So, here we
are. Stock indexes are through the roof
and making new highs almost every day.
Realized volatility is collapsing through the floor, and has never been
lower for such a protracted period. The
era of (normal) five, ten, or twenty percent corrections seem like a distant
memory of another time and place.
Interest rates remain near historical lows, with seemingly benign
duration risk in the bond market. Inflation
has all but been pronounced as “dead as a doornail”.
It was not
through brilliance in the management of our major corporations that account for
the (irrational) exuberance that the markets seem to be embracing. Though they
certainly did their part with stock buybacks that helped inflate prices and
knock compensation options “into the money”, thereby coincidentally increasing
their own personal incomes. No, it was
something even greater and more damaging that is responsible for the gross
inflation of financial assets. It was nothing less than the massive balance
sheet growth of the central banks of the United States, Europe, China, and
Japan that is responsible for what we have termed “The Free Lunch”. The “Free Lunch”, in this context, implies
there have been little to no negative ramifications to what we and some others
have described as “insane” policies on the part of the major central banks.
So let’s get
this straight. The “all knowing” central
bankers blew out their balance sheets to unprecedented levels. They bought not only government and mortgage
debt, but in Europe the ECB even bought bushel baskets of corporate debt. In Japan the BOJ upped the ante by buying
enough equity ETFs to become a top 10% shareholder in most companies in the
Nikkei Index. They supplanted the market
mechanism of pricing interest rates to the point that short term rates were zero
in the U.S., and negative in Europe and Japan (which continues). They forced savers to become investors and speculators;
thereby driving asset prices ever higher.
Given that capital is the life blood of capitalism; its mispricing can
result in nothing but mal-investment.
This is true across the entire spectrum; from governments, to
corporations, to individuals. And oddly,
during and possibly as a result of this “mad experiment”, the world has seen
the emergence of possibly the most strange of all assets, crypto currencies.
So all of
this happened; (disparate) wealth created out of thin air, inflation seems decimated,
stocks up, bonds up, real estate up, art up, and the amount of government,
corporate and personal debt in the stratosphere. CNBC
guest bears have been as rare as sightings of Bigfoot, all because central
bankers were so “brilliant”. If they can
just unwind their balance sheets with little or no disruption, they will have truly
gifted to the world this rarest of phenomena…”The Free Lunch”.
for us is that we were taught that there’s no such thing as a “Free Lunch”…
because someone ALWAYS has to pay. Sarcasm
aside, what the Fed and its central bank European, Chinese, and Japanese
counterparts have done is nothing less than caused what we believe will prove
to be the greatest asset bubble of the
modern era. As stated above, by not
allowing the free market to price capital, they have allowed years of
mal-investment, which will negatively affect growth long into the future. Furthermore, going forward, the impending new
federal tax legislation along with growth of entitlements will likely cause the
debt and deficit to further skyrocket.
And excessive debt lowers economic growth in the long run as debt
service consumes capital that could be used constructively. We don’t, for one
second, believe the projections of the administration, or anyone else, that
growth is set to “take off”. In the past
we’ve discussed how, just on demographics alone, the odds are greatly stacked
against returning to growth rates of the past.
To our way of thinking, short term blips aside, the economy will revert
to the anemic growth of the past eight, or so, years. The markets will ultimately return to more
traditional patterns of volatility as interest rates and risk become more
happens, it will be “look out below” for stocks, bonds, and financial assets in
general. The creators of the “Central
Bank Bubble” and their cheerleaders in the media may think they’ve given the
world a “Free Lunch”. But we continue to
believe the “check” is coming, and when it does, it will be a very, very