Banks can borrow for nothing (0%), expand their loan book by 2.5% (by the end of January 2018) and get an extra 40 bps kicker from the ECB. Get your “chicks for free.” OK, maybe not “chicks” but certainly “money for nothing.” What they are not saying is that the banks are in trouble. Let’s hope the banks can find some qualified and motivated borrowers.
This next quote pretty much sums it all up for me, “In the last three years plus, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable in order to restore sustainability.” – Mohamed A. El-Erian, The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse (Random House, 2016)
What does this mean? I explained it to someone on our research team this way: It’s like you have a shoulder issue. You go to the doc and get a cortisone shot. Perfect, you feel good again. Six months go by and the pain is back. Another shot, another short-term fix. You do it again until finally the doc tells you she’s done all she can do for you. All that cortisone is really bad for your system in the long term. You need to go to a different doctor, a surgeon, who has the tools to fix the structural problem in your shoulder.
El-Erian calls it a handoff: from the Fed (injecting the juice) to our elected officials (who have the power to implement structural reform). I.e.: Individual and corporate tax reform, U.S. foreign profit dollar repatriation, grand infrastructure projects (aged bridges, natural gas pipes, highways, technology) and entitlement reform/repair (we are nearing a breaking point). Simply, policies that stimulate growth. This requires action.
The problem is that the authorities who have the ability to fix the problem don’t seem to be motivated to get to work. Power struggle gridlock. At some point, they’ll get motivated but it might take another financial crisis to wake them up. This has to happen in Europe, Japan and China as well. Debt is a mess everywhere. See this study from McKinsey “Debt and Not Much Deleveraging“.
Are global central banks nearing the “unsustainable?” No one knows for sure. Stay alert and expect the unexpected. Is ZIRP, QEs 1, 2 and 3, TARP, LTRO, NIRP and coming QE4 (helicopter money) working? Going to work? My two cents is that we have a very long way to go.
Buying government and now corporate bonds. What are we enabling? Debt has not come down. What are we messaging to corporate fiduciaries, bank prop desks, levered investors? What did low rates and no-doc mortgages do for the housing market. Who are we helping or hurting with repressed interest rates? Keep your guard up. These are highly unusual times. Stay alert and expect the unexpected.
Equity market valuations remain high and the bull market is aged. Hedge that equity exposure, broadly diversify and overweight to non-directionally dependent strategies. I continue to favor a 30/30/40 (equities, fixed income and liquid alternatives) portfolio mix and hedge that equity exposure. We can change the tilts to overweight equities and remove hedges when forward return potential is high (at which point valuations will be lower and attractive).
To that end, this week you’ll find a great equity market chart that shows us what the forward S&P 500 Index returns are likely to be based on the percentage of household equity ownership. It may help guide your thinking as to when to become more aggressive again.
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.