If “Sea Level” Changes, Everything Changes. But How? Tsunami? Land Rush? Japan?

I’m still seeking clarity on what the heck is going on out there with interest rates.  I figured I’d lay out the questions and see if it helps spark any insight.

Interest rates matter like sea levels matter.  The tide goes up and down, but you sort’ve take for granted that “sea level” is a fixed constant average.  Most of humanity lives near water, so that’s an important measure.  But one we can safely ignore because, well, it’s a fairly fixed constant (leaving global warming aside for a moment).

Interest rates worldwide have tanked.  We have negative real rates (adjusted for inflation) in Japan, German, Sweden, etc…  The US is just barely positive.

These are market-driven rates (10 and 30 year).  The Central banks don’t have their thumbs on those scales.   The Fed’s recent move to stop raising rates is clean evidence its raising the short-term rate scale wasn’t doing squat with long-term rates.

If I traveled back in time 10-15 years and showed a current yield curve interest rate chart to an audience of investors and economists, they would.

  1. Not believe me.
  2. Assume 2019 must be experiencing a five alarm economic crisis.

In reality, we are just sort’ve chugging along.  So what are some plausible scenarios/expectations?  In sea level terms.

  1. Pre-Tsunami:  Apparently the sea receded noticeably before the Thailand Tsunami hit.   People wandered out to look at the near-shore sea floor.  Unaware all that water was going to come back in a wave of destruction.  Maybe today’s low rates are a prelude to another economic maelstrom as we destroy all the debt piled up and un-written off since the 2008 financial crisis.
  2. A permanent shift?  Maybe we’ve slain the inflation beast and the new normal is just that.  Normal.  In which case there’s not too much to worry about.  If anything, we should be rushing to buy all that new beachfront property where the ocean used to be.  Or something like that.
  3. Prelude to Deflation?  The Japan “lost decade(s)” scenario?  We’ve succeeded too well in slaying the inflation beast.  We’re tipping over into deflation.  We’ve over-cranked on monetary policy tools and won’t crank enough on fiscal policy tools.
    • Monetary:  The Fed only has 2-3 points of interest rate cuts available for the next downturn.  It typically needs 4 or even 5.
    • Fiscal:  Government spending to stave off recession is anathema to too many politicians.  Egged on by the .01% who can ride out a downturn but suffer disproportionately from inflation and hate to pay taxes.   Just look at what a heavy lift the lame, anemic, pop-gun “stimulus” was in 2008.

I am most concerned about Scenario 3.  Probably because I have a gut feeling it is what is actually going on out there.  Inflation is anemic everywhere.  A downturn probably tips that to deflation.  And deflation is really really hard to get rid of.  Inflation is like an illness requiring surgery.  It can be beat with enough short-term pain.  Deflation is like a chronic wasting disease.  It just lingers and lingers.  See “Japan 1990-2019”

The other reason I suspect scenario 3 is that most commentary seems as perplexed as I am.  And most if it is still centered around scenarios 1 and 2.  That is at least partly because we have the best explanatory tools for those scenarios.  Like the joke about the drunk fellow looking for his keys under the lamppost; “Well, I lost them somewhere over there, but the light’s better over here…

I have a nasty feeling Japanese economists have insight to offer, but I don’t speak Japanese.  Most economic thinkers and policy makers don’t either. So I’m left staring at the receding surf line and wondering to go forward, run to high ground, or buy an off-grid cabin stocked with canned food and a shotgun.

So that’s why I’m so worried about interest rates.  Any suggestions or comments would be welcome.  Sorry for any typos I’m on a flight later today and wanted to send this out.

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Technical Debt Leading to Technological Bankruptcy. Then Actual Bankruptcy. Cloud Computing Offers a Solution.

I figured I’d share part of an e-mail exchange this morning on the concept of “Technical Debt.” The term is well understood term in technology circles, poorly understood by investors, and totally ignored by accountants.  It explains a lot about winners and losers today.

Per the quote below, I wish this concept of “technical debt” actually sat on balance sheets. It is there regardless.

  • Keeping your software running can be thought of as paying the interest charges on a credit card.
  • Re-writing your software is paying down the actual principal amount you owe.
  • Skimping on software maintenance and replacement balloons that technical debt balance.  But that is the next CEO’s problem (repeat that phrase a few times over several decades).
  • Until the technical debt comes due.

This is a pretty clean way to understand a lot of older companies.  It is particularly applicable to Telecom companies worldwide.  They have 20-30 years of technical debt  coming due.  Millions of lines of rotten code in old billing systems, provisioning systems, and support systems.  Sitting on top of rotten copper in a non-data-friendly network architecture.  The telcos only paid interest and never paid down the principal.  So they are, technologically (and in some cases literally) bankrupt.

The article below is also an excellent explanation of why Public Cloud services can help minimize accumulation of technical debt.  Older companies with unpaid technical debt  balances will still have to pay them off – largely paying in to the Cloud.  Newer companies will use cloud to stay nimble.  Eventually killing off the old, encumbered behemoths.  That pattern will play out across a lot of industries over the next 20 years.

This dynamic is why AWS is going to be such a monster.  Hopefully one day Amazon does us all a favor and spins out AWS so we can invest in it directly.

https://techcrunch.com/2018/12/15/the-business-case-for-serverless/

“The problem with this approach comes back to an old axiom in software development: “code isn’t an asset—code is debt.” Code requires an entry on both sides of the accounting equation. It is an asset that enables companies to deliver value to the customer, but it also requires maintenance that has to be accounted for and distributed over time. All things equal, startups want the smallest codebase possible (provided, of course, that developers aren’t taking this too far and writing clever but unreadable code). Less code means less surface area to maintain, and also means less surface area for new engineers to grasp during ramp-up.

Herein lies the magic of using managed services. Startups get the beneficial use of the provider’s code as an asset without holding that code debt on their “technical balance sheet.” Instead, the code sits on the provider’s balance sheet, and the provider’s engineers are tasked with maintaining, improving, and documenting that code. In other words, startups get code that is self-maintaining, self-improving, and self-documenting—the equivalent of hiring a first-rate engineering team dedicated to a non-core part of the codebase—for free. Or, more accurately, at a predictable per-use cost. Contrast this with using a managed service like Cognito or Auth0. On day one, perhaps it doesn’t have all of the features on a startup’s wish list. The difference is that the provider has a team of engineers and product managers whose sole task is to ship improvements to this service day in and day out. Their exciting core product is another company’s would-be redheaded stepchild.

If there is a single unifying principle amongst a startup’s engineering team, it should be to write as little code—and be responsible for as few non-core services—as humanly possible. By adopting this philosophy, a startup can build a platform that can process billions of transactions at an extremely predictable, purely-variable cost with nearly zero devops oversight.”

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A Dead Canary In The Telecom Mines. Investors Beware.

Miners used to carry caged Canaries for early warning of toxic gas.  The Canaries would keel over from the gas before the miners would.

The Canary here is US Telecom CenturyLink, who recently cut its dividend by 53% while raising 2019 capital expenditures by 16%.  CTL is a $14.5B pipsqueak compared to $225b behemoths like Verizon and AT&T.  But its labored breathing is a dangerous sign across the Telecom complex.

If CTL had cut its dividend and its investment spending, this would just be a run-of-the-mill cash crisis.  What makes CTL’s move remarkable is plowing roughly half its $1.16B dividend cut back into network investment.  That points to a more existential crisis.

For all the talk of a fiber-optic future, huge swathes of CTL’s network are still old copper lines running to homes, small businesses, and even many large-ish businesses.   Most of that copper is mostly depreciated off CTL’s books.  But those assets are still generating cash.

Depreciation lives exist for a reason.  If you are making pots of cash off an asset past its useful accounting life, it’s a pretty good indicator those cash flows are at risk.  At some point, the actual physical assets go past their useful life and need replacing.

The rub is that delaying that replacement spend is lucrative for all concerned.  The cash keeps rolling in.  Investors are happy.  Managements are happy.  Why end the party?  That has been the fairly comfortable position of telcos for the past 20 years.

The responsible choice – replacing the asset – is particularly painful because it generates no incremental return for that incremental investment.  You spend a whole lot of money just to keep the cash flows already coming in.

This painful math is familiar to anyone who’s ever spruced up a rental property.  You might see a small boost in income from the investment, but you are mostly spending to maintain the current income stream.

The Telcos have, instead, taken the slumlord approach.  Just let the asset wither and lower rents to keep the place occupied.  This works until the building is no longer habitable and even low-rent tenants start to leave in droves.

The declining slum model fairly describes much of CTL’s network today.  Declining business and residential revenues providing an increasingly skimpy cover for largely fixed operating costs.  So CenturyLink is cutting it dividend and putting roughly half of that cash towards replacing its asset base.

CTL is the canary in this coal mine because they don’t have a wireless business to hide behind.  Or the media and entertainment assets that AT&T and Verizon have both diversified into.  So CTL can’t hide the rot at its core.  But that same rot affects most developed world telcos.  Deutsche Telekom’s recent capitulation on copper life-extending pipe-dreams in favor of fiber investment stands out in particular.

This explains why most Telcos are quietly embarking on massive new network builds without the fanfare of the dividend cut (yet).  Often blaming government prodding or under the PR cover of building out 5G.  Pulling shiny new fiber an re-starting the clock on a 30-year-depreciation lifespan.

Investors should expect the next 20 years to look very different from the last 20.  Steady spending of incremental capital for little or no incremental revenue.  Not to say the current model of over-earning on depreciated assets is dead forever.  Pencil it in for a return around 2050 to 2070.  But it will be a hard slog to get there from here.

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Amazon’s New York Pullout – The Questions Not Asked. Equity Spin Coming?

In all the comment around Amazon’s decision to cancel their “HQ2” in New York, I’m surprised to see some salient questions un-asked.

  1. After such an exhaustive public search, why didn’t Amazon just pivot to the #2 choice? If New York didn’t work, why not just call the runner-up?  It is obvious there wasn’t a credible #2.  So was the search itself just a sham PR exercise?   An attempt to shake down New York for concessions?
  2. What business units were to go to Amazon’s new headquarters?
    1. Northern Virginia is an obvious location for a unit that could use some structural breathing room – the Amazon Web Services Public Cloud.  It is already a stand-alone organization with its own compensation plan.  It has a huge government presence already.  With massive data centers located in Ashburn Virginia (just outside the blast radius of nukes hitting DC).  And AWS is the likeliest candidate for the DoD’s $10b over 10 years “JEDI” contract.
    2. New York would be an obvious location for….?  My best guess is Media and Advertising.  Two New York industries and two major Amazon initiatives.  In that case, the HQ2 search was always a sham and Amazon ends up building a similar sized presence in NYC (without all the fun subsidies).
  3. To what end all this separation? A spin-off of AWS and Media as separate stocks seems the most likely answer.  Eliminate the conglomerate discount, eliminate conflicts of interest, and fend of the anti-trust authorities.  
    1. The original HQ2 justification was talent diversification.  That no longer holds water given Amazon’s chosen locations were equally bad “war for talent” labor markets with equally bad traffic and growth-related challenges.
    2. AWS, in particular, would benefit from more formal separation from Amazon’s other businesses.  AWS wants to sell to all comers.  But Amazon’s ambitions in retail, health care, financial services, and transportation push a lot of potential clients into the arms of Microsoft’s Azure and Google’s Cloud Platform.  The two arms are already separate in practice.  A wider, more formal separation would eliminate a drag from AWS and give it a proper (probably astronomical) valuation.
    3. Media and Advertising don’t seem to suffer similar negative drag from linkage to Amazon proper.  It might be the simple (and probably valid) valuation argument.  Advertising business are generally worth more than an agglomeration of warehouses and grocery stores.
    4. Lurking behind all of the above could be a preemptive action on the anti-trust front.  If you see a potential break-up threat, why not do it yourself on lines of your own choosing?

I might circle back to these later.  Although, having written this, the itch seems pretty well scratched.  As always, any thoughts, feedback, or comments are deeply appreciated.

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Politics on a Left-Right Axis? No Worries. A Reality-Fantasy Axis? This Must Be Stopped.

A break from musing about monetary policy.  🙂  The main axis of political difference today isn’t left vs. right.  It is Reality vs. Fantasy axis.  A vicious cocktail of cynicism and self-delusion driving real-world policies with real-world consequences.

Madness is always seen clearest from a distance.  So start by looking at Brexit.  Fantastical, billboard-friendly promises grounded in a nostalgic fantasy of Little Britain.  Leaving the UK government trying to somehow force-fit reality into the shape of that fantasy.  Because the alternative – popping the bubble – seems too personally/politically costly to contemplate.  Better to double down on the madness than admit you were wrong.

Now look closer to home.  The mainstream of the Republican partly – 30% of the nation – now lives, breathes, and votes in a fantasy land.  Complete with…

  • …fantasy media (Fox News to Breitbart to Limbaugh to 9/11 conspiracy peddlers)
  • …fantasy economists peddling fantasy economics (The answer is “Tax Cuts” – now what was the question?).
  • …fantasy science (climate change, pollutants, food safety…)
  • …fantasy public safety (vigilance against potential Muslim terrorists matched with indifference to actual killings by actual race-war terrorists.   Gun policy set by lone-hero-movie-battle fantasies vs ballistic reality).
  • …fantasy race relations (“we’re a color-blind society”),
  • …fantasy outcomes (a “free market” economy is one where many full-time workers draw government Food Stamp etc. subsidies…).
  • …a fantasy President who is (literally) running the White House as Reality TV.
  • …a fantasy National Emergency to build a fantasy wall.
  • …a fantasy back-story of America that offers (fantasy) upward mobility to a (fantasy) wealthier, whiter, more rural/suburban populace  – ignoring all statistics to the contrary.

About here is where the Left-Right debaters pivot to “Well the Democrats have their fantasy ideas too (e.g. “Green New Deal).”  Seeking to shift the debate back to the rut of a Left-Right axis.

We realists can’t fall into that comfortable back-and-forth.  Yes the Democrats have fantasists of their own.  But they aren’t the Democratic mainstream.  Much of the Republican mainstream is living in an obvious fantasy.  Starting with expedient falsehoods and descending into madness – from Nixon’s racist dog whistles to Reagan’s deficits to Willie Horton’s explicit racism to Sarah Palin’s post-truth dress rehearsal to Trump’s shameless carnival of lies.  With 30% of the country still on board.

It reminds me of the waning years of Communism.  The fantasy became an obvious tissue of lies.  A shrinking minority kept doubling down on the con.  Some for power and perks.  A larger number just avoiding the shame of admitting they’d been conned.  At some point, the absurdity grew too obvious.  The system toppled.

People living on the reality-based side of the Wall rejoiced.  But we paid an ugly bill for those cynical delusions.  The madness burns out at some point.  Leaving no great joy for those left to pick up the mess.

  • Consider the bill West Germany paid to pick up the mess of East Germany.  To be repaid mostly with Ossi resentment as shame and fantasy nostalgia replaced memories of reality past.
  • Looking homewards, consider the bill paid during and after the US Civil War.  We freed America from an elite minority’s self-enriching fantasy of human bondage as a sustainable economic system.  To be rewarded by a similar creep-back of resentment politics based on fantasy nostalgia.  The truth of that “Republican Party Southern Strategy” may be a wee bit too much for many to face.  I’ll settle for a more reality-based debate around economics, climate, and gun control… 🙂

The first step to getting out of this rut is to stop letting people force-fit today’s politics into a comfortable “Left vs Right” construct.  It is well-worn ground.  But the debate has clearly shifted.

We realists need to square up and confront the fantasy head-on.  We have to keep the debate centered there.  In the madness.  The faster we shift the debate, the faster the madness breaks.  And the lesser the cost for us all.

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Do We Become Japan? Is Someone Trying to Say “Fire” Very Quietly in a Crowded Theater?

Trying to pull some recent threads together.  Still puzzling things out myself.  The charts below are the crux of the question.  Look at the bottom (purple) line – the Fed Funds rate –  vs the market-driven rates above it.

https://fred.stlouisfed.org/graph/fredgraph.png?g=mY7o

  1. The Fed has been raising its (short-term lending) rate since 2016 (purple line).
  2. The market-driven 10 year Treasury rate (green line) barely budged.  The Fed raised its rate zero to 2.4%.  The ten-year nudged up from 2.3% to 3.2% until it tanked back down to 2.6% when the market balked at the Fed’s last rate raise (Fall 2019).
  3. Corporate bonds followed the 10 year.  Which is what they are supposed to do.
  4. The Fed raised the rate it controls.  The market lowered the rates it controls.  All this noise and shouting about the yield curve inverting (when long-term rates are lower than short-term rates) ignored that humans were the ones doing the inverting.  The Fed led and the market didn’t follow.  Just like Greenspan’s “conundrum” years in the mid-2000’s.
  5. Clear as day, the charts below show an impotent Fed.   We have no Wonderful Wizard of OZ who can grant all our wishes.  Just old men making noise and smoke…

It seems pretty clear (to me at least) the bond market’s negative reaction is the mechanical reason the Fed got all dovish and signaled no more rate rises.  If you are trying to lead a charge and the troops start retreating instead…

That explains the Fed’s action.  But it doesn’t explain the market’s reaction.   What the heck is going on out there?  Why are long-term rates (the sum of real economic growth % + inflation % + risk %) only summing up to 2.6%?

  • Is that 2% growth and 0.6% inflation?
  • Or 2% inflation and 0.6% growth?
  • Or 1%-2% deflation and 3%-4% growth?

In some ways the answer doesn’t matter because all of the above are pretty terrifying.  And we HAVE seen this movie before.  In Japan.  That is about as far as I’ve managed to get.  Right now my brain is trying to wrap itself around the weird physics of the current scenario.  What the heck does that section in bold (from the 2019 American Economic Association (AEA) Presidential Address) actually mean?  Is this someone trying to say “fire” very quietly in a crowded theater?

[What is] the role of deficits and debt if we have indeed entered a long-lasting period of secular stagnation, in which large negative safe interest rates would be needed for demand to equal potential output but monetary policy is constrained by the effective lower bound. In that case, budget deficits may be needed on a sustained basis to achieve sufficient demand and output growth. Some argue that this is already the case for Japan, and may become the case for other advanced economies. Here, the results of this paper directly reinforce this argument. In this case, not only budget deficits will be needed to eliminate output gaps, but, because safe rates are likely to be far below potential growth rates, the welfare costs of debt may be small or even altogether absent.

Olivier Blanchard – 2019 American Economic Association (AEA) Presidential Address at the AEA annual meeting on the topic of “Public Debt and Low Interest Rates.” He sets out new theoretical foundations for how to think about fiscal policy and debt. Ben Bernanke provided the introduction.

A bonus graph going back to 1970.  The market once did respond quite nicely to the Fed’s rate moves.  That broke down in the 2000’s.

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“Its not a war, Its a Pageant…” Wag The Dog in Venezuela?

UPDATED:  From the FT and per the below:  “The prices of Venezuela’s government bonds have jumped from about 23 cents on the dollar earlier this month to over 33 cents on Monday, while bonds issued by PDVSA, the state oil company, have climbed from roughly 14 cents on the dollar to around 24 cents.

The drums of war have a certain rhythm.  I’m starting to hear that cadence building around Venezuela.  Not to say Venezuela and its government aren’t a disaster.  But that is hardly new news.  So why are we hearing so much about it now?

Because spending American lives and money could pay off nicely for a number of self-interested but influential parties.  Socialism with that neat plutocratic twist – privatize the gains, socialize the losses.

  • Trump et al need a distraction.  Trump failed on the Wall/Shutdown.  He needs to change the subject.  So you start a war and hide behind the flag.  A bi-partisan path so well worn they made a movie about it way back in 1997 (clip below).
  • The old crew wants their kleptocracy back and Florida is a swing state.  Venezuela’s current rulers aren’t Socialists.  They are just a run-of-the-mill kleptocracy who wrested the money spigot away from a prior pack of jackals.  Chavez’s crew took power by kicking out an entrenched 1% club of equally odious, country-wrecking self-dealers.  That upper crust crowd “fled” to their second homes in Florida.  So desperate and downtrodden some may have even flown Economy Class (gasp)!  There they dusted themselves off and started howling for a US intervention.  This should have a familiar echo.  The equally odious, country-losing Cuban kleptocratic exile elite have been howling for the USA to give “their” country back since the 60’s.  The Venezuelans just joined that chorus.  It is no coincidence that (Cuban, Florida) Senator Marco Rubio has “become a lead policy architect and de facto spokesman in a daring and risky campaign involving the United States in the unrest that is now gripping Venezuela.
  • Venezuela has 300 billion barrels of oil, we have oil companies.  Whatever the angle is, the oil companies probably stand to benefit.  The Koch brothers, in particular, own refineries optimized for sludgy Venezuelan heavy crude.  When Chavez turned on them, their first try was to replace that supply with Canadian Tar Sands (why we heard so much about the Keystone XL pipeline).  But why not just get the old gang back at the old source?  With some incremental new profit concessions for handing the slush money spigot back to the prior parasites.
  • Fox news et al need a “socialist” enemy – preferably a Hispanic one.  Alexandra Ocasio Cortez’s crazy Socialist ideas are getting way to much consideration.  That 70% tax on incomes over $10m proposal has support of 59% of registered voters, 45% of Republicans, 60% of Independent voters and 71% of Democrats?!?  Don’t those people understand they might win PowerBall one day? We’ve got the scare those folks back into their self-defeating crouch!   But she’s a good dancer and brutal on Twitter.  So lets attack her via proxy!  OK her parents were from Puerto Rico not Venezuela.  But who really knows the difference?  And dark threats about “Latin American socialists” hits the right nerves for a whole generation of older Americans (see “Cuban kleptocrats” above).
  • $90b in outstanding debt trading at pennies on the dollar but backed by all that oil:   Lets say you buy a bunch of debt at 5c on the dollar and it goes to 25c.  That is a damn good trade.  Worth spreading some bucks around DC to make it happen?  Definitely.  Venezuela probably can’t pay it all off, but those 300b barrels of oil means they can pay off some.  A short pause of responsible behavior to get the debt pumps primed again.   In gratitude for their “liberation.”  Before they get back to plundering the country for private gain.
  •  2020 elections are looming we all need a win!   Enough said.

Lot of upside, no downside.  Nobody important has their wallets or children’s lives on the line.  What’s not to like?

There are two positive (so far).

  • Its better than North Korea or Iran.  If we have to have a wasteful war, Venezuela is a lot less dangerous than some other intervention options.  The lesser of three evils.
  • The Pentagon and Military Industrial Complex haven’t joined the chorus (so far).  We’ve got a few wars simmering.  We probably won’t fire off enough munitions to make a decent profit.  And we risk bogging down in peace-keeping.

A nice little “Wag The Dog” clip below.  A brilliant movie except it keeps ringing true 20 years on.   “Its not a war, Its a Pageant…”

 

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Pay No Attention to the Man Behind the Curtain!

Have sympathy for the Wizard of Oz. And for the Fed. People really really want to believe in a Wizard. In control. Keeping us safe.

Every society carves out this lonely role role that someone must play – Wizard or Shaman or Priest or Fed Chairman. It is lonely because one must never, ever, betray that fiction that you are just as powerless as everyone else. Shuffling and shaking your bone rattle. Hoping it rains.

The Wizard of Oz didn’t get burned at the stake, but a failed shaman might. People forced to confront their collective powerlessness aren’t usually appreciative.  So you keep on banging the drums and shaking the rattles even if the curtain frays.

Not to say the Fed doesn’t have some power. They have 100% succeeded in raising short-term rates. Because they control short rates. 

The collective hope was long rates would follow.  Instead, the (free) market has responded by cranking long-term rates down down down.  Not just the US 10 year.  The German and Japanese 10 years bonds are back to 2016 lows (at or near zero).  

The simple explanation for rates that low?  An admixture of deflation and/or weak economic growth.  The market isn’t always right, but it can be pretty smart.  I (and many others) am hoping for a more complicated explanation that points elsewhere.

This isn’t just perplexing, it is downright terrifying.  Per a quote I recently saw – Warren Mosler has said: ‘Because we think we may be the next Greece, we are turning ourselves into the next Japan’.  Japan’s has been stuck in a deflationary ditch for about 20 years now. Its a hard rut to get out of. 

That scenario should scare the bejeesus out of all of us. That may be why we aren’t squaring up to it. Much easier to turn back to the Wonderful Wizard. He will keep us safe! He is all powerful! Really! Its going to be just fine…

Looking out a few years, I am more worried than I have been in a while.  Perplexing is not good.  Especially with so much recent analysis seeming to focus mostly on the drumming and rattling at the short end of the curve.  Ignoring the silent, free market at the long end.  

POSTCRIPT:  Per a prior post, low rates does mean the equity markets look reasonably valued.  Or the least ugly dance partner for the next few years.  But… 

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When the Facts Change, Just Pretend They Haven’t…? QT.

One of my New Year’s resolutions is re-starting the blog. Little Bear is at 16 months, still a bundle of fun, and a bit less work. I’ll probably focus more on Economics/Markets, but range around as before.

I am more than little perplexed by current commentary around the Fed’s QT (Quantitative Tightening) program. This keeps coming up as a cited cause of market’s recent sell off.

That would be fine if QT had followed expectations by driving Treasury Interest Rates UP. But the 10 year bond yield has gone DOWN since the Fed started QT’s planned shrinkage of their balance sheet in October.

QT starts in October, right where the line goes… down!?!

Before-the-fact commentary expected exactly the opposite. All the QT commentary I can find predicted lower Fed buying would drive up interest rates (and challenge the market).  As we go into October, rates went down. Low rates are usually seen as helping not hurting risk-asset markets. Although commentators have stuck to QE as a cause of the market’s troubles.

Something here doesn’t add up. I don’t have a definitive answer myself. I do have some ideas.

  • A crowd surge over-powered any (relatively weak) real world QT impact? The market created a self-fulfilling prophecy keyed to the start of QE. “Everyone” expected higher rates and planned to pull back accordingly – shifting into safe assets. That buying surge would explain the drop in yields (driven by an increase in demand for safe 10 year Treasury assets). Any real impact of QT got swamped by that wall of money. In that scenario, we could have a pretty big market rebound once everyone goes home and changes into clean underwear.
  • QT is (and always was) a red herring just like QE? Arguably QE didn’t do much and the unwinding of it (QT) isn’t doing much either. As Ben Bernanke said in 2014 “The problem with QE is it works in practice but it doesn’t work in theory.” In practice, QE did boost animal spirits. But the theory pat matters. It isn’t clear QE had much real impact on market interest rates (especially long-term rates). QT might not be doing much either. That debate is above my pay grade, but a relatively weak QE/QT effect would square with the “market over-reaction” scenario above.

The real culprit may lie (conveniently forgotten) in the recent past. The failure of the US tax cuts to deliver meaningful long-term stimulus.  Lower corporate rates gave us a one year earnings boost, but no real economic boost.  The market drop may reflect that US just fired most of its fiscal stimulus bullets funding a huge tax cut into an already-booming economy. Leaving it that much more vulnerable when the next downturn comes.

Why blame QT instead of a failed stimulus?

  • Blaming QT helps us pretend someone is in charge.  I always find it odd that Wall Street clings so hard to faith in the Fed. Markets are scary, uncontrolled places. Its easier to sleep at night believing the Fed has the helm. This ignores that the Fed has been pushing up short rates with dismally little impact on long rates so far. Which may suggest the Fed’s wheel is turning the wheel, but the rudder’s broken off. That is a scary thought, but it seems to fit the facts.
  • Blaming QT avoids a lot of politically awkward questions. If you acknowledge the tax cuts failed, you risk the general conclusion that taxes are a lousy stimulus mechanism. You end up bolstering the argument that deficit spending on affluent people (who save it) isn’t nearly as useful as spending on poorer folks (who spend it).  And that is political anathema to most (affluent) investors.  Much better to blame QT instead.     

Out in reality, however, the situation looks both encouraging and dire.

  • The market tantrum might be no more than that. There are certainly headwinds and risks, but the economy seems to be generally chugging along. By mid-year, all may be forgotten. Rates remain low. It is risk-on again.
  • But, when the downturn does come, the US has very few bullets in the gun.  The Fed can’t raise rates any further. So it won’t have much room to cut. Negative rates are a political impossibility until things get really bad. On the fiscal front, we just blew out the deficit on an ineffective stimulus.  And too many people cling to a belief in tax cuts evidence be damned.

In the short term, the Fed seems likely to pause and unlikely to do much if any rate raising thereafter. Especially as they can’t raise rates much without intentionally inverting the yield curve. Unless the market (and long-term rates) shoot up. Besides, the Fed’s behavioral model seems to be “raise rates until something breaks.”  Something just broke.  So mission accomplished. 

In the meantime, those market-driven long term rates remain stubbornly low. This is the most scary thing out there IMHO – implying low growth, deflation, or both.  It is also worrying that (market-driven) long-term rates are showing no inclination to follow the Fed. A broken rudder is a scary thing in any scenario.

In the short term, however, low rates make riskier assets attractive. Earnings multiple relative to those low long term rates look fine. Especially if you have a return target of 5%-7% in a world where risk-free returns are around 3%.

So maybe we go back to “risk-on.” Wary of when we finally do meet a bear. With very few bullets in the gun. But in the meantime, the music’s still playing. So we keep on dancing.

Cheers.

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GOP To the Merely Affluent – “Go F**k Yourselves.”

The House Republican Tax Plan’s most perplexing (and schadenfreude inducing) element is how badly it would screw a core Republican voter group.  The merely affluent.  That suburban/urban “I really just don’t want to pay taxes.” voter.

The calculus is clear.  “We’re gladly throwing all you measly 2-to-15 percenters out to the wolves in order to lighten up the sled for the 1% to .01%.

Its pretty amazing how targeted the plan is against at the merely comfortable.  Why?  That’s where the money is.  If you’re cutting taxes on the super-rich, you have to balance the equation on the backs of someone.

  • Eliminate the mortgage deduction over $500k.  POW! to the lawyers and doctors who bought that high-dollar home in that “good” school district.
  • No property tax deduction over $10k.  OOF! Another body blow to home values in those nice suburbs with the good schools.  Especially those prosperous pink-tinged “I’ll whore my vote to anyone who promises a tax cut” “socially liberal, economically conservative” suburbs of the more prosperous cities.
  • No state income tax deduction.  BLAM! to anyone living in any of the prosperous states.  Those Orange County, CA Republicans certainly weren’t expecting that when they voted to cap property taxes with Prop 13 (shifting the CA state funding base to income taxes).
  • Advantaging pass-through income over wage income.  WHAMMO! to anyone who merely works for a hedge fund vs owning one…
  • Etc. etc.

In summary – “We’ll gladly repeal the estate tax for a few hundred families and pay for it with your paychecks and home values.”

The schadenfreude comes from the burst bubbles of so many people who’d fooled themselves into thinking they were part of the protected classes.  Sure the Republicans are slanted toward the rich, but I’m with them right!  They’ll carry me along too!  Won’t they…?  Its like the suckers in a club who’ve paid extra to stand behind a red velvet rope with a dedicated (but cash) bar fooling themselves they’re actual VIP’s.  Meanwhile the real (comped) VIP room with the (comped) bar is someplace totally different.  With this note on the door.

You aren’t VIP’s.  You aren’t part of the protected classes.  Your’re just another bunch of suckers.  Like those anti-abortionists and evangelicals we’ve been stringing along for years.  Or those desperate deluded coal miners and factory workers whose votes we hijacked this cycle.  And if you really think we give a shit, then you deserve to get suckered because coffee is for closers (below).

With Warm Regards – The Koch Brothers et al.

The interesting question is whether those voters will ever listen.  Because even in 2016, the merely affluent “should” have voted for Hillary based on stated policy.  Bernie was right.  She was (and is) a triangulating creature of Wall Street and the merely affluent.  But not (as much) of the plutocratic classes.

Yet so many affluent suburbs dutifully voted for a Jabberwocky Plutocrat/Rural/ Southern coalition party that is (now) dutifully serving its core voters.  And they ain’t them.

“Coffee is for closers.” (click link for Video)

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