Wall Street's Best Minds


Byron Wien Looks at Ben Bernanke's Work


The Blackstone senior advisor wonders whether the Fed chairman has made lasting contributions to the economy.


Poor Ben Bernanke. He could step down as Federal Reserve Chairman as soon as next year and he must be thinking about his legacy.

Everyone considers him a hero now because he's adding a trillion dollars to the Federal Reserve balance sheet in this year alone and a good portion of that is finding its way into financial assets. Ten-year Treasuries are yielding less than 2%, making the budget deficit cheaper to finance, and the Standard & Poor's 500 has gained 10% in the first quarter alone, making investors feel better about their financial well-being.

It's true, however, that the Federal Reserve has to buy 57% of all securities the Treasury issues in order to clear the market because overseas sovereigns have become less enthusiastic. Unemployment is still high, but inflation is tame and there is a general feeling out there that the economy is improving. America still has plenty of problems, perhaps, but it is doing better tan any other major developed country. In the first quarter the Morgan Stanley Europe and Far East Index, which measures the performance of the world's developed markets, was only up 5.2%. The Morgan Stanley Emerging Markets Index was down 2.1%. All in dollar terms.

Byron Wien

Bountiful Ben learned what to do by being a student of the Great Depression. During the 1930s, under the influence of John Maynard Keynes, government spending provided the stimulus to bring the economy out of its doldrums. That option has not been available now because too many members of Congress are obsessed with cutting spending. Monetary policy is the only alternative to keep the economy growing at a satisfactory pace. Starting in 2008, the Fed has been increasing the size of its balance sheet from $1 trillion to the current $3 trillion. When it was only $1 trillion, the assets were all Treasuries. Today mortgage-backed securities make up 33% of the total, so the size of the balance sheet has increased and its quality has decreased, but yields on government securities are almost at a record low, so the man must be a genius.

The problem is that Ben knows this cannot go on forever. His initial hope was that the liquidity he was providing would be sufficient stimulus to get the economy developing a significant amount of momentum on its own. He is too learned and too experienced to have put all of his confidence in that, however. He knew that much of the liquidity would be used to inflate asset prices and his expectation was that the increase in house prices and portfolio values would improve household net worth, encouraging consumers to spend and the economy to grow, perhaps as much as 3% annually.

Whenever that objective was in sight, he could dampen (not reverse) the monetary stimulus and watch the economy expand as a result of natural forces. Since household net worth is almost back to its 2007 peak, he has reason to be optimistic. The risk, of course, was that the economy would become dependent on the stimulus and once it was no longer there, the stock market would decline, household net worth would diminish and the positive mood now sweeping the country would evaporate. If that happened, his legacy would be that he created an artificial prosperity that was followed by another period of dark reality.

Investors are well aware of the possibility of difficult times ahead if the Fed stops easing, but they believe that as long as money is flowing into the system at such a rapid rate, stocks are likely to move higher. Many professional investors have a short-term orientation anyway. Fifty years ago the average holding period for a stock bought on The New York Stock Exchange was eight years. It is now eight months. There is something else going on that is having a favorable effect on stock prices: investors are not selling.

Trading volumes are low because investors believe that the flood of liquidity from the Fed will drive equities higher. As a result a marginal amount of buying has a disproportionate effect on prices. We know from various measures of investor sentiment that a mood near euphoria prevails. This is confirmed by the latest figures on margin debt. At $364 billion it is almost one third higher than a year ago and only slightly below the 2007 peak.

There is no question that the economic data for the first quarter has come in favorably. In spite of the end of the payroll tax holiday as the year began, retail sales have been strong, automobile production is robust, industrial production is increasing and oil imports have not been this low since the 1980s.

Gasoline prices at the pump, however, remain relatively high at about $3.70 a gallon, not too far from the 2011 peak of near $4.00. House prices in a number of areas are increasing at a double-digit year-over-year pace because demand is increasing and inventories of both new and existing homes are low. Capital expenditures have been in a downtrend, but have hooked up recently. Both chief financial officers and chief executives have been cautious about the overall outlook, but they, also, have become somewhat more positive lately.

It may be important to remember that in the last two years, the first quarter has been strong, only to be followed by economic weakness later on in the year. The February employment report was positive in those two years as it was this year. This has reminded investors of the mantra "sell in May and go away" which most observers do not expect to apply in 2013. At the end of last year many were worried that economic growth for 2013 would have trouble reaching 2% and the Bloomberg survey of forecasts was below that level. The increased taxes and reduced spending represented by the deal on the so-called fiscal cliff and the sequester reinforced that view. Now we are beginning to see forecasts approaching 3% on the basis of economic performance in the first quarter. Earnings in the fourth quarter of 2012 were good, with 68% of all S&P 500 companies exceeding earnings expectations, but revenues were even better. After two quarters when only about 30% of companies in the index exceeded revenue expectations, in the final quarter of last year 54% beat revenue projections.

One of my biggest concerns is that earnings are going to be disappointing. In a market where the S&P 500 was up 16% (total return) last year and 10% so far this year, that could be meaningful. The consensus is for operating earnings for the index to be $110 in 2013, up from about $100 in 2012. I think earnings could be flat to down, which is clearly a contrary view. A study by Strategas Research Partners shows that the market is likely to look beyond current lackluster earnings performance if the following year is going to show improvement. We are now in the fourth month of the year, so analysts are willing to make a preliminary estimate of earnings for 2014 and they see another year of improvement, which increases investor confidence that stocks are headed higher this year.

Another study by Strategas shows that market performance is negative 19% of the time when earnings performance is positive and 8% when earnings performance is negative. Positive earnings comparisons only drive the market higher half the time. The market rises 23% of the time when earnings are negative (a recession) because investors are anticipating a recovery. Thus the market rises almost three quarters of the time no matter what earnings do. That is why the short-sellers have such a tough time of it.

Another study by Bianco Research shows that both strategists and analysts have consistently overestimated the earnings performance or the S&P 500 and I believe that could be particularly relevant this year. While Nike has reported better than expected earnings, that was because of the success of certain new products. Federal Express has disappointed and that may be more indicative of the performance of the overall economy; however, cost consciousness and increased competition may have played a role. Competition may also have hurt Oracle, which also disappointed.

The foundation of my thesis is that corporations have worked exceedingly hard to squeeze every bit of profitability out of their existing operations. As a result, from the recession trough, profits for the S&P 500 improved faster than sales for the first time ever in the post-war period. A recent Smithers & Co. study showed profit margins before depreciation, interest and taxes as a percentage of output were at 36%. That hasn't happened since World War II.

Nominal economic growth for the U.S. economy is only likely to be 4%–5%. That is not strong enough to provide revenue increases large enough to offset margin pressure. The first quarter earnings season is upon us and it will be important to see how the results come in. If shortfalls dominate, the animal spirits in the market may cool down.

Adding to fundamental concerns is the situation in Europe. The tax being imposed on bank deposits in Cyprus should unsettle depositors in other European Union countries like Spain and Italy.

Everyone argues that Cyprus is a small economy and relatively unimportant but, like a few other countries in Europe, it had substantial bank deposits from overseas investors (primarily Russian) because it is a tax haven and the interest rates Cypriot institutions were willing to pay were much higher than those paid in countries with stronger finances like Germany or the United Kingdom.

When weaker countries in the periphery get into financial trouble, they seek help from the European Central Bank in the form of "Emergency Lending Assistance." This allows public employees to be paid and countries to appear to be solvent. The problem in Europe is that in spite of all the talk about austerity, very little has been done to reduce the government expenditures of the weaker countries.

Most of the measures that have been taken are tax increases or deposit haircuts and bank closings (Cyprus) which are aimed at the wealthy. Apparently none of the weaker countries are willing to take on the political risk of broad-based expenditure reduction which would have the effect of weakening these economies further. In any case Europe remains in recession and that clouds the outlook for world growth and could put further pressure on the earnings of U.S. multinationals.

The European Union has always depended on Germany's resources and that country has been the primary beneficiary of the common currency. In spite of its commitment to austerity, Germany has compromised its principles and let the weaker countries make demands on the private sector rather tan reduce the size of government, according to Encima Global. Europe has also been slow to make progress on moving toward a banking union or other forms of convergence. Encima points out that euro-zone banks have three times the assets and liabilities of U.S. banks even though the European economy is smaller. The Cyprus initiative and other events in Europe will put more pressure on the Bundesbank and increase the possibility of instability on the continent. Monetary policy in Europe has followed the accommodative policy of the United States. The European Central Bank balance sheet has grown from less than €1 trillion in 2008 to €3 trillion now. Mario Draghi has abandoned the hypersensitivity about inflation that characterized the thinking of his predecessors.

Europe has chosen temporary solutions to its problems similar to the United States and failed to move meaningfully forward in making structural changes. Getting to tomorrow has been the objective; doing the right thing is too difficult there as it is here.

Federal Reserve Chairman Bernanke can take some pride in the improved tone of the U.S. economy, but he can only feel his positive legacy is secure if the growth path proves to be independent of the extraordinary monetary expansion currently underway. Market timers can continue to ride the liquidity wave hoping they are smart enough to get out gracefully, but Ben is counting on creating a positive set of economic conditions that lasts beyond his tenure, and it is still too soon to know whether he has done that.

Japanese bank governor Haruhiko Kuroda makes history with monetary blitz

The Bank of Japan has launched the most daring monetary experiment of modern times, aiming to double the money base within two years to overpower deflation and catapult the economy out of slump.

By Ambrose Evans-Pritchard

8:09PM BST 04 Apr 2013

Yen currency from Japan
Photo: Alamy


The BoJ’s new team under governor Haruhiko Kuroda voted 8:1 for a double dose of “quantitative and qualitative monetary easing”, vowing to inject stimulus for “as long as it takes” to break the deflation psychology.

This will be recorded in economic history books as a watershed in central bank action. Investors should be shocked and awed,” said Stephen Jen from SLJ Macro Partners.

The monetary base will rocket from 29pc to 56pc of GDP by 2014. The pace of bond purchases will rise to 7.5 trillion yen (£53bn) a month, almost three times the US Federal Reserve’s stimulus as a share of the economy. The maturities will stretch to 40 years, ending the three-year cap that has hobbled policy for a decade.

“This is a huge sum. It could set off a rip-roaring economic boom if they buy the bonds from insurance companies and boost broad money by 10pc over the next year,” said Tim Congdon from International Monetary Research.
Mr Kuroda said the bank had taken all available steps” to meet its new target of 2pc inflation within two years. “This is an unprecedented degree of monetary easing,” he said.

The scale of action caught markets off guard, sending 10-year bond yields tumbling to an all-time low of 0.44pc. The yen weakened threebig numbers” to 96 yen against the dollar, in the biggest one-day move for more than a year. The Nikkei index of stocks jumped 2.2pc, crowning a 50pc rise since October.

Hans Redeker, from Morgan Stanley, said the package was dramatic enough to breakEndaka” – strong yen once and for all. “The carry trade is going into full swing. Japan’s institutional funds are going to wind down their currency hedges from 70pc to a normal hedge ratio nearer 35pc, and that will free up $1 trillion of overseas lending,” he said.

“This is a gigantic fixed-income machine. They don’t buy equities and real estate. They buy bonds, and we think they’ll look at peripheral eurozone markets like Italy and Spain.”

Japan’s legendary housewives and grannies – so-called “Mrs Watanabe” – lead a phalanx of retail investors with another trillion dollars waiting to venture abroad once again in search of yield. In the 2003-08 cycle, the money leaked into everything from Australian Uridashibonds and Icelandic debt, to London property.

Simon Derrick, from BNY Mellon, said Japan’s battle-weary investors may be more cautious this time, chilled by North Korean jitters and tensions with China. “We don’t think the climate is yet right for the carry trade,” he said.

Hiroaki Muto, from Sumitomo Mitsui, said the Kuroda experiment could go badly wrong if markets started to think the BoJ was printing money to cover Japan’s fiscal deficits. “At some point, yields could spike”, he said.

Japan is the only major country yet to start retrenchment. Premier Shinzo Abe is boosting spending by an extra 2pc of GDP to kickstart recovery, though the budget deficit is already 9pc.

Japan has had no trouble raising funds from its captive debt markets so far, but ageing costs are rising and public debt will reach 245pc of GDP this year.

The International Monetary Fund says Japan may hit the buffers unless it changes course soon, warning that confidence can evaporate fast. A 200 basis point rise in borrowing costs would play havoc with public finances.

Mr Kuroda played down the concerns, insisting there was no risk of a “suddenjump in long-term rates or a fresh asset price bubble.

Japanese officials say monetary stimulus should protect against a debt compound trap by cuttingreal rates. While Japan’s borrowing costs look low, they are higher than in the US, Britain or Germany if adjusted for deflation.

The Kuroda policy is radically different from past episodes of BoJ stimulus, mostly half-hearted tinkering to fend off political pressure. It brings the BoJ into line with the US, UK and Swiss central banks.

The European Central Bank looks increasingly isolated after it sat on its hands on Thursday, offering little to soften the credit crunch in Italy and Spain. The hawkish stance is leading to an over-valued euro. “We’re afraid that the euro could rise further. That is the last thing that Europe needs,” said Mr Redeker.

The euro has risen 32pc against the yen since July, giving Japanese exporters an edge over European rivals. A Ford executive warned last month that Japanese car makers are poised to sweep the EU market.

An army of doubters question whether Mr Kuroda’s shock therapy will feed through to the real economy. Daragh Maher, from HSBC, fears a “damp squiboutcome that exposes the limits of central banking, or a “UK replaywhere inflation rises but wages lag, causing a squeeze in real incomes. “Neither would point to a new era for Japan’s economy.”

The Acute Jihadist Threat in Europe

April 4, 2013 | 0900 GMT

By Scott Stewart, Vice President of Analysis, and Sidney Brown

On March 26, the Belgian federal police's counterterrorism force, or Special Units, conducted a felony car stop on Hakim Benladghem, a 39-year-old French citizen of Algerian extraction. When Benladghem reacted aggressively, he was shot and killed by the police attempting to arrest him. The Special Units chose to take Benladghem down in a car stop rather than arrest him at his home because it had intelligence indicating that he was heavily armed. The authorities also knew from their French counterparts that Benladghem had been trained as a paratrooper in the French Foreign Legion.

Additional intelligence showed that Benladghem had traveled extensively and that, through his travels and email and cellphone communications, he appeared to be connected to the international jihadist movement. Rather than risk a confrontation at Benladghem's apartment, where he had access to an arsenal of weapons as well as a ballistic vest and helmet, the police decided to arrest him while he was away from home and more vulnerable. The Belgian authorities did not want to risk a prolonged, bloody siege like the one that occurred in April 2012 in Toulouse, France, when French police attempted to arrest shooter Mohammed Merah.


The intelligence regarding Benladghem's arsenal was confirmed when a search of his apartment revealed several weapons, including an assault rifle, a submachine gun and a tactical shotgun. He also possessed a large collection of tactical equipment, including a ballistic vest, a Kevlar helmet, a ballistic shield and two gas masks. With such equipment and training, Benladghem would have been well-equipped to not only handle an assault on his apartment but also to conduct an armed assault -- intelligence indicating that he was preparing to conduct such an attack March 27 is reportedly what led the police to try to arrest him. Authorities are still closely guarding the identities of Benladghem's targets, but given France's involvement in the case, it is likely they were transnational in nature; there are a number of such targets in Brussels, which houses NATO and EU headquarters.

Belgian authorities are now undoubtedly working with their European and other allies to investigate Benladghem's contacts in order to determine the scope of the network he was a part of and what threat his associates still pose. This potential threat is a reminder of the challenges that radicalized European Muslims present for European authorities.

The Roots of the Problem

There are long, historical ties between the Muslim world and Europe. From the earliest days of Islam and the Umayyads' invasion of Spain and France in the early 700s, through the Crusades and the European colonization of North Africa and South Asia in the 1700s and 1800s, to the fall of the Ottoman Empire in the wake of World War I and the European colonization of the Middle East, the threads of Europe and the Muslim world have been tightly woven together by geopolitics into a vivid tapestry of conflict and cooperation.

The proximity of North Africa to southern Europe and the Europeans' colonization efforts, combined with the many people in the Muslim world seeking education and employment in Europe, have resulted in large populations of Muslims living on the Continent.

But this close relationship has not been without friction. Though a large portion of Muslims in Europe come from families who have lived there for four or five generations, many have not become integrated into European society and frequently live in isolated, Muslim-dominated areas. Moreover, while Europe as a whole is suffering from the economic crisis, the Muslim population has been hit particularly hard and the unemployment rate for young Muslims is alarmingly high in many parts of Europe. This, in addition to the frequent discrimination against Muslims in the job market, leaves many Muslims feeling alienated, disenfranchised and resentful. When this resentment is combined with the European welfare state, in which working is not necessary to survival, many of these Muslims have the opportunity to be exposed to radical discourse and to become involved in radical political or even militant activity.

Europe's immigration and asylum laws, which granted refuge to many jihadist ideologues who were persecuted in their home countries, have exacerbated this situation. Men like Omar Bakri Mohammed, Abu Qatada, Abu Hamza al-Masri and Mullah Krekar, among many others, were allowed to set up shop on the Continent, and Europe's Muslim areas provided target-rich environments for the jihadist preachers, who were looking to recruit disaffected young Muslims to their cause.

Although European countries have taken steps to expel or extradite many of these jihadist theologians since the 9/11 attacks, they have been replaced by a second generation of preachers and the issue of disaffected Muslim populations has persisted and grown. Large numbers of vocal Islamist fundamentalists currently attend European universities. Incidents such as the French burqa ban and anti-Islamic rhetoric of politicians like Geert Wilders reinforce the narrative put forward by jihadist recruiters that Islam is under attack from Europeans and help the preachers' efforts to recruit new followers.

There is a great deal of variety in the way Muslims are radicalized, but recruiters have consistently used mosques, gyms and university Islamic associations as places to spot potential recruits. The recruits usually are then taken aside, away from the view of the community, and radicalized in a one-on-one or small-group setting. These recruiters often have contacts with other radical cells inside Europe, as well as links to jihadist and militant groups overseas, and use these links to facilitate travel to training camps and war zones.

It is important to recognize that while young Muslim men can become radicalized and are often sought for the purpose of recruitment, they are not the only demographic group susceptible to radicalization. We have also seen older adults become radicalized -- men like 39-year-old Benladghem or the 37-year-old French particle physicist, Adlene Hicheur. Such individuals with degrees, practical career experience and clean criminal backgrounds can more easily travel between Europe and other foreign countries if necessary and are less likely to raise suspicions than the younger men. Women can also become radicalized and can serve as important conduits for funds and intelligence or as recruiters and propagandists.

There are no accurate counts of European Muslims currently fighting or training abroad, but there are at least several hundred, and there have been thousands over the past decades. Not all are jihadists; many who have traveled to Libya and Syria are nationalists or non-jihadist Islamists. Nevertheless, there are many jihadists among them, along with other Muslims who become heavily influenced by the jihadists after fighting with them.

Taken together, these conditions have made it very difficult to mitigate the jihadist threat in Europe. If anything, based on the tempo of attacks, plots and arrests, the threat is growing more acute.


The Outlook for Europe

A timeline of attacks and thwarted plots in Europe shows that the pace of jihadist activity on the Continent is increasing. As was the case in the United States, major attacks like the March 2004 Madrid train bombings and the July 2005 London subway bombings have caused European authorities to become far more focused on this threat, and consequently they have become more proactive in their approach to combating it

However, the nature of the jihadist threat is slightly different in Europe than it is in the United States due to differences in the Muslim communities. In the United States, where the Muslim community is more integrated and less likely to be isolated in their own districts, plotters tend to be more self-radicalized and aspirational. Once they become radicalized -- frequently via the Internet -- it is quite common for them to be arrested as they seek assistance with their plots from individuals who are FBI agents or police informants working on sting operations. The Oct. 17, 2012, arrest of Qazi Nafis, who tried to bomb the Federal Reserve Bank in New York, and the Sept. 15, 2012, arrest of Adel Daoud, who thought he was bombing a Chicago bar, are recent examples of this trend. 

Aspiring terrorists in the United States also tend to be younger and have less experience than their European counterparts, though there have been some notable exceptions, such as U.S. Army Maj. Nidal Hasan. In addition, there are fewer cases of radicalized females in the United States.

Due to Europe's concentrated and disenfranchised Muslim population, it is not difficult for radicalized European Muslims to find confederates who are not police informants. Even more aspirational and inept groups -- such as the four men who were arrested in April 2012, in Luton, United Kingdom, and who pled guilty to plotting to attack a British army base on March 1, 2013 -- can be part of a larger radicalized community and have friends and relatives who have been involved in prior plots or who have traveled overseas to fight jihad. This was true for Toulouse shooter Merah: Although he conducted his shooting attacks alone, Merah had long been part of a larger militant community and had traveled to places like Pakistan and Afghanistan to train and fight. French authorities also reportedly investigated Merah's older brother, Abdelkader, in 2007 for helping European Muslims travel to Iraq to fight.  

The portrait of Benladghem that is beginning to emerge is somewhat similar to that of Merah. Benladghem maintained contact with a number of people associated with jihadist networks in France and Belgium as well as with jihadists overseas. According to news reports, he came to the attention of the French government after being denied entry to Gaza from Egypt while carrying ballistic vests and gas masks. Pressure by the French government after his return from Egypt may have caused his immigration to Belgium. Stratfor sources have said that French authorities alerted their Belgian counterparts about Benladghem when he moved to Belgium and that he was under close scrutiny due to his history.  

Nevertheless, Benladghem does appear to have been able to participate in some illegal activity while in Belgium. He was reportedly involved in the March 21 armed robbery of a restaurant outside Brussels as he attempted to steal weapons from the restaurant's owner. According to news reports, two accomplices accompanying Benladghem during the armed robbery were arrested, and both implicated Benladghem during the police interrogation.  

It is not clear if Benladghem was aware of his colleagues' arrest. He apparently did not attempt to cache or otherwise dispose of his weapons and equipment, nor did he flee the country, as he might have done if he had feared arrest.

Like Merah, Benladghem had armed himself and was competent with the weapons he had acquired. He did not have to reach out to a police informant to obtain the weapons. He also somehow had managed to support himself and acquire an expensive four-wheel drive vehicle, though he reportedly had not worked for years. It is not yet clear if he received outside support or if he supported himself through armed robberies like the one he conducted March 21.

Trained, dedicated and armed operatives with international connections, such as Merah and Benladghem, pose a very different threat than the aspiring and incompetent jihadists frequently seen in the United States. This means that European authorities will have their work cut out for them. But this is not only bad news for Europeans; it could also portend more anti-American attacks in Europe or even attacks outside Europe, as militants with European passports travel elsewhere.