RMG Investment Bulletins
To view a PDF copy of this report, click here.
We have been bombarded by Central Bank speakers in recent days. What does it all mean; if anything at all? Do we need to change our thinking on markets? These are serious questions for investors as we close out the first half of 2017. However, before we dive in, we want to step back and consider some previous things that central bankers have said at interesting economic and financial junctures in the past. The point of this is not simply to have a giggle at someone else's expense. We are simply trying to illustrate that central bankers can and do get things wrong.
Is it because they are human after all? Or are they being duplicitous? Frankly, we suspect they are simply clueless to the bubble blowing effect that their policies have had in the last 20 years or so, and that the negative impact on both markets and the real economy can be devastating when these bubbles pop. Let's start with some quotes from Ben Bernanke around the time of the housing peak in 2005/2006.
"We've never had a decline in house prices on a nationwide basis. So, what I think is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though." Ben Bernanke quote July 2005.
"Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise." Ben Bernanke quote 15th February 2006.
As it turns out, Dr Bernanke was wrong. House prices did not continue to rise, or even stabilise. Shortly after his utterances, Nationwide house prices started to fall, and would only begin to stabilise after a 25% decline over 5 years.
Chart 1 - US S&P CoreLogic Case-Shiller National House Price Index
Although Draghi captured most of the headlines, it is notable that fully seven G10 central banks have been talking recently either hawkishly, or in a manner which indicates that the next major move is away from extraordinary policies. Leading the pack is the Fed who are furthest along the normalisation process, and where the market is very much underestimating the amount of tightening if the Fed follow through on what they are saying.
But what really caught our eye from the Fed last week were comments about how high asset values were and that "high asset values may lead to future stability risks" (Stanley Fischer). This is central bank speak for; we are now worried that our extraordinary policies have created significant asset bubbles, and a future bear market would hurt both financial markets and the real economy. Simply put, when central bankers are telling us that asset values are "somewhat rich" (Janet Yellen) and that they are worried about future stability, whilst at the same time raising interest rates and potentially reducing their balance sheet, we as market participants should be very worried. Our view remains that the Fed will continue to tighten policy until something breaks, either at home or abroad...we have pencilled in late 2017 for greater market troubles, with a topping process starting in the current timeframe.
Of course, even if the Fed are worried that they have created a massive bubble, they will be very careful in the way they manage markets, and they have to keep their cheerleading hat on at all times. And so we get to the hubristic central banking comment of the week, when Janet Yellen said that she doesn't believe that there will be another financial crisis in our lifetimes. How can she be so sure? And frankly, we beg to differ. Every episode when asset markets have become this expensive and debt this high have been followed by a financial crisis.
The trigger for the crisis has always been falling asset values, and we now have a Fed that is acknowledging high asset values and yet are still tightening policy. We would humbly suggest that the chances of another crisis emerging from the next bear market in equities and credit are actually quite high, and perhaps the Fed are also worried about this privately, and are now trying to dig themselves out of a very deep hole with their policy tightening.
Which brings us to our last point, and the reason that many investors remain invested in risky assets despite the increasing warning signs. Many investors simply believe that during the next crisis, the Fed will be very quick to slash interest rates and print money - and why shouldn't they? After all, Fed governors have told us that this is what they expect to do. Perhaps the only issue at hand is how far the Fed will be happy to see equity prices fall before they step in - the so called strike price of the Fed put option. Is it a 20% decline? A 30% decline? Only time will tell.
We will leave you this week with perhaps the most gratuitous Bernanke quote we found;
"It is not the responsibility of the Federal Reserve ÃƒÂ¢Ã‚â‚¬Ã‚â€œ nor would it be appropriate - to protect lenders and investors from the consequences of their financial decisions." Ben Bernanke quote 31st October 2007.
This came literally days after the start of the bear market, and Bernanke is trying to tell us that it is not appropriate for the Fed to support financial markets, thereby protecting lenders and investors from the consequences of the financial decisions. The months ahead saw him do everything to protect lenders by being party to the bailout of a number of big banks and in the years ahead, he decided to print trillions of Dollars to buy assets in the hope that asset markets (assets held predominantly by the richest in society) would rise in value and this new found wealth would trickle down to the real economy. Frankly, the evidence suggests that the new found wealth has remained in the hands of the wealthy, and some would argue that Fed policies have not helped the real economy at all.
So, during the next crisis, we suspect the Fed to do the appropriate thing, and force feed liquidity directly into the real economy, thereby bypassing financial markets and allowing investors to live with the consequences of their financial decisions.
To view a PDF Copy of this report, click here.
We have talked about central bank policies extensively in recent years, and let's face it, it's a really dry subject. Unfortunately for us, Central Banks remain very important actors in the financial markets, and subtle changes can have both visible and hidden effects. Perhaps the most obvious changes are being seen at the US Federal Reserve, but we also detect more subtle changes in Europe and Japan. Spotting these changes is the easy part. Understanding what impact they have on market prices, both short and long term, is the hard part. With that caveat, let's have a look at what's happening.
First to Japan. In the immediate aftermath of the move to both QQE and Yield Curve Control (YCC) last year, we said that these policies goals were simply not achievable at the same time (SEE SEPT 2016 REPORT). The BoJ would simply not be able to expand its balance sheet by 80 trillion Yen a year and control yields out to 10 years (a target of zero was established at the time). What was not clear was whether in the pursuit of yield curve control, the BoJ would print more or less than 80 trillion per annum.
The first test of the yield curve control policy came in February when 10 year yields nudged above 0.10%. The BoJ promptly stepped in with increased bond purchases, and yields subsequently moved back towards zero. Since that increased intervention, BoJ bond purchases have slowed, as can be seen in the chart below (courtesy of MI2 Partners). Indeed, if BoJ operations continue at the current pace for the rest of May, purchases will fall below 8 trillion for the first time since October 2014.
Chart 1 - Bank of Japan bond purchases
- The slump of the 1930s, which followed the Wall Street crash of 1929
- The stagnation of the Japanese economy, which followed their stock market crash of 1990
- The Global Financial Crisis and economic weakness that followed sharp falls in share and house prices
- The BIS and Moodys are highlighting the fragility of the debt fuelled growth policy in China
- The OECD lowered global growth forecasts
- Both the OECD and UN are urging growth policies that benefit the masses rather than the few
- The US election is beginning to loom large
- The recent EU summit ended on a sour note
- The latest rumours from ECB sources say that policy changes may only be tweaks
- Messy geopolitics from the middle east, through Russia to China
- Where Goes the Pound?
- The End of an Era
- A Short Update on Our Equity Market View
- Some Extremes Held by Speculators Could Force Change
- Emerging Markets Challenging Our View of a Quiet Summer
- Has US Business Confidence Peaked?
- Central Banks
- Fixed Income
- FT Special Report
- General Update
- Show all