Juggling Dynamite

For some reason Bloomberg only posted a 2:23 minute clip of Komal Sri-Kumar’s appearance on Surveillance yesterday morning.  Here is a direct link to it.

However the preceding insightful discussion can be watched by advancing the play bar below to start at 1:32:37.

Bloomberg’s Tom Keene speaks with Komal Sri-Kumar, president at Sri-Kumar Global Strategies, on “Bloomberg Surveillance.”  Here is a direct video link to the full show, where you can advance the playbar to 1:32:37 to hear his worthwhile comments.

An estimated 75%+ of global market transactions are now driven by algo-wielding computers rather than humans. Moving at lightening speed, buy and sell orders trigger on data flow and headlines ‘fake’ and not.

The prevailing thesis held by many, is that market prices are always right, and markets driven by machines are smarter and more right than ever before.  And therein lie the seeds for great financial harm.

Contrary to popular assumptions, algorithms suffer from the same ‘garbage in garbage out‘ bias errors that plague their human creators.  Just as central bank members employ faulty models that never see financial bubbles or mean reversion cycles coming, most trading algos suffer from similarly selective assumptions.  See: Algorithms and bias, for a informative discussion:

In an algorithmic system, there are three main sources of bias that could lead to biased or discriminatory outcomes: input, training and programming. Input bias could occur when the source data itself is biased because it lacks certain types of information, is not representative or reflects historical biases.

Training bias could appear in either the categorization of the baseline data or the assessment of whether the output matches the desired result. Programming bias could occur in the original design or when a smart algorithm is allowed to learn and modify itself through successive contacts with human users, the assimilation of existing data, or the introduction of new data.

I recall having similar revelations as a young law student 27 years ago, when it became apparent that judges were humans and not the objective, fact weighing and law applying machines that our legal system assumed them to be.

All of this is relevant context to discussions like the one below on CNBC yesterday.  Note the host countering with the supposition that markets trading on headlines must be in the know.  Fascinating chapter in human history this.  Whatever the current preoccupation may be–gaming, gambling, speculation–it certainly does not belong under the seemingly rational heading of ‘investing’.  And there is the rub, because so many people have their life savings in this game not realizing the true nature of the activity and the horrendous odds they have taken on.

Francesco Filia, CIO of Fasanara Capital, told CNBC on Wednesday that financial markets had become “complacent” and “insensitive” to fundamental changes in the economy. Filia cited “Stein’s Law” as a fitting adage for the state of financial markets at present. Herbert Stein, chief economist to U.S. President Richard Nixon wrote: “If something cannot continue forever, it will stop.” Here is a direct video link.

Central bankers are out in force this week, talking up their growth and inflation expectations once more (that have been wildly optimistic and wrong for years now). In truth they all remain consumed with the same aspirational powers and self-delusion.

Yesterday US Fed Chair Yellen echoed obtuse observations from the Greenspan and Bernanke-led Feds over the past 20 years, saying to an audience in London:

“Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.”

For a well deserved criticism of Yellen’s comments see:  There is no excuse for Janet Yellen’s complacency from economist Steve Keen.

At the same time the Euro rallied the most in a year after ECB head Mario Draghi suggested persistent deflationary forces may be giving way in the Euro zone.  Hoping to relieve the resulting currency-carnage for European exporters, today ECB Vice President Vitor Constancio said that market reactions aren’t always understandable and Mr. Draghi didn’t say anything new in regards to ECB policy.

Next up, Bank of Canada’s Stephen Poloz boosted bets for a rate hike at the next July 12 meeting, by saying that Canadian policy rates are “extraordinarily low…It does look as though those cuts have done their job.”  The Loonie bounced sharply against the US dollar in response. As shown in this long-term view of the US dollar/CAD ratio since 2009 however, the Canadian dollar, while back to a 4-month high, is so far still within the channel of $US strength that has dominated since 2011 when commodity prices topped out.

But here’s the thing: West Texas Crude (WTIC) was in the $60 and $50 a barrel range when the BOC last cuts rates in January and July 2015. Today WTIC is less than $45 a barrel, global growth has slowed, a protectionist government has taken the White House, and the Canadian economy and households are more indebted and vulnerable to the inevitable and necessary downturn in exuberant realty markets than ever before.

Here’s the chart showing Canadian household debt (in red) versus average home prices (in black) and flat median incomes (at bottom).

No doubt, the BOC (like all zero-bound central bankers) would like to be at higher rates with more monetary torque staring into the next recession.  But the fact remains that the Canadian economy is less resilient in 2017 than it was in 2015.  Same for the much more indebted global economy, where the debt to GDP ratio has now risen to a record 327% from 276% in 2007.

Central banks orchestrated the present economic mess with years of near zero rates and asset flipping, by all means they should look to back out of their disastrous policies.  But pretending that won’t prompt mean reversion in asset markets and the economy, is cowardly nonsense.  The monetary piper must be paid.  Much better to be prepared, than taken by surprise.  But don’t expect bankers and politicians to see anything coming.