DAVE TEPPER, THE BOND MARKETS, INFLATION, AND THE FUTILITY OF CALLING MARKETS

9/5/14

Dave Tepper, the former Goldman trader who runs Appaloosa, one of the country’s more successful hedge funds, said yesterday

"It's the beginning of the end of the bond market rally. We are done." 

People in the market, or anywhere, for that matter, don’t get much smarter than Dave Tepper; see AN AMERICAN MANUFACTURING RENAISSANCE; IT’LL TAKE MORE THAN CHEAP ENERGY, 5/15/13  Still, I don’t know if he’s right or wrong here, and I’m not being coy by saying, as is the fashion nowadays, of saying “I don’t know if he’s right here” when one means “He’s wrong here.”   I genuinely don’t know whether Mr. Tepper is right because I fervently believe that very few people, even people as smart as Dave Tepper, can consistently call markets; see the already seminal BULLS,BEARS, AND BRAINS:   THE RELENTLESS PURSUIT OF THE FOOL’S ERRAND OF CALLING THE MARKETS, 8/29/14. But if Mr. Tepper is right about the bond markets, and there is about a 50/50 chance that he is, it won’t be because of the Fed, or at least not because of the Fed in the way that most people say. 

If the bond market rally is over, it will be because the inflation that we all see around us will finally find its way into the government’s questionable statistics and maybe into the markets.  But old guys like yours truly have been saying that inflation is just around the corner for years…and those of us who pay for college tuition, health care and insurance, gasoline, food, cars, restaurant meals, airline tickets…you know, those things that Wall Street tells us are inconsequential, have seen it.  But the government, and the markets, tell us that what is as plain as the noses on our faces doesn’t exist.  When they finally open their eyes and stop playing games, though, there is no doubt that Dave Tepper and like minded souls will be proven correct in their predictions of higher bond rates.

QUINN ON REDFLEX, RUBIO, ST. GERARD, DEBT, AND INFLATION

5/15/14

Since October, 2012, when the Tribune first broke the story, I have written that Redflex would turn out to be a huge story; now more chickens are coming home to roost on that front.  So I had to find time yesterday evening to write on that ongoing saga.  As things have slowed down just a bit, I’ve also managed to write on the economy, national politics, and the Church:

THE REDFLEX SAGA:  THE GIFT THAT KEEPS ON GIVING FOR CHICAGO POLITICAL JUNKIES

http://www.rantlifestyle.com/2014/05/14/redflex-saga-endless-entertainment-for-chicago-political-junkies/

Back in April, 2013, I spoke at a men’s club meeting at St. Margaret Mary here in Naperville and said that Redflex was the story to watch.  My prediction seems to be being vindicated.

BIZARRONOMICS:  FALLING CREDIT CARD DEBT IS BAD

http://www.rantlifestyle.com/2014/05/14/bizarronomics-falling-credit-card-debt-is-bad/

MORE BIZARRO ECONOMICS:  INFLATION IS GOOD

http://www.rantlifestyle.com/2014/05/14/more-bizarro-economics-inflation-is-good/

No, really…some of my best friends are economists.  One introduced me to my wife which, in our case, worked out very well.

MARCO RUBIO:  EVEN THE BEST POLS ARE FRAUDS

http://www.rantlifestyle.com/2014/05/12/marco-rubio-even-the-best-pols-are-frauds/

The incomparable H.L. Mencken saw the likes of Marco Rubio, and just about every other modern politician of all “ideological” and partisan stripes, coming.

THE CATHOLIC CHURCH, WOMEN, EXPECTANT MOTHERS, AND ST. GERARD

http://www.rantlifestyle.com/2014/05/12/the-catholic-church-women-expectant-mothers-and-st-gerard/

St. Gerard was a great guy, and I hope he’s praying for me.  But does empathy count for anything in the Catholic Church?

I thought I’d get this out early since the Redflex story is splayed across this morning’s headlines in Chicago.  Have a great weekend, everybody, and go (other) Hawks!

GOLD AND BONDS: STRANGE BEDFELLOWS IN A YIELDLESS WORLD?

5/18/13

Gold has taken a pounding of late, falling over $100 during the last seven trading; the June futures contract closed yesterday at $1364.70, a few bucks over its yearly intra-day low of $1360.90, touched on April 15.   Year to date, gold is down nearly 19%.  It’s been brutal for those of us disproportionately, a relative term in more ways than one, long gold.

As I have said numerous times and written numerous times in this and other forums, determining why an asset or a market has done what it has done is nearly as perilous as predicting what it will do.  But trying to glean meaning from market’s moves is instructive, entertaining, and (only) potentially profitable, so, against perhaps my better judgment, I have come up with a theory for gold’s problems.

One of the explanations for gold’s demise, i.e., no reported inflation (except in asset prices, grist for another mill or for later in this mill), would seem to make sense but is nothing new.  Why, then, should such explanation account for gold’s performance over the last few days?

Another theory, that traders anticipate that the Fed will begin to wind down its bond buying program (See my 5/11/13 post, THE FED’S EVOLVING APPROACH:  REDUCING UNCERTAINTY BY INCREASING UNCERTAINTY) might hold some water.   However, if you believe Mr. Bernanke and his cohorts when they argue that their objective in keeping us drenched in liquidity, and beating the living daylights out of elderly savers, is to support the economy, it doesn’t look like the Fed will take the turbochargers off the printing presses any time soon.  The economy still is only slowly recovering.  

On the other hand, believing anybody one has not known personally, and far more than casually, for at least twenty years is always a perilous proposition.   Believing a politician (And, believe me, these Fed guys are first and foremost politicians or they wouldn’t be where they are.) is perhaps the silliest, most irresponsible activity in which one can engage.  So if, as many of us have long suspected, the real object of the Fed’s money flood is to support the stock market, maybe they are going to start turning off the fire hoses. 

On the third hand (Where’s Harry Truman when we need him?), perhaps the Fed doesn’t dare slow down because the repercussions for the stock market might be disastrous as newbie risk takers decide they don’t have to own stocks to avoid a steady diet of dog food in their old age.

Despite all these hands, it really doesn’t matter.  As long as traders believe that the Fed will be winding down, there will be downward pressure on gold.   Whether those traders are right or not is of little or no consequence.  So the “Fed might unwind” argument for gold’s defenestration has some credibility.

Yours truly, however, likes another explanation for gold’s sudden unpopularity, to wit, gold has no yield in an almost suddenly yield obsessed world.   Gold has, of course, had no yield for the last 7,000 years or so that it has been trusted as a store of value, so what has changed?   The thirst for yield in the Bernanke created yield-parched desert has reached the point at which people are seeing mirages, like “safety” in overvalued high dividend yielding stocks.  (See my 4/29/13 post, YEAH, THE BIG DIVIDEND PAYERS ARE GETTING RICH, BUT…)  In such an environment, people tend to do irrational things…like suddenly feeling the near insatiable urge to toss the old standards over the side in favor of the hottest new item to come down the pike, in this case big dividend payers.  (See my 5/13/13 post, A “THIRST FOR RISK”?:  SOME BASICS ON RETURN, RISK, AND INVESTING .)

One can take this “no yield so no gold for me, thank you” argument a step further.   This disdain for assets with no, or close to no, yield transcends gold and other precious metals.  Notice how a virtually (certainly on a real basis) yieldless bond market has done of late.  The ten year treasury yield has gone from 1.67% at the end of last month to 1.95%.   The ten year reached a low yield of 1.38% last July, when gold was trading with a $1600 handle.   Could it be that gold, a yieldless asset, is trading with treasuries, which Mr. Bernanke have rendered virtually yieldless?

One might argue that of course gold will move in the opposite direction of yields, and therefore in the direction of bonds, because gold purchases are financed either by borrowing money or by foregoing yield.   But I am arguing causation here; perhaps both gold and bonds are getting pounded not for traditional reasons but because traders, and some investors, are abandoning low and no yield assets en masse in favor of big dividend paying stocks.

All this could be so much navel gazing, however, for two reasons.

First, gold is obviously getting pounded because big holders, or big shorters, are selling.   We don’t have to know why and we can’t, in most cases, know why.   So what difference does it make?   Big money people, or a lot of little people money, no longer like gold and have acted appropriately.

Second, the response of yours truly, and those I advise and would advise, will be to do…nothing.  The underlying reason for owning gold, i.e., an utter lack of confidence in the world’s, and perhaps especially, our, central bankers remains intact.   So I am staying in gold.  (See my 4/15/13 post, GOLD:  YES, I’M SCARED…BUT I’M STAYING, perhaps ironically (certainly not presciently) written on the date gold reached its (then) low.)  And when it comes time to rebalance, unless things change, I will be buying more gold and silver, just to maintain my long term allocation to that ancient object of kingly desire (gold and silver, not Zsa Zsa Gabor), not because I have any idea where gold will be going in the short to intermediate run.

GOLD: YES, I’M SCARED…BUT I’M STAYING

4/15/13

As one who is long gold in a substantial, for me, way, of course I’m scared by what that ancient object of kingly desire has been doing of late and for the last several months.   At $1,371.60 the ounce as I write this, gold is down 18% for the year and is so far off its high (I saw and recorded an intra-day high of $1,911.20 on 9/6/11, but the reportage pegs the high lower.) that one with less experience than yours truly might despair (or rejoice, depending on one’s position) of ever seeing that Everestian peak again.

But what am I doing in response to my fears regarding gold?   Nothing.   I suspect, but can never know, that this would be perhaps the worst time to sell gold; getting in the middle of what looks like a margin call induced unwinding of large leveraged positions is never wise.  Further, the underlying reasons yours truly owns gold, the most salient of which is a total lack of faith in the world’s central bankers as a group (See only my latest post on this topic, 4/5/13’s “(BEN BERNAKE) CAN ‘CAUSE HE MIXES IT WITH LOVE AND MAKES THE WORLD TASTE GOOD…”), remain intact.

Of course, I, like anyone else, could be wrong; what we are seeing may be an indication of a worldwide deflation, in which case we, and I, would have far more to worry about than the value of our gold positions.   But, at least for now, I am thinking that a lot of people have thrown in the towel on gold and are taking what remain huge long term gains in the metal and its cousins, such as silver and platinum.   When I rebalance I will act accordingly; if this swoon continues, or even if the prices of precious metals stabilize, I will probably be adding to my gold and silver positions as a part of the normal rebalancing process, which is a few months off at the earliest.

I do want to point out something that I said in my last defense of my Treasury Inflation Protected Securities (“TIPS”) position on 2/2/13, YES, I’M STILL HOLDING ONTO MY TIPS, when I was going over, and dismissing, the alternatives to TIPS:

Mr. Arends suggests that those who are buying TIPS for inflation protection go into real estate and commodities.   I, and those I advise, have plenty of gold and silver exposure, primarily through the ETFs GLD and SLV.   But one has to understand that TIPs and, say, gold, display profoundly different risk profiles and therefore are not ready or obvious substitutions for each other.  (Emphasis mine)

Now readers are getting a vibrant and glaring example of what I was talking about; gold and TIPS have radically different risk profiles and, even though TIPS have sometimes been referred to as “paper gold,” gold and TIPS are not ready substitutes for each other.

Speaking of TIPS…

First, they haven’t done all that poorly since my 2/2/13 post.  The 10 year TIP yield has gone down from a negative 57 basis points to a negative 73 basis points as I write this.  And the ETF TIP has gone up about a point to 122.   Yes, TIPS have underperformed conventional treasuries; the inflation assumption implied by the 10 year conventional and TIP yields has gone from 2.58% to 2.44%.  And stocks, again with a vastly different risk profile, have done far better.  But, on balance, if owning TIPS from the time I advised holding until now is the worst investment you ever make, you are indeed leading a charmed investment life.   If you’d held gold as an alternative to TIPS, you would have been licking your wounds.

Second, that TIPS are down slightly today while conventional treasuries are up, gold is down, and gold is getting pummeled lends credence to the deflationary argument.   But we are looking at one day’s trading, which is largely meaningless.  See, inter alia,  today’s other post, SO WHY HAS THE STOCK MARKET DONE SO WELL OF LATE?

THE NOT SO INCREDIBLE SHRINKING YEN

4/9/13

When we last visited the issue of Japan’s attempts to reflate its economy at the behest of Prime Minister Shinzo Abe (See two posts from the now defunct Rant Finance written early this year and late last year that are reproduced at the end of this screed.), yours truly expressed great concern about this seemingly necessary but inherently dangerous policy.   Now that new Bank of Japan (“BOJ”) Governor, and Abe henchman, Haruhiko Kuroda, has fitted the printing presses at the BOJ with turbochargers that would make native son Speed Racer envious, the obvious results are coming to fruition; the yen hit a four year low against the dollar yesterday.

The obvious response would be something like “Well, what did Messrs. Abe and Kuroda think would happen if they publicly stated that their aim was to print yen with reckless, carefree abandon in an attempt to infuse the Japanese economy with what they consider a salubrious bout of inflation?   Did they think a policy designed to weaken the yen domestically would not have repercussions in the foreign exchange (“FX”) markets?”   But such a question would be naïve.  Both Messrs. Abe and Kuroda knew that the yen would weaken; that was, while not the primary object of their loose money policy, certainly a secondary object.  A weak yen would not only make Japanese industry “more competitive,” according to the textbooks, but also would help domestic prices to rise.

Such a policy is always dangerous, largely because it is hard to put the inflation genie back in the bottle and attempts to make one’s self “more competitive” by weakening one’s currency are doomed in anything but the short run.   (If a weak currency made a country more competitive, Zimbabwe would be the world’s economic juggernaut, but that is grist for another mill.)  But such a policy is, ironically, especially dangerous for Japan, whose primary economic problem for the last twenty or so years has been deflation. 

Japan has the highest debt/GDP ratio in the developed world at 220%.   Yet it still has the lowest government bond rates in the developed world; as I write this, the Japanese 10 year yields 0.53%, less than 1/3 the rate on the U.S. 10 year and less than ½ the rate on the German 10 year.  Part of this is due to Japan’s experiencing deflation rather than inflation and thus having real rates closer to being in line with those of its developed world counterparts than are its nominal rates.   But even on a real basis, Japanese rates are far lower than U.S. and German rates.   Why?   Because Japan’s gargantuan public debt is largely financed domestically due to the formerly enormous Japanese savings rate.   But, as I pointed out in my 12/19/12 post,  SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!, the days of the 44% savings rate (That was in 1990, not in Cro-Magnon times.) are long gone; Japan’s savings rate is now around 2%, or the rate at which Americans declare that we have “deleveraged”…and then go back to our usual custom of excreting away money even faster than we earn it.   But I digress.  This decline in the Japanese savings rate is due largely to demographics; the Japanese population is getting older, and retired people tend to dis-save rather than save.   But it is also partially due to the infection of the Japanese psyche with the type of financial irresponsibility that is endemic to modern America.   Yet another case of our exporting our worst traits, but, again, I digress.

As yen are created by Mr. Kuroda and his subservient, to Mr. Abe, colleagues at the BOJ, Japanese investors pull their money out of yen denominated assets in order to protect themselves against the inevitable deterioration in the yen’s value both domestically and internationally.   This leads to further yen devaluation and starts a vicious downward spiral, further lessening the incentive not only for foreign investors to put money in Japan but, more importantly, for Japanese investors to keep their money at home.   This would be bad enough under any circumstance, but, in Japan, with its 220% public debt/GDP ratio, and which thus needs all the investment, both domestic and foreign, it can get, such a policy could be financial suicide.

The Japanese are very smart people, and one suspects, but can’t be sure, that  Mr. Kuroda nor Mr. Abe are not glaring exceptions to this rule.   However, one wonders how much Messrs. Kuroda and Abe have thought through this loose money, reflationary policy.   Sure, one must break the deflationary cycle and mindset in Japan.  But given the vulnerability wrought by the Japanese government’s inability to put its financial house in order, does the BOJ really have the latitude to so discourage people from financing the government’s debt?  Clearly, yours truly’s use of terms like “financial suicide” does not indicate that I would answer that question in the affirmative.

PROMISED REPRODUCED POSTS:

“I’M TURNING (AMERICAN) NOW!”

1/8/13

It seems that the same Japanese businessmen who were clamoring for a weaker yen now are concerned that new Prime Minister Shinzo Abe’s enthusiastic accession to their desires may be going too far.   The major fear of these captains of Japanese industry is the impact a too weak yen might have on imported energy prices, especially in the wake of Japan’s at least temporary denuclearization.

While the fears of these hard to please business titans regarding energy prices are justified, the larger fear ought to be the impact of a weak yen on the price and availability of imported capital.   As I explained in my 12/19/12 post, SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!, and in earlier posts to which it refers, Japan has the largest government debt to GDP ratio in the developed world… 220%.   Until recently, this wasn’t much of a problem because, with the prodigious savings rate of the Japanese people, this debt could easily be financed internally.   But with demographics, and, to a lesser extent, attitudes resulting in a more Americanesque savings rate of about 2%, Japan increasingly has to import capital to finance, among other things, its government’s budget deficits.   A weakening currency, and a decided and declared government policy to further weaken a currency, does not get international lenders excited about committing capital to a country.  Thus, unless Japan’s political and business leaders put away the Econ 101 textbooks with all their drivel about “terms of trade” and abandon that great nation’s newfound weak yen policy, Japan could face severe financial problems in the very near future.

Yes, a nation finds itself in a precarious position when it must import much of the energy it consumes.   But if you think importing most of a country’s energy leads to problems, consider the more debilitating impact of importing most of a country’s capital.   And Japan will soon be in a position of importing both energy and capital in brogdingnagian quantities. 

Yikes!

SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!

12/19/12

The effective election of third generation Japanese pol Shinzo Abe as Prime Minister last weekend spells trouble for the Japanese central bank.  

To the extent people over here have followed the Japanese election, they have focused on Mr. Abe’s nationalistic foreign policy views.  His most immediate, and at least for now, largest impact, should be on the Bank of Japan (“BOJ”).  Mr. Abe is pushing for abandoning the JGB’s current 1% inflation “goal” in favor of a firm 2% inflation “target.”   He also wants the BOJ to go into the business of creating money to finance government spending.   Perhaps most important, he wants to legislatively chip away at the Bank’s independence so that a even a more reasonable future prime minister will feel less compunction about using the BOJ as an arm of the government.

Having the BOJ join its brethren central banks in the developed world in emasculating its currency would be especially dangerous for Japan.  Japanese government debt stands at 220% of GDP, the highest in the developed world, even if we look the other way and expand the definition of “developed” to include Greece.   As I explained in my 9/21/12 post, JGBs AND THE JAPANESE SAVINGS RATE, this condition has prevailed for years but has not been a problem due to Japan’s historical gargantuan savings rate…as high as 44% as recently as 1990.  With people saving at these prodigious rates, even Japan’s brobdingnagian deficits could be financed domestically.  But now, due to demographics and the importation of more American attitudes toward saving and postponement of gratification, the Japanese savings rate has fallen to levels with which Americans are familiar…around 2%.  Thus, Japan’s customary huge deficits must increasingly be financed overseas; indeed, foreigners now hold about 9% of Japanese government debt, a record.

With Japan having to sell a rapidly growing share of its debt overseas, it is imperative that the yen remain strong.  But with Mr. Abe’s pressuring BOJ President Masaaki Shirakawa to pursue a 2% inflation rate and print money so Mr. Abe can spend more and threatening the central bank’s independence, we are beginning to see a very non-Japanese posture toward the value of the yen.   This should have a decidedly negative impact on the ardor of foreign investors for holding Japanese government bonds (“JGB”s).   Predictably, JGBs have taken a beating in the few weeks since it has become apparent that Mr. Abe’s Liberal Democratic Party (“LDP”) would win the election and are now trading at an eight month high yield of 1.74% on the twenty year.

One could argue that the Fed’s pursuing an expansionary monetary policy very similar to the policy proposed by Mr. Abe has done nothing to hurt foreigners’ enthusiasm for treasuries, and we have to finance a much larger share of our government debt overseas.  But one would be wrong.    More than ¾ of Treasury issuance is now being purchased by the Fed; no one, Chinese, Japanese, or American,  is lining up to buy U.S. treasuries at the prevailing 1.79% yield on the ten year, especially when the reason that paltry yield prevails is the Fed’s creating money to finance the government’s spending.  We will be in for a rude awakening when (if?) the Fed decides to throttle back and we expect our Chinese and Japanese friends to pick up the slack.  If the Japanese adopt American attitudes toward central banking, as they have toward saving, they will face the same problem, but with twice as much government debt, relative to GDP, as we have.