What Hath The Fed Wrought?

It’s Fed week once again and once again the group has decided to leave interest rates unchanged. This, despite the fact that, with core inflation running at just over 2% and jobless claims at their best levels of my lifetime, they have clearly met their dual mandate. In fact, they met these targets a long time ago. By any measure, the jobs market is very strong and, with core inflation rising, it’s hard to argue deflation poses any real threat whatsoever.

If their goals have been met, why has the Fed been so hesitant to abandon this emergency interest rate policy? I think it’s very simple. They are worried about spooking the markets and thus damaging the wealth effect they so aggressively and explicitly targeted over the past seven years.

The bigger (rhetorical) question, however, is this: In maintaining emergency policy for so long, what hath the Fed wrought? It only took a couple of years of emergency-level interest rates to inflate the housing bubble. After seven years (and counting) of emergency-level rates what hidden (or not so hidden) risks or mispricings driven by malinvestment have accrued this time?


The Greatest Money Manager Alive Attributes The Majority His Success To Just This One Thing

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“The Big Short” Is Only Half The Story

On Monday I finally got around to seeing “The Big Short.” I’m no film buff but I really enjoyed it and thought Christian Bale and Steve Carrell both gave amazing performances.

To me, the film did a great job of profiling a few of the guys who really nailed the mortgage crisis and fully understood its implications for the broader financial system way before anyone else even had a clue. I especially appreciated how the movie treated the abject loneliness of being a true contrarian. I’ve gone through it many times in my career. The film does about as good a job as I can imagine of putting you in their shoes as they are ostracized, ridiculed and eventually even victimized to some degree by their peers, clients, the media and the big banks before finally being vindicated.

There is one major component, however, that is glaringly absent from the movie and that is the role of the Fed in laying the groundwork for the crisis in the first place. For a more holistic view, I highly recommend my friend, Jim Bruce’s documentary, “Money For Nothing.”

Ultimately, I believe both films are “must watch” for anyone who truly wants to understand what really went wrong back in 2008 and why. More than that, they can help us understand just how history rhymes, knowledge which may prevent us from making these same, critical mistakes again and again, both as investors and as a society.

Get your copy of “Money For Nothing” at and follow Jim on Twitter. He may even have a few t-shirts left (pictured above).


Has Demand For Stocks Dried Up? Part Deux

A few weeks ago I took a look at the margin debt numbers using them to argue that overall demand for stocks could have already peaked. There are plenty of other indicators confirming what this one seems to be saying but this is just one slice of the demand picture. There’s an entirely unrelated demand factor that may be even more troublesome for the stock market.

Before we get to that, however, let’s take a look at the latest margin debt figures. From the chart below, it looks as if investors may have, indeed, run out of buying power. Total margin debt/negative credit balances peaked from all-time record levels just about a year ago and have essentially flatlined since.

NYSE-investor-credit-SPX-since-1980Chart via Doug Short

Taking a look at Rydex funds, the ratio between bullish and bearish funds is now greater than it was at the peak of the internet bubble, mainly because almost nobody sees the need for downside protection anymore (see assets in bear funds and the bottom of the chart). Even total capitulation by those invested in bearish funds would not move the needle much in terms of demand for stocks.


This is also confirmed by the total amount of money invested in equity funds in relation to money market funds. Like the Rydex indicator, the bullishness expressed here has never been higher. Of course, more money could flow from money market funds into equities but, considering how this indicator is already historically stretched, it doesn’t seem likely.

chartChart via SentimenTrader

What may be the most fascinating and underreported aspect of the demand picture, however, is the incremental demand the equity market has seen from sovereign wealth funds over the past few years. Considering these hold roughly $7 trillion in assets today, they are no small factor in the discussion.

The two largest funds in Japan and Norway now have equity allocations over 50%. This is already a fairly aggressive allocation these days for large pension-type plans so it’s not likely they will significantly increase this exposure. We certainly won’t see Japan go from a 0% allocation to equities to 50% again as we have recently.

And there is an interesting case to be made that this growing demand could be tapped out, or worse, convert to supply at some point in the near future. I’ll let Marc Faber, via Barron’s, explain:

Sovereign wealth funds rose to $6.8 trillion as of September 2014, from $3.2 trillion in 2007. Of that growth, 59% came from oil, gas, and related revenue. As oil prices fall, what will happen to the growth of sovereign wealth funds, which have been buying financial assets around the world? Their funding is going to evaporate, and they might be forced to sell.

If the price of oil doesn’t rebound relatively soon some of these funds may find their source of funding, which has grown dramatically over the past few years, has run dry hence their ability to purchase or even hold their current level of equities.

So domestic investors are already “all in” and foreign investors, via sovereign wealth funds, are essentially as well. Where then does the incremental demand come from to push the stock market higher?

Like these foreign funds, I guess if the social security trust fund could convert those IOUs it holds into dollars they could begin to allocate some of the $2.7 trillion there toward our stock market. However, considering the facts that, unlike other funds which are still growing, the social security trust fund is already facing large annual deficits and is due to run out of money altogether in about 15 years, this would be a very tough sell, especially to a congress now leaning fiscally conservative. And, sadly, these sort of proposals really never gather any steam when it’s truly an attractive time to do so.

All in all, I find it hard to imagine where the demand is going to come from to push stock prices much higher, especially when valuations are already historically stretched and fundamentals seemingly beginning to deteriorate. To me it looks like potential supply far outweighs potential demand at this point. In other words, potential risk far outweighs potential reward.


Wall Street Is #Winning In Full-Blown Charlie Sheen Fashion

We interrupt this financial blog for an important political message:

First of all, let me say I haven’t read the actual bill but I’m sure none of the folks in the house who voted for it haven’t either. What I do know is that Wall Street’s too-big-to-fail banks have basically held the federal government hostage by inserting their own provision into the latest spending bill that allows the government to avoid shut down.

The banks are essentially saying, ‘let us keep trading what Warren Buffett calls “financial weapons of mass destruction” with an explicit bailout backstop from the FDIC or else… [the government will cease to operate].’ To be clear, this is one way banks are allowed to play the heads I win (and keep all the trading profits), tails you lose game (and American taxpayers pick up the tab) in the markets.

What I find especially disgusting about this is that Citigroup lobbyists, not congress, wrote the entire provision that has been inserted into the spending bill. Then Jamie Dimon, CEO of JP Morgan, made personal calls to key players in the house to ensure the bill would pass.  What’s more, another provision in the bill allows for congresspersons to receive 10X as much money from lobbyists, like those from Citi who wrote the provision, in the future as they do already today.

Now I know this isn’t about ‘did we learn nothing from the financial crisis’? We certainly did learn something and the Dodd Frank reforms, with critical insight and input from Paul Volcker, went a long way toward rectifying the problems. No – this is more about the banks paying people off to put their interests above those of the American people.

And I, for one, am utterly ashamed of our political process at a time like this.

Full Disclosure: I have not been registered Republican or Democrat for over a decade because, in the words of Richard Jeni, it’s just too much fun to, “bitch no matter who wins.” 

Now back to your regularly scheduled market insights.