Juggling Dynamite

All the breathless reports on the “Fed watch” today remind me of how nonsensical thoughts are not only a waste of time and energy they are net negative as they hold us back from getting on to productive steps and meaningful solutions.  I am reminded of one of my favourite John Galbraith quotes: 

” It is far easier to be firmly anchored in the sea of nonsense than it is to set out on the sea of meaningful thought.”

(I miss JKG who passed in 2006, no one could cut to the meat of the matter faster.)

My friend Barry Ritholtz offers this excellent summary this morning on the prospects of more Fed magic: Pushing on a String, to wit:

Rather than repeat the usual blah blah blah, I thought I might raise a few points that might otherwise be overlooked:

1. Zero: With Fed rates pressing at the zero boundary, there is only so much ANY central bank can do to help the economy.

2. Not the usual cyclical recession: The Credit Crisis creates a specific recession recovery cycle. It is markedly different than a regular recession, and characterized by consumer de-leveraging. Hence, low rates are ineffectual to stimulating growth.

3. Fiscal vs Monetary: Problems with unemployment and weak growth will eventually be repaired via the elapsing of time. The alternative is concerted, targeted, intelligent stimulative action from Congress and the White House, unlikely to occur due to ideological rigidity, partisan posturing, and lack of economic intelligence in DC.

4. Wealth Effect: Is widely misinterpreted by economists, including those at the Fed. (It is more correlation than causation). Hence, the Fed’s focus on asset prices such as equities is utterly misguided, and doomed to disappointment (as we have already seen).

5. Liquidity vs Solvency: Central banks can provide a gusher of liquidity to prevent the financial system from seizing. They cannot make insolvent banks whole; they cannot turn debtor nations into creditors; they cannot spin dross into gold.

6. Bailouts: Do not resolve the underlying problems, they merely paper them over. Hence, the 2008 rescue plan, now 3 years old, is fading, once again revealing the underlying problem with a finance sector that still has too much debt, too little capital.

7. FOMC Transparency = Central Bank Failure. The Fed’s moves to be more transparent is an admission that their prior policies have failed to gain the traction they hoped. Interest Rates are totally transparent, the time period they will stay where they are has been unequivocally stated. More jawboning is not a solution.

In the midst of the 2007-2009 bear market there was a naive phase where bulls were optimistically chattering about Chinese Wealth Funds riding to the rescue to scoop up over-valued assets and prevent prices from declining further. We know how that panned out. Lately we have heard many of the same misguided comments about how China will backstop the Euro zone and stop the forces of gravity from knocking bubbly prices back down to earth. As I have said throughout, there is not enough money on planet earth to stop the natural correcting forces of a recession and cyclical bear market once it gets underway.

Jim Chanos, founder of Kynikos Associates Ltd. hedge fund, at the Clinton Global Initiative in New York yesterday, debunks many of the China miracle myths, discussing China’s economy, debt and real estate market, “their property market is hitting the wall now.”

“If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%. Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero.”

All important food for thought for stock and commodity bulls today. He also makes some important points on the belief in further bailout hopes for Europe.

Watch his video interview here.

Surprise find. Today I was looking for an old article on my hard drive and found a long-lost copy of the second segment of a two-part interview I did with Jon Chevreau of the Post on February 6, 2008. The first segment was uploaded to YouTube long ago and many viewers have asked me since for the second part. At that time, we were not able to upload segment 2 to YouTube as it was over 10 minutes in length and the Post somehow lost part 2 of the video from their website.

I did not think we had retained a copy until I found it in an unlikely file today. In any event, here it is at long last.

As I watch today, I am struck by a few things. At that time I was being labelled a bear and a pessimist because I was warning that asset prices were over-valued and at risk of the next big cyclical decline in the secular bear that began in 2000 and that in that environment, stock prices had the potential to retest the 2002 cycle lows. Most financial folks scoffed that this was ridiculous. We are no clairvoyants. But because we are humble market historians and disciplined risk-measurement takers at our firm, we were able to get a top down view of probable outcomes. In doing so one can take proactive steps to protect capital before the carnage.

When Jon says that the decline of then 20% on the S&P was already big and surely P/E’s of “14” were attractive and a buying opportunity, I said that the problem with that argument was that the “E” or expected earnings of the “P/E” quoted were overly optimistic and likely to decline further which would expose stock prices as still being too rich. This is precisely my concern again today.

Mostly I am struck today by how my comments in February 2008 (the S&P went on to lose another 30% and the TSX another 35% before they bottomed 13 months later) are very applicable to our concerns about the downside risks from where we are today in September 2011. Time will tell…