Boehner against Boehner

You have to feel for John Boehner.  All the self-appointed conservative pundits -- Peggy Noonan, Bill Kristol, etc., are telling Boehner to give up on holding the line on tax rates.  What happened to the argument that higher tax rates means slower economic growth?  Did the laws of economics suddenly get suspended to accommodate the political situation?

Raising tax rates in the midst of a sluggish economy is absurd policy.  Only a clueless President would suggest such a path.  Unfortunately Republicans are now climbing all over themselves to jump on the "higher tax rates" bandwagon.  If successful, many more Americans will be faced with a much more limited economic future.  Is politics worth this?

So, Boehner keeps offering up one compromise after another -- mostly, one suspects, to appease his own troops who are running for cover. 

It looks like Republicans may end up providing cover for Obama as they join hands to raise taxes and increase spending.  They never learn.

So what are the Republicans going to run on in 2014, having given away the smaller government, lower taxes argument?

Interesting Week Ahead.

Here we are, at the edge of the cliff and yet we are only 60 points down in SPX from the high of the year and that was almost 90 days ago. It has been incredibly choppy during all these days. So if we have stayed on the sideline with respect to equities for the last 90 days, have we really missed out on any great opportunity, particularly, if we are not day traders?  Bad news has piled up but equities refused to correct in any meaningful manner. One reason being the liquidity that is being pumped by the central bankers around the world. We know that it is not going to end well, one way or other, but we do not know when exactly.  The best thing to do in such situation is to keep the time horizon small, be ready to run quickly on any short trade and look for opportunities everywhere, not just in equities.

Last Friday was another teasing day. I sent out a tweet in the morning highlighting the levels for shorting the market.  Almost in each case the EOD was close but did not go below that. As a result short trades were not initiated. That is the beauty of following a system, when we can override emotions. As you know, most trading mistakes are made because of emotions. As of now the short side is bit over crowded and everyone and their grandmother are dead certain that bottom is going to fall out. It may not be so.

A correction can happen in price, in time or with both. In the last 90 days we have had a correction which consisted mostly time factor, less in price but the end result is none-the-less same. Folks out there are gloomy and they hate this market with a passion. Just look at the short interest.

The short interest is at levels next only to seen in last June.

This coming week, we may see some more price choppiness but definitely not a waterfall. If I may remind you, bear markets start at the height of euphoria, not on bad news.

While cycles are still down for most of the asset classes, they are now about to flatten out in the next 7-10 trading sessions and that makes me uncomfortable going short without price confirmation. There is simply not enough time. The most notable feature of Friday was the drop in US Dollar index. Apple tested its lows. I think it has another 5% to fall and that would drag the Indices down by about 2%-2.5% and that is the max. downside I can see for now. I will be going through all the data and algos over the weekend and the weekly newsletter will highlight if there is any trade worth taking. But safety comes 1^st and I am not going to be a testosterone driven rash adventure seeking aggressive bungee jumper. Been there, done that, learned my lessons.  

Not a day passes when we read some kind of gun violence and yet there is no political courage to stand up to this monster. Children pay the price and politicians shed crocodile tears. Its good television but after few days, everyone forgets about this killing to discuss the next. I feel sad for the kids who died in this senseless act of violence but more than that I am angry at the duplicity of the politicians and the authorities. How on earth a mentally unstable man could get his hands on assault weapons in the 1^stplace. The blood is in the hands of the politicians.

Enjoy the weekend with your loved ones and take some time to remember how blessed we are. See you all tomorrow evening with the newsletter.

The Fed's great experiment

So now you have it. QE4. The Fed will buy $85 billion of long term government bonds and mortgage backed securities, printing $85 billion per month of new money (reserves, really) to do it. That's $1 trillion a year, about the same size as the entire Federal deficit. It's substantially more each year than the much maligned $800 billion "stimulus." Graph to the left purloined from John Taylor to dramatize the situation.

In addition, the Fed's open market committee promises to

"..keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored." [Whatever "anchored" means.] 

This is a grand experiment indeed. We will test a few theories.


First, just how much of the labor market's troubles are the result of an ill-advisedly long maturity structure of government debt? How much is the result of 2% long term rates (negative in real terms) being too high and strangling credit? (If, in fact the Fed's purchases have any sustained effect at all on long rates, which I doubt.) At zero interest rates does the split between reserves (which are, in the end, nothing more than floating-rate, overnight, electronic-entry US government debt) and other forms of government debt mean anything at all? In short, is monetary policy of the buy-bonds, print-money sort completely ineffective at zero rates, yes or no? At a trillion bucks a year we will soon find out. I bet no. (The WSJ calls this the "more cowbell" approach to policy.) But nobody can say it wasn't big enough to test the theory.

Second, just how much is the economy suffering from a lack of promises from appointed officials? "Oh, well, sure, now I'll build that new factory and start hiring people. I just wanted to hear that Bernanke 'anticipates' that he will think low rates are appropriate until until unemployment hits 6.5%, not just into the 6th year of the Biden administration."

Fashionable new-Keynesian models give a big role to such pronouncements. I'm dubious.  Does the average Joe understand the difference between, say, the Administration's promises that sure, next year we'll cut entitlements, and the Fed's promises?

One big hole in the argument:  Charlie Evans (Chicago Fed president) calls this "Odyssean" policy, after Odysseus who had himself tied to the mast so as to hear the sirens. But notice a big difference between Odysseus and Bernanke. Odysseus did not "anticipate that remaining near the mast will remain appropriate so long as the call of the sirens is not too beautiful, the sea not too rough, the sailors manning the rigging doing their jobs, and no other ships we might crash in to."  Odysseus made an irreversible decision. Cortez burned his ships.

If you want people to believe you about the unemployment trigger, you have to remove the discretion to change your mind tomorrow if, say, the dollar crashes, Spain defaults, long term interest rates spike, the Chinese dump their bonds or whatever.  Otherwise, we know it is all hot air. If they can decide in this meeting 6.5% is the right target, they can decide in the next meeting, "whoops, no, we'll print money until China starts buying Chevys." (Sorry, that will be mumbo jumbo about "illiquid conditions in sovereign credit markets and global imbalances..")

I'm not such a fan of new-Keynesian models (here, with hard academic article warning) so this lack of real commitment doesn't trouble me that much. I don't think we would get immediate benefit even from a completely credible tied-to-the-mast commitment to buy trillions of dollars until unemployment hits 6.5%. (I do think rules-based policy in general is a good idea, not this sort of discretionary commitment-making. But  I can think of a lot better rules, like "the price level shall be CPI=130 forever, period.")

But we certainly will test whether this kind of open-mouth operation has any effect. My forecast: continued sclerosis, and, whatever happens, no evidence that these policies had any effect whatsoever.

Which puts me rather less critical of the Fed than many skeptics. I think money and bonds are perfect substitutes at the moment, so "no effect" means no hyperinflation either. The problems are not monetary, so the Fed is just trying to seem important though it's powerless. The major damage that I see in current policy is the implied shortening of the maturity structure of debt: If markets force interest rates to rise to 5%, the deficit doubles due to interest payments, and the US experiences a Greek death spiral. But nobody is even talking about that.

ECB dilemma

It was announced yesterday that  Europe will have a new, central bank supervisor run by the ECB, much as our Fed combines monetary policy and bank supervision. Be careful what you wish for, you just might get it.

One big unified central agency always sounds like a good idea until you think harder about it. This one faces an intractable dilemma.

Here's the problem. Why not just let Greece default?" is usually answered with "because then all the banks fail and Greece goes even further down the toilet." (And Spain, and Italy).

So, what should a European Bank Regulator do? Well, it should protect the banking system from sovereign default. It should declare that  sovereign debt is risky, require marking it to market, require large capital against it, and it should force banks to reduce sovereign exposure  to get rid of this obviously "systemic" "correlated risk" to their balance sheets. (They can just require banks to buy CDS, they don't have to require them to dump bonds on the market. This is just about not wanting to pay insurance premiums.) It should do for the obvious risky elephant in the room exactly what bank regulators failed to do for mortgage backed securities in 2006.


Moreover, it should encourage a truly European market. Greek, Spanish, Italian banks failing is no problem if large international banks can swoop in, pick up the assets, and open the doors the next day. Bankruptcy is recapitalization.  Greece needs a national banking system as much as Chicago (same population) does.

All well and good. And all diametrically opposed to the ECB's "crisis-fighting" agenda. The right arm of the ECB should be protecting the banking system in this way. But the left arm of the ECB is using banks as sponges for sovereign debt.

In trying to manage the sovereign debt crisis, the ECB has bought huge amounts of sovereign debt. It has lent  euros to banks that in turn have bought large amounts of sovereign debt (often, I gather, with not so subtle pressure from their governments).  It has lent more euros to the same banks to replace deposits that are quite wisely fleeing out of those banks.

How can the right arm protect the banking system from sovereign default, while the left arm wants to stuff the banking system with sovereign debt?

Converesely, how can the left arm do anything but print euros like mad, now that the right arm has responsibility for the banking system?  Lending to banks who buy sovereign debt was always excused by the idea that the bank shareholders bear the credit risk and national supervisors take care of that problem. Now it's in the ECB's lap. Politically, can the ECB really shut down national banks, stiff the creditors, and let them be taken over by big pan-european banks?

I bet on the outcome: print euros like mad, keep pretending sovereign debt is risk free, and prop up existing banks. Let's hope I'm too cynical. For once.

The Fed: What the Fed can do and What it Cannot Do

More ink and conversation is wasted on what the Fed is planning to do regarding interest rates.  The Fed doesn't set rates other than it's own lending rate -- nothing else.  Treasuries don't have low rates because the Fed wills it.  Treasuries have low rates for the same reason the US economy is in shambles -- everyone is fearful of the future.  As bad a bet as treasuries are, at the moment, most investors feel safer in treasuries than in other assets.  That's why rates are low.  The Fed has little or nothing to do with that.

What the Fed can do is change the money supply and they are doing that.  They can also "monetize" the debt and they are doing that.

Sooner or later a panic will take place and the world will run from US treasuries.  It won't be pretty and everyone will quit talking about the Fed and begin talking about the insolvency of the US, which is the real issue.  The Fed is a sideshow. 

Ben Bernanke, like lots of "political economists" is fighting the battle of the 1930s.  He thinks we have a liquidity problem.  That's why he indulges in Q1, Q2, and Q3.  We don't have a liquidity problem which is why Fed policy is having no impact on employment and aggregate demand.

America has a debt problem and a regulatory problem and a tax problem.  Unless you solve those things, the Fed and Obama and all the rest are completely irrelevant.  Obama is relevant only as the maestro leading the US economy to disaster.  But, don't look to the Fed.  The Fed is just Obama's handmaiden in all of this.

Confusion Compounded

The markets moved as expected and yet the confirmations of the roll-over are eluding us.

For e.g. I need SPX to close below 1410 to short it. The futures touched 1410 after close of the cash market and did not break it and are now creeping higher. I was looking for NDX to close below 2640 and here also it was close but not close enough to give the confirmation.

Same story with oil and silver.  I was looking for silver to close below $ 32.50 and despite intra-day below that level, silver did not close below that line in the sand. Oil did not close below $ 86 which would have made me comfortable to short it again. The US Dollar index stayed in flat line around 80.

All in all, it was kind of teasing frustrating day. Fingers itching to short and yet system tells you to hold on. Mind plays tricks that gosh, we are going to miss out and discipline holds back. I keep reminding myself it is not about winning the battle; it’s about winning the war.

Now, things may change overnight. /ES (SPX Futures) may test its high of yesterday and rollover and I would be happy to go along. But as of now, my belief and trading are not in sync and it would be foolish to risk capital based on belief and hope without confirmation. Giving up part of the profit while waiting for confirmation is more worthwhile than losing capital.

Let us keep in mind, time is running out for any meaningful short trade and that applies to all asset classes. We have max till end of the year for the cycles to bottom. While the downturn can be violent and severe in the next few days, it can also move sideways and create lots of whipsaws. That why confirmation is so important to me at this point of time.

For those of you who read ZH and have been brainwashed in believing that the end of the world is close, you may have read something idiotic like : "The Fed's QE half life is now down to 30 minutes of effectiveness."  This is far from truth and the system does not work like that. The best analysis of these kinds of stupid comments has come from Josh Brown of “TRB”:

First, the Fed is not a daytrader. They certainly don't make an announcement about hundreds of billions of asset purchases with the intention to "mark the close" on the day they announce.  Rather, what they are attempting to do is provide more time for housing to get off the mat and to push investors into riskier assets to improve credit conditions, balance sheet flexibility, and, indirectly, consumer confidence.

I'm sorry to inform those who are perpetually rooting for the next cataclysmic shoe to drop, but so far they're accomplishing these goals (even if not their greater, overarching goal - improving employment).  The housing market recovery is no longer up for discussion and one needs look no further than the inflows into high yield debt of all sorts to check off the "riskier assets" box on their scorecards.  As for consumer confidence, I am not a believer that the stock market is very important for the wealth effect (impact from housing is 10x that of the Dow Jones) but a glance at the market-leading consumer discretionary sector should tell you all you need to know about that.

But to pronounce a trillion-dollar program like this "DOA" after only a few hours' worth of trading is moronic. Please tune out the Twitter-addled, short-term myopics  who do so. They're living in a different world, one in which every headline is "playable" and every jerk in market has some kind of meaning.

It doesn't.

The Fed will continue to make cash intermediate-term inhospitable and bonds asymmetrically risky.

Act accordingly.

Very nicely said.

And it was one of the reason that I closed my short trades yesterday even when I continue to believe that risk assets have some more to correct.

Yes, the Fed will eventually blow things up but we do not want to be too early in the game, waste our capital and then miss the opportunity. May be that is what the doom and gloom gang want us to do.

If I have to pick up a mascot for my trading / investment style, I would choose “Leopard” . Silent like a shadow, fearless yet risk averse, when faced with a bigger or tougher opponent, it will leave its kill to retreat to fight another day and hunt another pray. Above all, opportunistic and patient.

Lets learn our hunting technique from this predator.

Marc Faber's advice to young people and the meaning of "success"

 

Greatly appreciated Marc Faber's advice to young people and his thoughts on "success", heard near the 8:00 mark of this interview clip. 

Kids today might wonder if they need a college education, or the certification conferred by a degree, to do well in life. Given the rising costs (and diminishing returns) of higher education and the problems of widespread student loan debt in the US, this is a subject for serious consideration.

Faber offers, "I don't think a degree is important. If you have parents that can pay for your degree, then take one. If I had to borrow a lot money to pay for the degree, I don't think I would take one... 

"...I would try first to work for someone who is successful in any industry and acquire knowledge from them. Whatever the area, you should like what you do. If you like what you do, you'll do a better job than if you are indifferent towards your job." 

Speaking to the idea of success, Marc adds, "I think in life success comes on many different levels. Monetary success is just one of them. If you have a happy family life or you can help other people, these are also measures of success. Our society maybe overrates monetary success...". 

Something for people of all ages to consider, now that I think about it. What do you think of Marc's advice? What would you say to young people starting out in life?

Related posts:

1. Ray Dalio: Meditation is the Secret of My Success.

2. Self-Education and the School of Experience. 

3. Michael Bigger on Starting Over.

4. James Altucher: 8 Alternatives to College.

5. Gary North: Find Your Calling (Making a Difference in the World).