December 26, 2013 at 3:14 pm #17667
Been thinking about QE over the holidays. How jolly.
Here are a summary of QE suppositions under which we at B & P have been operating:
1. Via QE, the Fed has decreased LT bond yields, and–via a list of transmission mechanisms nicely compiled by B & P–increased asset prices.
2. QE has not substantially increased loan growth, money velocity, economic growth, and “official” inflation. Why? Proceeds from Fed bond purchases sit idle in bank reserve accounts, and, further, reserves don’t beget loans anyway. (As an aside, lower labor costs–caused in part by QE’s lower borrowing costs–and lower energy costs also help reduce any inflationary effect QE might have.)
3. To some degree, lower borrowing rates caused by QE does allow the US govt to run deficits, redistribute income, and hence support consumption by, and thus contentment in, the “masses”. (This fourth “bread and circuses” supposition is more my addition to the debate than it is that of B & P.)
4. If QE did cause higher “official” inflation, it would also cause higher interest rates, and thus would become self-defeating. (B & P may not have asserted this supposition either, however, it is a widely accepted one derived from the economic equation: Nominal int rate = Real int rate + expected inflation.) Of course, this phenom was last observed in the 1970’s when inflation went north, and the bond “vigilantes” of that day drove up rates to cover their inflation losses. blah, blah, blah. Most of us know this story.)
Note that famed short seller Bill Fleckenstein recently opined on CNBC that, in 2014, the Fed “will lose control over the bond market”.
5. Taking that assertion in, here is more a question than a supposition: Well, if the Fed can control the bond market by purchasing a huge percentage of issuance, then how can it ever lose control of it? What if the Fed bought all the issuance? Could it not do so at any net rate it wished? Even if private bond buyers (many of whom are actually closely aligned with the Fed) wished to “fight the Fed” in the bond market, who would win that fight? . . . private buyers with limited resources, or a Fed with unlimited resources?
All the above stated, consider this added supposition:
If the Fed can employ QE w/o causing higher “official” inflation, it will do so ad infinitum. There are too many reasons to continue it (as B & P has shown), and not enough reasons to stop it. (An afterthought: Are there reasons to stop it we have not considered? See the three questions listed below.). Further, if the Fed continues QE, asset prices will continue to rise. With so many reason to rise, why would they drop?
Also consider this: There’s a bit of a conflict in our B & P case on QE, as follows:
1. We avoid a heavy US stock allocation partially b/c we assert that–b/c QE doesn’t foster loan growth and spending by wealthy stockholders–QE doesn’t aid the real economy. (QE’s inefficacy, however, is what insures its survival b/c, if it worked, it would kill itself via the nominal interest rate equation set out in paragraph 4 above. Stated differently, Fed officials should pray each day that QE never works. If it ever starts working, they’ll have to stop it.) Yet, . . .
2. At the same time, we at B & P admit that, for the long list of B & P compiled reasons, QE causes higher prices for the assets we avoid.
The conflict stated another way: We say QE does not work so we avoid US stocks; yet, it’s the very fact it does not work that insures its survival and thus the higher US stock prices we admit it causes.
A related question: Who decreed that the Fed really cares about economic growth? After all, it’s not accountable to the electorate, and it does not suffer from its own policies b/c its survival is not dependent upon economic growth. Is it not more beholden to the financial industry? If Fed’s true “fan base” and its true base of support is content, what is the Fed’s incentive to change courses? Because the US Congress is dependent upon the lower rates the Fed creates, how can that Congress afford to shut the Fed down?
This stated, I encourage the B & P team to focus upon three questions:
1. What factors, if any, could cause QE to work, and thus engender a bond market that’s “out of the Fed’s control”? and,
2. What factors outside of higher “official” inflation, if any, could blow up the entire QE experiment? Restated, what other “reasons to stop it” have we not yet considered? (e.g., Perhaps a global recognition that “official” inflation numbers are a sham?) and,
3. Even if QE never works, and thus never stops, and thus continues to drive up asset prices, what factors, if any, might still lead asset investors to sell said assets?
As Chris eloquently illustrated in France, we operate in economies and markets that resemble clouds. Well, as best we can, let’s carefully try to see what’s going on inside those many murky morasses.
HRE IIDecember 30, 2013 at 2:53 pm #27116
A quick summary-addendum related to my Holiday QE Post:
Given that we’ve shown how QE drives up asset prices, would it not be wise now to focus upon:
1. What factors could cause the QE mechanism-process to break down,
2. How long it might take the mechanism-process to break down,
3. The “tells” or signs of when the QE mechanism-process is breaking down,
4. If it breaks down, what will be the Fed and Govt responses, and will these responses be effective?
Let’s not kid ourselves: If QE breaks down, the emerging market assets in our model portfolio would also drop–perhaps severely. Perhaps these assets are already dropping b/c of global QE mistrust. Further, our Gold and real estate allocations could also be hit, as they were in 08.December 30, 2013 at 4:53 pm #27117
Thank you Hense for your toughts on QE. I think it is important for our group to be thinking about the medium and long term effect of QE on our individual portfolios. Even if B & P have a long term view of investing, I think it’s also important to understand and be aware of what is going on, medium and short term.
It is a known fact that the game of investing is played by two teams, the Big Boys with all the info on one side and Joe Public with nothing but hype and truncated info on the other. In looking back at 2013 it is easy to see that we have missed (since 2009 actually) a major uptrend in US equities. It’s never as easy when looking ahead and there lies the problem.
I have always appreciated the discipline that comes with sticking with an idea of investing. If you beleive in your ideas, it is, in my opinion, foolish to change it to embrace every new fads that comes out. In that regard, B & P has no fault. But this comes with an important caveat and it is that those ideas have to be forcefully challenged regularly. I read that they are.
Lets hope 2014 will see us more successful.
R BlaisDecember 31, 2013 at 5:50 pm #27118
Thank you for questioning the future at the end of this year 2013 when we may feel dejected and stupid because we missed the party of rising stock prices. Well, okay, the Fed has fed its pals and the market has risen more than expected since 2009. My guess is that those who are in the market now will stay in the market and take the hit when it comes, then be miserable and disagreeable.
The Fed’s biggest customer is us, the US Government which needs all the money, and low interest rates it can get … forever. The Fed is in a bind for all the reasons Hense poses. If they go against the government, they would face deadly consequences. So, they have done what they have done to survive and will do so until they are killed.
What about next year, almost here?
I suspect more of the same. What else can they do? But, the Fed is not quite as powerful as they would have us believe, or the public thinks they are. The US market is more powerful, but slower to respond, and the world market is much bigger and already responding with deflation. The world market is slowing down, with trouble spots all over the place. The US market is displaying clues of doubled interest rates in the last year, slow “growth”, declining population, fear and distress too in spite of almost universal optimism in the financial markets where they are happier than even in 1928.
Prices that are built on a hollowed out economy will not last. The Fed will keep pumping, but the optimism will not last. We may see another six months of rising prices, or six weeks, or at any time natural reality will come back to its senses and take back the false positions of what we have now. It may start slowly, but once it gets going it will go fast as the hedge and mutual funds “de-lever”. The event that triggers the turn is not important, but it will be what is blamed.
I think B&P are wise to be so cautious. Cash may not be very exciting, but it does have wonderful buying power when the opportunities present themselves. The alternative of being caught by a serious market downdraft may leave no exit strategy, and no cash. Then you are out of the game. It is very difficult to make new money, especially once the market declines because then there won’t be any work either.
With cash, you will be able to buy low, the prerequisite for selling high if any gains are to be made. Surviving is more important than gambling. On New Year’s Day, you can watch the sun rise and not worry about the computer ticker. That is happiness.
Thank you B&P for doing the right thing and not the opportunistic thing. 2014 will bring new adventures and new surprises.
CliveJanuary 6, 2014 at 2:53 pm #18130
Thanks, Clive and R, for adding to the QE discussion. QE merits the full attention of us all. After all, QE is the bailing wire that’s holding the US mkts and economy, and maybe even the world’s mkts and economy, together. My guess: In 2014 the strength of that wire will be tested. The wire is not going anywhere b/c the Fed can’t afford to remove it, but will it break? . . . or at least begin to fray. So far, world stk mkts indicate a bit of stress at the seams. Let’s keep our eyes on every possible mkt and econ indicator, and by the way, is there any law that says a Family Office can’t benefit from the occasional well placed short position? 😉 Regards, HRE II
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