Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. 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.
1. Does/Did Janet Yellen “encourage” bubbles?
The markets are utterly convinced that Dr. Janet Yellen will be nominated as the next Fed Chair. In fact, Bill Gross virtually guaranteed that on BTV Street Smart this week (see clip 1 below):
- “when Janet Yellen and I say when Janet Yellen is appointed… I cannot confirm it. I can give you 99.9% pure that she will be head of the Fed come six months from now”
Is there any one who can claim to know more than Bill Gross of Pimco? The only man who may so claim happens to the man who will actually nominate the next Fed head. President Obama described to CNBC’s John Harwood the type of person he is going to appoint:
- Harwood: “Fed nominee – … A lot of people have said, “Why is he taking so long on that appointment?”
- President Obama: “Well- keep in mind that— Ben Bernanke is still there and he’s doing— a fine job. … The person I’m going to be appointing will end up being somebody who reflects the Fed’s dual mandate…. They’re going to be making sure that— they keep an eye on inflation, that they’re not encouraging some of the bubbles that we’ve seen in our economy that have resulted in bust. But they’re also going to stay focused on the fact that— our unemployment rate is still too high. And ordinary workers out there— still— need— an economy that’s strengthened, aggregate demand that’s strengthened so that we can end up— putting more people back to work with better wages.”
President Obama can only appoint. He retains no post-appointment power to dictate to his appointee or enforce the mandate he has given his appointee. So how he is going to make sure that his appointee is “not encouraging some of the bubbles that we’ve seen in our economy”? Presumably by making sure that his appointee IS NOT someone who has already encouraged “some of the bubbles we’ve seen in our economy”.
Dr. Yellen was the San Francisco Fed president from 2004 to 2010. She became the Fed Vice Chairman in October 2010. So she has been at the Fed during the creation of the credit bubble from 2004 to 2008.
This is why we wonder whether Dr. Yellen did “encourage” that credit bubble? She certainly did not dissent harshly or openly with the 2004-2007 policies of Greenspan/Bernanke, at least not to our recollection. Of course, she might have dissented privately as David Rosenberg claims she did.
The key is whether President Obama believes she “encouraged” that credit bubble. Because if he thinks she did, then would he appoint her as the next head of the Fed given his clear description to John Harwood?
There is no appointment that is as important as that of the Fed Chairman, at least not to global financial markets. There is virtual unanimity in global markets about the inevitability of Dr. Yellen as the next Fed head. That is one huge reason that the global markets remain relatively sanguine in the face of the government shutdown. After all, if the economy gets affected, then you have Yellen to provide even greater QE.
But if someone else is appointed as the next Fed head, someone less eager to tolerate “bubbles” or QE4ever, then the calm may be shattered and markets could face another & more intense attack of taperitis.
So cast your own ballets, dear Readers – Did/Does Yellen “encourage” bubbles?
2. Government Shutdown & Debt Default
Like 99.99% of market participants, we do not believe the Congress will act to create a debt default situation. That would be catastrophic to use Bill Gross’ word (see clip 1 below). In fact, the outrage over the Government shutdown makes a conflict over debt default far less likely. So that may be one positive of the current fight over Government shutdown.
Amazingly, interest rates rose this week instead of benefiting from any flight to quality. Even the 5-year yield rose by 3 bps this week to 1.41% as did the 10-year & 30-year yields. Gold & silver fell while Oil rose. S&P 500 & Russell rose this week while the Dow fell. The data seems fine and a bit softer at the margin which again tells the market about inevitability of non-taper for rest of 2013.
With all this, the markets seem convinced of the inevitability of a strong 4th quarter rally. So every triple-digit decline in the Dow is being bought.
3. U.S. Equities
Many TV pandits seem worried or bearish on the near term prospects for the U.S. equity market. So we begin with the comments of one of the more steadfast bulls of 2013.
Tony Dwyer of Cannacord Adams on CNBC FM-1/2 on Thursday (his year-end S&P target 1760):
- “I think we’re going to have a pretty good fourth quarter so we would be aggressive into the weakness. the fundamental backdrop that caused the market to go up and movement into risk isn’t different. if anything, the DC shenanigans and ineptness between congress and the president will only make the fed postpone the tapering further and that reinforces the movement into risk.”
- “that’s been the case for the last two years. honestly since the valuation low began. I’ve heard in every quarter, earnings margins are at peak, earnings are going to be week weaker than expected, if it were the fundamentals and the speed of the fundamentals that created a movement into risk how come in the slowest economic recovery post-world war ii great depression have we had high yield debt go near record low default rate assumption. Doesn’t make any sense. again, it’s the movement into risk is being created by the need of returns. you just to have the directionally fundamentals right and then that money movement takes care of the rest.”
- “rates move to 3% and that created this fear that we’re going to have the massive economic slowdown. rates moved back to 2.6% which is close to kind of two fed rate cuts of 25 basis points.”
Michael Hartnett of BAC-Merrill Lynch on Friday:
- “Sell DC, Buy SPX – We maintain a core equity and high yield overweight and a tactically bullish stance on EM assets into year-end. … For asset allocators to reduce equities for bonds, we believe DC’s dysfunction needs to be exacerbated by
unambiguously weak economic data and big growth downgrades e.g., 2014E US GDP growth down from 2.7% toward 2.0%.”
Carter Worth of CNBC Options Action on Friday:
- “The first thing I want to talk about is breadth. … breath is deteriorating, it’s been deteriorating for months. We know the stock market made a high in may made new high in August and made a new high in September. Yet, as that happened, if you look at … the number of stocks, that are above their respective 100 day moving average. that peeked at 90%; it’s been declining every month since. We hit a low of 5960, we think this is going lower. But this is a divergence that’s not good. It speaks to fewer and fewer stocks participating, as we get sort of Nifty 50 type action in internet names.”
- “if you will, chart of the S & P.; we have 2000 high, 07 high, and where we are now. What drives this is the participation rate on the part of retail investor. S & P peak in 2000, peak in 2007, where we are now and then what this chart maps is margin debt. – debit balances in margin accounts peaked in 2000. it peaked in 2007. we are now at record levels of borrowing on behalf of retail investors, to buy stocks. this is not a good circumstance”
Lawrence McMillan in his Friday summary:
- The market is getting more volatile and bearish as the combined pressures weigh upon it. … The Standard & Poors 500 Index ($SPX) has support at 1660-1670 and at 1630 below that. There is resistance at 1730.
- Both [Equity-only put-call ratios] are on sell signals now. Both [Breadth indicators] of the ones we watch are on sell signals now.
- In summary, the market seems to be reluctantly slipping into a deeper correction. The bulls have fought this hard, but perhaps they should just let it go, for if oversold conditions truly arise, then that will be the time to buy stocks.
Tom McClellan in his Friday article Summation Indices’ Messages:
- “One of the great magic tricks of the McClellan Summation Index is to tell us when there is or is not sufficient liquidity to continue an uptrend. But the market does not always work perfectly.”
- “The RASI seems to be topping at a lower level of +315 (subject to subsequent action). If it does indeed turn down from here, that would be a much clearer sign that this latest price push is failing from a breadth perspective. But if the RASI instead keeps going upward, and is able to climb up well above +500, then the market will be telling us that liquidity is plentiful and that we can expect even higher highs.”
- “In a similar vein, the Summation Index for the stocks in the Nasdaq 100 Index is also showing a bearish message … But the chart also shows that there is a big divergence between the recent price action and the NDX’s Summation Index“
- “Past divergences like this, even if above +50, have meant trouble. And now we have a pretty decisive looking turn downward. When we couple that divergence with the NYSE RASI’s failure to climb back up above +500 this time, it is a pretty clear message of liquidity problems for the stock market“
Mark Newton of Greywolf via CNBC’s Melissa Lee on Thursday:
- Melissa Lee @MelissaLeeCNBC – Until Aug lows 1627 broken, can’t make bigger bearish case abt pullback being anything more than S-T correction: Greywolf’s Mark Newton
Michael Hartnett of BAC-Merrill Lynch on Friday:
- “The US in not Japan … right now investors are once again concerned that growth is becoming “Japanized” and thus impervious to asset price reflation. … Leveraged areas of the economy appear to be healing more strongly than they did in Japan, e.g., stocks, real estate, bank lending, small companies (Chart 1). In our view, investors need market corroboration via stronger corporate bond prices, bank stocks and a strong dollar. Once they get it, we expect asset allocations to collapse into equities, until liquidity expectations are threatened”
Hartnett’s point about US-Japan is best made by his chart below:.
Note: S&P 500 indexed to 100 on 9/29/2000; NKY indexed to 100 on 12/29/1989
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg
4. U.S. Treasuries
Bill Gross was clear in his comments on BTV Street Smart (see clip 1 below) on Tuesday, October 1:
- “policy rate for the next two or three years – What the market is interpreting is that the Fed will raise interest rates by 100 basis rates by December of 2015 and by another hundred by 2016. We do not believe that. We said bet against it. What does that mean? It means buy front end Treasuries” buy 3,4,5 year Treasuries that incorporate the mispricing in terms of fed policy rates going forward
- “The policy rate is the key. You should buy treasuries yes but on the front end. Don’t buy 30s, don’t by 10s because these are inflation incentive. Buy something that the Federal Reserve is going to guarantee for the next several years“
He reiterated this message in his tweet on Thursday:
- PIMCO @PIMCO – Gross: Don’t run for the hills b/c of the #shutdown or the debt ceiling – Run b/c the economy is slowing by itself
Bonnie Baha of Double Line on CNBC SOTS on Monday, September 30:
- “what makes it harder to gauge the market’s reaction now is quantitative easing. Ben Bernanke, after starting to the taper talk last May, decided it was a no-go in September which is looking like it was probably a very wise move. In fact, the markets may interpret this, in fact if there is a shutdown and GDP growth is compromised in the fourth quarter, this could wave the green flag for a QE-infinity.”
- you know, it’s a curious thing. they don’t have to move further. they just. reporter: to maintain a steady state. if you look at what is sort of a uneven, to be charitable, recovery at best, the idea of tapering amid the turmoil not only of our dysfunctional government but also who the next Fed chair’s going to be, I’d say tapering’s off the table until 2014. They don’t have to do anything further, the worst situation would have been if they had in fact tapered in September and then had to turn around and say we changed our minds. that would have destroyed their credibility.
Bill Gross may not like it and TLT didn’t act all that well this week. But Ryan Detrick of Schaffers remains a fan as his tweets show:
- Ryan Detrick, CMT @RyanDetrick on Thursday – Few assets are as hated as bonds. Consensus poll % bulls is just 27%. $TLT still looks good to me. stks.co/alBE
- Bill Gross on BTV Street Smart on Tuesday, October 1
1.
On how investors should be thinking about the looming debt ceiling:
- “Let’s look at this from two different angles. In this particular shutdown continues, it probably affects economic growth by .1% a week. That is what happened in 1995 with the Gingrich shutdown. It has happened before that. In terms of prior shutdowns, there have been many. There will be a slowdown in economic growth. Fourth-quarter economic growth will continue for three weeks. They quickly were repaired. There is no eventual impact in terms of economic growth. Much ado about nothing. The big date is October 17 on the debt ceiling. We will see if the dates can be merged together and show a category fivestorm instead of a category one.”
On whether there is a chance it could be a category five:
- “With the debt ceiling we will have to see. It is a delicate dance in terms of investor perception and rating services and the like. The rating services to this point, Moody’s very boldly suggested that they did not do anything. The real happy service compared to some of the other standard. It might take a more dour outlook. It is the investors. The vanguard of the world. The retail investors. The central banks of the world that will be affected by this delicate dance and so want to collect fiasco in Washington that continues and continues without some type of resolution. Yes, October 17th can be important. “
On what happens to the yield on treasuries if we default on our debt:
- “Catastrophic. And don’t just look to treasuries. Markets are interrelated. We have complex markets in terms of money market funds and repo and interconnected types of relationships that depends upon the solvency of the U.S. Treasury. The U.S. Treasury is basically the center of the global financial conflict. The default is unimaginable. If it happens, it will set into motion a complex series of events that affects not just bonds but credit transit transactions on a worldwide basis, equity prices, commodity prices. We do not want to see that happen.”
On whether people will be seeking a safe haven asset if US Treasuries default:
- “Well of course…If they did default, would there be a safer haven on a global basis? Of course there will be German bunds there will UK gilts there will be other sovereign entities that have not defaulted. Would there be a flock to U.S treasuries if they defaulted. Of course not. There will be a drastic movement away from U.S. treasuries because early investors simply do not like defaults.”
On what will happen to stocks:
- “The stocks are growth related. Stocks are default sensitive to a certain extent and if the sovereign mother defaults on their obligations then what could be next in terms of corporations so the whole intertwine connectivity of credit and credit markets and equity related securities will be unwound in drastic fashion. This is not going to happen but this is the potential if did happen”
On whether the government will get their act together by the deadline:
- “Treasury brings in perhaps 60-percent of the revenues. The debt service costs are about $25 Billion. The Revenues are $150 Billion per month. They cover their interest expense by six times. The Treasury is not going to default on their debt simply because the debt ceiling is not going to be raised. There will be other repercussions. There will be slow economic growth. The Treasury will not default. That is the last, that’s the last option.”
On whether buying credit default swaps on US debt is a ‘sucker’s bet’:
- “It depends on your cause. Credit default swap takes into consideration some very technical aspects. If it defaults the most deliverable security would be something that will be valued at $.85 or $.90. In other words, those selling protection would receive $.85 on the dollar even though the treasuries ultimately might be money good. It becomes very technical in terms of what it is worth. It has moved to 20 to 25 basis points to 35 to 36, 37 basis points. That see me still suggests an odds of maybe a million to one in terms of a treasury default.”
On whether he is staying the course with what he is holding now:
- “What we have done is to buy and hold treasuries at the front end of the curve. What we think is the most defendable aspect of policy going forward, whether it is the debt ceiling, the CR resolution, the Fed going forward, is the a fact that the Fed probably will stay put. In terms of 25 basis points, not talking taper here stay put in terms of policy rate for the next two or three years. What the market is interpreting is that the Fed will raise interest rates by 100 basis rates by December of 2015 and by another hundred by 2016. We do not believe that. We said bet against it. What does that mean? It means buy front end treasuries by 3,4,5 year treasuries that incorporate the mispricing in terms of fed policy rates going forward. We think, when Janet Yellen and I say when Janet Yellen is appointed… I cannot confirm it. I can give you 99.9-percent pure that she will be head of the Fed come six months from now. If she is, then she is a main proponent of forward guidance. She and Michael Woodford basically suggested that after taper that forward guidance is the thing. What we believe at PIMCO is forward guidance in terms of keeping the policy rate low under certain conditions that probably will not be met. The policy rate is the key. You should buy treasuries yes but on the front end. Don’t by 30s, don’t buy 10s because these are inflation incentive. Buy something that the Federal Reserve is going to guarantee for the next several years.”
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