Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. Our Web Software does not permit embedding of the clips into our articles. So we shall have to be content to include the links to the actual videoclips. We are very happy with the tremendous response from readers to this series of articles. We thank them sincerely and profusely.
This is an article that expresses our personal opinions about comments made on Television and in Print. It is NOT intended to provide any investment advice of any type whatsoever. No one should base any investing decisions or conclusions based on anything written in or inferred from this article. Investing is a serious matter and all investment decisions should only be taken after a detailed discussion with your investment advisor and should be subject to your objectives,suitability requirements and risk tolerances.
Absolute Power Corrupts Absolutely?
During this year, we heard experts tell us that there is a civil war at the Fed between the hawks and doves. We did not believe it. It is the nature of that Institution to discourage and disallow serious public dissent. When it comes time to making the final decision and articulating it to the world, the Chairman is the only one that counts at the Fed.
Chairman Bernanke demonstrated this with total clarity this week. Then he stated it again for the world to read in the Washington Post. He proved that he is today the Financial President of the United States (see our Oct 9 – Oct 15 Videoclips article) .
He is also the acknowledged expert on the Great Depression. It is his personal mandate to make sure that his Fed does not repeat the mistakes of the 1930s Fed. That is what he had promised Milton Friedman and he delivered on that promise this week.
Two years ago, in the depth of the financial crisis, he was not as sure as he was this week. During that period, he met with and sought advice from large investors, Wall Street dealers as well as the political establishment. This time, he did not need such counsel. He turned a deaf ear to published counsel from large, smart, experienced investors. He knew what was needed and he took the action he saw fit.
This is the behavior of dictators or all-powerful politicians. This was the action of Bernanke, America’s Financial President as we termed him in our article on October 16 .
Did any one see or hear from Tim Geithner this week or the week before? After one televised speech and one article, Mr. Geithner disappeared from public view. We have never seen this invisible a Treasury Secretary. The Obama Administration, in our opinion, washed its hands off Economic Policy after the public removal of Larry Summers.
This has left Dr. Bernanke as the sole leader of America’s Financial System, a virtual Emperor as it were. This week, he showed that he was up to the role by committing America’s financial system to a novel, bold and a huge adventure. We hope for all our sakes that he is proved correct.
However, the point is not whether Bernanke proves correct. The point is America is not supposed to be run this way. The American System was set up to function in disagreement, in vehement, sometimes vitriolic, debate and to end up in a compromise that does not stake all on one bet. This is why America has made many, many small mistakes since its formation but America has never made a big mistake.
America’s founding fathers knew that Absolute Power Corrupts Absolutely. They knew that if making laws was made easy, the people in power could turn America’s ship quickly and in any direction they chose regardless of the wishes of the American people or their long term welfare.
This is why we are very disturbed by the bold, unilateral and lonely gamble of Chairman Bernanke.
Bernanke’s Focus – The USA & only the USA
Various countries in the world have expressed their severe disapproval of the QE2 program announced by Chairman Bernanke. Brazil promised retaliation, Germany called QE2 clueless. We don’t think Chairman Bernanke cares. His mandate is not the welfare of the world or the preservation of the world’s financial & trade system. He does not care whether his actions create a bubble in Emerging Markets.
Bernanke is solely concerned about the American economy and America’s Banks. His inflation mandate now forces him to create inflation or increase current levels of inflation expectations. His growth mandate now forces him to add liquidity to America’s system in the hope animal spirits will be awakened and consumer spending will increase.
If that debases the U.S. Dollar, so be it. He thinks he knows how to tighten later and restore the Dollar to appropriate levels. He thinks he has substantial room to raise inflation before it gets to be a problem and in any case he thinks he knows how to squelch it when it does become a problem.
That is his conviction and he has used the awesome power at his disposal to commit America to his conviction.
If the rest of the world doesn’t like it, they can lump it. What can they do anyway? The deluge of money from Bernanke will flow into the high growth economies of the world, force their currencies to rise, increase the spending power of their consumers which shall in turn raise their spending. The decline in the Dollar will make America’s exports more competitive, punish mercantile nations like China & Germany for keeping their own currencies too low and help meet President Obama’s objective of doubling US Exports over the next 5 years. What’s not to like?
Perhaps, one tiny bit of inconvenient detail. In our opinion, the biggest problem for America’s families is Lack of Income. Bernanke’s solution is likely to make this problem worse, much worse before the benefits of his great solution trickle down to the folks.
- Bernanke’s QE2 will take short term rates down to negligible levels even lower than they are today. This will take down CD rates for American families to negligible levels. A hard hit on the key source of their investment income.
- Bernanke’s QE2 will raise prices of essential commodities to higher levels. Gas, groceries, heat and all essential commodities will rise to levels that will drain further income from already income-starved American families.
- The growth in emerging markets will encourage more and more operations to be moved overseas to capture the increased spending power. That means more jobs will be created overseas rather than in America.
We just don’t see how Bernanke’s QE2 will help Americans to get jobs, earn wages or investment income to support their families BEFORE the benefits of Bernanke’s vision kicks in.
The markets think that if QE2 does not work, he will do QE3, then QE4 and so on. This seems to us a real life implementation of Gambler’s Ruin. In this game, great fortunes are guaranteed if the player has unlimited capital and infinite time. Unfortunately, the game also guarantees bankruptcy if capital is limited and high probability of failure if time is finite.
The American people are not famous for their infinite patience as the Japanese are. Despite Bernanke’s beliefs, the American printing press is not capable of printing unlimited amounts of money.
But our analysis could be totally wrong. And Chairman Bernanke might well create a new virtuous circle, as he termed it.
Goodbye, Greenspan Put – Hello, Bernanke Collar
For years, we have heard about the Greenspan Put and then about the Bernanke Put. That’s so last bubble!
This week, Chairman Bernanke introduced the concept of what can only be called as the Bernanke Collar. This is the first time in our memory that the sitting Fed Chairman has called for higher stock prices. His words should be read again and again, we think:
- “And 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 cycle, will further support economic expansion.”
We felt so dumb after reading this. We have misjudged Ben Bernanke since 2003. Recall that he made the “helicopter” comment in the spring of 2003 after the stock market had begun its rally in March 2003. His comments, as we now see, were not designed to reassure about the economy but to push the stock rally higher. His behavior in the fall of 2007 was more obvious. Everyone of his easing moves was exquisitely timed to deliver support when the stock market was about to break down.
Is this why Chairman Bernanke delivered QE2 even when some economists think the economy is on the mend? They just don’t get it. QE2 is not about the economy. It is fuel for the stock rally. So investors should not fret that Bernanke would lose his nerve about QE2 if economy starts improving and data comes in stronger. He might actually step harder on the accelerator to keep it going.
If we are correct, then Bernanke has delivered a Zero-Cost Collar to stock investors. He has delivered a long put and a short call on stock portfolios. And this is a Knock-Up Collar. As stock prices rise, the strike price of the long Bernanke Put rises and the strike price of the short Bernanke Call also rises. So stock investors remain automatically hedged.
Our hats off to David Tepper for recognizing this simple fact back in September. That is why he is the master. That is why the words Tepper Corollary have entered the current investment lexicon.
Virtuous Circles Within a Vicious Ellipse?
The Emerging Market Debt crisis and Long Term Capital debacle in 1998 was a frightening event for investors. Chairman Greenspan was deeply concerned. He wanted to awaken animal spirits and create a virtuous cycle to change psychology. So Greenspan pumped liquidity to such an extent that he created an investment bubble in stocks and in technology-telecom sectors. When that bubble burst in 2000-2001, millions of American investors lost enormous amounts of money.
In 2003, two years after that bust, Greenspan became concerned about falling into a Japan-like deflationary trap. So he decided to add fuel to an already recovering economy by creating a new virtuous cycle in a different asset class, Housing. His goal was to awaken animal spirits and raise housing prices to a level that would tempt Americans to spend.
Again he was successful. House prices rose to extraordinary levels and Americans spent their new wealth. Greenspan kept rates low and created beautifully virtuous circles in Housing & Credit. The virtuous circles turned into full fledged bubbles. When these bubbles burst in 2008, the balance sheets of American families were destroyed, Banks got into deep trouble and the global economic system nearly broken down.
Now two years after that bust, Bernanke is increasingly concerned about falling into a Japan-like deflationary trap. So he has decided to add fuel to what appears to be a nascent recovery of sorts by creating a new virtual cycle in a different asset class, Stocks. His goal, like Greenspan’s in 2003, is to awaken animal spirits and raise stock prices to a level that will tempt Americans to spend. His goal is to force American Institutions and Individuals to buy stocks by making safe assets totally unattractive.
If Bernanke is successful, wouldn’t every Pension Fund end up owning massive amounts of equities just as American families ended owning too much housing in 2007-2008? Then, when the music stops, wouldn’t American Pension Funds find themselves in just as much trouble as American families found themselves in 2008? What would happen then to Firemen, Police, teachers and millions of Americans who rely on pensions for their survival? What would happen to the American people who get themselves fully allocated to stocks just before the inevitable fall?
Listen to the biggest supporters of Bernanke’s QE2. Listen for example to Barton Biggs (see clip 4 below). Mr. Biggs has no confidence that QE2 will succeed and benefit America. All he says is stocks will go up for the next 6 months or so. We have no found one serious voice, one solitary experienced voice who argues that creating a new virtuous cycle by inflating stock values is a real solution to America’s problems.
If Bernanke succeeds like Greenspan did in 2003-2006, if we see a new stock bubble (that even Biggs contends is possible) in the next couple of years with QE2, QE3, QE4 etc., then the bust in the stock market would be one for the ages. Would that bust lead the Dow to levels of 5,000-4,000-2,000 that Elliott Wavers and Cycle Theorists like Robert Prechter, Charles Nenner and Walter Zimmermann have forecast?
That would complete the elongated Vicious Ellipse investors have lived with since 1998, an ellipse which contained and confined the 3-4 virtuous circles created with the best of intentions by Greenspan and Bernanke.
The Anti-QE2 Investment
Almost every asset class went up in the aftermath of the Bernanke QE2 announcement. All except the 30-Year Treasury Bond. The sell-off in the 30-Year Bond was severe and fast. It continued on Friday afternoon when the Bond closed at its low for the day. The yield curve steepened to the unprecedented level of 155 bps for the 30-10 year yield spread and to the utterly ridiculous level of 304 bps for the 30-5 year yield spread.
We have devoutly wished for a steep sell off in long maturity treasuries. Thanks to Chairman Bernanke, our wishes might come true. Our favorite chant in 2006 & 2007 was “Give us 5, Dr. Bernanke!”. Buying the 30-year above 5% in June 2006 and June 2007 proved wonderful to the investment health of buyers. Oh, if we could get a 5% Bond again in 2011!
We might seem insane to most readers with our desire to buy the 30-Year Treasury Bond at an attractive yield level. But we are not alone. We actually heard someone on CNBC say that the 30-Year Bond is attractive at this level. This gentleman actually likes the 30-Year Zero Coupon strip as an investment today (see clip 1 below). This is like Frederick’s cry “L’Audace, L’Audace Toujours L’Audace” (see clip 1 below).
This gentleman, Jeff Kronthal, the famous voice of sanity at Merrill Lynch, is not alone in his audacity. Jan Hatzius of Goldman Sachs said that he does not expect QE2 to create inflation and his colleague Francisco Garzarelli predicted that the 30-10 year yield spread would fall from its current unprecedented level of 155+ bps to 110 bps, also historically unprecedented but much less so than 155 bps.
Treasury Auctions of next week should be fun to watch, especially the 30 year Treasury Auction.
- Jeff Kronthal on CNBC Strategy Session on Friday, November 5
- Richard Volpe on CNBC Fast Money on Wednesday, November 3
- Bill Gross & Ken Volpert on CNBC Street Signs on Wednesday, November 5
- Barton Biggs and Bill Fleckenstein with Bloomberg’s Betty Liu on Friday, November 5
- Julian Robertson with CNBC’s Erin Burnett on Thursday, November 4
- Chinese Professor – Ad by Citizens Against Global Waste
1. Bond Bubble Bust? – Jeff Kronthal on CNBC Strategy Session (05:11 minute clip) – Friday, November 5
Jeff Kronthal is now the Co-CIO of KLS Diversified, a Fixed Income Hedge Fund. He is much better known for his role at Merrill Lynch as one of the few men who could have saved that Firm had their warnings been heeded.
We value simplicity because true simplicity is both profound and hard to achieve. Listen to Mr. Kronthal explain why long dated Treasuries and treasury strips are so attractive to him. His audacity in the face of loud consensus is why we award this week’s pole position to this clip.
Read the summary of his comments at Long-Dated Treasurys are Real Opportunity on cnbc.com. A few excerpts are below:
- The market hasn’t fought the Fed and the fixed-income markets, either, and the government markets, so the belly of curve, which is where the Fed is focused at the moment, has rallied pretty significantly,
- The orphan child is the 30-year bond, the spread between 10s and 30s has widened pretty dramatically—widened into the announcement and has probably widened 15-to-20 basis points post the announcement,
- We look at long-dated Treasury strips as a real market opportunity. The long-dated ones yield around 450, they have positive convexity—meaning they get longer as the market rallies, and shorter as the market trades off,
- We really think they are, in most scenarios, gonna outperform the rest of the fixed-income market,
Mr. Kronthal explains his viewpoint about inflation simply and effectively:
- if real yields are supposed to be 1-1.5%, in that Bond is built in 3% inflation that is running 1%, you really have some room for inflation to go up and you are making a long term bet that the Fed can control it beyond 3%…..I would argue that the market is missing a couple of things about the fed announcement of QE2 and that is, they announced what part of the curve they buy and how much, they actually gave themselves some walking room in there, they said 5-6 year duration and there is nothing to say if we get to Jan & Feb and the long bond has underperformed that they won’t at the margin just shift more of their buying power into the long bond and there is not a lot of long bond issuance …that could be just the shift of QE2 in terms of where they buy and if they start buying the long bond and that starts performing against the 10-year, these long strips really outperform..
Now that is what we call a strategy session!
Later, Mr. Kronthal added that governments that want to push up the dollar may not have any choice but to buy Treasuries, a point that Richard Volpe of RBS makes in clip 2 below:
2. Will QE2 Work? – Rich Volpe on CNBC Fast Money (at minute 11:44 of the 17:27 minute clip) – Wednesday, November 3
Richard Volpe is the Head of USD Rates Trading at RBS. Some excerpts are below:
- Melissa Lee – I got a really interesting note from an economist this afternoon already talking about QE3 & QE4 and that the size of the Fed’s balance sheet could reach 4 trillion dollars in assets in the next year or two. Where do you stand on how big QE2 was?
- Rich Volpe – It came in a 100 billion more than the expectations of the street, the disappointment…we actually closed with lower prices today in Bonds and I think that reaction was, this was well anticipated , we rallied over the last 2 days on the thought process that they may extend the duration out given a more bang for the buck, they didn’t do that, its 5-6 years but it is 600 billion..we are talking about 5-6 billion a day..there’s a lot of buying power here…
- Melissa Lee – What is the tradeoff in this then? Do you buy the shorter end of the yield curve or do you go in the 30-years since we sort of corrected to pre-chatter of buying out on the yield curve?
- Rich Volpe – Absolutely not. I don’t think you buy the front end of the market…they talked about the duration as 5-6 years but 70% of the purchases take place between the 4 & 10 yrs and they eased the restrictions on the 35% buy rules so that they can buy rich portions of the seasoned paper..I think the intermediates are going to lead the market, we have a fair amount if supply next week and look to buy the dips and even though they are not buying the long bonds, I think 10 basis points back from here the private sector would come in, the pension funds will support the back end of the market..
In response to a question from Joe Terranova, Mr. Volpe added:
- “exporting countries around the globe are gonna look to buy dollars and sell their own currencies to protect their exporting businesses, those dollar FX reserves are gonna go into the Treasury market, I think a conservative estimate is 50%…it just adds more bang to the buck, you really need to be long intermediate Treasuries here.”
3. The Fed Decision – Bill Gross & Ken Volpert with CNBC’s Erin Burnett & Steve Liesman (12:42 minute clip) – Wednesday. November 3
Bill Gross & Ken Volpert, two managers of huge bond funds react on air to the Fed announcement. After the Fed announcement, Steve Liesman asked Bill Gross whether this was a “sell the news” moment? Bill Gross replied:
- “We have been buying over the past two months in anticipation of this statement. I think the statement was relatively neutral compared to what the market expects Erin, I think what investors need to know not just bond investors but stock investors as is where inflation is headed because as clearly you pointed out in the statement, they pointed it out twice that inflation was too low and their target is ….certainly 2% and may be even higher in price terms. So what an investor needs to focus on is not really the level of interest rates or even the six month period of time which is really the second stage rocket here, a rocket needs 3 stages to get into orbit and this is the second stage, to the extent that the Fed needs to get to 2% or wants to get to 2%, that may take longer than 6 months in answer to your question about selling or buying Treasuries, those who should have bought them have bought them already and that includes Pimco and we would be looking forward to handing them off so as to speak as we accelerate towards that outer orbit”
Come on, Mr. Gross, can’t you speak simply? Isn’t your answer that you have bought already and you will look to sell when inflation starts becoming more evident? Your convoluted answer above is sort of why we sometimes compare you to Talleyrand and his maxim of “Speech was given to man to conceal his thoughts”.
Then Erin Burnett asked Ken Volpert “do you see it the same way?” Mr. Volpert replied:
- ” I think the 600 billion is already priced into the market. We have seen it with a nearly 60 basis points drop in yields. Nominals haven’t really declined much because inflation expectations have increased which is what the Fed wants. Basically, the market is pretty fully priced in not just the Bond market but also the Stock market has priced in a lot of this news. We have seen a pretty good move in stocks, the Dollar has declined about 7% since the last Fed announcement ..so there has been a a lot of things that are already priced in reflecting this announcement that came out today….”
Well, Mr. Volpert, your analysis was off the mark, wasn’t it? Look at the violent move in the yield curve on Wednesday afternoon and on Thursday. Look at the explosive rally in the stock market, in Gold and the sell-off in the Dollar on Thursday. Is that what you call “priced in”?
After reading and watching the first two clips, we cannot but feel disappointed in the analysis and predictions of these two Bond Kings.
4. Barton Biggs with Bloomberg’s Betty Liu – Friday, November 5
This is a terrific clip. Barton Biggs says that the Fed was absolutely right with its QE2 announcement. Bill Fleckenstein thinks it is downright dangerous for the economy. Barton Biggs says that QE2 will make stocks go higher and that is what he as an investor wants. The issues raised by Bill Fleckenstein are more long term and relate to the impact of QE2 on the economy.
We strongly urge all to view this clip. It is probably the best debate we have seen on QE2.
5. Julian Robertson with CNBC’s Erin Burnett – Thursday, November 4
Julian Robertson, the founder of the Tiger Fund, is a legend in the hedge fund industry. Usually we like to listen to him just as we like to listen to George Soros, sometimes called the greatest investor of our era. But George Soros can often lead you astray with his public pronouncements even though his performance is usually superb. That is because he understands the difference between opining on TV and trading real money. Julian Robertson is similar, but more on that later.
Read the entire transcript of his conversation with Erin Burnett. You will see that Mr. Robertson is worried about inflation and discusses his favorite analogy to Zimbabwe.
We recall hearing this before from him. So we decided to go to cnbc.com and listen to his interviews with Erin Burnett in October 2008 and September 2009. We found the same obsession with inflation and recommendations of trades to benefit from hyper-inflation.
Julian Robertson’s Market Outlook – Monday, October 13, 2008 (at minute 01:45 of th 05:02 minute clip)
- My favorite trade right now is something I didn’t even know about probably 15 months ago; its called a curve steepener and that is a derivative which pays the… difference between two year interest rate on government bonds and the 10-year and the 30-year and my thought is that the Federal Reserve will continue to be very accommodative and they can help the 2-year rates a great deal; they have no control over the 10 & 30 year rates and I think gradually people will shy away from those particular investments particularly as the Dollar continues to weaken and so I think the curve steepener is best hedge I know against inflation and I think we are gonna have some inflation.
Well, Mr. Robertson was rather wrong. The 10-year and 30-year rates collapsed from November 1, 2008 to the first week of January 2009 with the 10-year yield dropping to 2% and the 30-year yield dropping to 2.5%.
Robertson on Markets – Thursday, September 24, 2009 (02;25 minute clip)
- As you can tell, I am not as beserk about owning stocks as I am shorting bonds…..I think we are going to have to pay the piper. I don’t know when that is but I would say we are going to pay the piper and it is when not if….meaning that if interest rates are going to go up and I would think what would go along with that in my kind of interest rate scenario that would put the brakes on the economy and earnings would go down like crazy but you know if we have 20% interest rates and 20% inflation and the stock market goes up 5% its not a really good scenario.
Probably, shorting bonds did not work too well for Mr. Robertson. Rather than go to 20%, interest rates went the other way. Today, the 10-year Treasury yields around 2.5%.
We find this very revealing and instructive. Mr. Robertson is one of the truly great investors. But even the great ones have their own blind spots. Blindly following them can lead to investment mistakes. The other lesson is just as instructive. Despite such totally wrong predictions, great investors like Mr. Robertson never suffer huge losses. This is because they follow their trading disciplines and limit their losses. That is a lesson we urge every single investor to follow.
We don’t blame Ms. Burnett for not pressing Mr. Robertson about his wrong predictions. He may not agree to further interviews if he is embarrassed on air. Then the loss would be ours. Ms. Burnett can find other guests but we may not find another Julian Robertson to listen to.
6. Chinese Professor – Ad by Citizens Against Government Waste –
Probably every one has seen this commercial. In case some one has not, we include it below.
The first 5 minutes or so of clip below feature a discussion between Tom Schatz, President of the Non-Partisan group Citizens against Global Waste and Neil Cavuto of Fox Business.
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