and Fed Leaders: No Bubble and U.S. Economy on Solid Course (Really?)
by Victor Sperandeo with the Curmudgeon
On Thursday evening April 7th, Fed Chairwoman Janet Yellen was joined by three previous Fed Chairs (Paul Volcker 1979-1987, Alan Greenspan 1987-2006, and Ben Bernanke 2006-2014) in a lively panel discussion at the International House in New York (a residential dormitory for foreign students). Alan Greenspan appeared by video link from Washington DC. The event was very significant, because a public conversation between all living Fed leaders had never happened before. [The four Fed chairpersons did gather to celebrate the Feds 100th anniversary in December 2013, but they didnt discuss the economy or the outlook.]
Together, the tenures of the four Fed leaders covered more than one-third of the Fed's 102-year history. Their stewardship included the double-digit inflation of the 1970s, the global banking and financial market crises of the 1980s and 1990s and the worst financial crisis and recession (October 2007-June 2009) since the Great Depression.
Fareed Zakaria of CNN (admired by the Curmudgeon for his knowledge and objectivity) moderated the discussion and asked a number of tough questions, some of which we examine in this post. As usual, Victor provides his incisive comments and opinions on the Fed leaders remarks.
Donald Trump, the GOP front runner for President of the U.S., recently voiced a very bearish opinion on the future of the economy and stock market in an interview with Bob Woodward and Robert Costa of the Washington Post. Trump said in the interview that economic conditions are so perilous that the country is headed for a very massive recession and that its a terrible time right now to invest in the stock market, embracing a distinctly gloomy view of the economy that counters mainstream economic forecasts and the current FOMC members.
The New York billionaire dismissed concern that his comments which are exceedingly unusual, if not unprecedented, for a major party front-runner could potentially affect financial markets.
I know the Wall Street people probably better than anybody knows them, said Trump, who has misfired on such predictions in the past. I dont need them.
Defending the Fed's Rate Hike & Denying a Bubble Economy:
Apparently, Trump's remarks scared Janet Yellen, who attempted to refute them during the April 7th panel discussion. Ms. Yellen, who succeeded Bernanke as Fed Chairperson in February 2014, was first asked by moderator Zakaria whether she felt the Fed's 25 bps rate increase in December 2015 had been a mistake. In January 2016, the global economy slowed and financial markets went into a tailspin triggered by rising oil prices and increased weakness in China.
I certainly don't regard it as a mistake,'' Yellen said referring to December's interest rate hike. Despite the global weakness, the U.S. economy remains on a solid course, she added.
Yellen disputed the suggestion that the Fed's low rates could be fueling a bubble economy, as implied by Zakaria.
Curmudgeon Note: Volker didn't name those, but one would expect he was primarily referring to financial market derivatives. You can read about OTC derivative statistics here.
Photo Courtesy of Associated Press. Federal Reserve chairwoman Janet Yellen alongside past chairs Ben Bernanke and Paul Volcker on April 7, 2016. Alan Greenspan joined via a video stream link.
The Fed leaders remarks denying a bubble economy were in sharp contrast to the conventional wisdom of the contemporary Republican party and many grassroots conservatives that excessive stimulus from the Fed (ZIRP and many rounds of QE) is either on the verge of sparking a drastic uptick in inflation, or already fostering a stock market or asset bubble.
-->The Curmudgeon and I agree with the conventional bubble wisdom, which is further documented below. Please see Evidence that Bubble Economy is a Reality.
Future Fed Rate Hikes: Last December, the Fed indicated that the pace of future rate hikes would be gradual and Yellen said that remained the Fed's expectation. The central bank's quarter-point move in December was the first rate hike after seven years in which the benchmark Fed Funds rate was kept at a record low near zero. Many private economists believe the next hike will not occur until June.
Yellen said: We think that a gradual pace of rate increases will be appropriate. The prospects for continued growth and progress in the labor market look good.''
Counterpoint: According to John Williams' in-depth April 1st report, Shadow Government Stats Report:
"The revamped aggregate UPSIDE BIAS for the trailing twelve months through March 2016 was 888,000 up 107,000 or 13.7% from 781,000 in December 2015. -->That means 74,000 jobs per month are assumed to have been created, but is a fabricated number and NOT real!
Limits to Fed Monetary Policy:
The Fed chairs also appeared to agree that there were limits to what the Fed could do on its own. Bernanke was particularly insistent that the Feds impact was limited by Congress march to cut spending under his watch. He cited a 2013 Congressional Budget Office report that found that the across-the-board budget cuts put in effect through sequestration, would significantly reduce economic growth.
Im not saying that the government should always be spending, Bernanke said. But at certain times, particularly in a recession, when the central bank is out of ammunition or ammunition is relatively low, then fiscal policy does have a role to play, yes.
Opinions that Bubble Economy/Markets are a Reality:
Trump's main man is Carl Icahn who is worth over $20 billion gained from trading and investing in companies. He said in September 2015:
"I think markets are overpriced, earnings are misstated No doubt, the market has come to depend on the Federal Reserve and the money printing and zero interest rates that have paved the way for more than $2 trillion in stock buybacks since the end of the Great Recession. Icahn's warning, though, came amid heavy market volatility that may simply have exhausted itself by the time he made the rounds justifying his downbeat assessment. Many have noted Carl has been bearish for a while, so his video is nothing new."
-->Global equity (and high yield bond) markets have not yet gone down beyond the first two months of 2016. They've rallied strongly from the decline that ended in early February. However, the fundamentals have gone Icahn's way. The market disconnect is a puzzle to many professionals, as we've detailed many times in previous Curmudgeon blog posts.
Matt Egan of CNN who wrote a piece titled: Here comes the worst earnings season since Great Recession
"The recession in corporate profits is about to get even uglier. Blame the oil crash and strong dollar. Wall Street is bracing for a 7.9% plunge in first-quarter profits in S&P 500 companies as earnings season kicks off next week. That would be the deepest decline since 2009, according to S&P Global Market Intelligence."
Also among the Bears is The Royal Bank of Scotland (RBS), which in January warned of a "cataclysmic year" ahead for markets and advised clients to head for the exits.
Do not wait. Do not pass go. Sell everything except high quality bonds," warned Andrew Roberts of RBS. He said the bank's red flags for 2016 (falling oil prices, volatility in China, shrinking world trade, rising debt, weak corporate loans and deflation) had all been seen in just the first week of trading. "We think investors should be afraid," he said.
Then there's Society Generale as detailed in "SocGen Swings From Biggest Bull on Europe Stocks to Most Bearish," by Roxanna Zega of Bloomberg.
We trim our equity market forecasts in light of the downgraded U.S. economic outlook, SocGen strategists led by Roland Kaloyan wrote in a report. We nevertheless maintain a positive stance on equities, as the recent correction already prices in this scenario to a certain extent. Equity indices should recover in the second quarter from oversold levels, followed by low single-digit quarterly declines in the second half of the year.
Finally, David Stockman's Contra Corner has warned of an imploding economic and financial bubble for several years. His latest post is titled: Simple JanetJabbering On the Edge of A Live Volcano.
Sidebar: Jamie Dimon's Letter to JP Morgan Shareholders
While "The Donald " is not known for his economic abilities he seems to have an indirect compatriot in Jamie Dimon, CEO of Chase/JP Morgan Bank, the largest U.S. bank with over $2 trillion in assets. Dimon wrote in a letter to investors, reported on April 9th by Zero Hedge titled Another Crisis Is Coming: Jamie Dimon Warns of the Next Market Crash:
Recent activity in the Treasury markets and the currency markets is a warning shot across the bow.
Dimon further states (bold font added): Then on one day, October 15, 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations an unprecedented move an event that is supposed to happen only once in every 3 billion years or so (the Treasury market has only been around for 200 years or so of course, this should make you question statistics to begin with).
Amusingly, Dimon seems to confuse cause and effect, as its really not the fault of statistics per se, but rather the fault of shifting market dynamics1 that have rendered the old statistical models obsolete.
Note 1. By dynamics we mean increased manipulation and never-before-seen financial market distortions and dislocations.
But at least Dimon sees that move in Treasuries and recent similar shakeups in FX markets for what they are: warning shots across the bow. In particular, Dimon noted turbulent FX conditions: Some currencies recently have had similar large moves. Importantly, Treasuries and major country currencies are considered the most standardized and liquid financial instruments in the world."
He engages in a thought experiment as to what the next financial crisis might look like and draws this conclusion:
The items mentioned above (low inventory, reluctance to extend credit, etc.) make it more likely that a crisis will cause more volatile market movements with a rapid decline in valuations even in what are very liquid markets. It will be harder for banks either as lenders or market-makers to stand against the tide.
Next, Dimon addresses the illusion of liquidity in financial markets:
There already is far less liquidity in the general marketplace: why this is important to issuers and investors.
Liquidity in the marketplace is of value to both issuers of securities and investors in securities. For issuers, it reduces their cost of issuance, and for investors, it reduces their cost when they buy or sell. Liquidity can be even more important in a stressed time because investors need to sell quickly, and without liquidity, prices can gap, fear can grow and illiquidity can quickly spread even in supposedly the most liquid markets.
You can read the entire 39-page letter here. ..
1. We could go on and on, but hopefully you get the point. Trump and others we've quoted are not alone. We know Yellen can't agree with the bubble scenario, but is she being truthful or least untruthful?
Let's reflect on what James Clapper said at the tail end of a rare open session of the Senate Intelligence Committee on March 12, 2013. Senator Ron Wyden, D-OR, asked National Intelligence Director James Clapper whether intelligence officials collect data on Americans. Clapper responded "No, sir," and, "Not wittingly."
THIS WAS DONE UNDER OATH. However, later in the interview, Clapper said: So, I responded in what I thought was the most truthful, or least untruthful, manner by saying no.
Yellen, who is not under oath, can therefore say anything that is "least untruthful." That appears to be the standard response of U.S. government officials/leaders these days. In this case, Yellen said the U.S. economy is on a solid course" but did not smile. Do you seriously believe her vs others we've cited above that disagree?
Of course, Yellen's "solid course" is based on "interventionism," assuming you wish to believe the U.S. is performing well and she is correct. The essence of the interventionist policy is to take from one group to give to another." (Ludwig Von Mises). For many years that was accepted. But in the last few years, central bankers, like Bernanke & Yellen (U.S.), Draghi (EU) Kuroda (Japan) and Carney (UK), have pushed the envelope beyond imagination. Very little economic growth has been "solid." It is more like an iron lung policy.
2. Is the U.S. stock market in a bubble? Let's look at the increase in U.S. stock index prices vs GDP growth rates.
-->You can be the judge on whether we are in a stock market bubble or not?
3. Now we all know this is the 82nd month of the U.S. economic recovery (from June 2009). It's a very old economic expansion that has been aided and abetted by extraordinary monetary policy (years of zero interest rates and QE). Yet the U.S. continues to experience very sluggish economic growth.
-->Yet the U.S. economy is on a solid course? Who's kidding whom? ..
4. Two historic recurring economic occurrences are "reversion to the mean" and "the business cycle."
Will the brilliant mentality and analysis of Fed Chairwoman Yellen and her Fed head colleagues be able to negate the former and suspend the latter? We don't think so!
In trying to repeal these historically guaranteed economic events one should ponder Doug Kass' insightful quote describing a bubble2:
When everyone thinks central bankers, money managers, corporate managers, politicians or any other group are the smartest guys in the room, you are in a bubble. (The Street)
Note 2. Other bubble quotes we especially like can be read
Good luck and till next time...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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