Let’s take a look at the UK.

An understanding of crowd behavior is a handy tool in delivering a leg up; this applies equally well in handling the analytical horde as the investment crowd. The following illustrates our point, and illustrates just why our clients had an advantage in understanding real-sector change in the UK, 2013 and Q1 2014.  We recommend the application of this technique.

From our Sep/2/2013 sketch: “In the Spring we isolated a flaw common to most UK economic models…”; well, common to most observers actually, “…almost all of whom were driving at 90, gazing in the rear view mirror; a perfect case of group-think in economics..” – holding hands, shouting out together in the dark. “Once we had that in hand we in effect had the financial headlines in hand.  And that is exactly how things worked out.”  

Naturally it was not a gangbusters UK economy; that was beside the point.

We predicted more of the same into 2014.  With a few exceptions, this too worked.  Thus the “triple dip” recession that so many economists had predicted Q1 ‘13 as a near certainty just ahead, was a no-show (if these guys were plumbers, they’d be out of a job). The Bank of England, the OECD and the IMF – all were cutting their forecasts as we grew more optimistic.

It was not all economics.  It was also our admiration for Osborne and his policies – why the economy would improve without an ease in the fiscal squeeze. We received hate mail when we called the administration’s economic policies “enlightened.” But we were right – thank you George.

Yet this satisfactory exercise did not come without disappointment. And that was the matter of translation. One would think that if one has the direction of miss, most key releases, one could do well in the matter of translation, intra or inter market. However, because FI price change in the UK and the US is now rigged, that part did not go as well.  In that sense we were ambushed by planners.

Now, after months of the economy “outperforming,” most analysts have caught on, or think they have.


What’s next?


Bank of England policy, H1, will be either a wash or a retardant; in other words, policy will get in the way.  Next, recent experience with “forward guidance” shows us exactly why King always thought the idea to be a foolish one. Carney will continue to switch targets and tools.

Administration policy (in direct contrast to its US counterpart) will continue to favor growth. This is not appreciated by some, especially the media and faculty-lounge types, and for that matter, perhaps over half of street economists who are still dusting off from their last encounter with reality.

Real sector activity will continue to outperform given consensus, but of course in semi-erratic fashion - not in a straight line. The major surprises are over for now; yet those along the way will be to the side of more, not less, or at least most of them will. Certainly services and manufacturing prints Q2 will tend to broach consensus. 

Finally and key remains the UK consumer. It is well known that now we have a record number of people in work, and of course we have the spark to consumption provided by the housing bonanza, and we have a shopper who will resort to increased leverage to linger in the mall. These things are known and priced in. It is ongoing attitude which is missing, most models.


Robert Craven

 

A Junkie

The Fed is a junkie. Like most junkies, this one tells us he is our friend, that he harbors only good intent and that he’s got the stuff to make us happy. This junkie explains his behavior through the exercise of “forward guidance.”

The Fed has made addicts out of banks, out of equity investors and of course, the US government-as-a-borrower; and while we’re at it, it’s made addicts out of S Africa, Brazil, India and other such credits.

This combination of dealer and addict can come to no good.

Background: The Founders understood the rule of law and how that concept should be imprinted over their Grand Document so that American citizens would freely function and prosper, without imperiling the rights of others. Everybody knows the rules. It worked. Now the world’s most powerful and most influential sovereign has ditched that same concept when applied to money and banking. No one knows what to expect next from government and Fed planners. There are no rules.

So the banks simply sit on their hands.  Why not? As addicts they rake in a nice spread playing couch potatoes, doing nothing because 0.25% on their excess reserves seems just dandy.

Others take the next step and reject caution entirely. That means buying stock for your 95 yr old grandmother when you know darn well, or should, that she has no business in anything but TBills.  But a 0.15% return does not excite, so discard discipline and look to the junkie.

And job creators? There has been no return to normal. My daughter’s family just moved to the South, so for fun we took a look at that market. The Atlanta Fed tells us that small-business job creation in its district is still 5% - 7% off the pre-recession level. Why? Uncertainty. Firms in that region reported there is more uncertainty now than when last canvassed in April, 2013.  As a result, their 1) hiring plans and 2) ability to make business decisions are both restricted.  And not just Fed-bred uncertainty we might add, but that spawned by our administration.

Now what for strategy?

In the broadest sense, look for “surprising” US weakness over the intermediate term, not surprising vigor. This will be within the US, and it will be vs other credits such as the UK and Germany.  We may have a bit of both, but “weakness” will trump.

This is a crude guide to be sure, but still useful. And why will this be so? Because most world observers, the majority of analysts still expect a conventional US recovery; they look for an acceleration ignoring those key factors that have so far prevented it.  “We’ll hit escape velocity pretty quickly now,” notes one analyst.  No we won’t. We could, but we won’t. The issue of substance abuse encouraged by the Fed is one reason why.

Those most handicapped in understanding US economic reality, whether on Wall Street or the corridors of Washington, are those who lack scholarship; those who ignore lessons of history and economics; those suffering of Hayek’s “fatal conceit” – the conviction that planners, the anointed, are capable of driving the US economic machine.  They are driving the machine alright, but it will be over a cliff.


Robert Craven
 

Post Turtles Running the Show?

We must be dreaming.

Or, could it be that Fed management is actually handled by post turtles? You know, like Obama - he didn’t get on top of that fence post by himself, he doesn’t belong there, he doesn’t know what to do while he’s up there, he’s elevated beyond his ability to function, that kind of turtle. 

Obama’s try at economics was “The Stimulus,” except that there was none.  Very early on into that debacle we warned, and did so repeatedly, that this, the economic equivalency of taking water from one end of the pool and pouring it into the other was at best a wash, more likely a retardant. We were right.

And now Bernanke has come along with his brand of “stimulus” which is also, our view, at best a wash. The QE’s have benefited equities because now companies can borrow cheap and buy back stock. But that’s it. Not much of a real sector benefit, and maybe none; one at any rate overwhelmed by the negative aspects, the uncertainty for real risk takers given we have planners at the helm.  For more on the negative correlation between Fed meddling – QE -  and growth, see this recent sketch by Forbes contributor Louis Woodhill: http://www.forbes.com/sites/louiswoodhill/2013/10/23/as-the-job-market-falters-even-some-democrats-wake-up-about-growth/.

Today we found the FOMC bunch are just a tad more optimistic. What? They are either full-fledged post turtles, or 100% cheerleaders. Yet they will still keep the gates open they say. How long? Until we have the equivalent of a Mount St Helens blowout, our bet.


Robert Craven

Change at the Fed

Janet Yellen will likely expand on Bernanke’s policy mix. She will sponsor Fed activism; she will continue to enable the Washington left.  

In a recent sketch, Thomas Sowell, the Milton Friedman Senior Fellow on Public Policy at the Hoover Institution notes that Yellen has a history of asking the right questions and giving the wrong answers: “Will capitalist economies operate at full employment in the absence of routine intervention,” she asked. “Certainly not” was her answer.  “Do policy makers have the knowledge and ability to improve macroeconomic outcomes rather than making matters worse,” she asked. “Yes.”

This reality -Yellen as chair - will prove to be a retardant to US growth.

We are going nowhere, and quickly. Any recovery will be in spite of, not because of this individual’s policies. Normal free-market pricing mechanisms will remain unplugged. 

Calvin Coolidge, help us.


Robert Craven

Roughed Up By a Planner

After all these years it still never gets easy. But now a new variety of snake has been thrown into the arena, one even more unpredictable and deadly than the rest.

For example, past years if we had a fairly good notion of relative performance, sovereign credits, we’d do alright. So early May we were pretty buoyant, pretty darn confident when we isolated what we thought would be “surprising” vigor in the UK and what we thought would be a “disappointment” in the US.  The simplest way to translate this view was to sell the Gilt 10 yr and own the US note. 

So that is what we did, figuring we were pretty sharp hombres, putting the trade on about flat, or 0 spread.

As it turned out, real sector results did cooperate; they still are.  However, the trade blew up in our face thanks to Bernanke’s mid-May hint that he may ramp in QE. US debt prices collapsed. Son-of-a-gun.  We had looked for something on the order of -20 come July (US -20 bps under UK) not +20!

This added dimension is why many experienced strategists are to be found in their garden, at least for this season.

Robert Craven

Praise for Mark Carney

Mr. Carney has very much limited his dialogue with the market crowd. For this effort he should be commended.

Recall that after the last meeting he said nothing.  Then last Friday (Yorkshire Post) he said he would likely leave things as is and pretty much left it at that.

We had noted that Carney was a quick study but we didn’t realize just how quick.

Early on we sensed “surprising” UK economic vigor and in which sectors and, we predicted much higher interest rates. That worked. 

But then in the last post we predicted that Carney’s reaction to higher long rates could well be an extension of QE, and that this would – contrary to conventional wisdom – drive long rates even higher due to elevated inflation reads. Finally, we noted that this situation could then arrest UK growth.

Carney is concerned with longer rates as a drag but – key - he also understands that chatter will inflame, not settle the market crowd. The less said the better (a lesson lost on Bernanke).

Carney has demonstrated the ownership of an asset rarely found in central banking - an understanding of crowd behavior.


Robert Craven

Wrong Discussion

The discussion in the world’s financial press regarding Fed decision making is framed inappropriately. The discussion is about what is next and how markets will react.

The insanity is that this dialogue passes the sobriety test. Most sit in the theatre, lemming-like, riveted to the action; instead of waiting for the next act, they should demand a refund.


Background:  From a recent sketch by George Will: “The Fed has become the model of applied progressivism, under which power flows to clever regulators who operate independent of political control. The Fed is, however, a creation of Congress, which may not forever refrain from putting a bridle and snaffle on a Fed that increasingly allocates credit, wealth and opportunity.” 

The tragedy is that Bernanke and others think they can “out figure” the free market, that they, the anointed, have been selected by the market god to efficiently direct resources. 


Key to today’s sketch is that this tragedy is expanded by the effort, any effort to communicate with, to embrace the FI market crowd.

As a central banker you must never, ever put yourself in a situation where you feel obliged to engage. You are then held hostage to what is almost always a reaction in the extreme – this is as true of a lynch mob or the Bastille as it is of this bunch.

So when our activist Fed chair hints of an ease in QE, rates erupt; he then feels forced to say he will continue with QE, and so on; thus additions are made to this house of cards before our very eyes.

Observers feel betrayed, pouting because in their view the Fed double-crossed them on Sep/18. The Fed’s credibility “is now shredded,” whines one street economist. “They can’t be trusted.”

KC Fed pres George warns that the Fed’s message has been muddled and the Fed has surrendered at least some of its credibility. The Fed, “…will have to think about the challenges that come with issues of credibility….”  “The actions at this meeting, and the expectations that have been set relative to how markets were thinking about this, created confusion, created a disconnect.”

Of course; there could be no other result.

There is nothing sinister here. There is perhaps no intent to deceive; policy makers are simply not trained for the task at hand. But it is “the task at hand” that is the problem.

Robert Craven