Saturday, March 2, 2013

What happens when the music stops?

Bernanke keeps printing and pumping while some investors start panicking. Andy Kessler is one such investor and wrote in the Wall Street Journal:


" The experiment to kick-start the economy with near-zero interest rates has failed. Maybe our central bankers have figured out that low rates are what is holding back lending and hiring and growth.

Meanwhile, even as the stock market hits highs not seen since 2007, everyone on Wall Street knows interest rates will go up—although no one except Mr. Bernanke knows when. Investors are playing a game of chicken with rates, enjoying the ride but bracing for a downturn when the rates turn up. When rates go up, bonds become more attractive than stocks because you get returns with less risk.

Those of us on Wall Street in 1994 witnessed something very similar. After several years of essentially flat short-term rates, the Fed raised rates by 25 basis points (or 0.25%) on Feb. 4, 1994. The Fed raised short-term rates a total of six times and 2.5% over the next 10 months.

In what became known as a bond-market massacre, the price of long bonds dropped almost 9%. The stock market dropped 9% in three months, killing a then-vibrant market for initial public offerings.

Today we are at the bitter end of a three-decade-long interest rate cycle, culminating in Mr. Bernanke's near-zero rates. You can't fall off the floor. And the prospect of higher interest rates is like the Sword of Damocles hanging over the stock market.

On May 13, 1981, the three-month Treasury bill rate was 17.01% and the Dow Industrials were just under 1000. Today, three-month rates are under 0.12% and the Dow is headed south from 14000. What should interest rates be? In January, the Consumer Price Index rose 1.6% year over year. In a normal economy with a normal Fed, short rates should be 2%-3%.

Investors beware: The unwind is going to be bumpy. The entire U.S. bond market is over $30 trillion. Any sudden increase in interest rates means current holdings would be worth less and might create turmoil from runs or even "breaking the buck" at money-market funds. Gold is already down over 15% from last year's October peak, anticipating this Fed move.

All along, Mr. Bernanke's intent was to allow banks to recapitalize despite all the toxic mortgage debt that he and Treasury Secretary Timothy Geithner left on their balance sheets, so we've lived with almost four years of sub-0.2% interest rates. The results of the latest bank stress tests are due out on March 7, but 15 of the 19 largest banks (Citigroup C +0.34% the glaring exception) passed the last one. The justification for low interest rates is no longer to save banks, but instead to goose the stock market as an indirect way to create jobs.

Mr. Bernanke told CNBC last year that, "Our policies have contributed to a stronger stock market just as they did in March 2009 when we did the first iteration of this program." No kidding. But as a policy tool, low interest rates are like using gasoline to light your charcoal grill. You may singe your eyebrows, but it will certainly light the coals. The question is will the coals stay lit when the gasoline burns off.

When rates rise, the bond market will sell off, but foreign investors seeking a safe haven from their messes may continue to pile in and limit the damage, especially if incoming Treasury Secretary Jack Lew implements rather than jawbones a strong dollar policy.

The stock market is another thing. Every day this trading venue captures collective expectations in prices—expectations of corporate profits and interest rates and risk. Stocks are nothing more than all the future earnings of a company discounted back to today. The discount rate is a combination of prevailing interest rates plus some factor of risk.

But there is no risk or discount number published anywhere. It's touchy-feely. Expectations change daily. That is why stocks are said to climb a wall of worry. When no one is worried, you run out of buyers and markets top. When everyone thought Apple's share price was going to hit $1,000, and every hedge fund owned it, of course it sold off as all that good sentiment was in the stock.

But there is one real market absolute: interest rates. Right now, mutual- and hedge-fund managers are scrambling their brains trying to figure out when rates will rise, trying to outguess the Fed, other investors and probably themselves. The economy dropped a tenth of a point last quarter, Spain and Portugal are still a mess, only 157,000 jobs were created in the U.S. in January, tax rates are popping and corporate earnings may grow only 1%-2% this year.

But if and as these worries ease, the Fed's Sword of Damocles will swing. The stock market is not going to like it one bit. But why should the Fed care? Banks are recapitalized and the charcoals are lit. Our central bankers should be agnostic to stock prices anyway. This doesn't mean the stock market is going to crash, though dropping 1,000 points in a few weeks would not be surprising.

There is a possibility that Mr. Bernanke will thread the needle and manage to gradually raise rates, grow the economy and keep the stock-market rally intact. Investors should be rooting for him. The Fed, when it does move, is going to be slow and steady. Dallas Fed President Richard Fisher told Bloomberg radio recently, "I don't want to go from wild turkey to cold turkey."

Rising rates are OK as long as corporate profits and the dollar are rising faster, especially if declining energy and food prices provide a boost. If I were Mr. Bernanke, I wouldn't wait. Tomorrow morning I'd start raising rates as a signal to all that the economy is on sound footing.

Announce loud and clear that you are going to raise the federal-funds rate 10 basis points (or 0.1%) every month, like clockwork, until it exceeds the inflation rate, and then declare victory. The stock market might even rally on the certainty and return to normalcy.

Rising rates are inevitable. But be advised that in selloffs, stocks fall into the valley of despair. The 1995-2000 bull run followed the bond-market massacre."

6 comments:

Anonymous said...

The health of our political system is what worries the rating agencies about US paper. The Fed, having bought up most of it, has the same concern. The trigger of a bond massacre will be our political leadership tripping up our economy with their games and juvenile statesmanship. Half of the business plans are waiting on federal budgets and taxation policy.

Anonymous said...

Devaluation is next. Followed by severe shortages. Then anarchy. The die is cast.

Anonymous said...

And what happens when TBond rates on $17 trillion go up to 6-7%......

We are doomed.

Anonymous said...

World growth has slowed and the demand for credit is not that significant now. China is at 6-7% growth. Japan has been financing their debt internally like the USA has been of late. Europe and the US are not growing and de-leveraging- so world money should available for everyone without rates rising. Austerity is not sexy and paying off one's debts doesn't generate jobs or economic excitement. Fiscal matters in the USA must be settled for any world optimism or growth to occur.

Anonymous said...

They can't stop printing, they are the only big player left buying US debt. When the Fed loses control and interest rates spike, the jig is up.

Physical precious metals, farmland, guns and good neighbors are going to be important in the future.

meople said...

Once again I am gonna play to the audience on this blog - "a true leader will do what is right by refusing entitled treatment when he knows that treatment is morally wrong". I. Cede Thatt. The 28th ammendment clearly states that most of the sh*t they do in Washington now is clearly illigal. I want the polititions who read this to question their dedication to their voters. The loyalty intrusted in you comes from the lowly people who you either trample upon or let get trampled by a government who is telling them that they know what's best for the voter is not best for the kings, senators, or representatives.

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Trollfest '09

Trollfest '07 was such a success that Jackson Jambalaya will once again host Trollfest '09. Catch this great event which will leave NE Jackson & Fondren in flames. Othor Cain and his band, The Black Power Structure headline the night while Sonjay Poontang returns for an encore performance. Former Frank Melton bodyguard Marcus Wright makes his premier appearance at Trollfest singing "I'm a Sweet Transvestite" from "The Rocky Horror Picture Show." Kamikaze will sing his new hit, “How I sold out to da Man.” Robbie Bell again performs: “Mamas, don't let your babies grow up to be Bells” and “Any friend of Ed Peters is a friend of mine”. After the show, Ms. Bell will autograph copies of her mug shot photos. In a salute to “Dancing with the Stars”, Ms. Bell and Hinds County District Attorney Robert Smith will dance the Wango Tango.

Wrestling returns, except this time it will be a Battle Royal with Othor Cain, Ben Allen, Kim Wade, Haley Fisackerly, Alan Lange, and “Big Cat” Donna Ladd all in the ring at the same time. The Battle Royal will be in a steel cage, no time limit, no referee, and the losers must leave town. Marshand Crisler will be the honorary referee (as it gives him a title without actually having to do anything).


Meet KIM Waaaaaade at the Entergy Tent. For five pesos, Kim will sell you a chance to win a deed to a crack house on Ridgeway Street stuffed in the Howard Industries pinata. Don't worry if the pinata is beaten to shreds, as Mr. Wade has Jose, Emmanuel, and Carlos, all illegal immigrants, available as replacements for the it. Upon leaving the Entergy tent, fig leaves will be available in case Entergy literally takes everything you have as part of its Trollfest ticket price adjustment charge.

Donna Ladd of The Jackson Free Press will give several classes on learning how to write. Smearing, writing without factchecking, and reporting only one side of a story will be covered. A donation to pay their taxes will be accepted and she will be signing copies of their former federal tax liens. Ms. Ladd will give a dramatic reading of her two award-winning essays (They received The Jackson Free Press "Best Of" awards.) "Why everything is always about me" and "Why I cover murders better than anyone else in Jackson".

In the spirit of helping those who are less fortunate, Trollfest '09 adopts a cause for which a portion of the proceeds and donations will be donated: Keeping Frank Melton in his home. The “Keep Frank Melton From Being Homeless” booth will sell chances for five dollars to pin the tail on the jackass. John Reeves has graciously volunteered to be the jackass for this honorable excursion into saving Frank's ass. What's an ass between two friends after all? If Mr. Reeves is unable to um, perform, Speaker Billy McCoy has also volunteered as when the word “jackass” was mentioned he immediately ran as fast as he could to sign up.


In order to help clean up the legal profession, Adam Kilgore of the Mississippi Bar will be giving away free, round-trip plane tickets to the North Pole where they keep their bar complaint forms (which are NOT available online). If you don't want to go to the North Pole, you can enjoy Brant Brantley's (of the Mississippi Commission on Judicial Performance) free guided tours of the quicksand field over by High Street where all complaints against judges disappear. If for some reason you are unable to control yourself, never fear; Judge Houston Patton will operate his jail where no lawyers are needed or allowed as you just sit there for minutes... hours.... months...years until he decides he is tired of you sitting in his jail. Do not think Judge Patton is a bad judge however as he plans to serve free Mad Dog 20/20 to all inmates.

Trollfest '09 is a pet-friendly event as well. Feel free to bring your dog with you and do not worry if your pet gets hungry, as employees of the Jackson Zoo will be on hand to provide some of their animals as food when it gets to be feeding time for your little loved one.

Relax at the Fox News Tent. Since there are only three blonde reporters in Jackson (being blonde is a requirement for working at Fox News), Megan and Kathryn from WAPT and Wendy from WLBT will be on loan to Fox. To gain admittance to the VIP section, bring either your Republican Party ID card or a Rebel Flag. Bringing both and a torn-up Obama yard sign will entitle you to free drinks served by Megan, Wendy, and Kathryn. Get your tickets now. Since this is an event for trolls, no ID is required. Just bring the hate. Bring the family, Trollfest '09 is for EVERYONE!!!

This is definitely a Beaver production.


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Trollfest '07

Jackson Jambalaya is the home of Trollfest '07. Catch this great event which promises to leave NE Jackson & Fondren in flames. Sonjay Poontang and his band headline the night with a special steel cage, no time limit "loser must leave town" bout between Alan Lange and "Big Cat"Donna Ladd following afterwards. Kamikaze will perform his new song F*** Bush, he's still a _____. Did I mention there was no referee? Dr. Heddy Matthias and Lori Gregory will face off in the undercard dueling with dangling participles and other um, devices. Robbie Bell will perform Her two latest songs: My Best Friends are in the Media and Mama's, Don't Let Your Babies Grow up to be George Bell. Sid Salter of The Clarion-Ledger will host "Pin the Tail on the Trial Lawyer", sponsored by State Farm.

There will be a hugging booth where in exchange for your young son, Frank Melton will give you a loooong hug. Trollfest will have a dunking booth where Muhammed the terrorist will curse you to Allah as you try to hit a target that will drop him into a vat of pig grease. However, in the true spirit of Separate But Equal, Don Imus and someone from NE Jackson will also sit in the dunking booth for an equal amount of time. Tom Head will give a reading for two hours on why he can't figure out who the hell he is. Cliff Cargill will give lessons with his .80 caliber desert eagle, using Frank Melton photos as targets. Tackleberry will be on hand for an autograph session. KIM Waaaaaade will be passing out free titles and deeds to crackhouses formerly owned by The Wood Street Players.

If you get tired come relax at the Fox News Tent. To gain admittance to the VIP section, bring either your Republican Party ID card or a Rebel Flag. Bringing both will entitle you to free drinks.Get your tickets now. Since this is an event for trolls, no ID is required, just bring the hate. Bring the family, Trollfest '07 is for EVERYONE!!!

This is definitely a Beaver production.

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