Wall Street's Best Minds

Janus’ Bill Gross: ‘The Good Times Are Over’

The fund legend writes that “there will be minus signs in front of many asset classes” in 2015.

By William H. Gross

Updated Jan. 6, 2015 11:47 a.m. ET

A January Investment Outlook should normally be filled with recommended “do’s and don’ts,” “picks and pans” and December 31, 2015, forecasts for interest rates and risk assets. I shall do all of that as usual when I travel to New York City for the annual Barron’s Roundtable in a few weeks’ time.
That is always an opportunity for me to engage in verbal jousting with Marc Faber, Mario Gabelli and the usual bearish forecast from the Gnome of Zurich, Felix Zulauf. So I’ll leave the specific forecasting for a few weeks’ time and sum it up in a few quick sentences for now: Beware the Ides of March, or the Ides of any month in 2015 for that matter. When the year is done, there will be minus signs in front of returns for many asset classes. The good times are over.

Timing the end of an asset bull market is nearly always an impossible task, and that is one reason why most market observers don’t do it. The other reason is that most investors are optimists by historical experience or simply human nature, and it never serves their business interests to forecast a decline in the price of the product that they sell. Nevertheless, there comes a time when common sense must recognize that the king has no clothes, or at least that he is down to his Fruit of the Loom briefs, when it comes to future expectations for asset returns. Now is that time and hopefully the next 12 monthly “Ides” will provide some air cover for me in terms of an inflection point. Manias can outlast any forecaster because they are driven not only by rational inputs, but by irrational human expressions of fear and greed. Knowing when the “crowd” has had enough is an often frustrating task, and it behooves an individual with a reputation at stake to stand clear. As you know, however, moving out of the way has never been my style so I will stake my claim with as much logic as possible and hope to persuade you to lower expectations for future returns over the next 12 months.
My investment template shares a lot in common with, and owes credit to, the similar templates of Martin Barnes of the Bank Credit Analyst and Ray Dalio of Bridgewater Associates. All three of us share a belief in a finance-driven economic cycle which over time moves to excess both on the upside and the downside. For the past few decades, the secular excess has been on the upside with rapid credit growth, lower interest rates and tighter risk spreads dominating the long-term trend. There have been dramatic reversals as with the Lehman Brothers collapse, the Asia/dot-com crisis around the turn of the century, and of course 1987’s one-day crash, but each reversal was met with a new and increasingly innovative monetary policy initiative on the part of the central banks that kept the bull market in asset prices alive.
Consistently looser regulatory policies contributed immensely as well. The Bank Credit Analyst labels this history as the “debt supercycle,” which is as descriptive as it gets. Each downward spike in the economy and its related financial markets was met with additional credit expansion generated by lower interest rates, financial innovation and regulatory easing, or more recently, direct central bank purchasing of assets labeled “Quantitative Easing.” The power of additional and cheaper credit to add to economic growth and financial asset bull markets has been underappreciated by investors since 1981. Even with the recognition of the Minsky Moment in 2008 and his commonsensical reflection that “stability ultimately leads to instability,” investors have continued to assume that monetary (and at times fiscal) policy could contain the long-term business cycle and produce continuing prosperity for investors in a multitude of asset classes both domestically and externally in emerging markets.
There comes a time, however, when zero-based, and in some cases negative yields, fail to generate sufficient economic growth. While such yields almost automatically result in higher bond prices and escalating P/E ratios, their effect on real growth diminishes or in some cases, reverses. Corporate leaders, sensing structural changes in consumer demand, become willing borrowers, but primarily to reduce their own outstanding shares as opposed to investing in the real economy.

Demographics, technology, and globalization reversals in turn have promoted a sense of “secular stagnation” as economist and former Treasury Secretary Larry Summers calls it and the “New Normal” as I labeled it as early as 2009. The Alice in Wonderland fact of the matter is that at the zero bound for interest rates, expected Returns on Investment (ROI) and Returns on Equity (ROE) are capped at increasingly low levels. The private sector becomes less willing to take a chance with their owners’ money in a real economy that has a lack of aggregate demand as its dominant theme. Making money by borrowing at no cost for investment in the real economy sounds like a no-brainer. But, it comes with increasing risk in an environment of secular stagnation, demand uncertainty, and with the ROI closer to zero itself than an entrepreneur is willing to bear.
And so the miracle of the debt supercycle meets a logical end when yields, asset prices and the increasing amount of credit place an unreasonable burden on the balancing scale of risk and return. Too little return for too much risk. As the real economy of developed and developing nations sputter, so too eventually do financial markets. The timing – as mentioned previously – is never certain but the inevitable outcome is commonsensically sound.
If real growth in most developed and highly levered economies cannot be normalized with monetary policy at the zero bound, then investors will ultimately seek alternative havens. Not immediately, but at the margin, credit and assets are exchanged for figurative and sometimes literal money in a mattress. As it does, the system delevers, as cash at the core or real assets at the exterior become the more desirable holding. The secular fertilization of credit creation and the wonders of the debt supercycle may cease to work as intended at the zero bound.
Comprehending (or proving) this can be as frustrating as understanding the differences between Newtonian and quantum physics and the possibility that the same object can be in two places at the same time. Central banks with their historical models do not yet comprehend the impotence of credit creation on the real economy at the zero bound. Increasingly, however, it is becoming obvious that as yields move closer and closer to zero, credit increasingly behaves like cash and loses its multiplicative power of monetary expansion for which the fractional reserve system was designed.
Finance – instead of functioning as a building block of the real economy – breaks it down. Investment is discouraged rather than encouraged due to declining ROIs and ROEs.
In turn, financial economy asset class structures such as money market funds, banking, insurance, pensions, and even household balance sheets malfunction as the historical returns necessary to justify future liabilities become impossible to attain. Yields for savers become too low to meet liabilities. Both the real and the finance-based economies become threatened with the zero-based, nearly free money available for the taking. It’s as if the rules of finance, like the quantum rules of particles, have reversed or at least negated what we historically believed to be true.
And so that is why – at some future date – at some future Ides of March or May or November 2015, asset returns in many categories may turn negative. What to consider in such a strange new world?

High-quality assets with stable cash flows. Those would include Treasury and high-quality corporate bonds, as well as equities of lightly levered corporations with attractive dividends and diversified revenues both operationally and geographically. With moments of liquidity having already been experienced in recent months, 2015 may see a continuing round of musical chairs as riskier asset categories become less and less desirable.
Debt supercycles in the process of reversal are not favorable events for future investment returns. Father Time in 2015 is not the babe with a top hat in our opening cartoon. He is the grumpy old codger looking forward to his almost inevitable “Ides” sometime during the next 12 months.

Be cautious and content with low positive returns in 2015. The time for risk taking has passed.

Gross is a bond portfolio manager with Janus Capital Group

Monday, December 22, 2014

Vineyard of the Saker White Paper: the China-Russia Double Helix

Dear friends,

Today I sharing with you a document which I personally consider as absolutely crucial: an in-depth analysis of the China-Russia Strategic Alliance (RCSA) written by somebody who looks at it from the "Chinese side".   I want to tell you a few words about how this document came into existence.

. I was talking with Larchmonter 445 about the development in Russia when I realized that a lot of his arguments centered around the relationship between China and Russia and when I probed him further I realized that he knew a lot about it.  Not only that, but he had come to the exact same conclusions about the RCSA as I had, but he came to the from the other, Chinese, side.  That's when I asked him to write a short analysis of this topics, and Larchmonter 445 agreed.  Except that is as a perfectionist workaholic and his short analysis ended up 25 pages long and with 39 footnotes!  As a result, what I can now share with you is a comprehensive survey of all the officially known components of the RCSA (you can bet that there are many more which I kept secret!).

. I find Larchmonter 445's image of a double helix particularly appropriate because what we are witnessing here is the birth of a new geopolitical "life form" so to speak, an informal alliance of two countries which goes much deeper than most regular alliances do: what we are seeing is the mutual agreement to establish a full-spectrum geostrategic symbiosis between two civilizational realms as both Russia and China are what used to be called 'empires' in the past but which today are what I call "civilizational realms": multi-ethnic, multi-national and multi-religious ex-empires whose influence extends beyond their current national borders and whose international strategic "weight" makes far more akin to continents then to countries.

Make no mistake, what we are seeing is something unprecedented in history and it is much more than just an "alliance".  After all, an alliance can easily be broken and country A can decide to switch from an alliance with country B to an alliance with country C.  In the case of the RCSA what we are seeing is something much more akin to the birth of Siamese twins: in a geopolitical tectonic shift, Russia and China have decided to be shared not just "at the hip", but with many "vital organs and systems" including energy and defense, of course, but also their economies and long term development policies.  Each symbiont will keep its own head and brain, but they will share "torsos".

.I would argue that this is by far the single most important political development since the end of WWII and probably the most important one in this century: it is hard to overstate the implications of what this means and Obama's famous "pivot" to Asia is completely dwarfed and, really, rendered utterly irrelevant by this new reality: typically, while the Obama roared and barked, Putin and Xi Jinping quietly, but profoundly, changed the planetary equilibrium.  I wonder if somebody will dare tell the White House.

I urge you all to carefully read Larchmonter 445' White Paper and to keep it for future reference (in particular all the recent developments he lists).  Since it was too long to post here, I have made it available for download from Mediafire in ZIP, ODT, DOCX and PDF file formats.  You can find the link to the Mediafire directory right under Larchmonter 445's introductory remarks below.

 A big THANK YOU to Larchmonter 445!

 I hope that you will enjoy this great read.


 The Saker

Introduction by Larchmonter 445:
Saker asked me if I could provide an article regarding China and Russia. I told him that I thought the entwining of the two was far deeper and meaningful than 'deals' for commodities and weapons. He added that the two militaries had gone through highly unique, for the two nations, training and had scheduled more for next year to push their integration capabilities.

I felt that what I had learned studying China for over a dozen years, the relationship was qualitatively unique in international history, far from just a special partnership category. There was a bonding in process. Double Helix was, to my mind, an ideal metaphor. Thus, the article became a large presentation. But the two nations are two of the largest and the bonding in process is comprehensive. To give it light, it took length and some depth.

One other note, I could have added another 20-30 footnotes, but it is another purpose of the philosophy of the Vineyard, as Saker has expressed, for the visitors, readers, commenters and participants do research of their own, contribute material and facts dug up and shared. In other words, one voice does not make anything authoritative and final. I agree. In the spirit of Orthodox practice, challenge whatever you find in error or doubt.

I found it best to read in pdf on my iPad. Merry Christmas, Happy Holidays and remember to donate to the Saker. He uses most of 18 hours a day of nearly every day to make this blog work for you. The Vineyard is our megaphone and resource in the resistance to hegemony and the destruction of life and human values. Chip in with 'green ammo'

Larchmonter 445

Mediafire download directory:



Why Gold May Finally Be Turning Higher

Erik Swarts

January 7, 2015


We came into last year with the idea that despite a historically low disposition at 3 percent, the 10-year yield had become stretched at a relative performance extreme. In less than two years, yields had run up over 100% above the July 2012 cycle lows around 1.4 percent. Even in context of previous rate tightening cycles, such as the one in 1994 that had caught the market offsides - the move was massive. When expressed on a logarithmic scale, the less than two year rip was the most extreme in over fifty years. 


Not surprisingly, when viewed in this light, our expectations going into last year were for 10-year yields to retrace a significant portion of the move; hence, strategically we favored long-term Treasuries relative to U.S equities, which by most conventional metrics as well as our own variant methods - were also extended. To guide the arc of those expectations, we referenced throughout the year the complete retracement profile of the 1994/1995 rate tightening cycle - as well as an inverse reflection of the secular peak in yields from 1981 that momentum was loosely replicating on the backside of the cycle. 

With a year of daylight between that extreme, yields are still following both retracement profiles - with 10-year yields just today feathering the panic lows from last October. While respective retracements in both Treasuries and equities may manifest over the short-term, strategically speaking, we continue to favor Treasuries - considering that the U.S. equity markets remained relatively buoyant last year.
What has been more difficult to handicap is the large differential in performance between durations in the Treasury market, with shorter durations greatly supported by expectations that a more conventional tightening cycle would eventually transpire, as well as the influence of ZIRP - which has muddled the waters from a comparative perspective. Over the past few months we have noted the significant spread in performance between 5 and 10 year yields, as a literal expectation gap in the market has continued to grow.
Generally speaking, this market mentality also maintained pressure on assets such as precious metals and emerging markets throughout last year, as traders waited for a second shoe to drop with further tightening delineated by the Fed. Our general take has been that the lion share of tightening - both through the posture and then completion of the taper, has already been completed. From our perspective, pivoting on a policy that actively and passively supported the markets to the tune of over 4 Trillion in net assets purchased, is the closest thing you will find to materially “tightening” at this point in the cycle. Actions and expectations are all relative, which is easily lost in this market - especially with the Fed at ZIRP for over six years. We fleshed some of these thoughts out in The World According to ZIRP last October. If and when the Fed eventually gets a window to cut the ribbon and take us off ZIRP, the move will likely be exceedingly modest and ceremonial at best. That said, we continue to be far less confident that even a modest rate hike arrives sooner rather than later and still expect that the equity markets will continue to normalize with current policy (i.e. QE free) - which for better or worst will broadly influence expectations of future policy.

Needless to say, market conditions are anything but conventional these days, although we do believe that gold - a leading market, has made its peace with policy first as well as digested the overshot from misguided inflation expectations that slammed shut in 2011. Over the past year we’ve posted a version of the chart below that showed gold relative to 10-year yields was at a level commensurate with significant lows in the past. And while 10-year yields played the part last year, the large expectation gap - that is captured below in red in the shorter end of the Treasury market, held gold in place - until now. Gold appears to be finally breaking out of its broad base as the extreme correlation drop between durations that began with the taper in December 2013 exhausts. As we pointed out last year, this same dynamic - to a lesser degree, manifested with the previous tightening cycle that began in June 2004. Once the policy shift was digested, gold broke out of its much smaller consolidation range and correlations were reestablished in the Treasury market.


Interestingly, the two other occasions where the Treasury market dropped out of tune with respect to durations and gold was during the 1970’s bull market, where the dynamic with the Fed was the polar opposite of how it reacts with policy shifts today - as well as in the Treasury market. Back then, when the Fed raised rates - gold rallied. When the Fed eased - gold corrected.  As such, gold trended with the relative performance between 5 and 10-year yields. 
That said, we continue to see the closest parallel with a broader cycle continuation period - such as the mid-cycle retracement in the 1970’s, that shook the tree strongly before another set of branches completed the larger move. While the saplings in this cycle have taken their sweet time to germinate over the past year, we like the long-term prospects for the sector - especially relative to the U.S. equity markets. 

- Photo courtesy of Lubaib
- This post from Erik Swarts (@MktAnthropology) originally appeared on Market Anthropology.

Heard on the Street

Fed’s Journey to Bizarro-World

Combination of Factors Makes Economists’ GDP Forecasts Look Too Low

By Justin Lahart

Jan. 7, 2015 3:51 p.m. ET

A container is loaded onto a ship in Baltimore. The Commerce Department on Wednesday reported that the trade deficit narrowed to $39 billion in November, and revised October’s deficit figure to $42.25 billion from $43.43 billion. Bloomberg News    

Even as consumers cashed in on lower gasoline prices and hiring strength, economists held that the economy slowed markedly in the fourth quarter. It’s a position that no longer seems tenable.

When forecasting firm Macroeconomic Advisers polled economists before Christmas, pump prices were down sharply, and the holiday shopping season was clearly strong. But the economists forecast fourth-quarter gross domestic product would grow 2.6%, at an annual rate, compared with 5% in the third quarter. To get there, they had to make an important assumption: that the boost the economy got from a pickup in government spending and a narrower trade gap in the third quarter would reverse itself.

The jury is still out on government spending, but the view on trade looks off base: The Commerce Department on Wednesday reported that the trade deficit narrowed to $39 billion in November, and revised October’s deficit figure to $42.25 billion from $43.43 billion.

Much of the decline came from the dropping value of petroleum imports—a consequence of the falling price of oil. But imports of food, capital goods and autos also weakened.

So the view that the narrowing of the trade deficit in the third quarter was somehow “borrowing” from the fourth may have actually got the direction wrong: Perhaps what happened in the third quarter was a response to the widening of the deficit that occurred in the first half.

Whatever the case, economists had to acknowledge after the trade report that their estimates looked too low. J.P. Morgan said fourth-quarter GDP growth looks closer to 3% than its 2.5% estimate. Barclays pushed its estimate to 3.5% from 2.7%.

Such estimates may still be too low. With oil averaging $59.29 a barrel daily in December compared with $75.79 in November, a further narrowing of the trade deficit may be in the offing. And with regular gasoline averaging $2.54 in December versus $2.91 in November, consumer spending may be even more robust than what economists have penciled in.

Indeed, a report from J.C. Penney late on Tuesday suggested that may be the case. The retailer said same-store sales in the nine weeks that ended in December rose 3.7% from a year earlier, at the high end of the 2%-to-4% range it had forecast.

On Monday, auto makers reported that last month was the strongest one for sales since 2006. A daily reading on Americans’ confidence in the economy from polling firm Gallup rose steadily through December.

Meanwhile, as growth goes one way, inflation is going the other, with the drop in gasoline prices looking likely to push the consumer-price index below its year-earlier level within the next month or so.

Falling prices—deflation—and strong growth is the opposite of the stagflation of the 1970s, but there is no term for it. Coldgrowth? Defjam? Groflation? Whatever it’s called, it’s an upside-down sort of world that will complicate the Federal Reserve’s thinking on the timing of an increase in short-term interest rates.

Read This, Spike That

Can Bonds Keep Defying Conventional Wisdom?

Long-term Treasuries trounced the stock market last year. Can this surprising outcome continue?

By John Kimelman

Jan. 6, 2015 5:34 p.m. ET

Since the financial press tends to be equities-centric, much has been made of the fact that the major stock indexes extended their gains for a sixth straight calendar year in 2014.
But the bigger investment story is the outsize return generated by long-term bonds, a category viewed by the market cognoscenti as toxic just over a year ago because of expectations of rising long-term rates.
This positive move for long-term bonds is one of the surprising investment outcomes of 2014, up there with the much-discussed plummeting price of oil
Over the past year, the iShares 20 + Year Treasury Bond ETF returned 28%, trouncing the 9% gained of the SPDR S&P 500 Trust. Even the SPDR Barclays Long Term Corporate Bond ETF, a good proxy for long- term corporates, was up 13.5% over the past year, edging out the stock market.
As Barron’s income-investment blogger Michael Aneiro put it late last week, the 30-year Treasury yield’s surprise fall from 3.942% at the end of 2013 to 2.749% a year later, per Tradeweb data, helped fueled this shocking outcome.
Few experts would have bet that long term yields could have moved down sharply last year. But all that talk about the end of the 30-year bull market in bonds was, in the end, just a lot of talk.
And some think that bonds can continue to perform well in the coming year for a variety of fundamental and technical reasons.
As the Wall Street Journal wrote Tuesday, many investors are seeking the safety of Treasuries because of the growing uncertainty over the global economic growth outlook, particularly in Europe and Asia, even though the U.S. economy is growing at a healthy 5% annualized clip in the third quarter and the Federal Reserve is moving away from keeping interest rates super low.
Indeed, during the last two trading days, the Dow has lost 462 points, while Treasury values have risen, pushing the yield on the 10-year note down to 1.95% on fears of a global slowdown that could impact U.S. companies with foreign exposure.
On the technical side of things, J.C. Parets, a chartist who is president of Eagle Bay Capital, writes in his All Star Charts blog that long-term Treasuries can continue to best the broader U.S. stock market this year.

Referring to a ratio of the aforementioned 20 Year + Treasury ETF compared to the SPDR fund, Parets writes that “not only does it appear [that this ratio] has found support at the 2007 lows, but we are now attempting to break out above the downtrend line from the March 2009 top.”
He concludes: “I see no reason to think that this [Treasury bond] outperformance will not continue. Economists keep telling us that rates are going higher. I’m not sure what they are looking at, but the Fed Fund Futures, that have gotten this dead right from the beginning, continue to suggest otherwise. We’ll stick with the market.”
Still, with the 10 year Treasury yield now below 2%, it’s hard to see that how Treasuries can eke out decent returns going forward.
On a very different topic, anyone who needs a reminder of just how difficult is it forecast the fortunes of individual stocks should read a Bloomberg piece today on some of the non-energy stocks that have been brought down by the bear market in crude-oil prices.
Who would have figured that regional banks like Fifth Third Bancorp or Cullen/Frost Bankers would be down 12% and 15%, respectively, since June because of big bets these banks made on loans to the domestic fracking industry?
And stocks prices have fallen more sharply for companies like Fluor Corp. and Flowserve which ““provide the services and sell the pipes, valves and assorted doodads used to pump oil and gas.”

After the oil price fall, is natural gas next?

Nick Butler

Jan 04 12:00

The process of adjustment in the energy market is far from over. After the dramatic halving of the oil price since June there is now every chance that natural gas will follow suit.

Indeed the fall has already begun. During December, US natural gas prices fell below $3 per million British thermal units for the first time since 2012. But that is just the beginning.

Two further factors suggest a continued, and worldwide decline in 2015. First, in Europe in particular, gas supply contracts — for instance from Gazprom into Germany — are tied to the oil price. The link is historic and is gradually giving way to direct gas-to-gas competition. But the older, longer term contracts remain in place for now and that means that a radical downward shift in prices will occur through the coming year.

Secondly, after years of uncertainty since the 2011 Fukushima disaster, there are signs that Japan is ready to accept the gradual reintroduction of nuclear power. The initial steps will be small — perhaps just one or two reactors at first. But even that will be sufficient to undermine gas prices in Asia which rose at times to almost $20/mmbtu as Japan was forced to substitute imported gas for nuclear. Each nuclear station brought back online will reduce demand for gas, and just as prices surged in 2011 now they will slip back. A Reuters survey of some serious analysts, including Wood Mackenzie, forecast a fall of up to 30 per cent in Asian natural gas prices in 2015.

Unlike the oil market, none of this has anything to do with the collapse of a producers’ cartel (or depending on your world view, with a dastardly plan to use falling prices to undermine one political enemy or another). Nor does it have anything to do with Ukraine or the relations between Russia and Europe. There is no gas cartel and no producer has the power to set prices.

The falling price is simply a matter of supply and demand. Supply is strong — driven on by high prices in the last few years and by the US shale revolution. Demand on the other hand is fragile and in Europe is being continuously eroded by subsidised renewables.

The trend in prices is bad for producers, of course, and particularly for Gazprom, which has seen its European sales fall by 9 per cent in the last year. In the US the shale industry appears determined to absorb the pain, for now at least, but there — and elsewhere — there must be a big question mark over new gas investments. Substantial amounts of gas in east Africa, the eastern Mediterranean, Alaska and Australia look likely to stay in the ground for the time being. In some cases costs can be reduced and margins cut, but the most vulnerable companies are those already investing in half-finished projects, which need prices to be maintained to produce the required returns.

Shale gas projects around the world are also in jeopardy. China will presumably continue with its development plans for reasons of energy security and employment, but in the UK the dearth of drilling activity in 2014 looks set to continue. The UK shale gas revolution is postponed.

Lower natural gas prices clearly have a knock-on effect in the electricity market, putting further downward pressure on coal prices and making new nuclear look even more expensive. The fall will also make the notion of freezing electricity bills redundant. To freeze prices which are falling is hardly good politics.

How far will this downward wave go?

At the basic level the answer is that the global market will have to find a new equilibrium and that will only come after a period of volatility. Supply and demand will have to be realigned and that is not a simple process in an industry where for most producers, operating costs (as opposed to the initial capital costs) are very low. Some production, including some US shale gas, can be held back temporarily, but as long as operating costs are being covered there is absolutely no incentive for producers to shut in capacity.

Eventually the cycle will turn. New investment will go down to the point where capacity is fully utilised, and then the cycle begins again. In many cases gas is a good example of economics in action and a business less shaped by politics than most parts of the energy sector. For natural gas, the duration of the present downward trend depends more than anything on the pace of demand growth in the emerging economies of China and India.

In China the issue is made more complex by the uncertain prospects for shale gas. The country has extensive shale resources but development has been slower than many hoped. However if Chinese shale becomes available soon and in substantial quantities, as suggested by some optimistic recent statements from Sinopec (who operate the important pioneer venture at Fuling), China will import less gas than most forecasters now expect, with an inevitably negative impact on world prices. In India, the future is clouded by doubts about the ability of even Narendra Modi’s government, which came to power with an exceptionally strong electoral mandate, to reform the energy market and put in place the infrastructure required if gas is to displace even part of the planned increase in coal consumption. In both cases the evolution of the market will take time. For the moment, across the world there is more available gas supply than demand, and in a buyers’ market, prices can only fall.

The Death Of A Nation: Japanese Births Drop To Lowest Ever, Deaths Hit All Time High

by Tyler Durden

01/02/2015 16:35 -0500

Supporters and opponents of Abenomics may debate the metaphorical death of Japanese society as a result of the terminal hyper-Keynesian, hyper-monetarist policies implemented by Abe and Kuroda for the past 2 years until they are blue in the face, but when it comes to the literal death of Japan, there is no debate: as the FT succinctly puts it "deaths outnumbered births in Japan last year by the widest margin on record, underscoring the scale of the challenge facing the government as it tries to ensure a dwindling pool of workers can support growing ranks of pensioners."
Indeed, while Japan may or may not surive the collapse in the Yen, which will send the Nikkei225 soaring although nobody will be able to enjoy this unprecedented paper wealth because nobody can afford to eat, drive or heat their house, and all Japanese companies will be long bankrupt, it now looks almost certain that the death of Japanese society will not be due to a runaway printer, but due to, well, death itself.
As the Ministry of Health, Labor and Welfare reported earlier this week, while Japan recorded 1.001 million births in 2014, or the lowest number in recorded history, this was offset by 1.27 million deaths: also the highest on record.
It's only downhill from here. More from the FT:

[T]he broader demographic problems remain. Last weekend, as the government fulfilled an election pledge to present an extra spending package, it outlined plans to arrest population falls outside the major cities, challenging local authorities to boost births via support to women aged 20 to 39, the group most critical to rebuilding the population.

If the current nationwide fertility rate of 1.4 stays unchanged, a task force warned in November, then Japan’s population of 127m would drop by almost a third by 2060 and by two-thirds by 2110.

Even if the fertility rate were to rapidly rise to the replacement level of 2.07 by 2030 and then stay there, the population would keep falling for another 50 years before stabilising at a little less than 100m.

Relaxing the nation’s relatively strict controls on immigration could provide some relief, but Mr Abe has made it clear that he is “flatly opposed to opening the door”, said Masatoshi Kikuchi, a strategist at Mizuho Securities in Tokyo.
Not surprisingly, the finance ministry declined to comment on the reported figures, ahead of the release of the draft budget around the middle of January.

Because what is there to comment? The data says it all.

And whatever you do, don't use the Birinyni extrapolation ruler here.


January 2, 2015 3:15 pm

US pullout of Afghanistan leaves Pakistan on edge

Farhan Bokhari in Islamabad

Local residents gather beside burning tyres and cloths as they block a street during a protest in Peshawar on December 31, 2014, held against the Taliban militant attack on an army-run school. A team of heavily armed Pakistani Taliban gunmen stormed the army-run school in the northwestern city of Peshawar on December 16, slaughtering 150 people including 134 children. AFP PHOTO/ A MAJEED (Photo credit should read A Majeed/AFP/Getty Images)

The end of the US combat missions in Afghanistan this week has left Pakistan fearing an Iraq-style breakdown in security leading to blowback from resurgent Islamist extremists.

The fears come as the country, labelled “half an ally” by some Western officials for its tolerance of Taliban safe havens along the border with Afghanistan, renewed its fight against the group after it launched a brutal attack on a school in the northern city of Peshawar last month.

The massacre of 150 people, mostly children, shocked the country and prompted senior Pakistani officials to describe it as the country’s 9/11 — a comparison to the New York terrorist attack of 2001 that sparked the US campaign in Afghanistan.

“If Afghanistan collapses like Iraq, we will live with the consequences,” said one senior security official. “The Americans came due to their own 9/11 and they are leaving Afghanistan right after Pakistan’s 9/11. For us [Pakistan], the Peshawar attack was a turning point.”

Since the attack, Pakistan tried to demonstrate stronger resolve in combating jihadi violence, resuming executions of those involved in previous terrorist attacks and debating the establishment of military courts to speed up trials of terrorism suspects.

The measures have coincided with a Pakistan army campaign against Taliban militants in the north Waziristan region along the Afghan border, which began in June 2014 after an audacious attack on Pakistan’s biggest airport in Karachi by Taliban-backed Uzbek jihadis.
But analysts warn that Pakistan’s future security prospects will be closely linked to the ability of Ashraf Ghani, the Afghan president, to steer his country through what is likely to be a tumultuous period.

In recent months, Taliban militants have increased their attacks on Afghan government targets and western troops, indicating a determination to gain the upper hand on the battlefield.

“The main problem for Pakistan is that more instability in Afghanistan will come around to hit us badly. It’s a high risk situation for Pakistan,” said Arif Nizami, a former Pakistani minister.

Pakistan / Afghanistan locator

“Looking at the situation from Pakistan, the government in Kabul is seen to be weak, which then raises questions over [Afghan] president Ashraf Ghani’s ability to take charge [of Afghanistan] after the US led war is scaled down.”

Others say that the return of the US to a more active combat role in Iraq in 2014 should serve as a warning of the fragility of Afghanistan’s security and how it could draw Washington back to a more active role in fighting Islamist militants.

“The risk of Afghanistan becoming just like Iraq cannot be ignored,” said Aftab Sherpao, Pakistan’s former interior minister. “Even though American troops are being drawn down and today the number of American troops in Afghanistan is fewer than at its peak, a future surge of US troops in Afghanistan is possible.”

But some western diplomats warned against drawing comparisons with Iraq.

“In Iraq, the US returned because it’s a more strategically important country. A collapse of Iraq and its takeover by Isis (the Islamic State of Iraq and the Levant) could have wider consequences for the surrounding Middle East,” said one. “Unless another 9/11 type of attack with global consequences comes from Afghanistan, why should the US go back there?” he asked.

Aziz Khan, Pakistan’s ambassador to Afghanistan during the Taliban rule from 1996 to 2001, said that Pakistan’s security risk will primarily result from challenges at home while the Afghan Taliban, led by Mullah Muhammad Omar, would “primarily focus on Afghanistan” to further consolidate the movement’s position.

In the past, Pakistani intelligence officials have said that the Afghani Taliban saw Pakistan as a potential patron, while their Pakistani brethren, the Tehreek-e-Taliban Pakistan, or TTP, led by Mullah Fazlullah, were seeking to destabilise the Pakistani state.
In the past year, however, there are signs that the aims of the two groups may have diverged. There have also been credible reports of Iraq-based Isis jihadis seeking partnerships with Pakistani and Afghan Taliban.
“I find it highly irresponsible for people to assume that the Taliban in Afghanistan and Pakistan will have separate interests. If Afghanistan spins out of control, Pakistani Taliban will find space there,” said one retired Pakistani intelligence official who served in areas along the Afghan border for more than 25 years. “The threat is very real.”

5 Things to Watch in the Fed’s December Minutes

By Pedro Nicolaci da Costa

7 Jan 2015 6:00am

The Federal Reserve on Wednesday releases minutes of its Dec. 16-17 meeting, held before a fresh round of market turbulence pushed oil prices below $50 a barrel, global bond yields to fresh lows and the U.S. dollar to new highs.

Investors will be looking for clues into the Fed’s thinking about how market movements might affect its policies. In addition, traders will be on the lookout for officials’ views on inflation and the labor market, and any hints about when the central bank is likely to start raising interest rates from near zero. Here are five things to watch: 
  • 1 Considerable Patience

    Fed officials decided at the meeting to say in their policy statement they would be “patient” in deciding when to lift interest rates. And just to make sure they didn’t freak out the markets, they also said this new phrase was consistent with the language in previous statements saying they would likely keep rates very low for “a considerable time” after they ended their bond-buying program in October. It was a wordy solution to the challenge of giving themselves more flexibility without signaling a policy change. Three policy makers were unhappy enough with the outcome that they dissented. The minutes could shed more light on the internal debate.
  • 2 Disinflation Worries

    Fed Chairwoman Janet Yellen indicated during her post-meeting press conference that she sees the drag on U.S. inflation from falling oil prices as a fleeting phenomenon. However, with Wall Street repeatedly revising down its views for the likely average oil price during 2015, there is a chance Fed officials will begin to worry the hit to overall inflation will spill over into so-called core prices, which exclude volatile food and energy prices. Inflation has been running below the Fed’s 2% target for the last 31 months. Inflation expectations will be crucial in this regard, and these have fallen to their lowest since 2009 by some measures. The minutes could show what Fed officials thought about inflation expectations in mid-December.
  • 3 Oil Price Plunge

    Were Fed officials still viewing the rapid decline in energy costs primarily as a boon to economic growth or were they beginning to worry that the sheer speed of the selloff could be signal of flagging overseas demand? Policy makers have made clear they see overseas weakness as the biggest obstacle to what otherwise forecast to be a fairly strong year for the U.S. economy. Any ongoing optimism about swooning oil costs would be important, signaling a continued willingness to raise rates.
  • 4 Employment on the Rise

    Unemployment has been falling much more quickly than policy makers had anticipated. This leaves them in a bit of a bind as they decide how much unused capacity, or slack, remains in the economy. Fed officials have indicated wage growth is a key factor they are looking for, but it is unclear that they would wait for a considerable pick up in compensation before starting to raise interest rates, which have been near zero since Dec. 2008. The minutes could clarify their thinking on the issue.
  • 5 The Dollar

    Fed officials have said a strong U.S. dollar has the potential to hurt exports and put downward pressure on inflation. The dollar rally has only gained momentum since the central bank’s last meeting. It will be interesting to see how much discussion of exchange rates took place during the meeting.

Why Greenspan Is Long Gold And Dissing Fiat Currencies

by: John Miller

Jan. 2, 2015 11:02 AM ET

  • Greenspan says unwinding the Federal Reserve and ECB balance sheets will cause turmoil.
  • Greenspan believes turmoil moves positively into the gold price because gold is the premiere currency.
  • History points towards gold’s intrinsic monetary characteristics. Today’s central bankers share the belief that gold is money.
At the end of October, former Federal Reserve Chairman Alan Greenspan sat down for a breakfast debate at the Council on Foreign Relations. He spent considerable time describing the unprecedented size of central bank balance sheets and excess bank reserves. He argued maintaining these levels in the future would require the Federal Reserve to raise the interest paid on reserves. He somewhat ominously hinted that keeping these dollars out of circulation would be controlled by bank return demands rather than Fed policy initiative.

Greenspan also stressed the heightened and continuing fear level in the market. He described fear at its maximum and interest rate spreads at historic and unnatural levels during the crisis. This fear led investors to seek safety and shy away from longer-term investment. Taken as a whole, Greenspan seemed to imply that while QE was successful in flattening the risk curve, yields are now out of balance with actual risk premium preferences.

Taper Tantrum

Toward the end of the interview portion of the breakfast Greenspan was asked if central banks can normalize policy and unwind the unprecedented and unnatural situation described above. His answer was that it would be impossible without turmoil. As evidence for this turmoil he referenced the first tapering of QE. Laughing he said, "that first tapering discussion we got a very strong market response... remember tapering is still slowing the rate of increase, we are still increasing the balance sheets." Just the discussion of lowering the rate of increase of the balance sheet crashes the market.

Interesting, when the host asked about gold in this tumultuous environment Greenspan seemed happy she had opened this can of worms. He noted that turmoil always moved into the gold price and described gold as follows:
It is still by all evidences the premiere currency where no fiat currency, including the dollar, can match it.
But it's also got a monetary characteristic which is intrinsic. It's not inbred into human beings. I cannot conceive of any mechanism by which you could say that, but it behaves as though it is.
Greenspan shared a few anecdotal stories about gold's preeminence. He recounted how at the end of World War II, Germany could not import goods without payment in gold. "The person who shipped the goods in would accept the gold, and didn't care whether there was any credit standing -- associated with it. That is a very rare phenomenon."

With a rhetorical "why," Greenspan emphasized that we still see this rare phenomenon today. As evidence, he reflected on the recent passing of the fourth Central Bank Gold Agreement among the Europeans. The banks agreed: "Gold remains an important element of global monetary reserves; …they do not have any plans to sell significant amounts of gold."

As further proof of the value bankers place on gold, Greenspan gave the following take on Bretton Woods Conference: "…the ultimate test at the Mount Washington Hotel in 1944 of the real intellectual debate between the -- those who wanted to an international fiat currency which was embodied in John Maynard Keynes' construct of a banker, and he was there in 1944, holding forth with all of his prestige, but couldn't counter the fact that the United States dollar was convertible into gold and that was the major draw. Everyone wanted America's gold."

Take Advantage of the Turmoil Trade

GLD Chart

To take advantage of the coming turmoil and its move into the gold price consider the SPDR Gold Trust ETF (NYSEARCA:GLD) and the Market Vectors Gold Miners (NGDX). Both offer diversification from more traditional equities, which are at historically elevated valuations. As a physically backed instrument, GLD offers direct exposure to movement in the gold price while removing the political, labor, and weather risks faced by the miners. The riskier GDX and its basket of miners, on the other hand, provides greater leverage to gold price moves; take for example a miner whose costs are $950 an ounce. A ten percent price move from $1000 to $1100 triples the miner's earnings. Both of these products are near multiyear lows providing an attractive entry point.

4:13 pm ET Jan 2, 2015


Is Global Poverty Falling? Not in Absolute Terms

By Pedro Nicolaci da Costa

An impoverished area of Swaziland, a tiny monarchy.
Agence France-Presse/Getty Images

Economic growth and social policies have helped pull millions out of poverty in the developing world. Or have they?

The often-heard narrative is based on data from the World Bank showing a sharp reduction in the number of people living below $1.25 per day, adjusted for inflation.

However, new research suggests a deeper look into poverty statistics paints a different picture. While there has been progress in reducing the number of people living below the poverty line, this has been achieved largely by raising those considered ultrapoor to just above the poverty line, rather than by boosting the standard of living of the poor more broadly, according to a paper from Martin Ravallion, economist at Georgetown University’s Center for Economic Research.

“There has been very little absolute gain for the poorest,” Mr. Ravallion writes in a new working paper from the National Bureau of Economic Research. “Using an absolute approach to identifying the floor, the increase in the level of the floor seen over the last 30 years or so has been small—far less than the growth in mean consumption.”

The author cites Mahatma Gandhi and the late philosopher John Rawls as a basis for looking at poverty in absolute rather than comparative terms.

“Recall the face of the poorest and the weakest man whom you may have seen, and ask yourself if the step you contemplate is going to be of any use to him,” the paper cites Mr. Gandhi as saying in 1948. “Will he gain anything by it?”

According to the data, the answer so far is not very much.

“The bulk of the developing world’s progress against poverty has been in reducing the number of people living close to the consumption floor, rather than raising the level of that floor,” Mr. Ravallion. “Growth in mean consumption has been far more effective in reducing the incidence of poverty than raising the consumption floor. In this sense, it can be said that the poorest have indeed been left behind.”