Os recomiendo este artículo de mi compañero Francisco Esteban:
REFLECTIONS: CENTRAL BANKS & ECONOMIC/ MARKET CYCLES.
Last May 13-14th I had the opportunity to attend the Central
Banking Series Event in Madrid, promoted by the Global Interdependence
Center and sponsored by BBVA. It was a great experience and the event
lived up to expectations as it allowed for the gathering of opinions
from some of the leading minds in the monetary policy arena.
The speaker´s panel included officials from the Fed, ECB, Bank
of Poland, Bank of Spain, Bank of Mexico, etc… pand reputable Chief
Economists from different financial institutions, corporations and
Asset Management firms.
After a series of very thoughtful and thorough presentations, a lot
of reflections came to my mind and that´s the reason why I decided to
put them together in this document.
As an asset manager I cannot
find the words to express my deepest gratitude to the Central Banks
for the Quantitative Easing experiments they are implementing. These
have allowed my clients and myself to benefit economically and placed
me into a personal transformation process. Now, thanks to QE, I am
more selfish, as I don´t care about the effects that this QEs may have
on the real economy and the rest of the citizens, my sole concern
being how QE will impact the financial markets, which is my principal
source of income. I am now a much greedier person for I now assume
greater risk when undertaking my investment decisions for I know I´ll
have the CBs to the rescue in case anything threatens the financial
panacea they have created. As a consequence of this personal
transformation, the first thing I´ve done in my new era is to make a
bonfire with all the text books that I studied at the university. I
now know that the major problems in the economy and in finance can be
fixed by merely printing more money. It just doesn´t matter about the
size of the problem, the country, its currency, its economic cycle
nuances, it´s geopolitical circumstances, etc… Quantitative Easing is
the new economic "Valhalla".
Of course, I am just
kidding…but I´m pretty sure that this describes the growing consensus
within the investment community (practitioners) and the Central Banks
alike as a means to keep kicking the can further down the road.
As an economist, I wonder why Central Banks have such an obsessive
need to intervene/ manipulate the very nature of economic cycles.
Economic cycles go from recovery to expansion and end with a slowdown
and subsequent contraction/ recession. Recessions are as important as
expansions within an economic cycle, as they act as filters on the
inefficient allocation of resources and capital within the system. By
killing recessions, we are merely perpetuating inefficiencies thus
exacerbating booms and busts during the subsequent cycles.
Central Bankers should know that the amount of risk in a system is
roughly constant over time and that any effort to minimize risk or
volatility at any point in time will lead to its more forceful
re-emergence later on.
If you take a look at the shape of both
the economic and the stock market cycles in the US during the last 25
years, a period with the highest and most systematic level of
intervention from the Fed, you´ll see that it looks like a roller
coaster. In just 25 years, the US has experienced the largest bubbles
and busts in history over short time periods. This should lead us to
question if the Central Banks are the solution or part of the problem.
The dual mandate of the Fed consists of two goals: full employment
and price/financial stability. During the last 25 years the former has
encountered problems during the aftermath of the financial crisis
(2008-2013), while inflation has never been an issue. Despite this
fact, the Fed has been actively manipulating the cost of money since
the early 90´s, thus creating false prices in exchange rates. From
there, all prices become false and the economy moves ex-growth after a
boom built on leverage and marked by a sharp rise in asset prices.
What follows is always a bust when the carry traders get killed.
I´ve been managing portfolios for 20 years and I´ve never witnessed
such an extended time period during which the only focus for
investors/markets have been on the Central Bank meetings, statements
and forward guidance. Macro and micro economics have taken on a
secondary role. Here I would argue that Central Banks should never
give forward guidance about its future actions. Never. By publicly
stating that they will keep interest rates low for a long time, the
first thing they are assuring is that they can see long into the
future, which is never the case. As a consequence, market participants
clamor for more and more of it, on the pretext that if that guarantee
where to be withdrawn, the markets would collapse. This policy of
forward guidance massively reduces the risk for borrowers over the
long run, so reducing risk on the liability side of leveraged
Mr. Massimo Rostagno, from the ECB, said during his
presentation in Madrid "one of the benefits of the QE is that it
improves the risk adjusted returns of the banks´ loan
portfolios…", but he forgot to talk about the monstrous asymmetry
that QEs create on the risk adjusted returns for investors (I better
call this a dislocation of financial markets).
consequence, the very first lesson that we are learning these days is
that QE only benefits those that have a close relationships with the
Central Banks, leading to a misallocation of capital.
me to a very simplistic explanation for one of the topics that was
addressed during the conferences in Madrid: "Why productivity is
Forward guidance is leading to an increase of leverage in the system
and to inflation in asset prices. Since assets are held by wealthier
people, the rich get richer. But the rich tend to buy existing assets,
not build new assets (which by definition have uncertain cash flow),
so the national stock of capital does not rise. As a result,
productivity falls, the structural growth rate of the economy
declines, and the poor get poorer.
In fact, there´s no question
that one of the very real consequences of the QEs on the US economy
has been in the form of growing inequality. Today the top 1% of
American tax payers pays 40% of the tax bill and the top 10% of tax
payers account for 90% of the total tax income. That means that only
11,7 million workers are supporting 108 million other people through
the government, while food stamp recipients total 46.2 million.
Statistics that are closer to those of a banana republic than those of
a First World country and the leading economic power in the
History tells us that whenever the stock market
performance exceeds economic growth, economic inequality follows and
consequently social unrest (is Ferguson just the canary in the coal
During the Madrid Events, the Fed officials put on the
table the evolution of some economic figures from the US economy
during the last few years (GDP, capital spending, employment etc…), as
a means to highlight the benefits of QE on the real economy. But on
the other hand, in a further presentation they showed a slide where we
could see the evolution of capital spending and investments on energy
infrastructure (which has been impressive during the last 10 years),
and the Oil & Gas industry employment (which has been growing much
faster than total private sector employment since 2007). Though they
argue that Energy remains a relatively small share of GDP, as it
totals less that 1%, I would say that this 1% is equivalent to at
least one third (if not half) of the real GDP growth in the US, thus
a very real contributor to growth rather than QEs.
this evolution from an oil consumer country to al oil producer one,
will be one of the reasons that explain the lack of transmission from
the oil prices slump into an increase in net income and consumption
during the last months, and a cause for concern in the structural/
transitory nature debate of the weak spate of economic data that has
been released during the first quarter of 2015.
bankers continue to search for clues on why despite these "long
for longer" monetary stimulus, saving rates keep growing (instead
of falling) and consumer spending does not take off (as should be the
case). Maybe they should simply revisit the "Animal Spritis"
term used by Keynes in his 1936 book "The General Theory of
Employment, Interest and Money". A term that he used to describe
how human emotion drives consumer confidence.
But the most fascinating thing of all, is that CBs not only try to
manipulate the nature of economic cycles but also try to manipulate
(in fact they do), stock market prices and, emulating market
strategists, make statements on their views on equity markets
expectations and valuations. Recent Janet Yellen´s remarks citing that
"overall measures of equity valuations are on the high
side", remind us of the famous "irrational exuberance"
by Alan Greenspan back in 1996. In fact, markets reaction have been
basically the same, as at the end of the day investors chose to ignore
what Yellen said and stay invested. In my view the reason for this is
that the market has already formed a mind of its own and is not in a
mood to listen, as the lure of free money and easy returns clouds our
vision. The bartender wants his customers to sober up but they want
more alcohol/ party. Maybe her warnings, like those of Greenspan in
the past, just come a little late.
But in fact those warnings DO
exist. Here are some signals of concern:
- Margin debt has
recently hit an all-time high at roughly $470 Bn. This shouldn´t be a
problem by itself, as it is highly correlated to the stock market
performance, thus fuelling more upside. But the problem is that when
it reaches such extreme levels in times of market overvaluation and
overbought condition, any sharp correction could fuel forced selling
to meet margin requirements. If the market declines further, the
problem becomes quickly exacerbated creating panic selling.
Both Market Cap to GDP (the so called "Buffet Valuation
Indicator") and Shiller P/E actual readings imply long term flat
or even negative stock market returns going forward. The first
indicator is flashing red at a 126,8% market cap over GDP. Just to put
things in context, this indicator was at 107% during the 2007
financial bubble, 136,5% at the peak of the dotcom bubble, and at
roughly 82% before de 1929 crash. At a 126,8% over GDP it stands more
than 2 std deviations above its long term average of 60-65%.
for the second indicator, Cape Shiller stands at 27,3x, which is 64,5%
higher that its historical mean of 16,6x, and is consistent with a
future market return of -0,4% a year over the next 8 years.
71% of the total debt issued in the US during the last 2 years is
"B" rated or less. This compares to the 28% level back in
2006-2007 (just at the peak of the financial bubble). So not only they
have issued a lot more debt, they´ve been doing so at much lower
- Again, back in 2006-2007, less than 20% of the
total debt was issued covenant light. Now the number is 60%.
- Last year corporations in America earned 2,5 Trn in operating cash
flow. They spent 1,7 Trn on business capital equipment and another 700
Bn on dividends. So virtually all of their operating cash flow has
gone to business spending and dividends, which is ok. But then they
increase their debt in 600Bn what makes no sense if they don´t have
negative cash flow. They basically went out and bought 567 Bn worth of
stock back by issuing debt. Their book value stays virtually the same
but their debt is skyrocketing.
- 80% of the IPO´s are
unprofitable when they come. The only other time we´ve seen those
levels or higher was in 1999.
- In 1987, when Alan Greenspan
took over from Volcker, the US economy went from 150% Total Debt to
GDP (Private + Public Debt), to 390% as they had these easy money
policies moving people more and more out of the risk curve. During the
deleveraging after the financial crisis, that ratio went down from 390
to 365%, but now because of government behavior, corporate behavior,
etc…that ratio is starting to go back up again.
- 18% of the
total high yield debt issued last year was concentrated in the energy
sector. The slump in crude oil prices and the contraction taking place
in the industry, poses a growing threat in terms of credit risk.
- Aging population has become one of the biggest structural
problems, not only for the US but for the majority of the western
economies. In the US, aging population is one of the reasons behind
the slump in the labor force participation rate (now roughly 62%).
Although this rate has been declining during the last 20 years, the
rate of decline has been specially steep since the beginning of the
financial crisis and subsequent QEs implemented by the Fed. If we take
a look at the evolution of the rate by age tranches we see that since
the financial repression started, the participation of people above 55
years has skyrocketed, while teenagers participation have been falling
dramatically. In my view, there´s no wonder why this has happened.
Apart from the obvious explanation coming from "aging",
people now need to work longer and save more if they want to get the
same retirement income they expected to get before both the crisis and
the financial repression started.
With an aging population
(which means more people living on pensions and public money,
increasing social security spending, etc…), a labor force base highly
dependent on those above 55 (so closer to retirement), and the
youngest falling apart…, I wonder how, when and who is going to pay
for those record and increasing Debt to GDP ratios.
to the Euro Zone and its common monetary policy, I would argue that
the different countries have (and have always had), completely
different "natural rates", so they should have completely
different "actual rates". A common interest rate would be
too high for some countries and too low for others. So the system will
be diverging until it finally explodes. No amount of QE will ever
My feeling after hearing officials from both the ECB and
the Fed talk in these Madrid Events, is that they have implemented all
these new age Quantitative measures simply because previously they
entered a vicious circle of systematic intervention in both the
economic cycles and the markets, things have spiraled out of their
hands, volatility is mounting with an unprecedented sequence of booms
and busts, and they found a huge asymmetry when they had to decide
between a "do nothing" response to the financial crisis
(taking the risk of letting the system explode), and an
"unprecedented active" response (taking the risk of
navigating unchartered waters and ultimately "perhaps" being
I think that we are simply in the last scenario, thus
navigating unchartered waters with no conviction on the final outcome
of the measures they have implemented, the forward guidance given time
after time, and all simply based on trial and error.
worrying aspect of all this is that as rates remain stuck at zero and
CBs run out of ammunition after the implementation of these immense QE
programs, they have no margin for error, which leaves the system
highly vulnerable to any economic or external shock.
At the end
of the day markets will find evidence that there´s no infallible
thorough model, no math, no science… but simply hope and time buying
behind CBs policies. It´s like the emperor without any clothes but
nobody will tell him. That´s why I think the next very big crisis
won´t be a financial crisis, but a crisis of confidence.
days we´ve been hearing about many forms of "exits" in the
markets (Brexit, Grexit, etc..), but I think that the very important
exit that we should be talking about is the "FEDXIT", and I
don’t mean tapering, but the real fall apart of the Fed (and CBs in
general) from the economic cycles and the markets.
Francisco Esteban, Portfolio Manager at Alpha Plus Gestora SGIIC