The ‘Beautiful’ Deleveraging

Saturday, August 18th, 2012

Submitted by Alex Gloy of Lighthouse Investment Management,

Some of my clients like to challenge my (admittedly gloomy) views, forcing me to think – which isn’t such a bad thing to do.

It started off with Cam Hui’s “A Dalio explanation of Evans-Pritchard’s dilemma“. After laying down his strategy on winning the game of Monopoly, Dalio goes on to model the economy onto the board game. So far so good.

Then, Dalio is quoted in a Barron’s interview, describing the current phase of the U.S. deleveraging experience as “beautiful”. He goes on to explain the three options for reducing debt: austerity, restructuring and printing money.

“A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.”

That sounds pretty good and makes sense. Or does it?

• I think Mr. Dalio would not be too upset if we labeled him a “Keynesian” (believing the government has to step in where private sector spending falls short).
• You could respond that it was Keynesian policies which brought us to the current situation in the first place (to which Keynesians will respond that their policies did not work out because there was not enough spending. Which is like saying “the kid is not behaving because you didn’t hit it hard enough“).
• Furthermore, how is the government sector on a different “planet” than the household sector? In the end, isn’t government debt (and hence fiscal deficits) supported and borne by taxpayers (read: household sector)? No sovereign entity in the world would be able to issue debt unless backed by taxpayers (or, for that matter, gold).
• As governments incur additional debt it is actually taxpayers’ future income that is on the block (as tax rates will have to go up to pay for additional debt service burden). Leverage is simply being shifted around. Oh, and for that time-shift argument (“tax receipts will have increased by the time the debt comes due”) – I believe it when I see it. There has been not a single country which has paid back its debt incurred under the fiat money system.
• If the future rate of inflation is below the interest rate paid on additional government debt, the net present value of deficit spending is negative (we are neglecting the argument over whether government can spend efficiently or not).
• Interest rates at issuance are fixed (exception: floaters). The decision whether to run fiscal deficits boils down to the following question: will future inflation exceed the interest paid (in order to devalue debt faster than accrued interest)?
• This makes the success of Keynesian policies dependent on elevated inflation. Governments are motivated, in a perverse way, to work towards reducing the value of money.
• This is in contradiction of central bankers’ (presumed) goal of preserving the function of money as a store of value, setting them up for a clash with governments (assuming they are not in cahoots anyways).
• However, there is no known case of a government successfully printing its way out of excessive debt (while there are plenty of examples for the opposite).
• It’s a lose-lose-situation: Should the government succeed in creating inflation, (1) financially prudent savers are punished, (2) low-income families are hurt (as they have no means to invest in assets benefiting from inflation) and (3) debt service costs are likely to increase as existing debt matures and needs to be rolled over.
• Should the government not succeed in creating inflation, future consumption will be burdened by additional taxes, lowering future growth and making excessive debt unsustainable.
• Will printing money “compensate” for money destroyed by debt write-offs? Turned the other way ’round, was money ever “un-printed” to compensate for money created from fractional banking and/or increased levels of debt?
• Cullen Roche of Pragmatic Capitalism states “QE [quantitative easing] doesn’t do much – it’s the great monetary non-event” (“Why QE is not working”).
• In the comments section of above article Cullen points out that

“It is flawed economic thinking to target nominal wealth. Stock prices are not real wealth until realized gains are taken. More importantly, stocks are based on the underlying value of the assets they represent. Pushing stock prices up does not make the companies more profitable. So hoping that people will spend more of their current income because of a false price appreciation in the market is a misguided policy.”

• So let’s take a look at Mr. Dalio’s “beautiful deleveraging”. Here’s US debt by sector:

Observations:

• Households are de-leveraging; so are financial corporations.
• This happens at the expense of the government sector, which continues to lever up.
• Total debt (government + households + corporations) is actually higher (by $800bn) than when the “beautiful deleveraging” began.

Let’s look at the numbers in percent of GDP:

• Peak debt-to-GDP has been reached in Q1 2009 for households, financial and non-financial corporations.
• Since then (latest data Q1 2012), households have de-levered by 11%-points of GDP (or $654bn).
• Non-financial corporations reduced debt by 3%-points (or $406bn).
• Financial corporations, however, de-levered by a stunning 33%-points (or $3,375bn).
• The flip-side of this: Federal debt-to-GDP increased by 27%-points (or $4,030bn).
• While the household sector has done “it’s thing” it usually does during recessions (de-lever), it become clear who the main beneficiary of additional government debt is: the financial sector.

Looking at quarterly changes in sector debt visualizes it nicely:

• Mr. Dalio and his firm (Bridgewater Associates, the world’s biggest hedge fund) are part of this financial sector. No wonder he describes this kind of deleveraging as “beautiful”.
• Mr. Dalio, who, according to a recent Bloomberg story (Connecticut offers millions to aid Bridgewater expansion), “was paid $3.9bn in 2011? is taking all kinds of tax breaks / “forgivable loans” to be lured to move from Connecticut to… Connecticut (at least UBS and RBS moved to the state when receiving tax breaks).
• I have walked through the waterfront area of Stamford. A lot of low-income families, often minorities, living in simple homes. The city is building new, expensive apartments for the new, well-paid arrivals, gentrifying the area.
• From Bloomberg:

“If the region [Fairfield county] were a country, it would be the world’s 12th-most unequal in terms of income, ranking just below Guatemala.”

• As for debt write-downs, this Zerohedge post speaks for itself: Deleveraging needed in next 4 years: $28 trillion

CONCLUSION:

While Mr. Dalio’s narrative reads well, it doesn’t stand up to common sense. Unfortunately there is lingering suspicion his views on government spending are a mere ploy to advocate for transferring even more debt from “his” sector onto taxpayers, while at the same time transferring taxpayers’ money to his firm via tax breaks.

Tags: Austerity, Barron, Board Game, Current Situation, Dalio, Debt Restructuring, Evans Pritchard, Fiscal Deficits, Government Debt, Government Sector, Household Sector, Incomes, Investment Management, Keynesian Policies, Keynesians, Lighthouse, Monopoly, Printing Money, Reducing Debt, Sovereign Entity, Winning The Game
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Lacy Hunt: Face The Music, Road Back To Prosperity Is Through Shared Sacrifice, Not Government Stimulus

Friday, February 17th, 2012

John Mauldin posted an extraordinary interview by Kate Welling of Dr. Lacy Hunt, the chief economist of Hoisington Investment Management.

Dr. Lacy Hunt correctly identifies fractional reserve lending as the culprit behind the massive rise in debt. Hunt also explains why government spending cannot help, why Europe is in worse shape than the US, why a US recession is coming, and why Ben Bernanke is an exceptionally poor student of the great depression.

The entire PDF is a lengthy 29 pages, but well worth a read in entirety.

Here are some pertinent snips from “Face the Music“.

Face The Music
Road Back To Prosperity Is Through Shared Sacrifice, Says Lacy Hunt.

Kate: Happy New Year, Lacy. And thanks for sending all those charts to background me for our conversation. I have to say the first one stopped me — showing debt as a percentage of U.S.

Lacy: If you confine your analysis to post-war period, you only have one major debt-dominated cycle and that’s the one we’re currently in — and have been in for a number of years. But if you go back far enough, you have three more. You have the 1820s and 1830s. You have 1860s and 1870s and then you have 1920s and their aftermath. Sometimes it’s essential to take your analysis back as far as you possibly can.

Kate: Doesn’t your second chart, on the velocity of money [below], show how none other than Milton Friedman was misled into thinking that it was a constant because he only looked at post-war data?

Lacy: That’s correct and, in fact, I was misled along with him because I was also doing analysis based on the post-war data. Friedman’s period of estimation was basically from the 1950s to the 1980s. Well, if you look at the velocity of money in that time period, it’s not a constant, but it’s very stable around 1.675. So if you tracked money supply growth then, you were going to be able to get to GDP growth very well. Not on an individual quarterly basis, but even the individual quarterly variations were not that great. Until velocity broke out of that range after we deregulated the banking system. Now, velocity is breaking below the long-term average and it’s behaving exactly like Irving Fisher said, not like Friedman said, absolutely.

Kate: What a perfect example of the difference your frame of reference can make.

Lacy: Keynes and Friedman both felt that The Great Depression was due to an insufficiency of aggregate demand and so the way you contained a Great Depression was by your response to the insufficiency of aggregate demand. For Keynes, that was by having the federal government borrow more money and spend it when the private sector wouldn’t. And for Friedman, that was for the Federal Reserve to do more to stimulate the money supply so that the private sector would lend more money. Fisher, on the other hand, is saying something entirely different. He’s saying that the insufficiency of aggregate demand is a symptom of excessive indebtedness and what you have to do to contain a major debt depression event — such as the aftermath of 1873, the aftermath of 1929, the aftermath of 2008 — is you have to prevent it ahead of time. You have to prevent the buildup of debt.

Kate:  And that your goose is cooked if you don’t you cut off the credit bubble before it overwhelms the economy?

Lacy: Yes, and Bernanke is thinking that the solution is in the response to the insufficiency of aggregate demand. That was Friedman’s thought. That was Keynes’ thought and most of the economics profession has traditionally thought the same way. They were looking at it through the wrong lens. Fisher advocated 100% money because he wanted the lending and depository functions of the banks separated so we couldn’t have another event like the 1920s.

Kate: You’re saying that Fisher argued against fractional reserve banking?

Pages: 1 2 3 4

Tags: 1820s, 1920s, Ben Bernanke, Chief Economist, Culprit, Face The Music, GDP Growth, government spending, Great Depression, Happy New Year, Indi, Investment Management, John Mauldin, Massive Rise, Milton Friedman, Money Supply Growth, Music Road, Recession, Snips, Stimulus, Velocity Of Money, War Period
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Bill Gross: “QE 2.5 Today, QE 3, 4, 5, … lie ahead”

Thursday, January 26th, 2012

PIMCO’s Bill Gross commented/tweeted yesterday that “Financial repression” and possibly three more rounds of QE lie ahead, in response to the Fed’s statement.

From Bloomberg:

• The U.S. will suffer “financial repression” as the Federal Reserve implements additional quantitative easing, according to Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co.
• A third, fourth and fifth round of easing “lie ahead,” Gross wrote in a Twitter post.
• The Fed will probably hold its benchmark interest rate at near zero percent for at least the next three years, the post said. Chairman Ben S. Bernanke said yesterday the Fed is considering additional bond purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014.

• “Financial repression depends on negative real yields and until inflation moves higher for a period of at least several years, central banks will hibernate at the zero bound,” Gross wrote in his monthly investment outlook on Jan. 4.
• Policy makers are “prepared to provide further monetary accommodation” and bond buying is “an option that’s certainly on the table,” Bernanke said after officials gathered for a meeting yesterday. The central bank has purchased $2.3 trillion of securities in two rounds of large-scale asset purchases known as quantitative easing.
• The Fed is in the process of replacing $400 billion of shorter-maturity Treasuries in its holdings with longer-term debt to “put downward pressure on longer-term interest rates,” based on a statement announcing the plan in September.
• Gross increased U.S. government and Treasury debt in the $244 billion Total Return Fund to 30 percent of assets in December, the highest in 13 months, after betting against the securities during a rally last year.

Tags: Asset Purchases, Benchmark Interest Rate, Bernanke, Bill Gross, Bond Fund, Central Banks, Downward Pressure, Federal Reserve, Financial Repression, inflation, Investment Management, Investment Outlook, Maturity, Pacific Investment Management Co, Qe 2, Term Debt, Term Interest, Treasuries, Trillion, Zero Percent
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TODAY! Beyond the Mattress: Income Strategies that Actually Work (CE)

Tuesday, October 4th, 2011

Tags: Accreditation, Broadcast Centre, Exchange Tower, Exchange Traded Funds, Fixed Income, Global Investments, Horizons, Income Strategies, Investment Management, Mattress, Natcan Investment Management Inc, Portfolio Manager, Rahim, Rouleau, Tmx, Toronto Stock Exchange, Tsx, Tuesday October, West Toronto, World Markets
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You Are Not as Dumb as You Think

Friday, September 23rd, 2011

by Vitaliy Katsenelson, Investment Management Associates

I was going to write something smart and pithy about this recent market decline, but then I realized that I’ve written about this in the past (more than once).  So here is an excerpt from the Little Book of Sideways Markets.  In addition, here is a copy of the presentation about sideways markets.  – Enjoy.

Secular sideways markets are comprised of many cyclical bull and bear markets [take a look again at the chart below].  Though cyclical bull and bear markets can provide great buying and selling opportunities, our emotions will try to get in the way between us and the right decisions. Markets will constantly try to brainwash us into doing the opposite of what we should be doing.  I hope [excerpt from] this chapter provides an antidote to this as it contains two missives.  Read the first one [You Are Not as Dumb as You Think] during cyclical bear markets and the second [You Are Not as Smart as You Think, which I did not attach] during the cyclical bull markets.  Good luck!

You Are Not as Dumb as You Think (Psychotherapy for Cyclical Bear Markets)

Lately I’ve been getting this nagging feeling that everything I touch turns to dirt. Every time I buy a stock that is already down a lot, the one that my analysis leads me to believe is cheaper than dirt, it declines more. Did I completely lose my ability to value stocks? Did I start ignoring Will Rogers’ advice to buy stocks that go up, and if they don’t go up, don’t buy them?

No, I didn’t get dumber, and my stock-picking skills haven’t diminished. I was simply a willing participant in the latest cyclical bear market. Bear markets make you feel dumber than you are, the same way bull markets make you feel smarter than you are.

Feeling dumb makes you do the opposite of what you should be doing. Fear and pain—yes, continued losses cause a lot of pain—are dangerous things because they can make you and me panic, lose confidence, and do the opposite of what we should be doing. To alleviate pain we sell, we react, we default to the only asset that made us money so far in the bear market—cash! Cash is only king when other assets are princes. When you cannot find a stock with a long-term superior risk/reward profile, then cash is King with a capital K. However, during a cyclical bear market, cash is slowly demoted to a prince as great companies are thrown out the window with the junky ones. You have to actively remind yourself of the eight-letter word T-O-M-O-R-R-O-W!  Yes, tomorrow.  Think of the lyrics from Annie:

When I’m stuck with the day that’s gray and lonely
I just stick out my chin and grin and say, ohhh

The sun will come out, tomorrow
So you gotta hang on’ til tomorrow

Of course, we don’t know if tomorrow is really tomorrow or five years from now. But investing is a marathon, not a sprint, and do not let the bear market turn you into a sprinter. First of all, remind yourself that you are not as dumb as your portfolio makes you feel. You have occasionally bought a stock that made you money. This is what I do: I pull out a chart of a stock on which I made a boatload of money or one I sold for the right reasons before it declined.  I do this with pleasure, trying to relive my smart days. We all have these stocks, the ones we nailed. We tend to forget about them during the bear market phase. But I suggest you remember them now, when you feel lonely and miserable, so you’ll have more of these names to remember in the future, since cash will not bring the pleasure of victory in the long run. The cyclical bull market is still there; it is just hiding under the ugly sentiment of the cyclical bear market. Believe me, it will show its happy face. It is just a matter of time.

In a bear market, it is easy to forget about buying. Selling is a much easier decision to make. Every time you buy a stock you look dumb because it usually goes down afterward. I recently bought a couple of incredibly cheap stocks and, of course, they declined. I don’t feel smart about these buys right now. However, a while back I analyzed these companies, figured out what they were worth, determined an appropriate margin of safety, and got my buy prices. The stocks declined but fundamentals had not changed, so I bought the stocks.

You cannot worry about marking the bottom in every buy. My objective is not to buy at the bottom and sell at the top. No, my objective is to buy a great company when it is cheap and sell it when it is fairly valued. I suggest you do the same. Will Rogers’ advice is great, but unfortunately I have yet to meet a human being who has figured out how to apply it in real life. No, you are not as dumb as bear markets make you feel.

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

Tags: Antidote, Bear Market, Bear Markets, Bull And Bear, Bull Markets, Cheaper Than Dirt, Confidence, Dangerous Things, Emotions, Excerpt From, Fear, Good Luck, Investment Management, Losses, Management Associates, Market Decline, Psychotherapy, Value Stocks, Will Rogers, Willing Participant
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Active Management: A Better Approach for Corporate Bonds

Monday, August 22nd, 2011

Active management: A better approach for corporate bonds

Marc-Andre Gaudreau, CGA, CFA, Senior Vice-President, Fixed Income, Natcan Investment Management, discusses why actively managed corporate bonds can benefit an investors portfolio, and how the Horizons Corporate Bond ETF (HAB:TSX), which he manages, outperformed its benchmark during its first year, since it was launched.

What’s your 6-8 month outlook?
What is your outlook for Canadian corporate bonds for the next 6 – 8 months. Do you expect the corporate bond spread above treasuries to continue to stay at current levels?
 

Gaudreau: Corporate spreads go hand in hand with the market risk appetite and economic climate and currently we are in a soft patch, so there is pressure. It seems, however, we’ve hit bottom, and we can expect the economy to pick up slowly, and hopefully the uncertainty in the market, whether its related to the government debt-ceiling issue or problems in Europe should reduce in the future, and spreads should perform well. Even if it remains at the same level, the expected out-performance relative to government bonds would remain very attractive.

Problems in the European Debt Market
Have problems in the European debt market increased the risk for corporate bond investing?

 
Gaudreau: In Canada, bondholders have limited exposure to the European crisis, however, all risky assets will be affected by what’s happening. We’ve seen it before and we can expect that uncertainty to put pressure on spreads in Canada. It will however create buying opportunities for good credit. If that continues, we’ll take that opportunity to load up on those and get very good risk-adjusted returns going forward.

What do you attribute HAB’s success to? 
Your ETF was able to beat the leading corporate bond passively managed index ETF on a year performance basis. What do you attribute this success to?

Gaudreau: To start, being passive implies that you’re able to replicate an index, and in the corporate bond space its very difficult to buy those bonds that are part of the index. Therefore, passive investors need to take deviation to try to match the index. From our standpoint, we’re not there to replicate an index; we’re there to take the best risk adjusted positions out there so we spend a lot of time looking at the risk reward. From a risk standpoint we don’t rely on ratings agencies; we meet management, and do our own internal credit research. From the reward standpoint, we look at where are bonds, what’s the spread to take on that risk, compared to where credit default swaps are trading on the name; what’s the equity market thinking about that credit, and then after that, we make our final decision. So I would attribut the value added over the years to good securities selection based on our own internal research.

Tags: Active Management, Bondholders, Canadian, Canadian Market, Corporate Bond, Corporate Bonds, Debt Ceiling, Debt Market, Economic Climate, Fixed Income, Gaudreau, Government Bonds, Government Debt, Investment Management, Market Risk, Outlook, Performance Basis, Risk Adjusted Returns, Risk Appetite, Risky Assets, Senior Vice President, Treasuries, Tsx
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Bill Gross on the S&P Downgrade and the ‘Big European Bazooka’

Monday, August 8th, 2011

Bill Gross shares his thoughts on the U.S. debt downgrade, and the ECB’s plans to support Spanish and Italian bonds, in this in depth interview with Bloomberg’s Tom Keene.

From Bloomberg:
Aug. 7 (Bloomberg) — Bill Gross, co-chief investment officer of Pacific Investment Management Co., talks with Bloomberg’s Tom Keene about Standard & Poor’s downgrade of its U.S. credit rating, and the outlook for the U.S. dollar and inflation. Gross said the dollar remains vulnerable in an economic slowdown after the country’s long-term debt rating was lowered by S&P.

Bill Gross, manager of the world’s biggest bond mutual fund, said Standard & Poor’s showed “spine” by cutting the U.S. debt rating, contradicting Warren Buffett and Legg Mason Inc.’s Bill Miller, who said the rating company erred.

“I think S&P has demonstrated some spine; they finally got it right,” Gross, who has been critical of Treasuries for months, said in a Bloomberg Television interview with Tom Keene yesterday. The U.S. has “enormous problems,” he said, referring to the country’s mounting debt.

(Source: Bloomberg)

Tags: Bill Gross, Bill Miller, Bloomberg Television, Chief Investment Officer, Depth Interview, ECB, Economic Slowdown, Enormous Problems, Gross Co, Investment Management, Legg Mason, Legg Mason Inc, Mutual Fund, Outlook, Pacific Investment Management Co, Spine, Television Interview, Term Debt, Tom Keene, Treasuries, Warren Buffett
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What if 8% is Really 0%?

Tuesday, June 21st, 2011

by Leo Kolivakis, Pension Pulse

Mebane Faber of Cambria Investment Management sent me an excellent paper he authored, What if 8% is Really 0%? Pension Funds Investing with Fingers-Crossed and Eyes Closed:

It is well known that pension funds in the United States are underfunded even if they achieve their projected 8% rate of return. The scope of pension underfunding increases to an astonishing level when more probable future rates are employed. A reduction in the future rate of return from 8% to the more reasonable risk-free rate of approximately 4% causes the liabilities to explode by trillions of dollars. As bond yields declined over the past twenty years, pension funds moved toward more aggressive equity-based portfolios in an attempt to reach for this 8% return.

By investing in a portfolio with uncertain outcomes, pension funds could experience increasingly volatile and even negative returns. Paradoxically, in an effort to chase the universal 8% rate, pension funds may be laying the groundwork for returns even lower than the risk free rate.

In an effort to offer an empirical basis for this possibility, we conclude the paper with a relevant comparison – the return of a hypothetical Japanese pension for the past two decades. We believe that pension funds need to at least prepare for the unfathomable: 0% returns for 20 years. Most pension funds, regrettably, have not adequately stress tested their portfolios for these scenarios.

So how does a pension manager get 8% in the current environment? Mr. Faber writes:

With government bonds yielding about 4% plan sponsors must invest in other outperforming assets to bring the cumulative return to 8%. The problem with allocating assets away from the risk-free rate is that they are, by definition, risky and uncertain. If a pension manager is employing the benchmark 60% stock/40% bond allocation, the 60% in equity or diversifying assets must return approximately 11% to achieve 8% total returns.

The second major problem outlined in this paper is that pension managers, in an attempt to deal with the realities of underfunding, may be tempted to chase higher performing and riskier asset classes, and may end up compounding the underfunding problem even more through exposure to these risky asset mixes.

Interestingly, according to Biggs, the targeted equity allocation does not correlate with projected return. Even worse, as shown in Exhibit 1 (above), funds using the highest return assumptions have the most underfunded pensions, a scenario that could be called, “fingers crossed and eyes closed”

Mr. Faber goes on to write:

The focus on illiquid assets (private equity, venture capital and timberland investments, for example) made the Endowment Model particularly attractive to funds that in theory have long time horizons, such as endowments and pensions.

Yet, as real money investors sought diversification through the same methodology, their portfolios were, in fact, becoming more correlated to each other while portfolio risks were becoming more concentrated and increasingly dependent upon illiquid equity-like investments.

Most real money funds were not prepared for the following stress scenario to their portfolio:

• US and Foreign Stocks declining over 50%
• Commodities declining 67%
• Real Estate (REITs) declining 68%

The figures above are the peak drawdowns from the bear markets of 2008-2009, and, importantly, they all occurred simultaneously. It is critical that pension funds – especially funds pursuing high equity allocations – consider all possible stresses to portfolio viability.

Mr. Faber then asks a simple question:

Are funds prepared for a lengthy bear market in equities like when stocks declined nearly 90% in the 1930’s? Are funds prepared for both raging inflation of the 1970’s and 1980’s and sustained deflation like Japan from 1990 to the present? It is our opinion that most funds do not consider these outcomes as they are seen as extraordinary and beyond the scope of either feasible response or possibility.

He’s absolutely right, the majority of pension funds are hoping — nay, praying — that we won’t ever see another 2008 for another 100 years. The Fed is doing everything it can to reflate risks assets and introduce inflation into the global economic system. Pension funds are also pumping billions into risks assets, but as Leo de Bever said, this is sowing the seeds of the next financial crisis, and when the music stops, watch out below. Pensions will get decimated. That’s why the Fed will keep pumping billions into the financial system. Let’s pray it works or else the road to serfdom lies straight ahead. In fact, I think we’re already there.

Below, Mebane Faber talks about the benefits of the ETF he manages, Cambria Global Tactical ETF (NYSE:GTAA). I thank him for sharing this paper with me.

Tags: Assets, Astonishing Level, Bond Allocation, Bond Yields, Cambria, Commodities, Cumulative Return, Empirical Basis, Faber, Fingers, Government Bonds, Groundwork, Investment Management, Liabilities, Pension Funds, Plan Sponsors, Portfolios, Rate Of Return, Scenarios, Trillions, Twenty Years
Posted in Commodities, ETFs, Markets | Comments Off

Bill Gross says QE3 Unlikely Even as Job Growth Slows; Gross Still Shuns Treasuries, Likes Dividend Yielding Equities

Monday, June 6th, 2011

Bill Gross says QE3 Unlikely Even as Job Growth Slows

Pacific Investment Management Co.’s Bill Gross, manager of the world’s biggest bond fund, said the Federal Reserve is unlikely to do a third round of quantitative easing even with the economy adding fewer jobs than forecast.

Central bankers are likely to “extend the extended period” language for longer in their policy statements, Gross said in a radio interview on “Bloomberg Surveillance” with Tom Keene. The less-than-projected pace of jobs growth in May that the Labor Department reported today shows that “there is a persistency here. It’s back to our old new normal,” he said.

“We don’t see a QE3. There has been too much discussion and dissent within the Fed to permit that type of program,” Gross said in the interview from Pimco’s headquarters in Newport Beach, California. Given the current pace of growth and inflation “they will speak to a fed funds rate that persists for an extended period of time, which in effect caps interest rates in the process.”

Investors could seek higher real returns than those now offered from government debt through investing in shares of “conservative” companies such as Procter & Gamble Co. (PG), Merck & Co. or those of utilities, according to Gross.

“The Treasury market up to seven or eight years is negative in terms of real interest rates, and that’s not a positive for savers,” Gross said. “But if they took that money and invested it in a conservative stock, such as a Proctor or a Merck or a utility yielding 4 percent; then that’s 3.5 to 4 percent real yield in comparison to those negative real yields in the Treasury side. So you have to take a little bit of a chance in order to avoid getting your pocket picked here.”

Video

I concur with Gross about the likelihood of QE3 in the near-term horizon and suggested the same thing in a recent interview on Market Ticker with Aaron Task. The key to that sentence is the phrase “near-term”.

Right now, the Fed does not want more froth in junk bonds, nor does it want higher commodity prices or $150 crude, especially since QE2 was a miserable failure in producing jobs or reviving housing.

However, should the economy enter a sustained downturn, and if commodity prices plunge (giving the Fed some breathing room), it’s a given the Fed will try something. Whatever the Fed tries will likely be good for gold.

Please see Why I Continue to Like Gold for a video discussion.

The problem with Gross’s dividend stock play is that it is likely all stocks get hit in another sustained downturn. A 4% yield may be nice, but not if it comes at the expense of a 25% haircut in equity prices.

With valuations stretched everywhere one looks, there is a lot to be said for waiting on the sidelines for better opportunities.

Mike “Mish” Shedlock

http://globaleconomicanalysis.blogspot.com

Tags: Bill Gross, Bond Fund, Dissent, Fed Funds Rate, Government Debt, Investing In Shares, Investment Management, Labor Department, Merck, Newport Beach California, Pacific Investment Management Co, Persistency, Policy Statements, Procter Amp Gamble, Procter Gamble, Proctor, Radio Interview, Tom Keene, Treasuries, Treasury Market
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Efficient Markets? (Saut)

Thursday, June 2nd, 2011

Efficient Markets?!

by Jeffrey Saut, Chief Investment Strategist, Raymond James

May 31, 2011

“Markets are efficient, or so we’ve been told. I am not here to put a rebuttal to this academic nonsense, but let me give you one of the core reasons why markets are and will remain inefficient: because human beings are efficient. To function in everyday life, our brains are used to simplifying complex problems, through pattern recognition. We become accustomed to drawing straight lines when we see two points, and if we get a third or fourth point that fits the line, our confidence about the longevity (continuity) of the line increases exponentially. We become excited, even certain, about prospects of the company we’ve invested in when its stock has gone up for a long period of time, while we often dismiss stocks that have declined or flat-lined, especially if that happened for a considerable period of time.”

. . . Vitaliy Katsenelson, CIO of Investment Management Associates

I met Vitaliy Katsenelson, professor, portfolio manager, and author of “The Little Book of Sideways Markets,” years ago at a Minyanville Festivus gathering. We became kindred spirits, for it was following the September 1999 Dow Theory “sell signal” that I opined the stock market was likely going to trade sideways, in a wide swinging trading range, for years just like it did between 1966 and 1982 following the secular bull market of 1949 – 1966. That is the history of equity markets, for after e-v-e-r-y secular bull market the indices have always traded sideways for a very long period time. While the 1966 – 1982 stock market sojourn sure didn’t “feel” sideways at the time, an index investor still failed to make a dime over that 16-year period. Obviously, the past 11 years have demonstrated the same point in spades. However, that does not mean you can’t make money in a sideways market. Indeed, just like Peter Lynch compounded money at better than 20% per year in the 1966 – 1982 affair, our annual Analysts’ Best Picks list has compounded money at better than 19% per annum over the past 10 years. The “trick” is to be more proactive (or tactical) in your investment approach, be sector and stock specific, and cut your losses quickly.

I revisit this sideways market theme today for a number of reasons. Firstly, because despite all the market’s shuckin’ and jivin’ over the past few weeks, the S&P 500 (SPX/1331.10) has not traveled more than 13 points either side of 1330 on a closing basis (read that as sideways). Secondly, the “sell in May and go away” crowd has become emboldened by softening economic statistics, the sideways stock market, and the fact that every week in May has been a down week. Yet as the insightful Bespoke Investment Group writes:

“So what does the S&P 500 do following a month where every week is down? Looking at average returns, the S&P 500 tends to rally over the following one and three months, with above average returns compared to all [other] one and three month periods.”

Thirdly, I got into a heated discussion last week with a portfolio manager (PM) who insisted markets are efficient and that you can’t “time” the markets. As Vitaliy writes, “I am not here to put a rebuttal to this academic nonsense, but let me give you one of the core reasons why markets are and will remain inefficient: because human beings are efficient.” Indeed, if markets were always efficient, you would not have had Select Comfort (SCSS/$16.19/Strong Buy) selling for $0.25 per share in January 2009. Manifestly, at major inflection points markets are anything but efficient. Vitaliy goes on to use Cisco (CSCO/$16.46/Market Perform) as an example:

“Cisco has shattered the dotcom dreams of many investors in the years following 1999, when it hit $80 a share and, for a brief moment, was one of the most valuable companies in the world, sporting a modest P/E of 100+.  Since then, gravity has caught up with Cisco’s stock, and it has declined almost 80% from its highs, to $17.  Most investors who bought the stock since ’99 either lost or made no money.  Draw a straight line through its chart (you have more than a decade’s worth of data points), and you see it’s either going to zero or at least will continue to go nowhere.  Now, you add to this performance a few quarters of disappointing Wall Street guidance, and you have an untouchable, un-recommendable stock.”

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