Outside the Box

Bad Omens

July 9, 2013

We have clearly been in a recent run of higher interest rates, with a looming "threat" that there might be less quantitative easing before the end of the year. It would appear now that Bernanke wants to leave his successor to implement what everyone knows must be coming at some point: a return to a normal interest-rate environment. While rising interest rates are bad for me personally (for another four months), a return to normalcy would be good for our future – though the transition is likely to be bumpy.

With this in mind, I offer this week's Outside the Box from Louis and Charles Gave. In a brief essay entitled "Bad Omens," they note: 

 … if the recent global equity market sell-off can be laid at the feet of the 100bp move higher in US bond yields, it is hard to know how another 50bp increase in real rates will be digested.

US investors might not have noticed, but there is carnage scattered here and there on the world's markets, and not just the equity markets. The central banks of the world, in their furious attempts to promote stability through easy-money policies, have cooked up a witches' brew of instability of unknown quantity and contents. There is no set formula for this concoction; they are making it up as they go along. Anything that seems to calm the storm momentarily becomes the order of the day. Bernanke hints at the mere possibility of less easing (not tightening, God forbid!), something that we all know must happen at some point, and the market throws up and half a dozen Fed governors go on the air to say "Not really … maybe … we are going to be cautious … we'll go slow … no one wants to do anything rash" – etc. It was almost comical. 

Thus we can expect a volatile summer (as the interns man the trading desks), and I think you will find the Gaves' insights useful. 

I am somewhat better, though still weak, but I'm glad to be home where I can pause and rest as necessary. I have not been down this long since I was a kid. For all those years of good health I am grateful, and I hope to go another 50 years without problems like the ones I've had this week. In the grand scheme of things, there are so many who are having to deal with so much more. I am a lucky man.

I feel I should have warned my readers about the rise in interest rates. Rates have risen since just about the day that I irrevocably committed to a large mortgage which I cannot lock in until construction is done. The interim loan rate is quite cheap, but I am made acutely aware of what rising interest rates can do to a home payment, since I must go to more conventional financing within a year. And hedge in yen. 

The weather here in Texas is abnormally nice for July. Instead of the typical 100s, highs are in the low 80s, at least in the shade. If it was this way all the time, our problem would be dealing with the tax refugees from California and New England. Have a great week. 

Your watching his new place begin to take shape analyst,

John Mauldin, Editor
Outside the Box

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Bad Omens

By Louis Gave & Charles Gave

In late May we published a debate piece on the near-term outlook for equity markets. Since then, emerging markets have once again lived up to their name by proving themselves hard to emerge from during an emergency (in USD terms, Brazil is down –35% year to date while Chinese valuations are back to 2008-crisis levels); for their part, European and US equity markets…

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Mike Kelly

July 30, 2013, 10:32 p.m.

Why do people talk about the Fed ending QE? When did Japan end its QE?

Dallas Kennedy

July 11, 2013, 11:23 a.m.

Rates are unlikely to rise any further and very likely to fall, perhaps by a lot, once QE ends. The controlling factor is ZIRP, which won’t end before some time in 2015, at the earliest. If there’s a recession before then, the end of ZIRP will be postponed until 2016.

Anticipation of QE raises bond prices, as traders front-run. Actual QE puts downward pressure on bond prices, at least in its simplest form—many price-sensitive sellers, one price-insensitive buyer. It’s a flow effect while it’s happening, not a stock effect. (See Japan right now for a perfect illustration.) The most recent episode was more complex, however, which has confused the situation. Speculative leveraged buyers came into the bond market, which, at the margin, has recently behaved more like a risky asset market (stocks, commodities).

But once such players are flushed out, the bond market’s classic behavior will return. The absence or decline of flow is one reason. The other is a cumulative stock effect. The amount of safe bond assets is shrinking, and they are desirable in themselves and as collateral. The end of QE will mean higher bond prices, without question. It will also mean lower stock and (probably) commodity prices.

This cycle’s low in interest rates is likely to be reached at the next recession. But the next cycle is likely to be more 1970s or late 1940s than 1930s—rising money velocity, inflation, and interest rates.

Tim warburton 20789893

July 10, 2013, 9:04 a.m.

The Gaves make the interesting point that “the investment rules after large declines in precious metals were almost always totally different from the rules which prevailed before the fall.”  Perhaps they might want to speculate further just what those rules might be, and discuss further the nature of the rule changes that occurred in the recent past as in the degree to which past is prologue.

The other point is the decelerating inflation discussion… While clearly they so state to provide evidence in the near term that the market is nearing a top, with a market fall soon to come… Long term whither inflation? Anyone contemplating real estate purchases believe that higher interests will drive prices lower in the near term, but with all the money (DEBT) floating around - Is not greater inflation just around the corner?

Matt Wilson

July 10, 2013, 2:28 a.m.

Unfortunately, the US, Europe and China are in the process of joining Japan who is sitting on the edge of a cliff. There are two options: One can jump or be pushed. The following article explains why this is so.

A System Collapse Framework for Societies - http://goo.gl/ndnsR

In a nutshell, suppressing collapses leaves all the underlying problems in place. These problems will continue to grow until they become unbearable. By that point it is too late, only a crash will fix the problem. Japan got there first. Now it is being joining by others.

Did you see this article: Financial Crisis and War by Harold James – Project Syndicate [July 4, 2013]?

Here is a short excerpt:

In 1907, a major financial crisis emanating from the United States affected the rest of the world and demonstrated the fragility of the entire international financial system. The response to the current financial crisis is replaying a similar dynamic.


Nick Jacobs

July 10, 2013, 12:43 a.m.

I know you like to quote Gavekal, but have the Gaves ever been right about anything?
Can’t help remembering their famous prediction, about three years ago IIRC, that the Euro would break up or cease to exist within one year.

Jonathan Milton

July 9, 2013, 7:19 p.m.

After reading this latest post and a similar post from another market maven, I am thinking more Japan 90s and 00s - low GDP, teeter-totter deflationary, demographic issues, ineffectual politicians, though no immigration issues in Japan.  Agree with Eric at Haahvahd - hard to see a recovery, more like a chronic illness.