The Daily Capitalist: I’m getting back to normal posting after travel, and want to uptake my “risk off ” posture. Regular readers know that I went 180 degrees to a “risk off” posture in early May from the aggressive risk on posture I had assumed in late August 2010, and then after the stock market hit what I had hoped was a major bottom in early August, went to some “risk on-ness”. However, three things happened in late September that changed my point of view. One was that despite increasing the late September meeting’s duration from two days from one, the Fed did no more than previously expected, namely Operation Twist, which merely allows more money to “hide” in the short end of the yield curve than before. Since the Fed can hold long bonds indefinitely, this was a “risk off” move given that the markets expected more. Then there was ECRI’s recession call, almost simultaneous with Goldman Sachs announcing a record rate of decline in analysts’ forward corporate expectations.
Naturally, the gods of the markets followed this set of information that was amassed in late September with a massive risk on rally. LOL!
Then came the MF Global disaster.
The SPDR S&P 500 ETF (NYSEARCA:SPY) peaked on October 28, the Friday on which that it was apparent that something truly bad was happening there. With the apparent misplacement of large amounts of supposedly segregated clients’ funds, I suspected from the start that MF Global would likely be at least a mini-Lehman event. The reason it could not be an immediate Lehman for securities and commodities prices is in part that in the futures biz, for every long there is a short position, so a liquidation event is in theory neutral for prices. But longer term, it’s worse than a Lehman, because standard brokerage customers were treated well in Lehman’s aftermath. Now after MF Global continues to roil, I think that the futures business shrinks and continues to shrink. Thus “liquidity” diminishes, and instead that liquidity flows to “safer” pastures, including stocks and bonds. And since I continue to take the “under” on the pace of economic activity for the months ahead versus, say, Ben Bernanke’s outlook for the U. S., I favor bonds over equities and commodities on a timing/trading basis.
The MF Global mess is not an isolated event in a broader context, I think. The collapse of giant banking companies in the summer and fall of 2008 was a similar event. If WaMu had not been absorbed by a TBTF, do you believe that there was anything approaching 100 cents on the dollar available to depositors even if equity and corporate bondholders took 100% losses? I can’t say for sure, but I doubt it. So what really happened in bubble lender after lender was that management took unbelievable risks with money that depositors lent to the bank. I’m not sure that this is all that different in terms of management’s responsibilities to the situation at MF Global; of course, the facts in both the 2008 situation can never truly be known given that the takeovers and bailouts did occur, and of course the MF Global story is a disaster in progress.
In the meantime, we have a sort of repeat now in Europe of what went on in the U. S. in 2008. The financial parasites who prosper from monetary inflation and most countries except (for now) Germany are bleating that the ECB or IMF must cap government borrowing rates at some arbitrary number (by buying the bonds in vast quantity). There are even almost insane cries that, sacre bleu, France has to pay the outrageous amount of 4% per year or so to take your money for a full 10 years. This is really nuts. The U. S. T-bond (10 or 30 years) on the futures market that is traded as a standard issue is a 6% bond. That’s an historically normal rate. So when France borrows at 4%, so what if Germany borrows at under 2%? When Spain borrows at 6%, so what? Let Spain borrow less. The same for Italy. If these governments are governments with real taxpayers (i.e., not Greece), let them raise taxes or cut spending if they don’t like the bids for their debt. Conversely, if for whatever reason they are deemed by the EU or the Eurozone countries worthy of foreign aid, let German et al send them some foreign aid. Meanwhile the U. S. does not want “Europe” to inflate the debts away, because then the euro will weaken and the U. S. would then be farther away than before from the Obama admin’s goal of pumping up exports. So Europe sits with a deflationary rec(depr)ession. As a consequence, my bearish commodities stance continues. We “could” easily see silver in the $20-25 range if the U. S. actually has a new recession (say, per NBER criteria, as how can one have a new recession when the old one never really ended?). We could see copper at $2-2.50 and oil at $60-$65 (don’t ask me “which” oil I mean).
I think that when Alan Greenspan famously worried about “deflation” about a decade ago, he knew or at least had more than an inkling that the U. S. had exhausted more of its unencumbered real capital than the public and the pros imagined. He just “neglected” to tell us. And then it got worse later in the decade, of course, as vast amounts of the remaining capital were obviously destroyed in that financial orgy. In this view, the collapse or near collapse of almost every large financial institution in America in 2008 was a direct result of the destruction of real capital that had occurred in the various booms and bubbles in the prior decades. That in my view is why there are only two major extant bull markets in the U. S.: gold and Treasurys. Money, and money, in other words. “Real” money and fiat, transactional money. You can put silver in with gold with an asterisk. Close to Treasurys in security of nominal principal are high grade debt of certain of the 50 sovereign states. While they do not “print” money, technically neither does the U. S. Treasury. Munis as well as Treasurys have a great multi-year after-tax total return compared to stocks. Like it or not, the power of the State, and the several States, is immense, and we are seeing unfold what unfolded in Japan as more aggressive investments in real estate and stocks were revealed to be destructive of nominal capital. When that occurs, it’s better to own a govvie that returns its nominal price plus some- any, in a crisis- interest. When does this cyclically end? When the acute crisis is perceived as ending. But in this cycle, I am prepared to be “shocked” by new cyclical low interest rates on Treasurys. Time will of course tell . . .
Meanwhile, I am assuming that after the Fed gets ahead of the curve on the economy and decides that one way or other, more “easing” is needed, the new faux capital it and the banking system provide will then probably be provided when economic activity is once again increasing or close to the trough, and then it will be time to head to the other side of the ship and go risk on.
But for now, both the fundamentals as I see them are aligned with the technicals on the downside, and thus I favor a plain vanilla risk off investment posture, with lots of dry powder to align oneself with the dominant trend of negative real interest rates in the Western world as far as the eye can see.
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