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Trusting Bond Market Signals Rather Than the Elites in Today’s Market Ride

Bond market signals


Feeling Uneasy?

Do you sometimes wonder if this market feels a bit hard to trust? In law school, I remember reading a case where a Supreme Court justice said he couldn’t define pornography—he just knew it when he saw it. The same is true of promiscuous –i.e. bubbly–markets, and this sure feels like a bubble to me.

But my opinion, likes yours, is only that: an opinion. Perhaps we need a little guidance from the experts—you know: the folks on TV or in the corner offices of the banks or Federal Reserve. Or do we? Maybe our own common sense (like porn or market bubbles) is something we just know when we see it.

And what are we seeing?

Wall Street continues to post record highs –including the fattest PE ratios recorded in our history. Since the Trump election, already over-valued stocks have risen by another double digits on hot air and hope (by the way, when Herbert Hoover was elected, the market rose by 13% before it, well: tanked…). Like Paul Tudor Jones , I think we (and Aunt Yellen) should be a bit worried (or as Jones says, “terrified”) by the nose bleed stock valuations we are seeing today.

Since November of 2016, we’ve seen the post-08 market bull run straight past the lessons of history and common sense—but that’s what markets do when a central bank rather than supply and demand determine prices. And as for volatility? What volatility?

Despite trillions of doping, negative interest rates, debt ceilings, government deadlock, bombs flying, sabers rattling, Europe holding its breath through a right vs left populist tango, a no-yield bond market, and globally stalled GDP, the VIX index of implied volatility tells us there’s nothing to worry about.  In short: the tapes—both equity and credit—don’t seem to have a care in the world.

A False Calm Before a Storm?

But I bet some of you are as troubled as I am by the present calm and confidence from on high. Are the wise experts who run the banks and the press smarter than us? Should we just relax, and trust their wisdom? The few hedge funds that I follow and invest in are worried; others are actually net sellers today. A market Legend is Worried.

They see markets heading for a big correction, in part because of insane valuations, and in part because companies are now selling their own shares in droves—like rats leaving sinking ships.

More importantly, they understand the bond market’s signals, and so should you, if you don’t already.

A key indicator in the credit market is the yield curve, which is flattening rapidly and dipping past the election night lows and approaching Brexit lows. Yields flatten as investors abandon stocks for the perceived security of bonds. This is a far better leading indicator of “nervous” than the VIX.

Meanwhile, the pundits and stock-only watchers, just smile for the cameras as if all is fine.  As for my own signals, they are a mixed bag of screaming red lights with very few green lights and a whole lot of momentum rather than valuation plays; that is: there’s very little that looks good (i.e. smart return rather than punting) on the long side.

The Endless Larry Summers—A Case Study in Elitism Gone Wild

Many of us are in fact skeptical of the almost hero-like accolades and attention which the financial press gives to expert commentaries, economists, political jockeys and banking cheerleaders tasked to guide us through this post-08 Twilight Zone of markets beyond sight, sound, or fundamentals.

It bothers me, for example, that the very personalities who got us into the 08 mess are the same ones the markets are looking to for leadership today. Even Larry Summers is seen as a kind of Oracle, despite having sold his soul to a market devil long ago. Yet the world of pundits and market cheerleaders continue to headline bow-tied economists and men with academic credentials to make the world seem normal and so oddities like Larry Summers still get a lot of applause.

Yet praising Larry Summers (whom I recently heard warning of market exuberance) for market straight-talk would be as odd to me as praising Lance Armstrong for his contributions to drug-free cycling. The ironies just abound.

Larry Summers. He gets a lot of attention. He was the president of Harvard. He worked for Clinton; served as a Treasury Secretary. He makes lots of opinionated (and well paid) speaking appearances.  The banks love him. He has been a handsomely rewarded consultant for Citigroup, did equal “work” $$ for the Nasdaq, D.E. Shaw, Andreessen Horowitz and Alliance Partners. I’ve sat with him at more than one paid for event.

But let’s not let credentials get in the way of facts (after all, there were in fact two Nobel Laureates on Long Term Capital’s payroll…) In short, and as La Rouchefoucauld noted, the highest offices are not always—or even often–held by the highest minds.

Opinions of course differ, but it’s hard not to list Larry Summers among the key architects behind the 2008 financial debacle. Where Larry Summers Went Wrong.  Most veterans of recent market cycles pre and post 08, concede that OTC derivatives were the heart of the 2008 darkness. Those instruments (what Buffet aptly described as “weapons of mass destruction”) were fascinating combinations of brilliant structural engineering and asinine value fundamentals.

These tranches of questionable (and largely misunderstood) asset backed collateral were passed about the prop desks from Goldman to Bear Stearns to Joe-trader like hot potatoes until eventually we discovered this wasn’t manna, but manure; thereafter: everyone’s hands were collectively burned…

The sordid history of CDO-driven pain is admittedly easy to critique in the 20/20 clarity of hindsight.  Michael Lewis and many others have made the WMD of 08 seem so obvious. In fairness to poor Mr. Summers, perhaps he meant well, perhaps there really was no way to know the dangers of those elusive derivatives and the collateral beneath (often very, very far beneath) their layers of levered tranches. And perhaps there is no way to know what lies ahead of us today.

But then again, perhaps Mr. Summers was just unable to see what other smarter people did see, though Larry, it has been argued, can’t imagine anyone smarter than him. In fact, at Harvard (where Summers ignored repeated warnings by its expert endowment staff and thus lost the university $2 Billion in funds, half of which were toxic interest rate swaps he helped mid-wife in the 90’s), Summers created another scandal as its President when observing that women students weren’t as mathematically gifted as male students. I remember: I was there.

Ironically, however, one woman in particular—Brooksley Born, then head of the CFTC–was a bit smarter than ol’ Larry when it came to the math of derivatives. More importantly, she had a ton of common sense, and to her, those derivatives sure looked pornographic… She wanted to clean up the market smut.

But in 1998, then Deputy Treasury Secretary Larry Summers telephoned her desk and openly bullied her: “I have 13 bankers in my office,” he shouted, “who tell me you’re going to cause the worst financial crisis since World War II” if she continued moving forward in bringing much needed transparency and reporting requirements to the OTC market.

Larry then went on to attack Born publicly, condescendingly assuring Congress that her concerns about the potential unwieldiness of these instruments were essentially silly, as “the parties to these kind of contracts are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counter-party insolvencies.”

In other words, the elites knew what they were doing—common sense be damned.

But fast-forward less than a decade later (and an OTC derivatives market which Summers helped take from $95 Trillion to $670 Trillion), and we all learned how those “eminently capable” and “largely sophisticate financial institutions” (Bear, Lehman, Goldman, AIG et al…) did in fact create the worst financial crisis since World War II.

It’s just too bad our elite Congress listened to the elite Summers rather than Born, even if her mathematical mind, according to Summer’s understanding of gender, wasn’t as strong as her male bully at the Treasury…

In addition to helping de-regulate the most toxic instruments to hit Wall Street since its inception, Larry Summers was a critical figure to the WTO agreement. This agreement, negotiated behind closed doors, effectively lead to the repeal of Glass-Steagall, the 1933 law which tried to keep commercial banks from becoming hedge funds—the very banks whose derivatives desks blew the markets to shreds in 08 before TARP (i.e. you and me) bailed them out.

Yet prior to the implosion he helped create, Mr. Summers described this agreement as “historic legislation [which] will better enable American companies to compete in the new economy.”  Thanks for that new economy Mr. Summers.

In fact, so little that Larry Summers has touched and/or pontificated upon has done any good at all (including the 2000 Commodities Modernization Act which created the “Enron loophole” for his friend Ken Lay), that it makes me wince whenever our gushing press seeks his guidance for the “new economy.”

And you? Do you still think Summers and his ilk are the exception or the rule? Do you think the private and federal bankers, the financial press or the experts at University X or Y can guide us through this current market porn?

It’s worth remembering that neither Greenspan in 01 or Bernanke in 08 ever saw the market crashes coming. Of course neither did any of the elites running the private banks or the US Treasury. So much for guidance.

As for me, I’m still looking for one of those elites to talk straight—and more importantly, take a little responsibility.

A Lesson in Philosophy for Investors

A man, we all know, is many things. Most would agree that we are philosophically, economically, morally and historically designed to screw up—over and over again. Mistakes—and the lessons derived from them–are how we mature, develop and improve in all walks of life, personal to professional, political to paternal. The very reality of our imperfection, at the broadest existential level, is thus forgivable.  In short: we all screw up. We are wonderfully, perfectly fallible.

What is less forgivable is not a lack of perfection, but rather a lack of accountability, even humility. Elites like Mr. Summers exhibit little of both. In fact, despite public mea-culpas (muted, but nevertheless sincere) from so many of the minds behind the 08 debacle, from Clinton and Greenspan to Levitt and Rubin, Mr. Summers , like so many other bankers and PM’s enjoying the spoils of this bubble, have never accepted any responsibility whatsoever for the last one.

Perhaps such hubris is why Summers did not get the job to Chair the Fed, as everyone anticipated. In fact, he lost the Chairmanship to a Chairwoman—out-smarted yet again by a member of that mathematically challenged gender. I bet that burned him. And again, the ironies abound.

Given the foregoing, Larry Summer’s current opinions, like so many other well-paid pundits, or current Goldman alumni in the Cabinet, don’t impress me much today. He’s trying to re-brand himself as cautious (and I’m cautious) but not because he’s worried about you—but because he’s worried about him.


So it’s no surprise that I am not overly impressed by the candid warnings as to the thin ice of an economy bankers and elites made all the more thin themselves. Why? Because it’s too late to do the right thing—namely curb monetary excesses accumulated in the last three decades under a Central Banking policy that believes creating new bubbles is the only way to recover from old bubbles.

Greenspan, Bernanke, Yellen and the central bankers of the EU and Asia are parties to the greatest experiment of central planning in the history of global markets. The faith in printing trillions per year, and hoping each billion after billion of daily liquidity will stimulate growth rather than just a useless credit bubble, is not a guarantee, it’s a gamble.

Our new normal is a world without pain, and as one bubble pops (say tech in 2001), a new one is created (i.e. the low-rate induced real estate bubble in 06). In the rubble of our latest popped bubble (the 08 mortgage-backed implosion), we now have a new “everything” bubble fueled by ZIRP, QE1 through a potential-Japan-like infinity and yet no measurable movement of the needle in growth or full-time employment, as Summers himself acknowledges.

But are more bubbles the answer? Like many of you, I’m less convinced that printing trillions (and trillions do matter) around the globe is doing anything more than leading the global economy towards a correction whose magnitude will be as unprecedented as the monetary experiment which led to it.

The Optimists

I see pain on the horizon. Staggering levels. But in recent weeks, I’ve debated over more than one table with smart credit and equity PM’s who just don’t see how the markets (or even inflation) could get out of hand, despite the trillions and trillions and trillions…printed since 08.

These are smart people. Really smart. Maybe they are right. Maybe Larry is too. Maybe everything will be fine. Truly. I can respect this.

But I don’t agree.  My common sense just keeps getting the best of me. In a world of low rates, trillion dollar annual increases in QE printed money supply and central banks around the world with no sign of any meaningful solutions other than can-kicking and finger-crossing, it’s just hard to see how financial karma won’t come, and come hard.

If that correction comes in 5 minutes or 5 years, is it any less prudent to be patient and wait for the storm to pass, or is the need to always seek return on investment keeping you fully invested? This is a question and risk assessment that each person must make for themselves—depending on age, income and personality.

Inflation or No Inflation?

You just can’t add buckets of water to a glass of lemonade and retain its flavor. The lemon gets diluted. The same is true of overly liquid currencies, from DC to Tokyo.

Perhaps I’m just crying wolf. A chicken little. But what does your own gut tell you?

And why no inflation yet? Why with all this money printing and my wolf-crying is the lemonade still tasting like lemonade? The simple answer is because the buckets of water have yet to ruin the flavor.  Right now, our private banks (the ones you and I bailed out with our tax filings) have massive balances of over $2.7 Trillion on deposit with the Fed just sitting there.

When that bucket of funds starts to enter the real economy, the lemonade will indeed lose its flavor. And when rates do go up (and a diluted currency eventually goes down), woe to the holders of long-term bonds.

Yields: The Real Tea Leaf

Remember: the bond market is key to understanding where the stock market is going. Look at yield curves and never forget that the central banks (and pundits) may like to think they control interest rates (i.e. short-term intra-bank rates), but the market, not the Fed, determines rates in the long-term.

At some point, that very same bond market is going to wonder if the yield it’s receiving justifies the risks it’s taking. As bonds sell off, you’ll see yields begin to increase—slowly at first, then dramatically. Watch that yield curve—it matters.

Long ago, Ludwig von Mises warned that low rates inspire stupid investments, the kind that lead to 1929-like results—and 2017-like bubbles. Japan did the same thing after the Nikkei crashed in 1989, and if it keeps printing and ZIRPing, eventually there will be less buyers of their JGB’s and more chances of a government default and economic shutdown. In short: the “unthinkable.”

We too are not immune to such a trajectory. Low rates and high liquidity can buy lots and lots and lots of time and indeed inspire stupid investments here too. But eventually, even our Treasuries can fall out of favor.  Even the US can see the unthinkable. Such an inflationary trajectory is no longer just a fear, but a very real possibility. That might explain why the cunning minds in China are importing over 100 tons of gold per month, as gold shines brightest when inflation rises highest.

What Can You Do?

The take-away? My advice to you? Be skeptical and informed. Don’t believe every gloom-and-doomer you read, but don’t just assume another 08 is impossible, or that even if so, another recovery will follow it. Central banks are using up all their dry powder right now, and if you are of an age where you can’t afford to wait decades to recover your losses, this bloated market may not be worth a full allocation.

I’ve written before about the risks of a can-kicking FED, austerity-averse monetary policies, the bogus scale that is the CPI and the increasing potential of hyper-inflation. These views remain and require no further ink here. As I tell my children: others don’t have to agree with you, but it’s important to be clear what you think.

The theme worth underscoring here is caution—caution for too much consensus-created faith in economic “leadership” or magical solutions from well-appointed elites.

History consistently reveals the danger of surrendering common sense, raw evidence and even intuition in favor of a wishful thinking which relegates personal responsibility to elites or even policies which are presumed effective merely because of the rank of their office or the strength of their PR machines and speaking tours.

America’s faith in meritocracy and elites from Larry Summers to Janet Yellen is bittersweet. We want to believe in something. But our obsession with smartness—the kind on Larry Summers’ CV–ignores another a kind smartness, what Christopher Hayes in his book, The Twilight of the Elites, described as more important but less valued today, namely: “wisdom, judgement, empathy and ethical rigor.”

Wisdom, judgement, empathy and ethical rigor. How much of that do we see anywhere today from our elites? Red or Blue, we can all agree that not much wisdom, judgement or ethical rigor defines our elected officials or experts right now.

Yet I see such qualities every day in the regular men and woman who worry about their savings, their investments, and their futures—the same folks burdened not by elite credentials, but exceptional common sense. I’m thinking of clients, like an old pal in Texas who amassed fortunes, friends and a 50 year marriage by trusting these basic values every day of their careers.

So what do I think of the experts, from NPR’s silly Market Watch to CNN’s pundit teams or Bloomberg Radio’s clever banter? Probably the same as you. A tinge of cynicism.

I am increasingly of the view that we should be less impressed by forced ovations and sound-bite opinions and more reliant on independent education and thought—including our own views, our own discernment.

The complexities of today’s markets, like life itself, are ultimately driven by simple themes. Clear themes. I frankly believe there are very simple sign posts ahead.  Obvious storm clouds, from PE ratios to yield curves. No weatherman (or even ex-Harvard President) is needed to tell you when it has already begun to rain. Just look above you.

Many disagree with the extent of the storm ahead, but we must each stick to our common sense, not the common buzz. I’ll quote Maimonides, who reminds each of us that “truth does not become more true by virtue of the fact that the entire world agrees with it, nor less so even if the whole world disagrees with it.”

And as for the market elites and their guidance in today’s “don’t worry, be happy” times, there’s no doubt they are comforting, nor is there any way to time when their cheerleading will be eclipsed by reality rather than stimulus. But as a veteran of those elite circles, I can only say that I’m done drinking their Kool-Aid. Again, C. Hayes sums it up well:

“It isn’t just a celebration of smartness that characterizes the culture of meritocracy. It’s something more pernicious: a Cult of Smartness in which intelligence is the chief virtue, along with a conviction that smartness is rankable and that the hierarchy of intelligence, like the hierarchy of wealth, never plateaus…Wall Street may have pretended to be a meritocracy, filled with the “smartest ever,” but it [is] really just a parking lot for the over-credentialed and underequipped.”

And you? Would you rather defer to your own head or a talking head?

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