Tagged: Monetary Policy

Vinnie the Face

How do you know macroeconomists have a sense of humor?  They use decimal points.

While you ponder, it’s that time again when the Federal Reserve meets to wring its figurative hands over decimal points, VIX expirations hit as volatility explodes anew, and Brits consider telling Europe to pound sand.  Wait, that last part is new.

And by the way, what’s with these negative interest rates everywhere?

I’d prefer to tell you how computerized high-speed market-makers have made “the rapid and frequent amending or withdrawing of orders…an essential feature of a common earnings model known as market making,” according to Dutch regulators studying fast trading (that nugget courtesy of Sal Arnuk at Themis Trading). If you as a human do that, they throw you in jail for spoofing. If it’s a machine programmed by humans, all’s well.

We’ll instead talk macro factors today because they’re dominating. Negative interest rates, the Brexit, currencies, stocks, share a seamless narrative.

First, the Brexit looms like a hailstorm in Limon, Colorado, not because the UK and Europe are terminating trade. No, nerves are rattled because it represents a fracture in the “we’re all in this together” narrative underpinning global monetary policy. All that’s needed – infinitely – if everybody lives within their means are currencies that don’t lose value over time. There’s not a single one like that right now.

Suppose on your street some neighbors were prosperous and others deep in financial trouble, and block leaders built a coalition around a mantra: The only way for us all to prosper is if the neighbors with money give some to the neighbors without.

It altruistic. It’s also untrue.  That will ensure nobody prospers. The EU strategy has been to get countries like the UK to agree to principles that let wastrel nations offload their profligacy on responsible ones.  It doesn’t matter how one views it ideologically. What matters is the math and the math doesn’t work.

The UK is threatening to quit the block coalition on a belief that the best way to ensure that the UK prospers is to stop taking responsibility for others.

Negative interest rates tie to the EU strategy. Contrary to what you hear from droning economists and central bankers, low interest rates aren’t driven by low growth prospects. If growth prospects are low and therefore risky, capital costs should be high.  Low growth is a product of lost purchasing power, defined as “what your money buys.” If what your money buys diminishes, you’ll be buying less, which leads to low growth.

The reason money buys less is because governments are filching from their citizens by trading money for debt, and falling behind on their payments.

I’ll explain in simple terms.  If you miss a credit card payment, your creditor doesn’t receive money it’s owed. Driving interest rates to zero is tantamount to skipping payments because it reduces the amount owed.  Interest is money owed.

Suppose you told your credit card company, “I will pay you only 1% interest.” That would be nice but generally debtors don’t get to set the terms.

The world’s largest debtors are governments, and they do get to control the terms.  What’s more, they alone create money. Heard of the California Gold Rush, the Alaska Gold Rush?  Why none now?  Governments outlawed the use of gold as money. Gold is valuable, yes. But it’s not legal tender. So you can’t mine for legal tender anymore.

It’s a great gig if you can get it, spending all you want and borrowing and telling creditors what you’ll pay, and then whipping up a batch of cash to buy out your own debt.

Except even governments can’t just prestidigitate cash like a single item in a double-entry ledger. It used to be central banks offset created cash with things like gold.  Now, the entire global monetary system including the dollar, euro, UK pound, Japanese yen, Chinese yuan, etc., is backed by debt.

What does that mean?  To create money, central banks manufacture it and trade it for debt. Why? Because much of what is measured as growth today is really just rising prices. So if prices stop rising, growth stalls, and economies slip into recession and then governments have an even harder time funding bloated budgets.

More money chasing goods drives up prices. So central banks attempt to encourage spending and borrowing by creating money to buy the debts of their governments and now private companies too. The idea is to relieve banks and businesses of debts, thus enabling them to borrow and spend more, which, the thinking goes, will produce growth.

This cycle creates extreme demand for debt, which becomes so valuable that the interest rates on it turn negative.  What happens to ordinary people who borrow and spend beyond their means is the opposite. The cost of debt keeps rising until you’re paying Vinnie the Face the 20% weekly vig in an alley as he smacks a baseball bat in a hand.

So you see, it’s all related. The strangest part is that all financial crises are products of overspending.  Yet governments and central banks cannot manufacture money to save us from our largess unless we rack up debts they can buy with manufactured money.

It’s like an episode of CNBC’s American Greed in which people engage in bizarre and irrational behavior to perpetuate fraud. The world’s money is entirely dependent on more debt. It manifests for you and me in how little our money buys now.  That’s stealing as sure as someone reached in your wallet and took money out. I was just commiserating with a client about the cost of NIRI National.  Our money doesn’t go as far as it did.

What’s it mean for the equity market? It fills up with arbitragers, who see uncertainty as opportunity rather than threat.  They’re not trading fundamentals but fluctuations. They can sustain stocks for a while. But sooner or later Vinnie the Face shows up with a bat.

Stuck Throttle

Imagine you were driving and your throttle stuck.

Our market Sentiment gauge, the ModernIR 10-pt Behavioral Index (MIRBI) has manifested like a jammed accelerator, remaining above neutral (signaling gains) since Feb 19. At Apr 15 it was still 5.4, just over the 5.3 reading at Feb 19, which proceeded to top (Positive is overbought, roughly 7.0) four consecutive times without ever reverting to Neutral (5.0) or Negative (below 5.0). That’s unprecedented.

Speaking of stuck throttles, I first drove a John Deere tractor on the cattle ranch of my youth at age seven.  It was a one-cylinder 1930s model B that sounded like it was always about to blow up or stall. My dad let me drive it solo and I was chortling down our long driveway with the throttle set low and the clutch shoved forward.  I was approaching an irrigation ditch. I yanked at the clutch (on these old tractors, it’s a long lever, not a pedal). Nothing.  I shouted to my dad that I couldn’t budge it, looking wildly at the ditch.

“Turn the wheel!” he yelled.

Disaster averted. I felt sheepish for not thinking of it. But it illustrates the dilemma a stuck throttle (or a stiff clutch) presents.  No matter that sense of stolid progress, something with a mind of its own will run out of road.

Another time decades later I had driven myself from Cancun through the jungle of Quintana Roo west of Belize to a resort called the Explorean Kohunlich (awesome place). After two beautiful days, I hopped in the rental car and headed north.  I became gradually aware that the little Chrysler was bogging down. I mashed the throttle and yet the car wheezed and slogged. Then it died.

Took me two hours to hike back to Kohunlich.  “Mi coche expiró en la selva,” I explained in my ill-fitting Spanish. Your car died in the jungle? Yup. It all worked out to another day in paradise. Nothing lost.

Gained: Two contemporary lessons about the stock market.  Stocks should generally describe fundamentals. If they don’t, we’re all lacking “price discovery,” the jargoned term meaning a good understanding of valuations.  It’s as vital to companies as investors, else how do any of us know if shares are fairly valued?

No matter what some say, global economic fundamentals are like a wheezing car with the throttle mashed flat. In the US right now, economic growth projects below 1% for the current quarter, and inflation is over 2%, so consumers are losing purchasing power. And consumption is our engine (purchasing power is the key to growth).

Across the planet, from Europe to Asia to the emerging markets, debt-to-GDP ratios are up and economic growth is down.  So why has the market been a tromped throttle on an unprecedented positive run? Meaning resides in patterns and correlations. It’s the central lesson of data (which we study for a living).

And there is one.  Emerging-market central banks have sold foreign currency reserves at unprecedented rates (matching our Sentiment), and the US Federal Reserve has pushed hundreds of billions of dollars into bank reserves (by buying debt from them) in recent months.  And the dollar has fallen sharply off December highs. When other central banks sell dollars, it weakens our currency, and when our Fed buys assets from banks, it weakens our currency.  And when the dollar falls, stocks, commodities, and oil rise.

On one hand central banks have mashed the monetary accelerator to the floor and still everything is wheezing and coughing and slowing down.  It’s taken unprecedented effort to create this gaseous cloud.

But it’s on the other hand a two-by-four jammed on the equity market throttle, sticking it in Positive and disconnecting it from reality, and sending it screaming up the road out of control.  It’s entertaining, and good for our portfolio values, all of us, and it makes the pundits breathlessly rave about returns to all-time market highs.

But the throttle is stuck.  I’m reminded of a funny bit from a set of paraprosdokian sentences, witty combinations of unexpected or opposing ideas, sent to me by good friend Darwin:  “I want to die peacefully in my sleep like my grandfather. Not screaming and yelling like the passengers in his car.”

It’s better to have a market with its own throttle controlled by facts and fundamentals than one flattened by a bail of depreciating currency. Because we don’t want it dying in the jungle.

The Escalator

As the US investor-relations profession’s annual confabulation concludes in the Windy City, we wonder how the week will end.

The problem is risk. Or rather, the cost of transferring it to somebody else. Today the Federal Reserve’s Open Market Committee Meeting adjourns with Janet Yellen at the microphone offering views on what’s ahead. The Fed routinely misses the economic mark by 50%, meaning our central bank’s legions of number crunchers, colossal budget and balance sheet and twelve regional outposts supporting the globe’s reserve currency offer no more certainty about the future than a coin flip.  That adds risk.

The Fed sets interest rates – not by ordering banks to charge a certain amount for borrowing but through setting the cost at which the Fed itself lends to banks. Higher rates paradoxically present lower risk because money can generate a return by doing nothing.  Idle money now wastes away so it’s getting deployed in ways it wouldn’t otherwise.

If you’re about to heave this edition of the Market Structure Map in the digital dump, thinking, “There goes Quast again, yammering about monetary policy,” you need to know what happens to your stock when this behavior stops. And it will stop.

When the dollar increases in value, it buys more stuff. Things heretofore made larger in price by smaller dollars can reverse course, like earnings and stock-prices.  As the dollar puts downward pressure on share-prices, derivatives like options into which risk has been transferred become valuable. Options are then converted into shares, reversing pressure for a period. This becomes a pattern as investors profit on range-bound equities by trading in and out of derivatives.

Since Sept 2014 when we first warned of the Great Revaluation, the apex of a currency driven thunderhead in things like stocks and bonds, major US equity measures have not moved materially outside a range. Despite periodic bouts of extreme volatility around options-expirations, we’re locked in historic stasis, unmatched in modern times.

The reason is that investors have profited without actually buying or selling real assets. This week all the instruments underpinning leverage and risk-transfer expire, with VIX volatility expirations Wednesday as the Fed speaks. The lack of volatility itself has been an asset class to own like an insurance policy.

Thursday, index futures preferred by Europeans lapse. There’s been colossal volatility in continental stock and bond markets and counterparties will charge more to absorb that risk now, especially with a sharpening Greek crisis that edges nearer default at the end of June. Higher insurance costs put downward pressure on assets like stock-prices.

Then quad-witching arrives Friday when index and stock futures and options lapse along with swap contracts predicated on these derivatives, and the latter is hundreds of trillions of notional-value dollars. On top of all that, there are rebalances for S&P and Nasdaq indices, and the continued gradual rebalancing of the Russell indexes.

Expirations like these revisit us monthly, quad-witching quarterly. That’s not new. But investors have grown wary of trading in and out of derivatives. Falling volumes in equities and options point to rising attention on swaps – the way money transfers risk. We see it in a trend-reversal in the share of volume driven by active investment and risk-management. The latter has been leading the former by market-share for 200 days. Now it’s not. Money is trying to sell but struggling to find an exit.

Here at the Chicago Hyatt Regency on Wacker Drive, when a NIRI General Session ends, the escalators clog with masses of IROs and vendors exiting. Index-investing, a uniform behavior, dominates markets and there is clogged-escalator risk in equities.

It may be nothing.  Money changes directions today with staccato variability. But our job as ever is to watch the data and tell you what we see.  We’ve long been skeptics of the structure wrought by uniform rules, and this is why.  It’s fine so long as the escalator is going up.  When the ride ends, it won’t impact all stocks the same way, however, because leverage through indexes, ETFs and derivatives – the power of the crowd – has not been applied evenly.

This year’s annual lesson then is no new one but a big one nonetheless. Investor-relations professionals must beware more than at any other time of the monumental uniformity-risk in markets now, wrought not by story but macroeconomics and structure.

So, we’re watching the escalator.

Market Facts

Volatility derivatives expire today as the Federal Reserve gives monetary guidance. How would you like to be in those shoes? Oh but if you’ve chosen investor-relations as your profession, you’re in them.

Management wants to know why holders are selling when oil – or pick your reason – has no bearing on your shares. Institutional money managers are wary about risking clients’ money in turbulently sliding markets, which condition will subside when institutional investors risk clients’ money. This fulcrum is an inescapable IR fact.

We warned clients Nov 3 that markets had statistically topped and a retreat likely would follow between one and 30 days out. Stocks closed yesterday well off early-Nov levels and the S&P 500 is down 100 points from post-Thanksgiving all-time highs.

The point isn’t being right but how money behaves today. Take oil. The energy boom in the USA has fostered jobs and opportunity, contributing to some capacity in the American economy to separate from sluggish counterparts in Asia and Europe. Yet with oil prices imploding on a sharply higher dollar (bucks price oil, not vice versa), a boon for consumers at the pump becomes a bust for capital investment, and the latter is a key driver in parts of the US that have led job-creation.

Back to the Fed, the US central bank by both its own admission and data compiled at the Mortgage Bankers Association (see this MBA white paper if you’re interested) has consumed most new mortgages coming on the market in recent years, buying them from Fannie Mae and Freddie Mac and primary dealers.

Why? Consumption drives US Gross Domestic Product (GDP), and vital to recovery in still-anemic discretionary spending is stronger home prices, which boost personal balance sheets, instilling confidence and fueling borrowing and spending.

Imagine the consternation behind the big stone walls on Maiden Lane in New York. The Fed has now stopped minting money to buy mortgages (it’ll churn some of the $1.7 trillion of mortgage-backed securities it owns, and hold some). With global asset markets of all kinds in turmoil, especially stocks and commodities, other investors may be reluctant successors to Fed demand. Should mortgages and home-values falter in step with stocks, mortgage rates could spike.

What a conundrum. If the Fed fails to offer 2015 guidance on interest rates and mortgage costs jump, markets will conclude the Fed has lost control. Yet if a fearful Fed meets snowballing pressure on equities and commodities by prolonging low rates, real estate could stall, collapsing the very market supporting better discretionary spending.

Now look around the globe at crashing equity prices, soaring bonds, imploding commodities, vast currency volatility (all of it reminiscent of latter 2008), and guess what?  Derivatives expire Dec 17-19, concluding with quad-witching. Derivatives notional-value in the hundreds of trillions outstrips all else, and nervous counterparties and their twitchy investors will be hoping to find footing.

If you’ve ever seen the movie Princess Bride (not our first Market Structure Map nod to it), what you’re reading seems like a game of wits with a Sicilian – which is on par with the futility of a land war in Asia. Yet, all these things matter to you there in the IR chair, because you must know your audience.  It’s comprised of investors with responsibility to safeguard clients’ assets. (more…)

CYNK Me

Movie tip:  Karen and I took our visiting teenaged nephew to see Edge of Tomorrow, starring Tom Cruise. Hysterically entertaining. Appropriate for teens (scary monsters but no gore), and gripping for adults!

There was a 1982 movie called The Scarlet Pimpernel (from the 1905 novel by Baroness Emma Orczy) in which the dashing protagonist Percival Blakeney (played by Anthony Andrews in the film) goes around saying, “Sink me!” with a lilting accent. Great movie.

I thought of it when this week’s theme came to us through alert reader Emily Walt at Carbonite, who first gave us a salacious peek at a firm burning up the pink sheets:  CYNK Technology (OTCMKTS:CYNK).

Most of you may now know that CYNK rose from nothing to $6 billion between June 17 and July 10, a return of 20,000%. Last Friday the SEC abruptly halted trading, with market cap still at $4 billion.

The pink sheets or the grey market, or what used to be called the OTC market, should not be confused with “over the counter,” which often refers to shares on the Nasdaq or securities trading between brokers. This is the market where standards are loose and risk is high.

CYNK Technology is run by a guy in Belize. This one fellow is listed as CEO, President, CFO, Board Secretary and the only director. SEC documents suggest the company has no revenues and no real business plan and few if any assets.

But something got folks going and it seems the germinating seed was the suggestion that the company’s website offers introductions to celebrities for a fee.  It aims, we gather, to be the social networking site where common everyday dweebs and goofballs can meet Johnny Depp and Angelina Jolie. (more…)

The Short Fed Story

Is the Federal Reserve fueling stock-market gains?

When St. Louis Fed president James Bullard addressed the Bowling Green, KY, Chamber of Commerce in February 2011, he pinpointed correlation between Ben Bernanke’s September 2010 Jackson Hole speech on “QE2,” the Fed’s second easy-money program, and the stock-market rebound that followed. Classical effects of monetary easing include rising equity prices, Mr. Bullard said.

The Fed wanted market appreciation because people feel better when the stuff they own seems more valuable. But I think we’re having the wrong debate. The question isn’t if Fed intervention increases stock prices, but this: Can prices set by middle men last?

Before actor Daniel Craig became the new James Bond he starred in a caper flick called Layer Cake that posited a rubric: The art of the deal is being a good middle man. The Fed is the ultimate global middle man. Since the dollar is the world’s reserve currency, the Fed as night manager of the cost and availability of dollars can affect everybody’s money. After all, save where barter still prevails, doing business involves money. Variability in its value is the fulcrum for the great planetary teeter-totter of commerce. The risk for the Fed is distorting global values with borrowing and intermediation.

In the stock market, we’re told it’s been a terrible year for “the shorts” – speculators who borrow shares and sell them on hopes of covering at a lower future price. The common measure is short interest, a twice-monthly metric denoting stocks borrowed, sold, and not yet covered. Historically, that’s about 5% of shares comprising the S&P 500. (more…)

You Never Know

An ode to erudition in professional sports, these pearls of wisdom overheard on sidelines come thanks to ESPN’s halftime report during the unfortunate demise of our Denver Broncos in Monday Night Football:

“If you hadn’ta been where you was, and did what you did, we wouldn’ta got what we got.”

“You can sum it up in one word: You never know.”

“You never know” is a good way to describe markets. And reason why market-structure analytics are essential to IR. Paul Rowady at TABB Group, the top market-structure authority today, wrote extraordinary commentary at TABB Forum yesterday saying monetary intervention by central banks poisons market data.

What’s the real price of your stock? As you ponder, Rowady says, “At any moment in time, one could argue that there simply cannot be true price discovery in any market where intervention occurs – which is most of them.”

Why? Because central banks, unlike the rest of us participants, can use unlimited money and unrestrained access to information – the Federal Reserve is not bound by “insider trading” constraints like you – to affect prices of every asset, every commodity, every currency. (more…)

NIRI Seattle-Style

If you like your NIRI National Conference crisp, Seattle delivers.

Gray days in the 50s gave those from the south a welcome break from drenching June humidity. Yesterday morning, the sun at last teased us as we savored our westward view of Puget Sound one more time from the Grand Hyatt before winging east to Denver.

One thing stood out this year to me. By my ground-floor observation walking and talking, paneling, chatting with clients and friends, Market Structure finally moved off the back row at NIRI.

It was like the markets yesterday roaring back nearly 300 points. People are starting to grasp that things like that aren’t fundamental. The Eurogloom didn’t miraculously give way to golden shafts of heavenly light. Spain and Italy didn’t wake suddenly to healed capital access. Economic readings weren’t swept skyward overnight on the economic equivalent of a giant stalk from a magical bean. Nothing changed.

So why did markets jump? Because policy makers said so. Federal Reserve officials were talking the dollar down in force – something we noted in your Market Structure Report macro sections, clients. And European officials huddled over strongly worded statements about the exigency of remedies.

Markets reacted like oil prices anticipating surging OPEC output. Ben Bernanke observed in a 2002 speech before he was Fed chairman that the act of credibly threatening an increase to the supply of money can have the same effect as if the supply has actually grown. He likened it to rumors of an alchemist claiming a way to conjure unlimited supplies of gold – and what the mere rumor would do to gold prices.

We saw this Emperor’s Clothes effect in sentiment. Last week sentiment was neutral, investment weak, the dollar marching relentlessly up. But right away Monday the dollar weakened, program trading picked up, and the occasional positive sentiment peeked out from data apathy. We’ve been telling clients since then in the “What’s Ahead” section of trading summaries to expect temporary improvement (that’s what it is).

In effect, we have the same thing in our equity market. Markets don’t behave the way most think they do – or how they should – and we’ve thus far been bystanders. A NIRI board member who stopped by our booth to gauge our views of the show said, “Market Structure has got to get higher priority. People are talking about it. It’s going to move up on the radar screen.”

Why is it so critical? Because lots of CEOs and CFOs don’t know how markets work. And when they ask us how they work, we IR pros often don’t know either, right?

If IROs don’t shoulder the educational challenge of crafting a clear picture, who will? Nobody. And if nobody does, our job security declines just like our ranks, which have thinned by an average of 270 companies each year for the past 14 years (no typo). That means we’ve lost a minimum of 3,780 IRO roles since 1998.

One grand bright spot on getting that clear picture shone during the panel on which I sat (if you’re a NIRI member, downloadslides or listen to a replay). Panelist David Weild, head of capital markets for Grant Thornton and chairman and CEO of the Capital Markets Advisory Group, proposed an Issuer’s Bill of Rights. Would you favor these five things? Would your executives?

1. Equal Standing for Public Companies. Issuers must have equal input to the trade execution community on market structure.

2. Representation. A standing issuer advisory council to the SEC made up of issuers and issuer advocates.

3. Transparency. Timeliness and completeness in trading and ownership data.

4. Choice in Market Structure. An end to the one-size-fits-all marketplace.

5. Centrality of Investment. A market structure that encourages fundamental investment strategies over trading tactics.

A client and good friend came up as we were dismantling the booth and said, “If we’re serious about this Bill of Rights, I’m willing to burn some political capital on it. We need to get organized.”

If these five rights make sense to you, kick them around with your CFO and CEO – and tell NIRI. Change rarely occurs from the top down, but from the bottom up.

Maybe we can at last rally as an industry and save ourselves. Seattle gave us hope.

Arbitragers Love Monetary Intervention

Say you were playing poker.

I don’t mean gambling, but real cards. You’re engaged with some seriousness. You’re watching how you bet and when, reading the players ahead and after you.

Then The House starts doling out stacks of chips. Would you play more or less cautiously if you had free chips?

Apply this thinking to equity markets, IR folks. In trading data, we saw European money sweeping into US equities Nov 28. Why did markets trembling Nov 25 decide by the following Monday to up the ante in risk-taking? Primary dealers implementing policy for global central banks also drive most program-trading strategies.

Thus, European money surmised that central banks would intervene, and their behavior reflected it. The rest caught on, and markets soared Nov 30 on free chips from central banks. It was short-lived. By Dec 2, we saw institutions market-wide assaying portfolio risk and locking in higher derivatives insurance. The chips were gone.

Money sat back expectantly. On Dec 8, The House delivered chips as the European Central Bank lowered interest rates. That’s devaluing the euro. At first, cheapening the euro increases the value of the dollar – which lowers US stocks (a la Dec 8). But if you’d hedged with derivatives as most of the globe did, you bluffed The House. Plus, the Fed will likely have to follow Europe’s bet up with a see-and-raise to devalue the dollar back into line with the euro (expect it next week, but before options expirations).

In poker, having “the nuts” is holding the best cards, and knowing it. Central banks have given arbitragers the nuts. (more…)

The lawyers doing the writing at the SEC are good. The 104-page novella the Commission released last week with the Commodity Futures Trading Commission gallops readers spritely to an inconclusive denouement.

No offense intended. For anybody versed in trading markets, the report is logical and easy to follow. We agree with the description of underlying trading activity, even so far as the report’s conclusion that real buyers and sellers are about 10% of the market. There are charts that look somewhat like our models of market structure, illustrating trading share by market center (we do it by behavior). (more…)