For the last nine years, central banks drove interest rates to nil and pumped money into the system creating favorable carries and abundant cash. These actions pushed up asset prices, drove nominal interest rates below nominal growth rates, pushed real interest rates on cash negative, and drove real bond yields down to near zero percent, which created beautiful deleveragings, brought about balance sheet repairs, and led to more conventional economic conditions in which credit growth and economic growth are growing in relatively good balance with debt growth. That era is ending.Ray Dalio and other elite hedge fund managers should thank global central bankers for effectively shifting massive private sector debt onto their balance sheet, allowing the best hedge funds to "keep dancing" and charging their clients huge fees as they skyrocketed up Forbes' list of the rich and famous.
Central bankers have clearly and understandably told us that henceforth those flows from their punch bowls will be tapered rather than increased—i.e., that the directions of policy are reversing so we are at a) the end of that nine-year era of continuous pressings down on interest rates and pushing out of money that created the liquidity-fueled moves in the economies and markets, and b) the beginning of the late-cycle phase of the business/short-term debt cycle, in which central bankers try to tighten at paces that are exactly right in order to keep growth and inflation neither too hot nor too cold, until they don’t get it right and we have our next downturn. Recognizing that, our responsibility now is to keep dancing but closer to the exit and with a sharp eye on the tea leaves.
Wonderful Monetary Policies
Generally speaking (depending on the country), it is appropriate for central banks to lessen the aggressiveness of their unconventional policies because these policies have successfully brought about beautiful deleveragings. In my opinion, at this point of transition, we should savor this accomplishment and thank the policy makers who fought to bring about these policies. They had to fight hard to do it and have been more maligned than appreciated. Let’s thank them.
As you know, looking ahead, we don’t project a big debt bubble bursting any time soon (because of the balance sheet repairs that have taken place), though we do see an increasingly intensifying “Big Squeeze” (see the Big Picture).
When I read books on inequality, and I have read many of them, I'm astounded at how very few academics have focused on the link between public pensions and elite hedge fund and private equity managers making off like bandits.
"But Leo, these elite managers have to perform and deliver to earns their 2&20 in fees." This is true for some but far too many of them are nothing more than glorified asset gatherers with beautiful marketing techniques which are consistently pooling the wool over their unsuspecting clients.
Let me blunt here. All these elite hedge fund managers are lucky they rode the big alpha wave at the right time in history because if they had to start all over again, there is no way they would have achieved a fraction of the success they have achieved in their lifetime.
Also, I have nothing against Ray Dalio, Ken Griffin, Izzy Englander, Paul Singer, Jim Simons, David Shaw, John Overdeck, David Siegel, Dan Loeb and many more top hedge fund managers, but I have no problem sitting in front of them to explain why they're part of the problem when it comes to underfunded pensions and the unfolding global pension crisis.
While Ray Dalio talks about the the Big Picture, I'm more worried about the Big Squeeze on public pensions at a time when the pension storm cometh.
As I have repeated many times, the global pension crisis is deflationary. So is unbridled inequality. Elite hedge fund managers can warn of inflation, because maybe they're praying for it to justify their outrageous fees, but the truth is we're entering a prolonged era of debt deflation and infinite QE from central bankers.
In my blog, I keep referring to six structural factors that lead me to believe we are headed for a prolonged period of debt deflation:
- The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
- Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
- The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
- Excessive private and public debt: Rising government debt levels and consumer debt levels are constraining public finances and consumer spending.
- Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
- Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create. read my comment on the Bezos and Buffett effect.
Ray Dalio is right, central banks did a great job after the crisis preventing another Great Depression, but I am afraid they are making a monumental mistake here, one that Dalio's friend Larry Summers knows all too well.
I have explained why I believe the Fed is making a mistake. Raising rates at a time when the US economy is clearly slowing (never mind Fridays' jobs report) is dangerous but I believe the Fed wants to raise rates to have ammunition to cut rates when the next crisis hits us in the not too distant future.
And it's not just the Fed. Central bankers all over the world are increasingly hawkish, much to my dismay, including here in Canada. Steve Poloz is dead set on raising rates and all I can say is keep shorting the loonie on any strength.
In fact, here are my global currency positions:
- Long the US dollar. Buy this weakness. The weakness in the US dollar is only temporary. As the US economy slows and everyone is talking about how great Europe is doing, pounce on the opportunity to load up on the greenback. Europe and Japan will also enter a significant slowdown over the near term and their currencies will bear the brunt of this slowdown.
- Short the CAD, Aussie, Kiwi and commodity-related currencies, including many emerging market currencies.
Even Jeffrey Gundlach is disappointing me, stating the bond wipeout is just beginning. Really Mr. Gundlach? My advice to institutional investors is the same as at the start of the year when some were warning it's the beginning of the end for bonds, namely, keep loading up on US long bonds (TLT) on any weakness. When the next crisis hits in the near future, you will thank me for saving your portfolio from being obliterated.
In short, I remain long US long bonds (TLT), the US dollar (UUP) and select US equity sectors like biotech (XBI) and technology (XLK) and I'm underweight/ short energy (XLE), materials (XME), industrials (XLI), financials (XLF) and emerging markets (EEM).
That's all from me because I can hear Ray Dalio screaming at his computer: "What's your track record?". Ray, it's getting better with each passing year and I can tell you my portfolio has been on fire with my barbell approach of Long Biotechs/ Long US long bonds to hedge for disaster risk.
On that note, let me end with a serious comment. Yesterday, I saw a great discussion on CNBC where a psychiatrist, Dr. Kenneth Davis of Mount Sinai Health System, explained what is ailing the US healthcare system. Listen carefully to what he says because this too is deflationary and bond friendly.