Wednesday, October 6, 2010

Economic Outlook Remains Unclear

I wanted to discuss a series of videos that I had a chance to watch today that featured Kyle Bass, of Hayman Capital, and Alan Fournier, of Pennant Capital Management.

Both of these hedge fund managers called the 2008 credit crisis and are very smart cookies.   I believe Kyle Bass made a 600% return by shorting tranches of mortgage debt.

Take a close look below because there is some incredibly good insights by two extremely bright people about where we are headed economically.

I will have a few comments at the end:

Part 1

Part 2

Part 3

My Take:

As you can see above, even the smartest guys in the room don't have a good grasp as to where we head from here.

Alan was the first to admit that he is very "hedged".  This is a nice way of saying I'm really not sure.  You can see why the stock volumes are so anemic on Wall St when you listen to these two guys.

I thought Kyle's take on the markets were very interesting and he made a great point about Zimbabwe's stock market which has the best performing market in the world over the last 10 years.

What you have to ask yourself is are you really getting anywhere on a relative basis when the market goes up if the currency it is priced in keeps dropping.

The answer of course is no.  This goes for any other assets priced in dollars as well.  

A great example of this is seen here when you look at what gold has done in the US versus Europe as our currency continues to drop versus the Euro:

As you can see above, the fall of the dollar has decreased our purchasing power.  The cost of gold keeps rising in US dollars.  We are seeing the opposite effect across the pond as their currency strengthens.

You could look at a chart of any commodity and I sure it would look the same.  Oil soared once again today.

The Bottom Line

The debasing of our currency is having a dramatically negative effect on our relative wealth versus the world. 

If the Fed continues down this path of destroying the dollar then it will eventually bring down our standard of living because everything that's needed in order to survive rises in price. 

As a result of this insanity, many people will be forced to live without many luxuries in this new world.  Others may not be able to afford to live at all.

This is where the risk of social chaos kicks in.  If a guy can't afford to feed his family he will take from someone who CAN in order to survive. 

The recent surge in equities was explained nicely above.  Fund managers are once again using old outdated financial models that are telling them to buy stocks.

Stocks are "supposed" to be a buy when the yields on stocks are higher than treasury yields.  The problem is treasury yields are now close to zero. 

Usually, corporate yields rise after stocks get pummeled in order to attract buyers.

The problem today is we haven't seen the sell off in stocks that usually triggers this "rising corporate yield" phenomenon which is usually is a signal to buy equities.  

In other words:  Treasury yields have dropped instead of stocks.  This has triggered a false buying signal.

Corporate yields are basically the same because the market is holding up rather well. 

IMO, as a result, I think the market has it wrong. 

As I said yesterday, once oil gets over $100 a barrel the economy is going to be stopped dead in it's tracks.  This will then hit earnings and we'll head right back down the crapper again just like we were in 2008 when the last commodity bubble hit.

The difference from 2008's bubble in commodities and today is the 2010 commodity bubble is a direct result of the Fed's reckless zero interest rate/cheap dollar policies.  The 2008 bubble was fueled more by speculators as commodities turned into a Wall St. feeding frenzy.

The Fed is going to have a real tough decision to make in the near future.  The way I see it they have two choices: 

Risk hyperinflation and push the QEII button which then destroys our currency in a last ditch effort to stimulate the economy(which won't work).


Stop the QEII/bailouts and save the currency as they let the credit bubble burst which then triggers a deflationary collapse.

Tough choice.  Glad my last name isn't Bernanke


getyourselfconnected said...

What I cannot figure out is how the dollar can swing from 72 to 85 on the index in a year or so, that is wild! The Euro as well has moved monster in a year. I would have expected some huge blowups in the forex markets but it is not so. Maybe all I think I know is just plain wrong.

Jeff said...


Yeah me too.

I think even the FX guys are playing small ball right now.

No one is really sure how this thing is going to unravel so they are sitting on their hands for the most part.

I don't think anyone is too confident as to where we head from here.

James B said...

I'm willing to bet it will all just hold itself together until after the election.

The conspiracy theorist in me believes that it's no coincidence that many of the banks have had to stop foreclosures. How convenient.

Jeff said...


Good point. I thought about that too.

What scares me about that idea is they tried to keep it together in 2008 too and look how that turned out.

Sept and October were a disaster right before the election.

It's definately a possibility though. The light volumes make the market easier to manipulate.

It's going to be an interesting season for sure!

CABeachBum said...

I'm an avid, anonymous (until now) nearly daily reader of your blog. I agree with a lot of the sentiments that you post, however it seems like the constant doom and gloom approach would hamper your trading. I'm not trying to criticize since I share many of the same viewpoints you have, however I like to trade with the trend...even if it's completely irrational and propped up by the government. Barry Ritholtz wrote a great blog post today that I wanted to share:

With all the doom and gloom outlook, do you feel like it's affecting your trading and that you're missing out on opportunities?

Anonymous said...


You are right on all counts about Jeff. However, dont give him too hard a time on his constant doom and gloom agenda - thats just his nature - in all likelyhood, he truly cannot help himself.

He will never change, meaning yes, he will miss out on significant opportunities, but also, he likely wont get burned as much as the rest of us do. Less risk less reward and all that.

All you can do is hope to keep him honest which is what I do by calling him out now and again.

Jeff said...

CA Beach

I hear you and thanks for reading everyday.

As you well know by now I am a macro guy not a trader. There are plenty of great trading sights as I am sure you know.

Evil speculator, Icoin, the market ticker, and slope of hope come to mind.

Being bearish or "doom and gloom" has been good for me. It's what pushed me into bonds and gold this year.

Both are kickingg the market's ass this year so I am way ahead in the game.

My major holdings have been bonds and gold for the whole year.

Most of my bond funds are up 9% YTD.

I am having a great year from a performance standpoint.

The market has pretty much gone nowhere for the year. The recent bounce is just making up for the losses seen earlier in the spring/summer if you have been all in long since Jan.

I really don't have any use or interest in the market right now. To me it's trading like a giant casino.

I will get interested again at some point but I don't have the time to get in and out of trades so it's pretty useless for me.

If you have the time to trade the tape and its profitable then that's awesome.

Best of luck

That's how I see it anyway.

Jeff said...

"You are right on all counts about Jeff. However, dont give him too hard a time on his constant doom and gloom agenda - thats just his nature - in all likelyhood, he truly cannot help himself."

The economy is what it is. I am a realist.

Call it doom and gloom if you like. My views on the market have saved me and made me a good chunk of cash.

Sure I miss opportunities. I am conservative by nature as you know by now.

The focus during these times should be preservation of capital versus return on capital.

I think the world will become much more risk averse in the future.

getyourselfconnected said...

As a fellow Doom and Gloomer (except friday nights!) I can say I gladly do not participate in the the big ramp up in terrible names fuled by government liquidity. I wrote about Barry's piece as well last night. I ahve zero issue with traders, heck i even played SLV for a 20% plus move in about 40 days myself as of late, but overall I go long term and stick with macro.

CABeachBum said...

Thanks for the responses. Anon, I wasn't intending to give Jeff a hard time about his doom and gloom outlook. Just wanted to hear how others trade off of it...or if they do. I'm not a buy and hold investor, but rather prefer to trade off the trends (technical indicators that give me confirmation on which way the market is heading), even when it makes no sense why the market is rising when it should be plummeting. Sounds like you all have a system that works for you as well...and one that you won't lose sleep over. Best of luck to you and I'll go back to lurking on this blog until I feel compelled to chime in again. Thanks.

Jeff said...

Glad you found a system that works CA!

Best of luck