September 19, 2017, 6:00 pm EST              Invest Alongside Billionaires For $297/Qtr

BR caricatureWith a Fed decision queued up for tomorrow, let’s take a look at how the rates picture has evolved this year.

The Fed has continued to act like speculators, placing bets on the prospects of fiscal stimulus and hotter growth. And they’ve proven not to be very good.

​Remember, they finally kicked off their rate “normalization” plan in December of 2015.  With things relatively stable globally, the slow U.S. recovery still on path, and with U.S. stocks near the record highs, they pulled the trigger on a 25 basis point hike in late 2015.  And they projected at that time to hike another four times over the coming year (2016).

​Stocks proceeded to slide by 13% over the next month.  Market interest rates (the 10 year yield) went down, not up, following the hike — and not by a little, but by a lot.  The 10 year yield fell from 2.33% to 1.53% over the next two months.  And by April, the Fed walked back on their big promises for a tightening campaign.  And the messaging began turning dark.  The Fed went from talking about four hikes in a year, to talking about the prospects of going to negative interest rates.

​That was until the U.S. elections.  Suddenly, the outlook for the global economy changed, with the idea that big fiscal stimulus could be coming.  So without any data justification for changing gears (for an institution that constantly beats the drum of “data dependence”), the Fed went right back to its hawkish mantra/ tightening game plan.

​With that, they hit the reset button in December, and went back to the old game plan.  They hiked in December.  They told us more were coming this year.  And, so far, they’ve hiked in March and June.

​Below is how the interest rate market has responded.  Rates have gone lower after each hike.  Just in the past couple of days have, however, we returned to levels (and slightly above) where we stood going into the June hike.

But if you believe in the growing prospects of policy execution, which we’ve been discussing, you have to think this behavior in market rates (going lower) are coming to an end (i.e. higher rates).

As I said, the Hurricanes represented a crisis that May Be The Turning Point For Trump.  This was an opportunity for the President to show leadership in a time people were looking for leadership.  And it was a chance for the public perception to begin to shift.  And it did. The bottom was marked in Trump pessimism.  And much needed policy execution has been kickstarted by the need for Congress to come together to get the debt ceiling raised and hurricane aid approved.  And I suspect that Trump’s address to the U.N. today will add further support to this building momentum of sentiment turnaround for the administration. With this, I would expect to hear a hawkish Fed tomorrow.

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January 19, 2017, 4:15pm EST

The Treasury Secretary nominee was being “grilled” by Congress today. I want to talk a bit about this hearing because it brings up the subject of the housing crisis.  The who and the whys.

First, Mnuchin is a Wall Street guy. Even worse, he’s a hedge fund and Goldman Sachs guy. That’s like blood in the water for the sharks in Congress.  They get to put on a show with live TV cameras in the room, publicly showing disgust for Mnuchin (and those like him), to cozy up the less informed segment of the country.  And they get to project the blame for many things in life on the rich and their “bottom-line” business world.

This is a stark contrast to a decade ago. The media, especially, was in the business of making guys like this out to be super heroes. They wrote about them as mythical creatures – the world’s gene pool winners: the best and the brightest.

But times have changed.

In the hearing today, Mnuchin was accused of everything from tax evasion to unfairly kicking an 80-year old woman out of her house in Florida.  Sounds like a really bad guy.

Though it appears that he had IRS compliant offshore accounts (not tax evasion, but tax compliant). And his company had purchased defaulted mortgages, claimed the collateral (the house) and sold the collateral for a profit.

So, just as you and me may take a tax deduction for our children, and just as an individual may sell his/her house for a profit, perhaps Mnuchin made rational financial decisions and followed the laws that were created by Congress.

So if we can’t blame Mnuchin and Goldman Sachs for nearly blowing up the global economy, who can we blame.

With all of the complexities of the housing bubble and the subsequent global financial crisis, it can seem like a web of deceit.  But it all boils down to one simple actor.  It wasn’t Wall Street.  It wasn’t hedge funds.  It wasn’t mortgage brokers.  These entities were operating, in large part, from the natural force of economics: incentives.

It wasn’t even the government’s initiative to promote home ownership that led to the proliferation of mortgages being given to those that couldn’t afford them.

So who was the culprit?

It was the ratings agencies.

Housing prices were driven sky high by the availability of mortgages. Mortgages were made easily available because the demand to invest in mortgages, to fund those mortgages, was sky high.

But what drove that demand to such high levels?

When the mortgages were combined together in a package (securitized as a mix of good mortgages, and a lot of bad/higher yielding mortgages), they were bought, hand over fist, by the massive multi-trillion dollar pension industry, banks and insurance companies.  Yes, the guys that are managing your pension funds, deposit accounts and insurance policies were gobbling up these mortgage securities as fast as they could, but ONLY because the ratings agencies were stamping them all with a top AAA rating.  Who would encourage such a thing?  Congress.  In 1984 they passed a law making it okay for banks, pension funds and insurance companies to buy/treat high rated secondary mortgages like they would U.S. Treasuries.

So as investment managers, in the business of building the best performing risk-adjusted portfolio possible, and in direct competition with their peers, they couldn’t afford NOT to buy these securities.  They came with the safest ratings, and with juicy returns. If you don’t buy these, you’re fired.

To put it all very simply, if these securities were not AAA rated, the pension funds would not have touched them (certainly not to the extent).

With that, if the there’s no appetite to fund the mortgages, the ultra-easy lending practices never happen, and housing prices never skyrocket on unwarranted and unsustainable demand. The housing bubble doesn’t build, doesn’t bust, and the financial crisis doesn’t happen.

That begs the question: Why did the ratings agencies give a top rating to a security that should have received a lower rating, if not much lower?

First, it’s important to understand that the ratings agencies get paid on the products they rate BY the institutions that create them.  That’s right. That’s their revenue model.  And only a group of these agencies are endorsed by the government, so that, in many cases, regulatory compliance on a financial product requires a rating from one of these endorsed agencies.

So as I watched the grilling session of Mnuchin today by Congress, these are the things that crossed my mind.

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December 1, 2016, 4:00pm EST

Tomorrow we get the last jobs report of the year.  And unlike the other 11 this year, this one doesn’t have the same buzz surrounding it, even though we have a big Fed meeting coming in just two weeks.

Why? It’s no longer a Fed-driven (monetary policy-driven) world.  The switch has been flipped.  With the Trump presidency bringing structural change and fiscal stimulus to the table; the markets, the economy, sentiment that has hinged so tightly to each data point has become far less fragile.

Earlier in the week, I talked about the inflationary effect of an OPEC cut. That’s continuing to reflect in the interest rate market.  The 10 year yield ran up to just shy of 2.50% today.  On a relative basis, it’s a huge move.  Given where it has traveled from, it looks like an incredibly dramatic and even a destabilizing move.   But on an absolute basis, a 2.5% interest rate on lending your money for 10 years is peanuts (i.e. it remains a highly attractive borrowing environment).

And if we step back and consider where we were last December, when the Fed made its first move on rates, the market had priced in the rate hike, and stood at 2.25% going into the decision.  Following the Fed’s move, the bond markets started expressing the view that the Fed had made a mistake in its projection that the economy could withstand four hikes over the subsequent 12 months.  That’s what they were telegraphing.  And for that, the bond market began telegraphing chances of a Fed-induced recession.

Given the events of the past month, and the outlook for a more pro-growth environment for next year, the message that the bond market is sending is simply a perfectly priced in 25 basis point hike by the Fed this month, into an economy that can withstand it.  Imagine that.

The fact that the jobs numbers and the Fed are becoming a smaller piece of the market narrative is very positive.  In fact, I would argue there hasn’t been a jobs report, with a Fed meeting nearby, that has been less scrutinized in eight years.

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November 30, 2016, 3:25pm EST

Over the past year we’ve talked a lot about the oil price bust and the threat it represented to the global economy.  And in past months, we’ve talked about the approaching OPEC meeting, where they had telegraphed a production cut – the first in eight years.  Still, not many were buying it.

Remember, it was OPEC created the oil price crash that started in November of 2014 when the Saudis refused a production cut.  Ultimately the price of oil fell to $26 a barrel (this past February).

Their strategy:  Kill off the emerging threat of the U.S. shale industry by forcing prices well below where they could produce profitably.  To an extent it worked.  More than 100 small oil related companies in the U.S. filed for bankruptcy over the past two years.

But it soon became evident that cheap oil threatened, not just the U.S. shale industry (which also turned out to threaten the global financial system and global economy), but it threatened the solvency of OPEC member countries (the proverbial shot in the foot).

The big fish, the Saudis, have lost significant revenue from the self-induced oil price plunge, starting the clock on an economic time bomb. They derive about 80% of their revenue from oil.  With that, they’ve run up their budget deficit to more than 15% of GDP in the oil bust environment.  For context, Greece, the well known walking dead member of the euro zone was running a budget deficit of 15% at worst levels back in 2009.

So OPEC members need (have to have) higher oil prices.  Time is working against them. With that, they followed through with a cut today.  Remember, back in the 80s when OPEC merely hinted at a production cut, oil jumped 50% in 24 hours.  Today it was up as much as 10% on the news. But this cut should put a floor under oil in the mid $40s, and lead to $60-$70 oil next year.

All of this said, given the increase in supply from bringing Iran production back online, and from increasing U.S. supply, no one should be cheering more for the pro-growth Trump economy to put a fire under demand than OPEC, especially Saudi Arabia.

Now, as we discussed this week, oil has been a huge drag on global inflation.  With that, the catalyst of a first OPEC cut in eight years driving oil prices higher could put the Fed and other global central banks in a very different position next year.

Consider where the world was just months ago, with downside risks reverting back to the depths of the economic crisis.  Now we have reason to believe oil could be significantly higher next year. That alone will run inflation significantly hotter (flipping the switch on the inflation outlook). Add to that, we have a pro-growth government with a trillion dollar fiscal package and tax cuts entering the mix.

As I said yesterday, we may find that the Fed will tell us in December that they are planning to move rates more like four times next year, instead of two.

The market is already telling us that the inflation switch has been flipped. Just four months ago, the 10 year yield was trading 1.32%, at new record lows.  And as of today, we have a 10-year at 2.40% — and that’s on about a 60 basis point runup since November 8th.

With that said, there has been a shot in the arm for sentiment over the past few weeks. That’s led to the bottoming in rates, bottoming in commodities and potential cheapening of valuations in stocks (given a higher growth outlook).  As a whole, that all becomes self-reinforcing for the better growth outlook story.

And that reduces a lot of threats.  But it creates a new threat: The threat of a collapse in bond prices, runaway in market interest rates.

But what could be the Fed’s best friend, to quell that threat?  Trump’s new Treasury Secretary said today that he thinks they will see companies repatriate as much as $1 trillion.  Much of that money will find a parking place in the biggest, most liquid market in the world:  The U.S. Treasury market.  That should support bonds, and keep the climb in interest rates tame.

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