesn't catch on, Gary.
おやすみなさいそしてご多幸を祈りつつ、ゲーリー
Here's an excerpt from David Merkel's blog (which is excellent IMHO). Merkel and several other US bloggers met with US Treasury officials on Monday. Merkel's comments in part:
ReplyAs I commented to a Treasury staffer after the meeting, with financing rates so cheap to buy financial debts, regardless of what kind, it is no surprise that corporate bond spreads have tightened, while there is still little lending to finance growth in the real economy. That is why there is such a gap between Wall Street and Main Street.
Main Street sees unemployment and low capacity utilization. Wall Street looks at bond spreads and P/Es. Those are not the same things. The current stimulus has emphasized healing the financial sector in an effort to avoid contagion and depression. It does not directly address slack in the real economy. The real economy funds the bailout of financials, but does not directly benefit. Thus the disconnect between Main Street and Wall Street.
Many financial measures and companies have rebounded, but little expansion has occurred in the real economy. Even with companies that have done bond offerings, they have often used the proceeds to bolster the balance sheet, rather than expand capacity. Safety first is the watchword.
Gary and LB, excellent debate last night lads...
ReplySkippy -- glad you are all informed and entertained (not necessarily in that order)
ReplyThe benefits of having a blog (not a Yahoo insult board) are great, but only if more people throw in opinions. It shouldn't be mostly MM, Nemo, LB and myself ... you should join in and make an @ss of yourself just like the rest of us.
Its good entertainment when you are bored and don't have Nemo's "patience bordering on disengagement"
As for me, while I think many of LB's comments are insightful, I get the impression he manages a very small fund or maybe just his PA. That gives him a much shorter investment horizon than the people I work with (he can always jump in / out of any position, even if he "intended" to hold it longer). It also means he is allowed to go "all in" on one position, which I've never heard professional PM's do (even in small funds).
Nemo makes great comments -- but I wish he would make more or get in on a debate or two.
If you happen to agree with what people are writing -- take the other side. I've done that several times and it helps you clarify what risks you are taking
Thanks Gary, I try to contribute to the debate and provide some ideas from Asia every-now-and-then, but I usually miss the live banter between you and LB due to the time zone.
ReplyCheers,
Skippy
SFOT - the really amazing thing imho about Lee Kuan Yew is not that he's still giving interviews or traveling actively around the world but that it was so comprehensive, concise and in depth. Accurate too. As an analyst I'd submit his only peer is Henry the K. Ironically Lee's nickname is Harry.
ReplyMM (LB,Gary and other disengaged observers)
Reply1) nice job on the post and interesting debate. Clearly you guys have the time and are disengaged :)
2) sorry to say didn't find the language all that obfuscating but then Uncle Alan always made sense to me
3)Fed policy has always struck me as perfectly decodable
4) and perfectly represented by a modified Taylor Rule
5) Right now our problem is the obvious flamingo-passing carry trade but hiding behind that is when reality sinks in so...
6) we're in a regime were market cap vastly exceeds intrinsic value in my humble estimation
7) and a lot of folks are going to get trimmed up when the other blade of the scissors closes (think Monty Python and what happens during branding season; cf. steer).
Try this for a bit of discussion and citations to back it up if you're so inclined:
http://llinlithgow.com/bizzX/2009/11/cuspiness_collisions_conundrum.html
Friday will be "interesting" as my old climbing buddy said looking up the couloir as the snow fell.
Gary - re: your comments at 1:47
ReplyTaking the other side is fine and a healthy debate is great. But why all the personal insults and attacks? Why not just stick to the issues?
You guys both bring up great points but you have to wade through a petty little cat fight to get there.
It's certainly not just you and I don't know who threw the first stone. But constantly calling the other side an idiot is counterproductive and brings down the level of the conversation.
Tyler, you have a point about the name calling and constructive debate/ideas.
ReplyBut I am guessing that Gary and LB both have pretty thick skins. Afterall, LB has had years of watching England losing to Australia in the cricket (and in most other sports for that matter) :)
Gary and LB,
ReplyA MOST informative interaction....stuff like this is why I drop in on a regular basis. Both of you made telling points, and there was more than enough wheat to warrant dealing with the chaff.
Btw, I'm just a tadpole, dealing with my PA, so you won't hear much from me...
Old Trader
I am always bemused by the mutual contempt with which large RM guys (GaryY and hedge fund guys (LB) regard each other.
ReplyTo the PF guy, the hedge fund guy manages a bit of loose change with the attention span of a gnat...and gets richly reawrded for it. Oh, and he doesn't have to worry about stuff like liability matching, long run return assumptions, or Jimmy Hoffa.
To the HF guy, the pension fund guy has the ease of not marking to market or getting tinned/losing assets after a small cold streak. Responsibility for losses can be dispersed amongst the many heads around the committee table. Benchmarks are for sissies: it's all about absolute return, baby! (Well, except for 2008, natch)
Unsurprisingly, there is some truth in these caricatures...but caricatures they nevertheless remain.
Ironically, among the greatest PF/endowment managers are those that trade more like HFs. Jack Meyer, et al at Harvard managed a clip of capital that I assume Gary would concede was reasonable, but traded many of those assets much more tactically than most PF...with spectacular results.
Of course, they also got paid like HF managers...and some alumni decided that paying 8 figure salaries to a small group of people (who generated 1/3 of the univeristy's operating budget, btw) was unacceptavle.
And so Meyer, Samuels et. Al left, to be replaced by a group of successively cheaper, more real money-ish managers. And surprise....performance has gotten a lot worse!
I suppose the point is that there is a lot more overlap in the Venn diagram of good PF and HF managers than most would believe..
MM Blackberry..
Risky currencies have gone nuts in the last two hours. In contrast, even thought the S&P futures are fairly sedate.
ReplyHappy payroll Friday!!
I notice in this little debate over styles, time horizons, 'external constraints' etc no-one saw fit to mention the influence of the consultant firms on the actions of the real money guys. Typically a 3 ish year attention span, sorry, 'evaluation period'. Not to be underestimated, and in the current climate I would wager their voices are even louder......
ReplyGary -- I don't disagree with you about what Obama wants; but he's shown precious little desire to actually try and get what he wants (so far)! While I was no Bush fan, give the man credit...when he decided he wanted something (no matter whether we agree with it or not) he (and his folks) made sure they got it.
ReplyOur Man in NYC: I don't know whether Obama wants Geithner gone or not. I only know that the staff around him does.
ReplyI think (not sure) that Obama is a survivalist, at least politically speaking, so while he may not make bold decisions on Afghanistan, Iraq, etc -- he will make a bold decision to defeat Hillary Clinton in the primaries. Quite a few Democrats have accused Obama of still being in campaign mode / not switching to President mode
Given his staff's opinions on Geithner, and Obama's political survival / campaign instincts -- the scuttlebutt around the White House water coolers is that Geithner's day's at Treasury are numbered because he is hurting Obama's "campaign"
Gary -- fair points.
Reply