by Ambrose Evans-Pritchard, International Business Editor
The Telegraph
January 29, 2015

 Markets have woken up to Greek nuclear risk. Bank stocks on the Athens exchange have crashed 44pc since Alexis Tsipras swept into power this week with a mandate to defy the European power structure.

Greek bonds bought with such zest by investors last April - entranced by the mirage of recovery, and deaf to simmering revolution below - are signalling a rapid slide towards bankruptcy. Five year yields spiked to 13.5pc today.

Contrary to expectations, Mr Tsipras has not resiled from a long list of campaign pledges that breach the terms of Greece's EU-IMF Troika Memorandum, and therefore put the country on a collision course with the Brussels, Berlin, and Frankfurt.

He told his cabinet today that the government is willing to negotiate on its demands for debt relief but will not abandon its core promises to the Greek people. “We will not seek a catastrophic solution, but neither will we consent to a policy of submission. The country is holding up its head,” he said.

If anything, he is upping the ante. He could have gone in into coalition with the centrist, pro-EU Potami party, and could have explained any softening of his line towards Europe as a necessary move to hold the government together. Instead he chose to go with Independent Greeks, a nationalist party that is even more virulently hostile to the Troika. This has been a cannon shot across the bows of creditor states.



Mr Tsipras is clearly gambling that the Germany and the creditor powers will not let monetary union break up at this late stage, over a trivial sum of money, after having already committed €245bn, for to do so would shatter the illusion that the eurozone crisis has been solved. This may be a misjudgment.

“We will immediately stop any privatisation,” said Panagiotis Lafazanis, leader of the Marxist Left Platform, the biggest bloc in the Syriza pantheon. Plans to sell the PPT power utility and the Piraeus Port Authority have been halted. The minimum wage will be raised from €500 to €751 a month as a first order business. This is an explicit rejection of Troika austerity terms.

We are witnessing a democratic revolution. Never before have the EMU elites had to face a eurozone government that refuses to play by any of their rules, and they have yet to experience the lascerating tongue of Yanis Varoufakis, a relentless critic of their 1930s ideology of debt-deflation and "fiscal waterboarding".

Mr Varoufakis told me before his appointment as finance minister that Syriza will not capitulate even if the European Central Bank threatens to cut off €54bn of liquidity for the Greek banking system, a move that would almost certainly force Greece to nationalise the banks, impose capital controls, and would - in my view, though not in his - force it to reintroduce the drachma within days.

"A freshly elected government cannot allow itself to be intimidated by threats of Armageddon," he said. His first act in office today was to announce that 600 cleaners in the finance ministry will regain their jobs, paid for by cutting financial advisers. The corridors erupted in cheers.

Whether you are "staunchly" on the Left or "unashamedly" on the Right - as the BBC likes to characterise opinion - it is hard not to feel a welling sympathy for this popular revolt. If it takes a neo-Marxist like Alexis Tsipras to confront the elemental folly of EMU crisis strategy, so be it.

The suggestion - almost a mantra in EMU power circles - that Syriza is retreating from "reform" is risible. There is no reform. The two dynastic parties in charge of Greece for over three decades have always treated the state as a patronage machine, and seem to have great trouble shaking the habit.

"The concept of reform has been gradually discredited during the current crisis," says Athens think-tank IOBE. The IMF's mea culpa on the Troika's mishandling of Greece admits that the policies imposed were mostly wage cuts and brute austerity, with precious little reform of the state structure or product markets. Greece's ranking on the World Economic Forum's competitiveness index has dropped from 67 to 81 over the last six years, below Ukraine and Algeria.

If there is any party that can put an end to this oligarchy it is probably Syriza. They are outsiders, without vested interests. Mr Varoufakis has vowed to smash the "rent-seeking" kleptocracy that enjoys legal tax immunity and have turned state procurement into an enrichment scam. "We will destroy the bases which they built for decade after decade," he said.

What Syriza is really retreating from is a scorched-earth austerity policy that has slashed investment by 63.5pc, caused a 26pc fall in GDP, pushed the youth jobless rate to 62pc, ravaged the tax base, and sent debt spiralling up to 177pc.

We have witnessed is "The Rape of Greece", to borrow the title of a new book by Nadia Valavani, suddenly catapulted into power as Syriza's deputy finance minister. IMF officials privately agree. The Fund confesses in its candid report that the Troika fatally under-estimated the violence of the fiscal multiplier.

Yes, successive governments lied about the true state of public finances in the years leading up to the crisis, but this is a distraction in macro-economic terms. The flood of French, German, Dutch, and Anglo-Saxon capital into Greece was so vast that the drama would have unfolded in much same way even if Greek politicians had been angels.

The greater lie was the silent complicity of all the relevant players in allowing the deformed structure of monetary union to incubate disaster. Surveillance reports by EU bodies in did not sound the alarm during the boom years, though one of the authors told me at clandestine lunches in Brussels that the whole of southern Europe was heading for disaster. Internal critics were silenced.

What has happened to Greece since then is a moral scandal. Leaked documents from the IMF Board confirm that country needed debt relief at the outset. This was blocked by the EU for fear that it would set off contagion at a time when the eurozone - negligently - did not have a lender-of-last resort. Greece was sacrificed to buy time for the euro.

The EU-IMF Troika forced a bankrupt country to take on further loan packages, allowing foreign banks to dump their bonds onto Greek taxpayers and trap Greek citizens in debt servitude. To add insult to injury, this was called a rescue.

The IMF minutes for May 2010 said Troika loans “may be seen not as a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece’s private debt holders”. Greece suffered IMF austerity without the usual IMF cure of devaluation and debt relief. It has every right to demand redress.

Yet Mr Tsipras faces a tortured moral choice. If he defaults, he walks away from debts owed to taxpayers in countries that are also net debtors with mass unemployment. Italy's contribution to the Greek loan package is €41bn and Italy too is in crisis. The Mezzogiorno's GDP has fallen by 15pc since 2008, and levels of hardship are comparable to those in Greece. All of Southern Europe is on the hook due to the insidious mechanisms of EMU crisis strategy.

Syriza's manifesto - the Thessaloniki Programme - demands cancellation of "the greater part" of Greece's public debt, comparable to the relief secured by Germany at the London Conference in 1953, and necessary to pave the way for the post-War boom. It wants a broader "European Debt Conference" to restructure the debts of all southern European states, and in a sense it is right.

Mr Varoufaki says the eurozone will be "toast within a couple of years" unless it comes to terms with the fundamental absurdity of eurozone capital flows. Either the surpluses of the North are recycled into the South, or the bloc as whole will remain trapped in a deflationary vortex. "You can't have a monetary union that pretends it can survive by simply lending more money to debtor countries on condition that they must shrink their income," he told the BBC's Paul Mason.

Yet it is not within Syriza's power to bring about such a broad change. The cold reality for now is that Athens is now on a war footing with an EMU power-structure controlled by the creditors. The chorus of warnings over the last two days has been painfully loud and clear.

It is one thing to soften the terms of Greek debt repayment and cut the primary surplus from a target of 4.5pc to maybe 3.5pc of GDP. It is another to overthrow the Troika altogether. “We expect them to fulfil everything that they have promised to fulfil,” said Jyrki Katainen, EU's economic enforcer.

The dawning awareness of this unbridgeable chasm is what is frightening investors, and events are now moving with lightning speed. Barclays says capital flight may have reached €20bn since early December. The pace is surely accelerating.

Greece will hit its first crunch-point at the end of February when its bail-out extension expires. No doubt there will be an emergency extension of some kind - perhaps a month - but the debt redemptions will pile up soon after that, culminating in a €7bn repayment to the ECB in July and August that Greece cannot possibly meet without a deal. The mere anticipation of this awful moment will bring it forward.

Marcel Fratzscher, head of Berlin's DIW institute in Berlin, told Reuters that Mr Tsipras is playing a "very dangerous game" that ris. "If people start to believe that he is really serious, you could have massive capital flight and a bank run. You are quickly at a point where euro exit becomes possible," he said.

Holger Schmieding from Berenberg Bank says he has returned from Athens in despair, seriously worried that events may soon spin out of control. "Vicious circles can start fast,” he said.

by Stephen S. Roach
January 26, 2015

NEW HAVEN – Predictably, the European Central Bank has joined the world’s other major monetary authorities in the greatest experiment in the history of central banking. By now, the pattern is all too familiar. First, central banks take the conventional policy rate down to the dreaded “zero bound.” Facing continued economic weakness, but having run out of conventional tools, they then embrace the unconventional approach of quantitative easing (QE).

The theory behind this strategy is simple: Unable to cut the price of credit further, central banks shift their focus to expanding its quantity. The implicit argument is that this move from price to quantity adjustments is the functional equivalent of additional monetary-policy easing. Thus, even at the zero bound of nominal interest rates, it is argued, central banks still have weapons in their arsenal.

But are those weapons up to the task? For the ECB and the Bank of Japan (BOJ), both of which are facing formidable downside risks to their economies and aggregate price levels, this is hardly an idle question. For the United States, where the ultimate consequences of QE remain to be seen, the answer is just as consequential.

QE’s impact hinges on the “three Ts” of monetary policy: transmission (the channels by which monetary policy affects the real economy); traction (the responsiveness of economies to policy actions); and time consistency (the unwavering credibility of the authorities’ promise to reach specified targets like full employment and price stability). Notwithstanding financial markets’ celebration of QE, not to mention the US Federal Reserve’s hearty self-congratulation, an analysis based on the three Ts should give the ECB pause.

In terms of transmission, the Fed has focused on the so-called wealth effect. First, the balance-sheet expansion of some $3.6 trillion since late 2008 – which far exceeded the $2.5 trillion in nominal GDP growth over the QE period – boosted asset markets. It was assumed that the improvement in investors’ portfolio performance – reflected in a more than threefold rise in the S&P 500 from its crisis-induced low in March 2009 – would spur a burst of spending by increasingly wealthy consumers. The BOJ has used a similar justification for its own policy of quantitative and qualitative easing (QQE).

The ECB, however, will have a harder time making the case for wealth effects, largely because equity ownership by individuals (either direct or through their pension accounts) is far lower in Europe than in the US or Japan. For Europe, monetary policy seems more likely to be transmitted through banks, as well as through the currency channel, as a weaker euro – it has fallen some 15% against the dollar over the last year – boosts exports.

The real sticking point for QE relates to traction. The US, where consumption accounts for the bulk of the shortfall in the post-crisis recovery, is a case in point. In an environment of excess debt and inadequate savings, wealth effects have done very little to ameliorate the balance-sheet recession that clobbered US households when the property and credit bubbles burst. Indeed, annualized real consumption growth has averaged just 1.3% since early 2008. With the current recovery in real GDP on a trajectory of 2.3% annual growth – two percentage points below the norm of past cycles – it is tough to justify the widespread praise of QE.

Japan’s massive QQE campaign has faced similar traction problems. After expanding its balance sheet to nearly 60% of GDP – double the size of the Fed’s – the BOJ is finding that its campaign to end deflation is increasingly ineffective. Japan has lapsed back into recession, and the BOJ has just cut the inflation target for this year from 1.7% to 1%.

Finally, QE also disappoints in terms of time consistency. The Fed has long qualified its post-QE normalization strategy with a host of data-dependent conditions pertaining to the state of the economy and/or inflation risks. Moreover, it is now relying on ambiguous adjectives to provide guidance to financial markets, having recently shifted from stating that it would maintain low rates for a “considerable” time to pledging to be “patient" in determining when to raise rates.

But it is the Swiss National Bank, which printed money to prevent excessive appreciation after pegging its currency to the euro in 2011, that has thrust the sharpest dagger into QE’s heart. By unexpectedly abandoning the euro peg on January 15 – just a month after reiterating a commitment to it – the once-disciplined SNB has run roughshod over the credibility requirements of time consistency.

With the SNB’s assets amounting to nearly 90% of Switzerland’s GDP, the reversal raises serious questions about both the limits and repercussions of open-ended QE. And it serves as a chilling reminder of the fundamental fragility of promises like that of ECB President Mario Draghi to do “whatever it takes” to save the euro.

In the QE era, monetary policy has lost any semblance of discipline and coherence. As Draghi attempts to deliver on his nearly two-and-a-half-year-old commitment, the limits of his promise – like comparable assurances by the Fed and the BOJ – could become glaringly apparent. Like lemmings at the cliff’s edge, central banks seem steeped in denial of the risks they face.

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Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. He is the author of the new book Unbalanced: The Codependency of America and China.

by Bill Gross
January 6, 2015

A January Investment Outlook should normally be filled with recommended “do’s and don’ts,” “picks and pans” and December 31, 2015, forecasts for interest rates and risk assets. I shall do all of that as usual when I travel to New York City for the annual Barron’s Roundtable in a few weeks’ time. That is always an opportunity for me to engage in verbal jousting with Marc Faber, Mario Gabelli and the usual bearish forecast from the Gnome of Zurich, Felix Zulauf. So I’ll leave the specific forecasting for a few weeks’ time and sum it up in a few quick sentences for now: Beware the Ides of March, or the Ides of any month in 2015 for that matter. When the year is done, there will be minus signs in front of returns for many asset classes. The good times are over.

Timing the end of an asset bull market is nearly always an impossible task, and that is one reason why most market observers don’t do it. The other reason is that most investors are optimists by historical experience or simply human nature, and it never serves their business interests to forecast a decline in the price of the product that they sell. Nevertheless, there comes a time when common sense must recognize that the king has no clothes, or at least that he is down to his Fruit of the Loom briefs, when it comes to future expectations for asset returns. Now is that time and hopefully the next 12 monthly “Ides” will provide some air cover for me in terms of an inflection point. Manias can outlast any forecaster because they are driven not only by rational inputs, but by irrational human expressions of fear and greed. Knowing when the “crowd” has had enough is an often frustrating task, and it behooves an individual with a reputation at stake to stand clear. As you know, however, moving out of the way has never been my style so I will stake my claim with as much logic as possible and hope to persuade you to lower expectations for future returns over the next 12 months.

My investment template shares a lot in common with, and owes credit to, the similar templates of Martin Barnes of the Bank Credit Analyst and Ray Dalio of Bridgewater Associates. All three of us share a belief in a finance-driven economic cycle which over time moves to excess both on the upside and the downside. For the past few decades, the secular excess has been on the upside with rapid credit growth, lower interest rates and tighter risk spreads dominating the long-term trend. There have been dramatic reversals as with the Lehman Brothers collapse, the Asia/dot-com crisis around the turn of the century, and of course 1987’s one-day crash, but each reversal was met with a new and increasingly innovative monetary policy initiative on the part of the central banks that kept the bull market in asset prices alive.

Consistently looser regulatory policies contributed immensely as well. The Bank Credit Analyst labels this history as the “debt supercycle,” which is as descriptive as it gets. Each downward spike in the economy and its related financial markets was met with additional credit expansion generated by lower interest rates, financial innovation and regulatory easing, or more recently, direct central bank purchasing of assets labeled “Quantitative Easing.” The power of additional and cheaper credit to add to economic growth and financial asset bull markets has been underappreciated by investors since 1981. Even with the recognition of the Minsky Moment in 2008 and his commonsensical reflection that “stability ultimately leads to instability,” investors have continued to assume that monetary (and at times fiscal) policy could contain the long-term business cycle and produce continuing prosperity for investors in a multitude of asset classes both domestically and externally in emerging markets.

There comes a time, however, when zero-based, and in some cases negative yields, fail to generate sufficient economic growth. While such yields almost automatically result in higher bond prices and escalating P/E ratios, their effect on real growth diminishes or in some cases, reverses. Corporate leaders, sensing structural changes in consumer demand, become willing borrowers, but primarily to reduce their own outstanding shares as opposed to investing in the real economy. Demographics, technology, and globalization reversals in turn have promoted a sense of “secular stagnation” as economist and former Treasury Secretary Larry Summers calls it and the “New Normal” as I labeled it as early as 2009. The Alice in Wonderland fact of the matter is that at the zero bound for interest rates, expected Returns on Investment (ROI) and Returns on Equity (ROE) are capped at increasingly low levels. The private sector becomes less willing to take a chance with their owners’ money in a real economy that has a lack of aggregate demand as its dominant theme. Making money by borrowing at no cost for investment in the real economy sounds like a no-brainer. But, it comes with increasing risk in an environment of secular stagnation, demand uncertainty, and with the ROI closer to zero itself than an entrepreneur is willing to bear.

And so the miracle of the debt supercycle meets a logical end when yields, asset prices and the increasing amount of credit place an unreasonable burden on the balancing scale of risk and return. Too little return for too much risk. As the real economy of developed and developing nations sputter, so too eventually do financial markets. The timing – as mentioned previously – is never certain but the inevitable outcome is commonsensically sound. If real growth in most developed and highly levered economies cannot be normalized with monetary policy at the zero bound, then investors will ultimately seek alternative havens. Not immediately, but at the margin, credit and assets are exchanged for figurative and sometimes literal money in a mattress. As it does, the system delevers, as cash at the core or real assets at the exterior become the more desirable holding. The secular fertilization of credit creation and the wonders of the debt supercycle may cease to work as intended at the zero bound.

Comprehending (or proving) this can be as frustrating as understanding the differences between Newtonian and quantum physics and the possibility that the same object can be in two places at the same time. Central banks with their historical models do not yet comprehend the impotence of credit creation on the real economy at the zero bound. Increasingly, however, it is becoming obvious that as yields move closer and closer to zero, credit increasingly behaves like cash and loses its multiplicative power of monetary expansion for which the fractional reserve system was designed.

Finance – instead of functioning as a building block of the real economy – breaks it down. Investment is discouraged rather than encouraged due to declining ROIs and ROEs. In turn, financial economy asset class structures such as money market funds, banking, insurance, pensions, and even household balance sheets malfunction as the historical returns necessary to justify future liabilities become impossible to attain. Yields for savers become too low to meet liabilities. Both the real and the finance-based economies become threatened with the zero-based, nearly free money available for the taking. It’s as if the rules of finance, like the quantum rules of particles, have reversed or at least negated what we historically believed to be true.

And so that is why – at some future date – at some future Ides of March or May or November 2015, asset returns in many categories may turn negative. What to consider in such a strange new world? High-quality assets with stable cash flows. Those would include Treasury and high-quality corporate bonds, as well as equities of lightly levered corporations with attractive dividends and diversified revenues both operationally and geographically. With moments of liquidity having already been experienced in recent months, 2015 may see a continuing round of musical chairs as riskier asset categories become less and less desirable.

Debt supercycles in the process of reversal are not favorable events for future investment returns. Father Time in 2015 is not the babe with a top hat in our opening cartoon. He is the grumpy old codger looking forward to his almost inevitable “Ides” sometime during the next 12 months. Be cautious and content with low positive returns in 2015. The time for risk taking has passed.

by the editors of Men's Health
January 2, 2015

It's a new year, and a new opportunity to get rich. Or at least start making better financial choices.

But where to begin? You could seek guidance from your uncle, who swears he has investing ideas that could make you a small fortune. You could watch that Mad Money CNBC show, where Jim Cramer smashes red buttons and pretends he has any idea what he's talking about. You could find a broker who hopefully isn't a crook, or a penny stock investment guru who hopefully isn't full of shit. Or you could skip the middlemen and just ask a billionaire.

Let's try the billionaire approach.

Mark Spitznagel is the founder of Universa Investments, a Miami-based hedge fund that specializes in profiting from stock market crashes. He also owns and operates Idyll Farms in northern Michigan, and he's the author of The Dao of Capital: Austrian Investing in a Distorted World, which Forbes Magazine called "one of the most important books of the year, or any year for that matter."

We're not entirely sure of Mr. Spitznagel's net worth, but it's a lot. It's reportedly in the billions, but we can neither confirm nor deny this. Which is weird, because this story was edited by his older brother, who just so happens to be a full-time employee of Men's Health. All he could tell us is that his brother once lived in a house with a moat—a freaking MOAT, like it was a castle that was constantly invaded by Spanish conquistadors—and now he lives in a different, slightly larger house, which has no moat but is surrounded by hedge mazes so big you can see them from space.

We asked Spitznagel the questions you want to know. We also asked him the questions you didn't know you wanted to know, but you really should know if you're serious about making a lot of money in 2015. And of course, we asked him at least one question about the likelihood that we'd ever own a private island, because how cool would that be?

What's the easiest, fastest way to get rich in 2015?

Here's a better question: What's the easiest, fastest way to get very poor in 2015? Answer: Going for the easiest, fastest way to get rich in 2015—or punting on what's worked in the recent past.

Don't fall for the trap of myopically following yesterday's winners. Protect yourself, keep your powder dry (meaning, the cash you’ve set aside for investing), and wait for a better day. Think more about getting rich in 2020 or beyond.

How do I decide whether a stock is a bargain?

If you’re searching for stock-market bargains, this is the wrong time to be looking. The Federal Reserve has been single-handedly setting interest rates at essentially zero and purchasing everything from government debt to mortgages—all of which has turned the entire investing population into zombies (with a gambling addiction, I might add) wandering aimlessly in search of any tiny extra return to ravenously consume.

This has left stock markets as elevated and overvalued as they’ve been since the dot-com mania (and more than they were in 1929 and 2007), which history has shown will likely lead to significant declines ahead.

I’m not saying the market is going to drop like a stone tomorrow (although with each passing day, the odds of that happening increase), but these aren’t ideal conditions for investing, to say the least.

I want to be a hedge fund manager. Should I bother with college, or should I be out in the real world, getting first-hand experience?

Hedge fund management is essentially a rather sophisticated form of casino-like gambling. College would be a good way to learn the financial tools to play that game.

But why do you want to be a hedge fund manager so badly? There are far more important (and likely more lucrative, in the future) real-world things to do for a career in this life than waste your time punting on irrelevant financial variables (most of which are controlled by the Federal Reserve). Try medicine, medical research, manufacturing, or farming and make something new and more efficiently that people really need.

But if you still insist on becoming a hedge fund manager, the most valuable things you'll need to learn to be good at investing are patience, resilience, and self-discipline. You aren't just going to learn these in school. My best financial advice: practice yoga.

You built a goat farm. Are you just being quirky, or is this some genius investing plan that's going to make you another billion? Should I be investing in goats too?

C’mon, there’s more to life than just money! My farm, Idyll Farms, is all about sustainable agriculture, making delicious goat cheese in a natural, healthy and ecologically sustainable way—that is, through pasture management rather than the use of factory-like monoculture feed.

But, to answer your question, I’m a firm believer that agriculture is going to be a great investment and entrepreneurial opportunity for the next generation. Farming is headed for a sea-change: farmers are getting old, we’re depleting the fertility of our topsoil, creating highly susceptible GMO monocultures, and we don’t fully appreciate the implications of water—just to name a few.

So in that sense, yes, it wouldn’t be a terrible idea to start investing in goats. But my motive is to change the way that we approach agriculture in this country, not just profit.

What's the worst investment you've ever made? How about the best?

The worst investment I ever made (other than when I acquired my pug Papageno, who constantly uses my kitchen floor as his personal toilet—especially when I’m eating breakfast) was a derivative contract (a financial instrument that’s based on the value of something else, such as a stock option that derives its value from the stock itself) where I lost 100% of my capital investment. And, I’ve done this countless times.

You see, this has been both my worst and my typical investment. But, as they say, the poison is in the dosage. Each time, I only invested a tiny amount of capital—not enough to hurt me.

In fact, I love to lose small amounts frequently and then occasionally score big. (Every so often, these derivative contracts turn out to be huge winners.) I call this my “roundabout” strategy, which is also the subject of my book The Dao of Capital.

The best investment I ever made (surely in October 2008) was on a derivative contract where I made thousands of percent more than I lost on my worst investments.

I’m approaching 40, and my savings is pathetic. Am I doomed, or is there still hope that I can retire on a tropical island?

Sounds like you aren’t all that unusual. After all, why should anyone save when the Fed has set interest rates at zero?

One word of encouragement I can give is that I am certain that there will be generational investment opportunities to come in our lifetime. Fortunes will be made by those with the dry powder of capital to invest when everyone else is stampeding for the exits and trying to sell their investments—because few others will have kept their powder dry.

Most everyone is all-in today. So, despite the markets’ run-up, you aren't necessarily really missing much. As has always been the case when Federal Reserve monetary policy creates asset bubbles, these bubble profits are ephemeral.

So let this light a fire under you to start socking savings away, starting now. Every dollar saved will be worth many multiples later if you have the stomach to wait while the market keeps going up and invest them once all the zombies have finally been obliterated in the next crash.

You’ll know when that happens, because everyone will be crying over their losses, and the TV pundits will be wearing signs that say “the end is near.”

by John Hussman
January 5, 2015

Probably the most interesting response to the cognitive dissonance provoked by the present yield-seeking mania comes from Hugh Hendry at Eclectica (h/t ZeroHedge) who quite clearly recognizes the repulsive long-term situation, but has embraced central-bank induced speculation out of the necessity of self-preservation as a money manager. I would actually agree with him here were it not for the fact that the behavior of market internals and credit spreads doesn’t really recommend an outlook tied to the world of illusion. That may change, and if it does, it would admit a greater range of investment outlooks in the category of “constructive with a safety net.” Hendry’s own struggle with the cognitive dissonance of this period is evident:

“There are times when an investor has no choice but to behave as though he believes in things that don’t necessarily exist. For us, that means being willing to be long risk assets in the full knowledge of two things: that those assets may have no qualitative support; and second, that this is all going to end painfully. The good news is that mankind clearly has the ability to suspend rational judgment long and often.

“Remember the film The Matrix? Morpheus offered Neo the choice of two pills – blue, to forget about the Matrix and continue to live in the world of illusion, or red, to live in the painful world of reality… I have long thought of myself as one of the enlightened. My much thumbed copy of Kindelberger’s Manias, Panics and Crashes aided and abetted my thinking as I correctly anticipated and monetised profits from the crisis of 2008 for example. But it isn’t always good. Kindelberger has been absolutely detrimental to my investment performance for the last six years and as a result I have changed. I still believe that the attempt by central bankers to prevent the private sector from deleveraging via a non-stop parade of asset price bubbles will end in tears. But I no longer think that anyone can say when.

“The economic truth of today no longer offers me much solace; I am taking the blue pills now. In the long run we will come to rue the central bank actions of today. But today there is no serious stimulus programme that our Disney markets will not consider to be successful. Markets can be no more long term than politics and we have no recourse but to put up with the environment that gives us; the modern market is effectively Keynesian with an Austrian tail.”

Pater Tenebrarum offers a thoughtful (and respectful) counterpoint:
“It seems possible that there is a catch. If no-one can say when, then the ‘blue pill’ strategy has a major weakness. It means that things could just as easily go haywire next week as next year. It should be noted that the focus of Austrian business cycle theory is really on the boom, its chief causes and effects, and the fact that instead of increasing prosperity, it will lead to impoverishment in the long run. The major difference between someone simply taking the blue pill and an ‘Austrian’ investor in the current situation is probably that the latter attempts to incorporate all possible outcomes in his strategy, instead of trusting that central bank interventionism will continue to ‘work’ for investors.

“We believe that there is a grave danger associated with simply ‘taking the blue pill.’ First of all, in the context of ‘risk assets,’ having faith in central bank magic is most definitely not a contrarian position anymore – less so than at any other time in the past six years. Contrarian views have actually worked very well in treasury bonds and crude oil in 2014, so it would also be quite wrong to state that ‘contrarianism no longer works’ as a general proposition. The majority is of course always right during a strong trend. However, there inevitably comes a time when a trend has lasted long enough and gone far enough that the ranks of doubters have been thoroughly thinned out and the majority ceases to be correct.

“We perceive a ‘greater tolerance for short term drawdowns’ as quite dangerous in connection with risk assets at this juncture. In asset bubbles there are usually a number of short term breakdowns that are immediately followed by prices moving to new highs, a fact that greatly cements the confidence of market participants – usually to the point where it becomes fateful overconfidence. The main problem with this ‘tolerant’ approach is that one simply cannot differentiate a run-of-the-mill short term correction from a short term downturn that ends up heralding something far worse. Initially, all corrections look similar… The initial downturn is never seen as a cause for alarm. Sometimes this can however be followed by a decline so swift that having a tolerance for drawdowns can end up leaving one with very big losses in a very short time period.

“Such sudden reassessments of market valuation can rarely be tied to specific fundamental developments. Rather, anything that is reported is all of a sudden interpreted negatively and becomes a trigger for more selling, even though similar news would have been shrugged off a few days or weeks earlier. After all, nearly every economic news item can be interpreted in a number of different ways, so that even superficially good news can become a problem (in the current situation they could e.g. create fears of a faster tightening of monetary policy).

“We will readily admit that one cannot know with certainty whether the bubble in risk assets will become bigger. However, it seems to us that avoiding a big drawdown may actually be more important than gunning for whatever gains remain. One can of course endeavor to do both, but that inevitably limits short term returns due to the cost of insuring against a potential calamity.”

My own view is that Hendry and Tenebrarum are both right – only that the appropriate pill is conditional on the state of investor preferences toward risk-seeking and risk-aversion – preferences that can be largely inferred from observable market action. In an environment where market internals and credit spreads are deteriorating, betting on risky assets is extraordinarily dangerous and subject to abrupt air-pockets, free-falls and crashes – the “sudden reassessments of market valuation” that Tenebrarum correctly recognizes. That’s what we presently observe, and it demands the red pill that makes one conscious of the painful reality of the present situation. But those conditions may change, and in that case, the immediacy of our concerns should ease accordingly.

There is one main lesson that should be drawn from our own experience in recent years – and it is a lesson that can be demonstrated across every bubble-crash cycle in history. In an environment where internals and credit spreads uniformly convey risk-seeking preferences, the market may be severely overvalued, but pointed expectations about impending losses are best deferred. That doesn’t mean swallowing the blue pill whole or living in the untethered world of speculative fantasy. It would surely require insurance or some other safety-net at current valuations, but there is a tendency for overvalued markets to become more overvalued in that environment. For now, we view the market as vulnerable to vertical losses. That risk will change with market conditions, and we will take that evidence as it emerges.

I’ll repeat emphatically what I noted a few weeks ago. The set of market conditions that we observe at present are supportive for steep losses to emerge because present conditions join compressed risk premiums with a measurable shift toward risk-aversion by investors. If further speculation is to emerge – and this is borne out even in data from recent years – that speculation is likely to be supported by a measurable shift toward risk-seeking that can also be inferred from the behavior of observable market internals. We need not hope for a major market decline, nor do we need to dread a major resumption of speculation. Each of these will manifest because conditions are supportive for them to manifest. As the Buddha said, “This is, because that is. This is not, because that is not.”

by Ambrose Evans-Pritchard
The Telegraph
1 January, 2015

 America’s closed economy can handle a surging dollar and a fresh cycle of rising interest rates. Large parts of the world cannot. That in a nutshell is the story of 2015.

Tightening by the US Federal Reserve will have turbo-charged effects on a global financial system addicted to zero rates and dollar liquidity.

Yields on 2-year US Treasuries have surged from 0.31pc to 0.74pc since October, and this is the driver of currency markets.

Since the New Year ritual of predictions is a time to throw darts, here we go: the dollar will hit $1.08 against the euro before 2015 is out, and 100 on the dollar index (DXY).

Sterling will buckle to $1.30 as a hung Parliament prompts global funds to ask why they are lending so freely to a country with a current account deficit reaching 6pc of GDP.

 There will be a mouth-watering chance to invest in the assets of the BRICS and mini-BRICS at bargain prices, but first they must do penance for $5.7 trillion in dollar debt, and then do surgery on obsolete growth models.

The MSCI index of emerging market stocks will slide another third to 28 before touching bottom.

The Yellen Fed will be forced to back down in the end, just as the Bernanke Fed had to retreat after planning a return to normal policy at the end of QE1 and QE2.

For now the Fed is on the warpath, digesting figures showing US capacity use soaring to 80.1pc, and growth running at an 11-year high of 5pc in the third quarter.

 The Fed pivot comes as China’s Xi Jinping is trying to deflate his own country’s $25 trillion credit boom, early in his 10-year term and before it is too late. He does not need or want uber-growth. The Politburo will more or less keep its nerve as long as China continues to meet its target of 10m new jobs a year – easily achieved in 2014 – and job vacancies outstrip applicants.

Uncle Xi will ultimately blink, but traders betting on a quick return to credit stimulus may lose their shirts first. Worse yet, when he blinks, a tool of choice may be to drive down the yuan to fight Japan’s devaluation, and to counter beggar-thy-neighbour dynamics across East Asia. This would export yet more Chinese deflation to the rest of the world.

 At best we are entering a new financial order where there is no longer an automatic “Fed Put” or a “Politburo Put” to act as a safety net for asset markets. That may be healthy in many ways, but it may also be a painful discovery for some.

A sated China is as much to “blame” for the crash in oil prices as America’s shale industry. Together they have knouted Russia's Vladimir Putin. The bear market will short-circuit at Brent prices of $40, but not just because shale capitulates. Marginal producers in Canada, the North Sea, West Africa and the Arctic will share the punishment. The biggest loser will be Saudi Arabia, reaping the geostrategic whirlwind of its high stakes game, facing Iranian retaliation through the Shia of the Eastern Province where the oil lies, and Russian retaliation through the Houthis in Yemen.

 Mr Putin will achieve his objective of crippling Ukraine’s economy and freezing the conflict in the Donbass, but only by crippling Russia in the process. Controls will not stem capital flight. Mr Putin will have to choose been a dangerous loss of foreign reserves and a dangerous chain of corporate bankruptcies. He will continue to pawn Russia’s national interest to Beijing in order to save his Siloviki regime, but wiser heads in Moscow will question how a perpetual dispute with Europe and the revival of a dying NATO can possibly be in Russia’s interest. They will check his folly.

The European Central Bank cannot save the day for asset markets as the Fed pulls back: it does not print dollars, and dollars are what now matter. Nor is it constitutionally able to act with panache in any case. While Mario Draghi and the Latin bloc could theoretically impose full-fledged QE against German resistance, such Frechheit would sap German political consent for the EMU project. Mr Draghi will accept a bad compromise: low-octane QE that makes no macro-economic difference, but noisy enough to provoke a storm.

The eurozone will be in deflation by February, forlornly trying to ignite its damp wood by rubbing stones. Real interest rates will ratchet higher. The debt load will continue to rise at a faster pace than nominal GDP across Club Med. The region will sink deeper into a compound interest trap.

 The political triggers for the next spasm of the EMU crisis are complex, yet trouble must come since the North-South gap is as wide as ever in key respects, and the depression drags on. The detonator may of course be Greece. If Syriza rebels hold their poll lead into the snap-election this month, a cathartic showdown with Brussels will occur in short order.

The EU creditors may agree to debt forgiveness for Greece, but they might equally refuse to talk with a gun held to their heads. There is a 50/50 risk that they would instead switch off life-support and eject Greece, calculating that they now have the back-stop machinery to stop contagion. In this they would be wrong.

Breaking my normal rule of discussing equity prices let me say only that the S&P 500 index of Wall Street stocks will not defy monetary gravity or the feedback loops of global stress for much longer. Half the earnings of US big-cap companies come from overseas, repatriated into a stronger dollar, and therefore worth less in reporting terms.

 The index has risen at double-digit rates for three years, further inflated this year by companies buying back their own shares at a pace of $130bn a quarter, often with borrowed money. The profit share of GDP is at a post-war high of 12.5pc (much like 1929), an untenable level as US wages start to rise and the balance of power swings back to labour. The S&P index measuring the price-to-sales ratio is higher today than at its pre-Lehman peak.

Expect a shake-out of 20pc comparable to the LTCM crisis in 1998 when the wheels came off in Russia and East Asia, though don’t be shocked by worse. Emerging markets are a much bigger part of the world economy today, and their combined debt ratio is a record 175pc of GDP.

Once these hiccups are behind us, we can look forward to sunlit uplands as always. Happy New Year.