Now that everyone has finally figured out that the only way to not get steamrolled in this “market” is to frontrun central banks – something we have been pounding the table on since mid-2009 when we said that the only two financial statements that matter are the Fed’s H.4.1 and H.3 – and not just central banks, but central banks who are now so intimately intertwined in capital markets that the moments they adjust one variable, they unleash a torrent of “reflexive” actions which promptly leads to a cascading effect across the markets and promptly undoes whatever it is that they wanted to do in the first place (Yellen’s recent failed attempt at hiking rates which unleashed chaos in China being the best example), we are glad to see that what was until recently yet another apocryphal “conspiracy theory” is the de facto norm.
In the latest note from Eric Peters, CIO of One River Asset Management, he cites another CIO who basically breaks down the convoluted pathway in which monetary policy “works” as of this moment, and explains what, in a world in which “central banks are mistaken”, is “the only way to make money this year.“
From Peters:
“The world doesn’t work anymore when interest rates go up,” said the CIO, explaining his model. “Since the taper tantrum, the S&P 500 has gone nowhere.” Each time bond yields rise, with a lag of 3mth (but continually getting shorter), risk assets have fallen. “At first people felt it was ok, any Fed tightening would be offset by ECB and BOJ easing.” But this simply sparked a dollar rally that in turn tightened global financial conditions. “The issue is that the world is not growing fast enough to service its debt, so if rates rise you get massive defaults.”
“The Japanese private sector appears unwilling to increase leverage at any level of interest rates, which is a remarkable fact,” continued the same CIO. At this level of global debt, without new leverage we get no growth. “This is becoming true in Europe too.” And with the US energy sector now unable to re-leverage, the only solution is increased government leverage. “We’re in a temporary reprieve because China stepped up in Q1 and increased its balance sheet.” So where to now? “The world needs to keep re-leveraging or asset prices will go down again.”
And the punchline:
“Central banks are mistaken. They think they’re targeting employment and inflation,” he continued. “They’re actually targeting asset prices and leverage.” When asset values rise, inflation and employment gradually increase. When assets fall, inflation collapses; it’s a coincidental variable. “At these levels of asset prices, it takes a lot of leverage to lift them further.” So the second central banks see a little inflation and curb leverage, rates rise and it all unwinds. “The only way to make money this year is to understand this sequence, and trade it.”
Translation: when the market is broken, and is getting more broken with every passing day as central banks soak up even more of the marketable assets up until the point where, like the BOJ they will soon end up LBOing virtually everything, the only way to make money is to bet that these same central bankers will continue getting everything wrong and doubling down when they do; from a trading standpoint it means running away when CBs are confident they finally have it right, and BTFD when they are once again scrambling to undo the consequences of their actions by doing even more of what got the world into its current debt dead-end state.
After all, the endgame is now clear: a monetary paradrop which will unleash out of control inflation. At that point the only thing that will have value is hard assets and – to a lesser extent – those assets which generate cash flows which rise higher than the rate of (hyper)inflation.
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