by Danielle DiMartino Booth
April 26, 2017

How do you take your plaque?

C’mon, we all have our victual vices that risk turning the gourmet in us gourmand. Those naughty nibbles that do so tempt us. Is it a bacon, cheese, well…anything? Maybe a slice of pie – pizza or otherwise? Or do you take yours scattered, smothered and covered? As in how you order your late-night hashbrowns at Waffle House – scattered on the grill, smothered with onions and covered with melted cheese. That last order is sure to do the trick if clogging your arteries is your aim. Too exhausted to trek inside? Hit the drive through. It’s the American way.

Enter Morgan Spurlock. In 2003, he had grown so alarmed with the ease with which we can go from medium to jumbo (in girth) he conducted a filmed experiment. For 30 days, Spurlock consumed his three squares at McDonald’s, a neat average of 5,000 calories a day, twice what’s recommended for a man to maintain his body weight. Fourteen months later, Spurlock managed to shed the 24 pounds he’d packed on.

Released in 2004, Super Size Me garnered the nomination for Best Documentary Feature.

And since then? A freshly released paper finds that more than 30 percent of Americans were obese in 2015 compared with 19 percent in 1997. Of those who were overweight or obese, about 49 percent said they were trying to lose weight, compared to 55 percent in 1994.

One must ask, where’s that “Can Do!” spirit? Why acquiesce given the known benefits of restraint? Perhaps we’d be just as well off asking that same question of the world’s central bankers who seem to have also thrown in the towel on discipline, opting to Super Size their collective balance sheet, the known hazards be damned.

At the opposite end of the over-indulge-me spectrum sits one Harvey Rosenblum, a central banker and my former mentor who sought to push his own discipline to the limits throughout his 40 years on the inside, to take a stand against the vast majority of his peers. Consider the paper, co-authored with yours truly, released in October 2008 — Fed Intervention: Managing Moral Hazard in Financial Crises.

In the event your memory banks have been fully withdrawn to a zero balance, October 2008 is the month that followed the magnificent dual implosions of Lehman Brothers and AIG.

To speak of insurers and quote from our paper: “Moral hazard, a term first used by the insurance industry, captures the unfortunate paradox of efforts to mitigate the adverse consequences of risk: They may encourage the very behaviors they’re intended to prevent. For example, individuals insured against automobile theft may be less vigilant about locking their cars because losses due to carelessness are partly borne by the insurance company.”

As it pertains to central banking, we had this to say: “Lessening the consequences of risky financial behavior encourages greater carelessness about risk down the road as investors come to count on benign intervention. By intervening in a financial crisis, the Fed doesn’t allow markets to play their natural role of judge, jury and executioner. This raises the specter of setting a dangerous precedent that could prompt private-sector entities to take additional risk, assuming the Fed will cushion the impact of reckless decision-making.”

What a redeeming difference eight years can make?

If you’ve read Fed Up, you’ll recognize these words, which open Chapter One: “Never in the field of monetary policy was so much gained by so few at the expense of so many.” Every chapter of the book begins with a quote, most of them ill-fated words straight out the mouths of Greenspan, Bernanke and Yellen, chief architects of the sad paradox that’s benefitted “so few.” Those prescient words were written in November 2015 by Bank of America ML’s Chief Investment Strategist Michael Hartnett, before Brexit was on the tips of any of our tongues, before the anger of the “many” erupted at voting booths.

Chapter One goes on to recount the Federal Reserve’s December 2008 decision to lower interest rates to zero. According to the Bernanke Doctrine, the Fed’s purchasing securities, quantitative easing (QE) could not commence until interest rates had hit their lower bound. To suggest the chairman’s blueprint was arbitrary requires a vivid imagination. Few appreciate the Doctrine was conceived in August 2007 in Jackson Hole, in the tight company of his chief architects. But one can breathe a sigh of relief his models did not necessitate negative interest rates.

We know it’s been over two years since the Federal Reserve stopped growing its balance sheet to its current $4.5 trillion size. And yet, investors are anything but alarmed, comforted in their knowledge that Liberty Street stretches round the globe. There are plenty of corners on which moral hazard dealers can ply their wares, luring animal spirits out of their lairs. QE is global, it’s fungible and it feels so good.

As Hartnett reminds us in his latest dispatch, global QE is, “the only flow that matters.” Add up the furious flowage and you arrive at a cool $1 trillion central banks have bought thus far this year (note: it’s April). That works out to a $3.6-trillion annualized rate, the most in the decade that encompasses the years that made the financial crisis “Great.”

“The ongoing Liquidity Supernova is the best explanation why global stocks and bonds are both annualizing double-digit gains year-to-date despite Trump, Le Pen, China, macro…”

As so many sailors fated to crash onto the rocky shores of Sirenuse, investors have complied with central bankers’ biddings. And why shouldn’t they?

As Bernanke himself wrote in defense of QE in a 2010 op-ed, “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will support further economic expansion.”

What a relief! This won’t end as tragically as the Greeks would deem fit. It’s the wealth effect, a different myth altogether, protected by virtue herself.

Investors are excelling at obedience in such rude form they’ve plowed fresh monies into emerging market debt funds for 12 weeks running. As for stocks, forget the fact that it’s a handful (actually two hands) of stocks that are responsible for half the S&P 500’s gains. Passive is hot, red hot. According to those at Bernstein toiling away at tallying, within nine months more than half of managed US equities will be managed passively.

As if to celebrate this milestone, Hartnett reports that an ETF ETF has completed its launch sequence. What better way to mark a decade that’s seen $2.9 trillion flow into passive funds and $1.3 trillion redeemed from active managers? In the event you too need a definition, an ETF ETF is comprised of stocks of the companies that have driven the growth of the Exchange Traded Funds industry. But of course.

In the event you’re unnerved by the abundance of blind abandon in our midst, it helps to recall the beauty of moral hazard. Central bankers know what they’re doing in encouraging moral hazard and they’ve got your back. If they can’t prevent, they can at least mitigate the future economic damage they’re manufacturing.

As Bernanke said in a 2010 interview, “if the stock market continues higher it will do more to stimulate the economy than any other measure.” If that was true then, isn’t it even truer today? More has to be more. Why diet when it’s so much more satisfying to indulge to our heart (attack’s) abandon?

by Katherine Burton and Katia Porzecanski
Bloomberg Markets
April 21, 2017

Billionaire investor Paul Tudor Jones has a message for Janet Yellen and investors: Be very afraid.

The legendary macro trader says that years of low interest rates have bloated stock valuations to a level not seen since 2000, right before the Nasdaq tumbled 75 percent over two-plus years. That measure -- the value of the stock market relative to the size of the economy -- should be “terrifying” to a central banker, Jones said earlier this month at a closed-door Goldman Sachs Asset Management conference, according to people who heard him.

Jones is voicing what many hedge fund and other money managers are privately warning investors: Stocks are trading at unsustainable levels. A few traders are more explicit, predicting a sizable market tumble by the end of the year.  Last week, Guggenheim Partner’s Scott Minerd said he expected a "significant correction" this summer or early fall. Philip Yang, a macro manager who has run Willowbridge Associates since 1988, sees a stock plunge of between 20 and 40 percent, according to people familiar with his thinking.  Even Larry Fink, whose BlackRock Inc. oversees $5.4 trillion mostly betting on rising markets, acknowledged this week that stocks could fall between 5 and 10 percent if corporate earnings disappoint.

Caution Flags

Their views aren’t widespread. They’ve seen the carnage suffered by a few money managers who have been waving caution flags for awhile now, as the eight-year equity rally marched on.  But the nervousness feels a bit more urgent now. U.S. stocks sit about 2 percent below the all-time high set on March 1. The S&P 500 index is trading at about 22 times earnings, the highest multiple in almost a decade, goosed by a post-election surge.  Managers expecting the worst each have a pet harbinger of doom. Seth Klarman, who runs the $30 billion Baupost Group, told investors in a letter last week that corporate insiders have been heavy sellers of their company shares. To him, that’s “a sign that those who know their companies the best believe valuations have become full or excessive."

He also noted that margin debt -- the money clients borrow from their brokers to purchase shares -- hit a record $528 billion in February, a signal to some that enthusiasm for stocks may be overheating. Baupost was a small net seller in the first quarter, according to the letter.  Another multi-billion-dollar hedge fund manager, who asked not to be named, said that rising interest rates in the U.S. mean fewer companies will be able to borrow money to pay dividends and buy back shares. About 30 percent of the jump in the S&P 500 between the third quarter of 2009 and the end of last year was fueled by buybacks, according to data compiled by Bloomberg. The manager says he has been shorting the market, expecting as much as a 10 percent correction in U.S. equities this year.

China Slowdown

Other worried investors, like Guggenheim’s Minerd, cite as potential triggers President Donald Trump’s struggle to enact policies, including a tax overhaul, as well as geopolitical risks.  Yang’s prediction of a dive rests on things like a severe slowdown in China or a greater-than-expected rise in inflation that could lead to bigger rate hikes, people said. Yang didn’t return calls and emails seeking a comment.  Even billionaire Leon Cooperman -- long a stock bull -- wrote to investors in his Omega Advisors that he thinks U.S. shares might stand still until August or September, in part because of flagging confidence in the so-called Trump reflation trade. But he said that they will eventually resume their climb and end the year moderately higher.
Likely Culprit

While Jones, who runs the $10 billion Tudor Investment hedge fund, is spooked, he says it’s not quite time to short. He predicts that the Nasdaq, which has already rallied almost 10 percent this year, could edge higher if nationalist candidate Marine Le Pen loses France’s presidential election next month as expected. Jones tripled his money in 1987 in large part by correctly calling that October’s market crash.  While the billionaire didn’t say when a market turn might come, or what the magnitude of the fall might be, he did pinpoint a likely culprit.

Just as portfolio insurance caused the 1987 rout, he says, the new danger zone is the half-trillion dollars in risk parity funds. These funds aim to systematically spread risk equally across different asset classes by putting more money in lower volatility securities and less in those whose prices move more dramatically.  Because risk-parity funds have been scooping up equities of late as volatility hit historic lows, some market participants, Jones included, believe they’ll be forced to dump them quickly in a stock tumble, exacerbating any decline.  “Risk parity,” Jones told the Goldman audience, “will be the hammer on the downside.”