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The contents of the @ttmygh & @fleckcap 'End Game' podcast is a must listen. My notes on the key points for 6 of the worlds best investors provide not only a framework for investment decisions, but will be very interesting to review in time to come.
Episode 1 with @AlderLaneeggs was a brilliant insight into short selling. The episode didn't delve into the end game predictions, except to say that increasing demand for short equities exposure will not exist until the unlimited money printing regime stops.
Next episode with @AitkenAdvisors, who has been sanguine on inflation post GFC due to the combination of it being a demand shock with limited fiscal response, now believes that the probability of inflation now is higher than what's priced in markets.
We now have a supply shock to deal with, fiscal policy 'and then some' & the potential need for companies to bid up to get people back into the workforce. Inflation is thought of as a monetary problem, but is it more so a political choice?
If the yield curve is parked near 0% and the Fed can't get inflation, real yields go up sharply which is in direct opposition of what they're trying to achieve. Powell learned the lesson in '18 and will never try again to pop an asset bubble again.
Given they haven't been able to create inflation for 12 years, they will let it run once they do get it.
If higher inflation is a thing, we probably won't see it in traditional places like long duration bonds, but rather in non-administered markets that are generally clearing. It will likely happen slowly, then all at once.
If passive dominates equity markets and central banks dominate bond markets, then the pressure valve will be in foreign exchange.
The part of the plumbing that's most at risk is central clearing. We had a stern test of daily margin calls in March/April, but we've not seen a sustained margin call or reversal of tend that's lasted months.
Keeping an eye for fault lines in markets and evidence that something is different. Watching commodities, gold & perhaps even more so silver if these themes play out.
Next up @profplum99 for a masterclass in the rising influence of passive. Despite many investors believing they've seen this setup before and know how it plays out, there's evidence that we're playing a new game.
Passive ownership is heterogeneous. Boomers, who are leaving the market, have a higher proportion of discretionary ownership. Under 40's, who are entering the market, are weighted to passive. That inflation is extraordinary and exponential in its power.
Rules of discretionary: As price goes up, propensity to buy goes down and when markets crash, reduce redemptions. Rules of passive are literally the exact opposite. Every price is the right price, it simply does not matter.
The dominant force in passive is momentum. Momentum is a strategy that rewards low volatility (eg 10% up and 10% down = 1% down). Money that is flowing into passive that is allocating on the basis of market cap, high volatility becomes a negative momentum contributor.
Discretionary funds carry ~5% cash, passive funds carry 10bps. The math says that is we move from a 5% to 10bps cash universe, the market goes up by 50x, simultaneously taking volatility through the roof.
As long as you can ride through the volatility, you want to be buying stocks. But there are simulations with this market dynamic where the price goes to $0. In an all passive market when passive wants to sell, there's no price at which the market will clear.
In March when discretionary tried to unwind it was not that passive sold, it was that it did not buy any more.
The problem is when they get large enough in the market where the net buying, or more importantly net selling, becomes large enough that the scale that hits the market is incapable of being absorbed by the market.
The Fed thinks that by printing money it is lowering the incentive to defer consumption, but all the empirical data shows the exact opposite. What the Fed is actually doing is increasing the price of bonds, which is increasing the value of collateral.
If the price of a 10yr bond goes up, a portfolio that is 60/40 needs to rebalance by selling bonds and buying equities. Modern portfolio theory tells us that an asset has a negative correlation with risk assets, yield must be less than risk free rate, otherwise optimal = levered.
The 10yr bond has 'put like' characteristics, because I'm being paid to own it as it has a positive yield. The minute 10yr US bonds have a negative yield then you cease to have a positive carry put and those portfolios have to collapse. Think this could be the end game.
The objective of financial markets is to facilitate capital flows to pursue positive NPV projects, but if we continue to follows this passive path the catastrophe becomes so large that capital markets cease to function and the Fed is forced to step in as its too big to fail.
We have created a system that is so stable and where the focus itself become stability / preserving the status quo, that we’ve created all the problems of specialisation, fragility and inequality associated with it where very few members of society control the resources.
The reasons we adopted the ‘fictions’ of the limits of government spending is because by allowing governments to spend at will, eg MMT, is because it makes them all powerful.
Typically what kicks off a debt jubilee is that there is so much societal pain that comes with the repayment of debt, that it is recognised you’re either going to have a revolution at the lower end or the elites are going to have to forgo some of their claims against them.
Next up @GrantsPub with some lessons on what the setup for inflation looks like, recounting a story of arbitrage on silver coins in the 60's that showed they had a hold on monetary conditions that at the time the bond market did not.
If you're looking right now for a potential inflationary setup, there is a significantly deflationary undertow of debt, but on the contrary there is an expression of sentiment in deeds.
$10 trillion worth of bonds are satisfied to accept less than nothing with the assurance of getting something from a government that is issuing currency it intends to debase. Commodities trading at the lowest point relative to the DJIA in 120 years.
The world has bought into the monetary regime that interest rates only decline, as they have done for 40 years, so we’re setup for a surprise.
The sentiment in mid 60’s was that they'd found the philosophers stone with the Keynesian method of managing economic affairs. Inflation & interest rates stable, unemployment low, economy going like gangbusters. Then then removal of the gold standard.
Narrative from mid 60’s to 80’s was that at first ‘how can inflation come out of no inflation?’ Then in 80’s ‘how can low inflation come out of high inflation?’ and both times it played out against the narrative.
Increasing deficits have not led to inflation, 10 year yields are at 50bps which is increasing the popularity of MMT as they can simply say ‘it works’ vs critics who are having to say ‘just wait’, which many people find unpersuasive.
Inflation is not always a monetary phenomenon, although it may always have its basis in an excess of currency, it is also a phenomenon of confidence in the central bank. When people don't trust money, they don't want to hold it.
Yield curve control is not here in name, but it is here in fact, volatility in the bond market is dead. If there were to be unscripted inflation, the fed would have to decide what to do.
Presumably people would want fewer treasury securities if realised inflation was to occur, so the Fed would need to work harder against selling pressure to keep yields low which would mean it would have to buy more, meaning it would have to print more money.
If the Fed were inclined to change tack and pull back inflation, it would have to offer securities to the market that the market doesn't really want at yields the Fed would prefer to offer them at. It would need to be a driver of a bond bear market.
What would this do to corporates that had levered up to exploit opportunities inherent in a zero / negative interest rate world?
Fed would have to decide between deflationary credit action and inflation at the checkout counter. The Fed is on record as saying that they will be late to hold back inflation and would therefore choose the latter.
This wont work, The Fed will lose the bond market. The bond market has been getting ahead of the bond buying, it will do the exact same in reverse and get ahead of the selling. It will be the opposite of the 30 year financial asset bull market, which would be disturbing.
Though reluctant, if The Fed moves to negative rates, it could be the starting pistol for an orderly thoughtful reconsideration of the nature of fiat currencies and the cost/damage that this rapid manipulation of currency has cost everyone.
If we made a move to renounce debt, institutionalise inflation, or to debase the dollar it would likely be bullish for stocks and the gold market.
The idea that the Fed would do QE, use proceeds to buy up outstanding debt and stockpile it, but then engage with treasury in an agreement where they would be held harmless from any sort of mark to market losses. This might seem far fetched, but may not actually be that far away.
Next up Russell Napier, who has just changed his mindset from disinflation to inflation. The key factor is the introduction of bank loan guarantees by the Fed, sending money into the economy via small businesses in distress. As a politician, the strategy makes a lot of sense.
Therefore there’s very few people against it vs straight MMT. It's a contingent liability that will simply be written off if it ever defaults. It can be positioned as an emergency measure that will be wound back, but it's a magic money tree that will be very hard to stop.
As asset prices go up, people gear them up and authorities can’t afford for them to go down. Socially and politically is a one way bet for asset prices. Post the savings and loan crisis, the belief that you’d never be allowed to lose money has on the whole been the correct belief
Financial engineerings and capitalism are two different things and what’s happened post Milken has not been positive at all for capitalism. The overuse of debt to gear up existing assets and cash streams has not been an overly productive use of capital
Two challenges for the Fed are that 1. You need to create inflation but 2. You need to stop interest rates from rising, not just short term but the whole yield curve. The biggest problem with yield curve control is the huge effort it takes to hold the curve down.
Yields start to rise because worry about inflation, the last thing that can then happen is the Fed commits to an infinite rise in its balance sheet to buy the treasuries and cap the yield curve. Instead, they force savers to buy treasuries, which wipes out the middle class.
