Count Me Out

Couldn’t resist taking a time out from our work on The Great ‘flation Debate (and a new short thesis which we’ll be laying out for investors next week) to share this one.  It’s not often you get an opportunity to insert New Edition into a blog post.  But Hussman’s recent Case Against the Fed opened the window just wide enough for Ronnie, Bobby, Ricky and Mike to slide through: 

It should be obvious that the Maiden Lane arrangements didn’t represent “discount” transactions under any reasonable interpretation of the Federal Reserve Act. Instead, the Fed created shell companies to stash long-term securities of questionable credit quality, bought them outright, and still holds them more than two years later. This is simply illegal.  


These arguments are not about whether various financial institutions should or should not be bailed out. They are about whether we have any interest in preserving a representative democracy that operates under the rule of law; or whether we instead want a fourth branch of government that operates independently of Constitutional checks and balances, where unelected bureaucrats can arbitrarily commit a greater amount of public funds in a day than the National Institute of Health spends on public research for cancer, Alzheimers, Parkinsons, autism and other disorders in a year. Count me out!! 


Needless to say, we have been underwhelmed with The Ben Bernanke to date and even become a bit queasy when we consider that his Chairmanship does not end until 2014!  Heli-Ben has made it abundantly clear that he does not share the concerns of the growing list of academics, global policy makers and investment managers scared to death about the (un)intended consequences of another round of Quantitative Guessing.  To be clear, it’s not the first $600B we are particularly worried about.  It’s the TRILLIONS likely to follow once it’s widely recognized that this $600B may have been better spent on Bernanke Action Figures!! 


QE2 will be successful, but not so much in generating employment or economic growth.  Throw enough dollars at the problem, and Ben will eventually be wildly “successful” in crushing the dollar and sending commodity prices into the stratosphere.  This is “good” because investors have been trained to associate a lower dollar with a rising stock market over the past year or two.  Dollar down equals risk on.  Dollar up equals risk off.  Simple enough, even for us to understand.  At the most basic level, this relationship should also drive the textbook Third Year Presidential Cycle Rally we are looking for over the next eleven months.  But like everything else in finance, it works until it doesn’t.  And then . . . bad things happen. 

Bad things happen when a lower dollar fosters inflationary pressures.  The first signs of trouble appear in emerging markets.  Note the most recent CPI print in China and the ensuing tightening of monetary policy followed by a double digit “correction” (read – crash) in equity prices.  The larger impact to the global economy occurs when emerging market inflation flows through to developed world consumers.  It is difficult to pin point the exact level that a weaker dollar translates into higher commodity prices and lower aggregate demand.  But we don’t have to look back too far for an example.  In 2007, while most of the world was raising rates to battle inflationary forces, the Fed was doing its best to engineer a lower dollar.  We seem the same divergences across global monetary policy today.  This Central Bank Game of Chicken will not end well. We promise you that. 

The Ben Bernanke’s “monetary” policy is best described as a weak dollar policy.  The Tim Geithner may not wish to admit it publically, so we’ll lay it out there for him.  We can hope that a weak dollar will stimulate exports, although we have trouble seeing where global demand would emanate from.  More importantly, any “benefits” (i.e. asset prices higher than they otherwise would be) of a weak dollar will be predictably offset by the drag it puts on the consumer.  With roughly one in five Americans underemployed and federal stimulus about to fall off a cliff, higher commodity prices have the same impact as higher taxes on consumer spending.    But even more worrying, is the long term impact of U.S. policy on the billions living near poverty across emerging market countries.  While consensus has ever-so-quickly latched back onto the Decoupling Tit, the ultimate determinate of emerging market success will be a smooth transition from export driven economies toward domestic consumption.  This transition is required to offset slowing aggregate demand in the developed world. But we are beginning to question the likelihood of said long term success given the global distortions created by Heli-Ben, which are likely to continue through 2014.  The vast bulk of emerging market consumers are likely to suffer from Ben’s Dollars. Despite a recent (continued) correction, crude oil prices have climbed to a two-year high, up over 100% from early 2009 lows. General commodity prices are up over 50% in the same period. Sugar prices have doubled since early 2009, corn prices are not far behind, food prices generally are up 20-50% for many basic items in the last year and cotton prices are at all-time highs, up 300% from early 2009. Such dramatic increases have a much more negative impact on the purchasing power and health of the emerging market consumer than the rich. 

Source: Hedgeye Risk Management


We don’t see an immediate threat as there is plenty of room for cyclical inflation to rise before interest rates create real trouble and bad things happen. The potential for a Third Year Presidential Cycle Rally is high and the reward is potentially higher although not without risk. As such, we are still looking for a near-term correction (to relieve sentiment and return markets to oversold conditions) to provide us with an opportunity to reposition portfolios for strength into the coming quarters.  But as Quantitative Guessing is unlikely to generate economic growth, rising inflation and rising interest rates are likely to become a rally killer sometime next year.  Ironically, cyclical Inflation is Deflationary, particularly within the context of an Extended Deleveraging Process. Any cyclical rise in interest rates and inflation is likely to choke off the global “recovery” providing us with another opportunity to position for lower rates in the years ahead. The logic is flawed. Global monetary policies may unleash a speculative dash into natural resources and emerging markets near term.  Long term, they are set to crush them. 

Heli-Ben might be better served listening to the classic advice of Ronnie, Bobby, Ricky and Mike . . . and just Cool it Now!!