Q&A = An Endless Road

I enjoy writing about the markets as it clarifies my thought process but, frankly, it is quite laborious.

Several hours to construct/edit a timely and relevant post. Many times I wish to write but am pulled in too many other directions. Managing Money + Client Interaction + Business Operations = Not much time left to write…although I try.

Also, I regularly receive questions from existing clients, prospective clients + professional associates.

So I am introducing a new feature answering a variety of queries…seemingly most topical…in a briefer but singular format…still publishing longer form posts…time permitting


Topic: Volatility

Question = Can You Comment On The Historically Low Level Of The VIX?

It has been widely reported that the suppression of the VIX indicates EXTREME INVESTOR OPTIMISM. However, I believe this is Entirely Inaccurate.

The Low VIX Level = Ironically…Indicates Significant Investor Angst.


The Angst = Tied To The Idea That Central Banks Will Never Release Their Grip On Global Capital Markets…And That Financial Actors, Rather Than Relying On Their Own Analysis/Intuition, Are Entirely Resigned To Adhering To Central Bank Wishes…That Is…Asset Prices/Financial Markets May Only Move Upward.

Any Investment Actions Counter To That Will be Punished…Thus…Investors Simply “Toe The Line”…despite price distortions that most realize are Not Sustainable…simply fueled by endless Quantitative Easing + 672 Global Interest Rate Cuts Since 2008.


It is almost like “A Master [Central Bankers]/Slave [Financial Actors] Relationship”.

The Masters [Central Banks] Will Only Tolerate Relentlessly Higher Asset Prices.

The Slaves follow…behaving as The Master indicates…constantly seeking and receiving, reassurance from The Master [weekly Fed-Speak]. And of course the Slaves are rewarded, for their compliance, with Exceptional Risk-Adjusted Returns.


Eventually this relationship will decouple…as Central Bank Credibility Erodes.

The Slaves will eventually realize that Master’s Global QE was merely a temporary salve on a deepening global economic wound… much of Master’s own making [flawed policy decisions] just after the turn of the century.

As indicated previously…How Firm/Reliable Is An Economic System Reliant on Shaking A Money Tree [for 8+ Years] + NIRP/ZIRP + Negative Sovereign Investment Yields…when the Economic S-H-_-T “hits the fan?”

It Seems Vulnerable.


Topic: Global Bond Yields

I saw your post about 10 Year Bond Yields…What about 2 Year Note Yields?

Again…Absolutely Low But Relatively High.

Australia 1.666
U.S. 1.361
Canada .91
U.K. .240
Japan -.101
Spain -.296
Italy -.333
France -.464
Germany -.631


The Critical Data Point = “Negative” 2 Year Yields in Europe + Japan…that is…Sovereigns Receiving Income to Issue Debt.

2 Problems =
1. Debt Ought To Always Include A Cost…Here It Is Perversely Rewarded
2. Typically…Lower Credit Ratings = Inferior Ability To Repay Debt = Higher Costs. Yet with QE = Lower Rated Credits = Not Just Lower Cost [which is bad enough]…But Rewarded With Income

This IS NOT CAPITALISM…As The Laws of Economics…Transmitted Via QE…Completely Inverted.

The Real Losers = Sovereigns With Higher Credit Ratings = Penalized For Having The “Dubious” Distinction = A Superior Ability To Repay Debt Obligations.


Topic: GDP Impact On Equity Prices

Question = Is There A Direct Correlation Between U.S. Economic Performance [as measured by GDP] and Equity Prices?

There have been countless studies on this matter and the short answer = Sometimes…like most Macro/Micro Fundamental + Technical indicators.

It is not as “Hard + Fast” as it would logically imply.


In the current economic environment it seems the most important indicator = Liquidity…that is Low Interest Rates + QE…NOT A COMPANY’S ABILITY TO GENERATE CASH.

For example consider that NFLX does not generate any FCF [Free Cash Flow] and has proudly proclaimed that it anticipates another 3 years of Cash Burn…and Wall Street oddly applauds by valuing NFLX with an Equity Value of $68B + $9B of Net Debt = Enterprise Value $77B…as their content costs serially exceed robust revenue growth.

You really cannot blame NFLX management…they are just ‘Feeding The Monkey.”

The Fools = Wall Street Investors desperate for organic revenue growth…no matter the cost…just like TSLA = burning cash at an alarming rate while revenue growth = primarily dependent on Global Sovereign Subsidies.

Both Stocks = At/Near All-Time Highs = Indirect Result Of Easy Money + QE = Stretching Valuations To Drive Returns …Without Regard For Associated Risks.


Topic: QE and Price Impact on Financial Assets

Question = I’ve read much about how QE Distorts Asset Prices. Can you provide a detailed explanation?

QE, quite simply, DISTORTS ALL FINANCIAL ASSET PRICES…meaning that we currently do not know the REAL price of any Financial Asset…that is until QE is completely withdrawn.

In the absence of QE almost all financial asset prices [Equities + Corporate Bonds] ought to be priced lower…for a variety of reasons…particularly since Global Central Banks Have Distorted Financial Asset Prices For 8+ Years…while also suppressing interest rates to purposely effect Capital Markets Decision/Valuation Models.


And while Distorting Asset Prices is extremely controversial and problematic it also creates another very large problem…that is…

How To Make Informed Monetary Policy Decisions Relying On Economic Data That Is, In Many Ways, Necessarily Reflective Of Price Distorted Assets?

For example, it is frequently cited that the U.S. Treasury Yield Curve, though currently sagging, is still positively sloped…and that is a good sign for the U.S. economy.

In actuality the Federal Reserve has been manipulating the Yield Curve’s shape for many years.

Only with The Federal Reserve’s removal from the fixed income market will we know the true shape of the Yield Curve.


Still…U.S. Central Bankers frequently jawbone that removing QE will NOT have a tremendously deleterious impact on Asset Prices…And That Belief = “Pipe-Dream”…of which most market professionals are well aware….no matter how slowly QE = withdrawn.

You just cannot have it both ways…boosting asset prices with QE and then expecting that QE’s removal will not weigh on asset prices.


Still, The Most Current Dilemma Facing Central Banks = “Traditional” Inflation measures have not been especially responsive to lower interest rates [with the help of QE] since 2008.

And Stimulating Inflation = One of The Primary Goals Of Easy Money + QE.

Why Is That?

Because without it the economy will grow at a much lower pace or even contract …which to Central Bankers = Nightmare Scenario.

So while Central Banks have essentially failed in stoking “Traditional” Inflation measures, such as wages + commodities, they’ve succeeded in massively inflating financial asset prices…which they do not consider as legitimate inflation metrics.

Perhaps they ought to…as the Combined Value of U.S. Equities + Corporate Bond Market is a quite significant portion of the U.S. economy?

For example…Publicly Traded U.S. Equities are currently valued at 157% of Calendar ’16 U.S. GDP.


After almost one decade of interest rates at/about the zero bound and with unemployment seemingly near its bottom …if this is all the “Traditional” Inflation that can be generated [which is still stubbornly below the Federal Reserve’s target of 2%] …it is difficult to envision a sharp step-up from current levels.

And it is Clear That The Fed’s Board Members Are Frustrated With This Shortfall…Yet They Still Robotically Apply The Same Salve To This Not Mended Financial Wound…Mistakenly Expecting A Different Result.


Then how to equivocate between Dormant “Traditional” Inflation Measures & Active Financial Asset Price Inflation?

Suppose The Following = The Tools Failing To Ignite “Traditional” Inflation Are Much More Effective At Inflating Financial Asset Values…With Staggering Risk-Adjusted Rates of Return.

So the Transmission Mechanism Between Lower Interest Rates and Traditional Inflation Measures…is Not Only Failing But, Paradoxically, Has Contributed to Lower “Traditional” Inflation Via Mal-Investment…Sustaining Inefficient Providers of Goods + Services …especially when combined with macro-population demand/growth plateaus + technology innovations wringing out excess costs from business operations …allowing for product/service price declines to approximate cost cuts.

Moreover…If Asset Price Inflation Were Included In A Blended Inflation Measure With “Traditional” measures [perhaps weighted as to their per/capita impact]…then the current regime of exceedingly low interest rates = A Significant Monetary Policy Error…As Inflation Would Likely Be Well Beyond Their 2% Target.

Fueling Already “Inflated” Asset Prices With Even More Combustibles…Rather Than The Sharp Reduction Most Likely Warranted Could Prompt Another U.S. Economic Shock Similar To Both ’00 & ’08 [both ushered in by too easy Federal Reserve Monetary Policy].

It is, at the Very Least, a Risk to be Seriously Considered.


Topic: Global Bond Yields

Question: 10 Year Treasury Yields, A Proxy For Many Loan Products, Still Seem Exceptionally Low. How do they compare with the rest of the Developed Economies?

Actually…Absolutely Low But Relatively High.

Australia 2.417
U.S. 2.171
Spain 1.932
Italy 1.929
Canada 1.54
U.K. 1.003
France .633
Germany .271
Japan .005


Topic = Technology Stocks As A Proxy For Market Risk

Question = Can you explain the rationale behind many technology company valuations and recently sharp price moves upward notwithstanding the recent sell-off? Especially interested in FAAANG-CMT?

For Those Unaware…The Acronyms = Facebook [FB], Apple [AAPL], Amazon [AMZN], Adobe [ADBE], Netflix [NFLX], Google [GOOGL] – Salesforce [CRM], Microsoft [MSFT] and Tesla [TSLA].

In the current market environment Revenue Growth = The Most Appreciated Financial Metric…Irrespective Of Whether That Translates Into EBITDA and/or Profit Growth.

And all of the names above are growing revenue…some generate cash [i.e. FB/AAPL/ADBE/GOOGL/MSFT] while some generate very little cash…if any [i.e. AMZN/NFLX/CRM/TSLA]…while most also PREFER to present their financial statements in a less strict/more financially favorable alternative format [Non-GAAP]…in addition to GAAP [Generally Accepted Accounting Principles].

But ALL share the same trait of “rich” valuations [EV/EBITDA].
Even EBITDA, though, is presented in GAAP/Non-GAAP format.


However the MOST IMPORTANT factor driving equity valuations is Global Liquidity = Central Bank Money Printing [U.S. U.K. E.U. S.N.B. Japan and China] In Order To Acquire Financial Assets collectively = 40% of Global GDP for the 1st 4 months of calendar ’17…and at least 25% of Global GDP EVERY YEAR SINCE ’09.

Despite The Fed’s Anticipated Balance Sheet Reduction…that no legitimate market professional believes will ever amount to their $2T trimmed goal…there is little indication the Global Printing Presses will halt anytime soon.

Nevertheless…The Market Red Flags Are Mounting:

1. Historically Low Actual/Expected Equity Volatility
2. Excessive Equity Valuations: EV/EBITDA
3. All-Time High Equity Trading Margin Application
4. The Lack of Any Meaningful Equity Capital Draw-Down
[last 18 months] reflecting a robotic Buy Any Market “Dip” Mentality…As The Draw-Downs = Increasingly Shallow
5. The Advent Of Black Box/Passive Investing = Top Heavy.Capitalization Weighted Structure


Still…another SIGNIFICANT FACTOR contributing to seemingly insatiable risk appetite is the perception that Central Banks have trapped the bears.

That an uptick in global growth will be greeted positively by the equity markets while any slowdown will be met with more Money Printing…further propelling stocks. That no matter what occurs in the future = it can only be positive for stocks.

That precept is certainly debate-able but it does seem to be a current consensus belief…and in its own right…is just another sign of the market excesses. Perceived Equity Market Risk…as noted earlier = Virtually Exterminated.


It could even be said that the Global Central Bank’s Greatest Achievement, in this 8 year economic cycle, was NOT their ability to positively impact asset prices but their ability to Intentionally Destroy Moral Hazard = Lack of incentive to guard against risk where one is protected from its consequences.

Because If You Believe This QE Driven Economy Is A Function of Unadulterated Capitalism and Animal Spirits…then you are Very Badly Mistaken.


Topic = The Economy

Question = Do you believe the U.S. economy’s performance relies on QE and, therefore, without it will stagnate?


The economy has become too reliant on The Fed’s stimulus and without it will assume “stall speed”. The irony of QE = one of its goals was to suppress interest rates below market achieved levels but I believe QE is was never required to suppress rates. The economy was stagnant enough to achieve that on its own.

The primary motivation of QE was to shift dollars from “lower risk” assets to “higher risk” assets via increased liquidity…and that has occurred…but now the gap between financial asset values [equities + corporate bonds] is widely detached from an economy that can sustain these heightened asset values …which were driven by Central Bank Asset Purchases.

Withdraw the Central Bank Printing Presses/Liquidity = Asset Values Ought To Decline.

The Big Question…By how much?


Topic = Your Blog

Question = Why have you password protected most of your content?

Because a lot of other sites were using my content without asking me [which was fine] + editing it [which was not fine]. Most requesting to read the posts [as many already are aware]…happy to provide a password.

Also, this is not intended to be a commercial site. There is no advertising, etc. It is primarily intended for clients + professional associates…to get a view into my market insights…as described in my “Mission Statement” tab.


Topic = Central Banks

Question = You’ve been quite critical of Central Banks for a long while. However the global economy has improved dramatically. Since the advent of QE [or you like to say Money Printing] in March 2009 what do you believe is their biggest accomplishment?

That they’ve quashed just about any dissent regarding the non-conventional use of Money Printing to acquire financial assets [public + private]…rather than their traditional role of controlling interest rates via the money supply

That QE has continued for eight years has transformed many market participants views that it is a legitimate policy…as it has not met too much resistance [that is…other than just prior to its initialization in March 2009].


And now Central Bankers wish to institutionalize it further [frequently suggesting that they must now taper asset purchases in order to create room on the balance sheet for further asset purchases in the future…rather than considering it as a one time “emergency” tool…as it was initially characterized].

The economic emergency was over long ago. That QE has continued for so long is likely tied to monetizing sharply higher U.S./Global budget deficits since ’09. Correlations between the two are quite high.


The Fed cannot let go, it seems, as it will likely cause some market pain/volatility.

For some reason they refuse to tolerate any market turmoil…even going as far as stating that if the markets do not cooperate [that is…go down] then the balance sheet reduction pace will be purposely slowed. Their sensitivity to market volatility is obvious however it is NOT part of their mandate.


Further, The Fed points to the capital markets’ positive response, to their actions, as a rationalization for their strategy…despite enormous global capital markets distortions i.e. negative interest rates.

I say they’ve breached Moral Hazard [lack of incentive to guard against risk where one is protected from its consequences] & that the markets would have properly reset without their steep financial stimulus.

Let’s face it…if interest rates at ZERO [for many years] are NOT enough to stimulate the economy to ESCAPE VELOCITY…then there are, likely, serious structural problems within the core capitalistic system…that nobody has the professional courage to address.

Plus the “monetary stimulus” ultimately introduces more risk to the capital markets i.e. excessive risk taking via increased debt issuance…due to its manipulated low cost.


It is also important to understand that the architects of QE/Money Printing [Bernanke/Yellen] were the same folks that created the Housing Bubble after 9/11 that lasted until 2007/8…and then they simply watched as the bubble pooped and created a downward spiral in the Global Economy…despite a front row seat at The Fed. So their demerits, at the least, are as significant as their merits.


Finally, the ultimate measure of QE comes with the its removal [which will likely occur over many years]…the easy part [printing + spending + reinvesting maturing securities] seems to be very close to ending in the United States.

The primary concern is that the unraveling of QE will simply erase the monetary benefits it created over 8 years. We’ll see.