Keith, last time we had you on the program everybody and his brother was screaming, hey, the top is in, this is it, stock market’s about to roll over, get out, get out, get out! And you very boldly and confidently told us, look, it’s expensive. And expensive things get more expensive. That’s just how it works. And you were very bullish.
And, of course, you’ve been proven right to date. It’s so timely: As we speak again, on Wednesday morning, we’ve got the equity market down a few percent. And, of course, once again, the chorus is all over the internet: The crash has begun, it’s all over, the end is nigh, it’s all coming. What are we down? Three–four percent? And the world’s coming to an end.
Where are you at now? Is it time to join the chorus of bears? Or are you still on the bullish side of this camp?
Keith: Well, thanks for the lovely introduction. It’s always good to be, I guess, a bull when most people doubt the bullish narrative. What’s interesting, and actually the S&P 500 – it depends on where it finishes today – but, as you know, the correction was literally 60 basis points from its all-time closing high. Not just year-to-date high, or some kind of a trending high – I mean from the all-time. Which I continue to remind people is a very long time.
And if you go all the way back – and I’m sure we’ll review this – all the way back in market history, you’ll learn that, provided that profits and growth are accelerating, what happens to an “expensive market” (and I argued that it wasn’t expensive enough) is that they get more expensive.
So at this stage I think it’s less easy, obviously, that an epic move to the upside. The 60 basis point corrections clearly aren’t corrections. The ramp – and particularly in growth stocks – if you look at the returns associated with either growth as a style factor or just being long in the Nasdaq, they have been equally epic.
So it begs the question as to what happens next. I mean, a couple of the river cards that I was looking for fundamentally were 3% GDP, back-to-back quarters, which we got in both Q2 and Q3. It’s unlikely that we get a third here in the fourth quarter – our predictive tracking algorithm on GDP is currently tracking around 2.5 to 2.6 – so it’s marginally less great. And on the margin I think that might matter.
The other thing is that, clearly, earnings, in terms of the easy comparisons of earnings, which was really our call for the last 12 months, they get harder because of the acceleration. And I know that that might be a little quirky or geeky to call out. But that’s a big concern of mine, as we go more so into 2018, is that the massive acceleration that we saw in both S&P and tech earnings really has a massive comparison in the first quarter.
Of course, that’s not reported until April of 2018. So, between now and then, it is Mr. Market’s debate on what does and does not matter. And, frankly, I think that there’s – not that I wouldn’t be frank – but there are a lot of different macro tourist ideas out there on why the market should have always gone down, so I expect to hear and see a lot of those things. It’ll be fun to risk manage it or to trade it.
Please note this was transcribed to best of the ability of the transcriber and may have minor errors. Please refer to the podcast itself to clarify anything.
Jeff: Again, we want to keep in mind that over time this behavior evolved more and more at the margins. And originally, you’re right, the role of banking in society is to manage savings. And, throughout this evolution of the Eurodollar system, that role, or that intention, became eroded and replaced by what really is a bastardization of the entire idea of not just banking but money itself.
And so, you know, that stuff still went on. Banks were still lending to companies so that they could invest in their vital operations and do productive things with it. But the whole concept of savings itself was obliterated and replaced with what is essentially a system unto itself.
In fact, I think, in the housing mania portion of the middle-2000s, it came to that kind of an extreme where this financial system just – for no other reason than just expansion for the sake of expansion.
Your point about regulators and regulatory review is well taken. But by their own standards these banks were behaving according to regulatory standards. Nothing we see here is illegal. That’s an important point to stress as well. This is not illegal. It’s just a very poorly-designed system where the flaws apparent in it – that are very apparent today – weren’t readily anticipated at the time.
Erik: Now, Jeff, in the last series of slides that we’ve been through we’re talking about Bank A, Bank B, Bank C -- obviously these are fictional entities. Let’s try to pull this together in a real-world example. How real actual financial entities have manipulated balance sheets and -- give us an example. I think that’s what you’re coming to on Slide 45.
Erik: Joining me next is the one and only Grant Williams, the author, of course, of “Things That Make You Go Hmmm,” probably one of the most interesting and well-known newsletters in the business. Grant, thanks so much for joining us again.
I want to start, as we always do, with the US dollar, because everything else is priced in that. I know your partner Raoul Pal has been a secular dollar bull, but I think last time we talked to you, you had a different view.
What’s your current outlook for the US dollar? It seems like maybe we’re seeing the Raoul scenario play out, where the secular bull market is going to continue. Certainly the chart’s been looking pretty good for the last couple of weeks.
What do you think?
Grant: Hi, Erik. Great to speak to you again. Yeah, Raoul and I have differed in the last, I guess, year or so about this. We were very much aligned and I kind of – I went to the dark side and figured that the dollar had run its course, and became, not a bear as such, but I figured we’d seen the highs, and the likely future path was down. Not any kind of crash, but it was going to move lower over time.
And I based that on the fact that (A) it was in everybody’s interest – I mean, everybody’s interest for it to work lower – and (B) I figured that the US finances would actually start to matter at some point. That last point certainly doesn’t seem to be the case.
But in the last few months there certainly have been signs that perhaps the bull market is going to take one more try at going higher. The Fed seems determined to hike. And, as always happens, I think the vast majority of recessions post-1980 have been – sorry, post the US Civil War, according to a chart I saw recently – have all occurred due to one interest hike too many.
So I understand that in the short term the dollar could go higher, and I can see how that could happen. But I still think that over time the dollar is going to move lower, perhaps significantly so. But I don’t expect any kind of crash any time soon.
Erik: Joining me next on the program is Convexity Maven founder Harley Bassman. Harley, I think some of our listeners may not be completely aware of your very extensive background in the industry. You were one of the principle designers and creators of the MOVE index, which is essentially the VIX for the bond market, and held some senior roles at Merrill Lynch and PIMCO.
So why don’t we start with a little bit on your background. And particularly how the MOVE index came about.
Harley: Thank you for your time on the show. The MOVE basically came about a year or so after the VIX. It became obvious that volatility was becoming more and more important in the bond markets. People actually thought of volatility as an asset class to some degree. It’s certainly one of the three main risk vectors. Being duration, credit, and volatility. I view myself as a convexity maven; I focus on volatility and that sort of risk.
Duration is when you get your money back. Credit is if you get your money back. And volatility convexity, how you get it back. It’s a path-dependent risk.
And so creating the MOVE was a way of basically creating a language for people to look at volatility as an index as opposed to a number. And see if it’s high or low relative to where it’s been historically.
Erik: MacroVoices Episode 85A was produced on October 20th, 2017. I’m Erik Townsend.
Our Eurodollar University series featuring Alhambra Partners CIO Jeffrey Snider has been extremely popular with listeners. We originally planned to air Parts 3 and 4 over the Holidays. But thanks to some generous donations we’ve received in the last few weeks, we’re able to accelerate the release schedule. This episode contains Eurodollar University Part 3.
Today’s feature interview with Alhambra Partners CIO Jeffrey Snider was pre-recorded back in July of 2017 as Part 3 of our Eurodollar University project. There’s a slide deck to accompany this interview, and we recommend that you download it before listening as we’ll be referring to the charts and graphs it contains throughout this program.
Registered users at macrovoices.com will find the download link in your Research Roundup email. If you’re not yet registered, just go to www.macrovoices.com and look for instructions to register and get the download, above Jeffrey Snider’s photo on our home page.
This four part series came about after listeners to the MacroVoices weekly podcast asked for more in-depth coverage of the Eurodollar system.
In Part 1 we discussed how the Eurodollar system came about, how Milton Friedman demonstrated in a series of articles that fully $30 billion in new US dollar money supply was created by the Eurodollar system in the 1960s, and how this occurred at the stroke of a bookkeeper’s pen without a single penny of actual cash issued by the Treasury or a single ounce of gold bullion to back this $30 billion of new money supply.
In Part 2 we learned about the wholesale component of the Eurodollar system. And we discussed the role that the repurchase market used by banks to secure short-term financing played in expanding the wholesale Eurodollar market.
We discussed why investment banks went on a collateral-buying binge in the early 1990s and how the Fed’s policy change to target the Fed funds rate rather than the money supply was probably influenced by the Fed’s inability to accurately measure the money supply creation that was going on in the wholesale Eurodollar market.
The next subject I discussed with Jeff Snider was the role of the Basel Banking Accords on the development of the Eurodollar system.
So, without further ado, let’s jump right back in where we left off and hear Jeff Snider talk about the Basel Accords. Here is Alhambra Partners CIO, Jeffrey Snider.
Jeff: The Fed flew by the seat of its pants throughout the 1990s. But, because things seemed to be very good and very well behaved (especially inflation), everybody assumed that the correlation was between the economy (especially inflation) and monetary policy. In other words, Greenspan must have been a maestro for doing whatever it is he did.
And, in fact, Greenspan never actually came out and said exactly what they were doing. All he did was raise and lower the federal funds rate. But nobody could really determine – nor did he specify – exactly how they did that. What caused the Fed to raise the rate 25 basis points one day and then the next meeting perhaps lower it. And, in fact, what we know today is that it was a completely discretionary policy that had absolutely nothing to do with money whatsoever.