socgen

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The Contrarian Indicator of the Decade?

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

Sir John Templeton

Buy the fear, sell the greed. Since bottoming-out in 2009 markets have seen an uptrend in equity prices:

Now it seems like the euphoria is setting in. And in perfectly, deliciously ironic time, as shares of AIG — the behemoth at the heart of the 2008 crash — are returning to the market. Because reintroducing bailed-out companies to the market worked well last time didn’t it?

Joe Weisenthal:

Markets are down a hair today, but the theme of the morning is clear: Uber-bullishness. Everywhere.

This is the most unanimously bullish moment we can recall since the crisis began.

Note that this comes as US indices are all within a hair of multi-year highs, and the NASDAQ returns to levels not seen since late 2000.

Big macro hedge funds, who have been famously flat-footed this year, are now positioned for a continued rally.

Bank of America’s Mary Ann Bartels:

Macros bought the NASDAQ 100 to a net long for the first time since June, continued to buy the S&P 500 and commodities, increased EM & EAFE exposures, sold USD and 10-year Treasuries. In addition, macros reduced large cap preference.

J.P. Morgan’s Jan Loeys:

We think the positive environment for risk assets can and will last over the next 3-6 months. And this is not because of a strong economy, as we foresee below potential global growth over the next year and are below consensus expectations. Overall, we continue to see data that signal that world growth is in a bottoming process.

SocGen’s Sebastian Galy:

The market decided rose tinted glasses were not enough, put on its dark shades and hit the nightlife.

And the uber-bullishness is based on what? Hopium. Hope that the Fed will unleash QE3, or nominal GDP level targeting and buy, buy, buy — because what the market really needs right now is more bond flippers, right? Hope that Europeans have finally gotten their act together in respect to buying up periphery debt to create a ceiling on borrowing costs. Hope that this time is different in China, and that throwing a huge splash of stimulus cash at infrastructure will soften the landing.

But in the midst of all that hopium, let’s consider at least that quantitative easing hasn’t really reduced unemployment — and that Japan is still mired in a liquidity trap even after twenty years of printing. Let’s not forget that there is still a huge crushing weight of old debt weighing down on the world. Let’s not forget that the prospect of war in the middle east still hangs over the world (and oil). Let’s not forget that the iron ore bubble is bursting. Let’s not forget that a severe drought (as well as stupid ethanol subsidies) have raised food prices, and that food price spikes often produce downturns. Let’s not forget the increasing tension in the pacific between the United States and China (because the last time the world was in a global depression, it ended in a global conflict).

It would be unwise for me to predict an imminent severe downturn — after all markets are irrational and can stay irrational far longer than people can often stay solvent. But this could very well be the final blow-out top before the hopium wears off, and reality kicks in. Buying the fear and selling the greed usually works.

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Ron Paul & Austerity

Regular readers will be aware that on the topic of austerity, I generally agree with John Maynard Keynes:

The boom, not the slump, is the right time for austerity at the Treasury.

Regular readers will also know that I like Ron Paul — a Presidential candidate who promises a $1 trillion spending cut in his first year in office.

Is that a contradiction? I don’t think so.

Why?

In comparison to most austerity-stricken nations, the United States under Ron Paul would be a special case, for one key reason.

Ron Paul’s cuts — rather than destroying productive output like Brüning in the 1930s, or Papandreou today — are aimed at cutting the two greatest wastes of productive output: financial sector corporate welfare, and imperial military spending.

This topic cuts to the heart of the Keynesian and Rothbardian views on recessions in general, and depressions in particular.

Essentially, the Keynesian position (and its later monetarist adaptation) is that a slump in aggregate demand (i.e. GDP) is — for whatever reason — the problem, and that this can be remedied by the government doing whatever it can to raise aggregate demand (Keynesian stimulus, quantitative easing, nominal GDP targeting).

The Rothbardian position is that the problem is caused by government-led malinvestment, and that the junk must be allowed to liquidate before an organic recovery can ever take hold (zombification).

Both views have something to them, but both views overcomplicate the problem. The real issue is the drop in productive output.

As I have shown before, it is perfectly possible (and actually quite common) for monetary and fiscal policy to raise or stabilise aggregate demand without actually addressing the underlying productivity issue — leading to superficial (and hollow) recovery, like Japan in the 90s and (probably) America today.

Austerity policies during a recession can often totally choke off productivity (Brüning, Papandreou, etc). This is particularly true in nations that are very centralised, and where government has become a very important economic actor.

Now Austrian economists may say that government spending is always a misallocation of capital. Well, I agree that central planners lack the information of the free market. But government is useful in supporting underlying productivity (as Adam Smith noted) through infrastructure creation, the rule of law, etc, and withdrawing that support during a slump for the purpose of paying down debt is detrimental.

So the key here is that government should do what it can to support productivity. What the Keynesians (and monetarists) got wrong is the idea that aggregate demand was somehow a good reflection of underlying productivity, and that underlying productivity can be effectively supported with money pumping, or by digging holes. My model is that the best means to sustain and increase underlying productivity is that government should let failing economic systems completely fail, end wasteful and capital-destroying activities like imperial adventurism, and recapitalise the broader people of the nation. Ron Paul’s aim of cutting taxes and simultaneously cutting military adventurism and corporate welfare would do that.  His policies are not the austerity policies of tax hikes and spending cuts which constrict the economy by sucking money out to pay down creditors without putting anything back in.

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Can I Have a Bailout?

Am I about to get regulated?

From Zero Hedge:

SocGen’s Todd Martin, who is the bank’s Asia equity strategist, appeared on Bloomberg earlier today to discuss the Volcker Rule and prop trading, against which the anonymous blogosphere had some very “strong views” back in 2009. Sure enough, prop trading ended a few months later with the adoption of the Volcker Rule. Somehow, the topic of the Volcker rule shifted to the topic of whether or not Morgan Stanley is exposed to France, and its insolvent banks, and who is to blame: “For example one blog just a week ago, had a very, very strong view against Morgan Stanley. They quoted Sanford Bernstein who actually was telling people to buy the stock. And then they were quoting Gross Exposures not Net, and then concluding that Morgan Stanley had to go down and be dismembered [sic]. Now I have a serious problem with this. If I get regulated why isn’t this place regulated. It’s also very dangerous because they are using psudonames [sic] and we don’t know who they are. They could be the guy on the street. They could be a hedge fund dangling out information. It could be the head of a prop desk. Thing is it is supposed to be regulated. And they get their revenues from trading platforms on US soil. And I don’t think it’s fair. And I think the US should go and take a look and regulate the blogosphere. I think it’s really, really out of control.” In other words: it is all the blogosphere’s fault.

Of course, it is a simple fact that while the promise of bailout money hangs over markets, some traders and executives will take huge risks with other people’s money (shareholders, taxpayers, anyone with a loose chequebook). This agency problem creates huge fragility — especially in a system like modern international finance which is prone to the default cascade, where one bank failure can potentially bring the system down. And it is also true that Dexia — a bank that only recently passed the regulators’ stress tests with flying colours — just failed (ouch) and had to be bailed out.

The reality is that the only way to create a system based on responsible behaviour is to enforce the idea in capitalism that actions have consequences —  no bailouts for screw-ups, no free lunch, remove the money from politics, etc.

The real issue here, though, is just how “regulated” I might end up being.

From Wikipedia (surely this needs to be regulated, too?):

Censorship in Nazi Germany was implemented by the Minister of Propaganda, Joseph Goebbels. All media — literature, music, newspapers, and public events — were censored. Attempts were also made to censor private communications, such as mail and even private conversation, with mixed results.

The aim of censorship under the Nazi regime was simple: to reinforce Nazi power and to suppress opposing viewpoints and information. Punishments ranged from banning of presentation and publishing of works to deportation, imprisonment, or even execution in a concentration camp.

Hitler outlined his theory of propaganda and censorship in Mein Kampf:

“The chief function of propaganda is to convince the masses, whose slowness of understanding needs to be given time so they may absorb information; and only constant repetition will finally succeed in imprinting an idea on their mind.“

Right — citizens need to have the right ideas imprinted on their minds.

Repeat after me:

The Euro is not failing.
The Euro is not failing.
The Euro is not failing.
The Euro is not failing.

Let’s try another one:

Goldman Sachs is doing God’s work.
Goldman Sachs is doing God’s work.
Goldman Sachs is doing God’s work.
Goldman Sachs is doing God’s work.

Feels good, doesn’t it?

More importantly, now that I am doing God’s work (by proxy), can I get a no-haircut bailout if I leverage myself 100:1 selling out of the money S&P calls and lose all my capital?

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Will Warren Buffett Bail Out the World?

According to Buffett: No.

From Bloomberg:

Berkshire Hathaway Inc.’s Warren Buffett, who has sold most of his company’s holdings of European sovereign debt, said his firm isn’t interested in helping to bail out lenders on the continent.

“They need capital in their banks, in many of their banks,” Buffett, Berkshire’s chairman and chief executive officer, told Bloomberg Television’s Betty Liu on “In the Loop” today. “We would not be a good prospect,” he said in an interview from the New York Stock Exchange. He’s received “very, very few” calls about putting capital into European banks. “Not quite none at all,” he said, declining to name any institutions.

On the other hand, I’m pretty sure Warren Buffett will soon be channelling vast quantities of cash (Berkshire is sitting on a $50 billion heap) into European banks at liquidity-crisis prices.

Why?

The global financial system is an absurd interconnected house of cards. One falling card (like a Greek default) or ten falling cards (like the European banks who were foolish enough to purchase Greek debt) might just bring down the entire banking system, and its multi-quadrillion-dollar evil twin, the derivatives system.

Why?

Well, one insolvent institution that isn’t bailed out means that all of its outstanding debts don’t get paid, which creates huge holes in the balance sheets of other institutions. That’s why a system based on debt is so stupendously fragile. Caution will be thrown to the wind, and salvaging the remnants of the incoherent shit-heap tumbling into the earth and attempting to hold it up will once again become the mode du jour.

And just what might be brought tumbling down in the inevitable cascade of defaults?

Well, taking J.P. Morgan as an example (others are considering Morgan Stanley) just over $90 trillion of liabilities.

From Reggie Middleton:

When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM’s derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008).

The bailout-crisis-bailout approach is another reason why we haven’t had a real recovery: all the time effort, labour and capital that could have gone into solving the West’s challenges (like energy independence, sustainability, infrastructure, reindustrialisation, job creation) has instead gone into saving a system that at absolute kindest is a theatre of the absurd.

The calamity of 2008 has had practically no effect whatever in reducing systemic risk, or institutional leverage, because politicians and regulators colluded with the banks to prop the system up.

Regulators are repeating the same mistakes and hoping for a different outcome.

Meanwhile, many bankers are repeating the same mistakes and hoping for the same outcome — a massive bailout paid out from the earnings of future generations.

Perhaps eventually it might dawn on the public that the problem is the system, and that to cure our affliction, the system must be allowed to fail.

Or perhaps not…