Extreme Monetary Policy, a Profits Recession, and Asset Prices Floating Higher (w/ Ken Grant)
KEN GRANT: I'm Ken Grant. I am the founder of General Risk Advisors LLC, which is a risk management solutions company domiciled in New York. And I've been doing market risk management for more than 30 years. I find this to be a very interesting pass, somebody who has been actively involved in the capital economy for-- shame to say-- more than three decades here. But that's the way it goes. But what has transpired is that we have a situation where we know that what really drove a lot of the recovery from the crash is monetary policy. And I'm happy to debate anybody about where we might be, if there hadn't been $20, $30 trillion equivalents printed into the global economy and all of the knock on effects. And that has had the effect of creating an economic recovery that I think, on some levels, was pretty miraculous. It's worked for a long time. And I think we can all be glad that it actually did happen that way, though there are a lot of economists that don't believe it was the right thing to do. To them I'd say, well, if we hadn't done that, if we hadn't done these quantitative easing, do you think that any of the financial system of America would be left? And then what would happen to things like housing and the entire economy? But the fact is we did print all of that money. We pushed down financing costs. And it did catalyze what is now a 10 year recovery, which historically anybody will tell you is a very long period for a recovery to last. It's not necessarily over. It is slowing on a global basis. It's corroborated by statistics all over the world. Germany may in fact be in a recession right now, depending on how you measure it. PMIs manufacturing statistics in the US show a slowdown. There's a slowdown in capital expenditures. And this would be a normal, healthy part of the cycle. But because financing costs have been so astonishingly muted, it has done what the good Lord intended it to do, which was to incentivize borrowing. And we now are at a point where all published statistics will tell you there's more indebtedness in the world than ever before. And corporate credit in developed countries is 2 and 1/2, 3 times what it was in 2007. So were all of those good loans? Probably not. And if they start to default, it's a cascading effect that happens. And again, against the backdrop of a slowing global economy, you have real forces for suppressing interest rates going into the future. And what my expectation is, is that, yes, it will dampen the effects of what by now would probably look like it's time for a recession. It's also going to lead to a distortion of asset prices. I think it lasts several more quarters. But there's nothing that they can do. They've tried to raise interest rates in the past. And it has been a disaster. Well, in terms of what I call the real economy, which is a difficult term to wrestle with and put into a box-- but when I talk about the real economy, what I'm talking about is actual economic agents going out there and buying and selling for utility and to separate that out for things that are done for investment purposes, which maybe for this discussion, we can call the capital economy. Well, the real economy, I believe, there are serious deflationary pressures. I think one of the biggest driving forces of that is actually technological innovation. We all feel it. Every minute of every day there is perfect price information availability at zero cost to every economic agent at least in the developed world. When my daughter just bought a bunk bed for her two boys, she's reasonably tech savvy. But she didn't even need to be to punch up 50 price alternatives in five minutes and to make her purchase decisions on the basis of that. And we all have that ability. And that means that, for anything that's commoditized-- and this includes labor-- there is really no pricing leverage in the economy. The same thing is true on the business side. Businesses can't raise prices. Businesses can only lower prices. So everybody is acquiring goods and services at the lowest price possible. And this is what's interfering with anything that would look like the holy wage inflation that we'd all like to see. And if wages can't go up, other than you'd buy nominal amounts in fits and starts, then there's really no way that interest rates can go up. If interest rates can't go up, then they can only go down. And that means that our economic agents-- and if we shift over to the capital economy-- are receiving the gift of the ability to borrow at really unreasonably low levels. And what are they doing? They're borrowing and they're investing. They're buying back their stocks. They are out there acquiring the assets of the world. And they are getting more concentrated as a result. And I mean, I'd say to anybody, if you are an institutionalized enterprise of any kind-- I don't care whether you're talking about a financial institution or a large corporation-- if you have the ability to borrow and you are not camped out on your banker's reception table, then I think that you're making a mistake. But the fact is is that this credit is accumulating, and it's being used to purchase a finite pool of assets in the world. So what we have is a big trend towards asset inflation with commodity and real economy deflation and uncharted territory, as far as I'm concerned. I mean, I'd answer that question two ways-- maybe 2 and 1/2 ways. First off is, could we have a recession at any time? Of course, and it would be foolish to ever suggest that a recession is an impossibility. I think that it is unlikely over the next several quarters because I believe everything all the time goes through a political lens. And as we approach the quadrennial political cycle, all of these things get more politicized. And one thing that I encourage everybody to bear in mind, everybody's going to be fixated 400% on the presidential election. But for instance, 435 members of the House of Representatives have to go back to their districts and don't want to do it in a recessionary environment. And there's state level. There's local level. There is a global level. So whatever can be done to protect those franchises, those political franchises, I think I would be shocked, just on a pure incentive basis, if they didn't move heaven and earth to kick that can down the road. Now if we were to have a recession-- so let's just say that I think it's unlikely. But if we were to have a recession at this point, say going into the real core of the election cycle, well, what I'm most convinced of is that interest rates in the US globally, they are going to drop like a lead balloon. And I don't know that what happens is that it's not reinforcing to exactly what I was talking about before with free money used to continue to grab the demand and own up all of the assets in smaller concentration and tighter concentrations. But at the same time, yeah, people will be laid off. There will be hardship. So if anything, a recession to me might exacerbate exactly what I'm talking about. They both rally in my opinion. Bonds definitely rally. And I mean, if you've been paying attention this year, anything that has caused even just the most benign level of worry and caused the market to go down in May, when Cinco de Mayo, their first tweets about, we're going to load in on the tariffs on the Chinese; again, in August when that particular cycle repeated itself-- anything that is viewed as negative market or economic news is causing one of the most frenzied bids for global bonds that I have ever witnessed. The post Labor Day cycle of this-- I mean, it took Germany to negative 1%. France was like negative 0.7. We're at like 1.4 in the US. Now bonds have backed up a little bit in the US. And mostly, it's because of the elimination of some concerns. I think it's completely optical. I don't think anybody knows what's going on between us and China, including us and China, by the way. But anything that would be viewed as bad news-- we've just extended the tariff deadline to, whatever, two weeks. Those tariffs go into place. Yeah, the stock market's going to drop. The bond market is going to rally like a beast here. And then what happens in the aftermath? You have a buying opportunity for equities at that point. And that's how I'll be advising my clients. So the economy slows down. And in this world of scarcity of financial assets, you want to own them on the dips. That's how I think you make money right now. Well, I think the profits recession is real. It's statistically corroborated. If I'm not mistaken, we had our two consecutive quarters of negative earnings growth as of the second quarter results, which came out this summer. These are things that are happening out there. And it's going to be a high drama reporting cycle that will start the second or third week in October. My guess is that profits remain impaired. So this is a problem. Now here's the counter side to that, because this is a real important part of the message that I'm trying to convey in my business. If you look at a declining profit picture, then the mathematical implications of that, the price earnings ratio, is higher. And a lot of people in the markets, a lot of investors are trained, very justifiably so, to make these valuation comparisons. P/E ratios, all of the valuation metrics are already extended. And my very strong advice to anybody who cares to listen to it is that you have to ignore them, because this is uncharted territory. We've never been in a situation where we're approaching $20 trillion of debt assets that are priced to negative yields where there are countries where the mortgages are negative. And this is something which makes you have to throw out all those books. And by the way, I'm not suggesting that everybody load the boat here. But I am always really leery of the short side. I'm more leery than I've ever been of it here. And I think you have to make money by buying dips. So I am not expecting the profit picture to improve immediately. And my belief is that it's not going to-- even if it's a disaster, all that's going to do is mean that, if stocks get cheaper, buy them. Without making any representations about a crystal ball-- and for the record, this taping happens on the day of the ECB announcement, which I believe is chairman Draghi's last turn at the podium. So as expected, they cut the deposit rate for banks, which is obviously a very financing friendly move. And they did announce further asset repurchases. This is his last hurrah. I believe that Madam Lagarde was his chosen successor. She is known to be an aggressive monetary dove, if such a term is not oxymoronic. And I think that Europe is going to-- the ECB is going to be printing to beat the band for the foreseeable future. How much impact? I think there is a dilutive impact on the Eurozone on that. And there's a lot of crosswinds. I mean, nobody needs me to tell them about all the problems, say, between the UK and the Eurozone. And my belief for a long time is entities like Deutsche Bank have been economically insolvent since before the crash. They have never embarked even some of those mortgage securities from 12 or 13 years ago to market. If they tried to sell their portfolio, it would eradicate all of their equity and more. So they need that support. And whatever forces are causing this extraordinary accommodation in the United States on the monetary side are true in spades in Europe. The bad news is that I don't know if it's going to save those economies. I think they're going to continue to struggle for any number of reasons. The US dollar should strengthen. I mean, I will admit to being increasingly mystified by foreign exchange flows and what moves them around. There has been more affects volatility this year than probably any time since really in the wake of the crash and its immediate aftermath. But for all of that, you're talking about it having moved a few percentage points. I know that the politicians care about the value of the US dollar. And of course, we're in a battle with countries like China about this and even Japan. I don't know that the US-- that these FX rates are going to move dramatically. And I don't believe that the Federal Reserve is going to do any surprise moves. I think they are going to continue to shade towards doing the things that they can control, like probably another one or two cuts in the foreseeable future. What I do believe is, again, at the long end of the curve, there is nothing that they can do to stop this monster of a bid. And Japan has been in this for 20 years. I don't think there's anybody in Japan that likes zero or negative interest rates. And they've been trying to get out of that for a long time. We may be headed there. But in terms of just to be very specific about the Fed, it's going to, in my opinion, do very telegraphed and benign things until there is an economic problem. And then they are absolutely in my opinion prepared to do very significant quantitative easing. It's my belief that there's a imperfect understanding in the marketplace about what can be controlled by the central banks and what can't. So we were at zero interest rates in terms of the rates that are explicitly controlled by the Fed. Those are all the very short term rates. We did certainly bring long term rates in the US down dramatically through quantitative easing. That is something which-- really, I know of nothing to suggest that there's a finite limit to how much of that you can do to prime the economy. I mean, at some point-- the extreme measures are things like monetization of the debt, which we used to laugh at South American countries about and which is actually taking place in the US. We are just supporting this this deflation everywhere in the world. And if anybody who's got a beef about that, it's probably pretty legitimate. In terms of things like yield curve targeting and inflation targeting, first off, again, I don't think that there are good tools to create an upward sloping yield curve, at least not by policymakers. And again, I point to Japan. They could sell down what is still almost a $4 trillion balance sheet. Right now I'm not even sure that that would take rates up that much. I think that that supply could be absorbed at almost zero impact right at the moment. That's what I believe. In terms of targeting inflation, letting the economy so-called run hot, I think that's a big hill to climb. There's a lot of economists out there and I think legitimate ones-- I don't know the answer to this question. But there's a very strong argument that you could make that measures like the GDP deflator and CPI and PPI, their way overstating inflation. So we're not anywhere near 2% by certain measures. The problem is not keeping the kettle from over boiling. It's actually boiling the kettle itself. And I think it's a problem because of the deflation pressures that are out there. So I don't know how to heat up this economy using policy. I mean, there is-- we haven't spoken at all about fiscal policy. But there are so many political obstacles to getting that right-- not just in the US. You think about Europe or something like that. It's like, whatever, 20 jurisdictions agreeing how to do that. So I think it's about-- the gravitational forces are downward. And I don't know how we get out of it. I really don't. I envision there's some dramatic event in the next two to five years. We can talk about what that might be. But I don't think that there's an-- I can't really visualize an adjustment here. What I can visualize is a paradigm shift. And I don't even want to think about what that looks like. I would say that would ideally come around the year 2010. But then again, it's 2019 right now. So it's not like these things aren't-- there's not an awareness of them. There's a structural impediment to getting there. There's two types of stimulative fiscal policy. And they are gall and wormwood to one half of the electorate, no matter what they are. I mean, I will tell you that. Though it's somewhat blasphemy, I would push hard on the tax cut string, if I was in charge of things. And I think that you could get some of this Laffer Curve results where deficits actually go down because the economic impact is greater than the reduction in the tax revenue. And so you end up on the good side. It probably won't be a newsflash to you. But there is a significant portion of the American electorate that would rather see the planet explode than to see tax cuts. And on the other side, there is the actual expenditures of increase entitlements, redo infrastructure, upgrade, spend money on the military. That is really the other side of the coin where the people that want tax cuts really push back against that. And the people who hate tax cuts, that's what they would like to do, is just to do a great deal of Keynesian fiscal spending. And I think that until-- we're all pretty comfortable here right now. For all the complaining that we do, I think there's a lot of blessings out there in terms of how we came to this pass over the last decade. Until we get uncomfortable, nothing dramatic is going to happen. You're not going to get a consensus in that's signed by any president to either cut taxes, raise taxes, or do real, real infrastructure. And this is, why-- and I think this is the most important point-- is that the whole world has pushed with all its might on monetary policy because of the political obstacles to do anything meaningful on the fiscal side. First off, me connecting the dots says that it is really about a potential credit implosion that has caused all of the central banks to act in such an alarming fashion. It's because of a credit bubble. And I think it's important to bear in mind that it was absolutely a credit bubble that led to the crash. It's oriented in a different part of the global capital economy. I mean, I don't think that the housing market is as impaired on a credit basis as it was. I think the banks are better capitalized. But there's so much debt out there. And it's increasing every single, solitary day. And I think there is an absolute terror by policymakers that somebody wakes up and says, we are lending money by the bushel basket to entities where the underwriting standards have absolutely been obliterated. And I really don't see that ending for the next several quarters. As a matter of fact, I think it's one of the main things that I'd convey to, say, my clients. If anything, impaired enterprises are probably going to have the best access of credit that they have had maybe ever. And that, again, has to do with politics. So if you think about companies-- and particularly, say, in the energy complex, which relies heavily on debt-- and a lot of it is short term debt. So a lot of it is rolling over. And I think it's terrifying the policymakers. If the banks do not want to renew that debt, say, on a driller in Oklahoma and that driller in Oklahoma is then forced to lay off a couple of thousand of somebody's constituents, they will be sorry they were ever born in terms of the regulatory response. So I think that entering into this political cycle, we're just making matters worse. But I don't think that anybody, that there is really anything more than just a very immaterial amount of default risk in terms of defaults manifesting themselves versus what a rational world would do. And I think it's because of politics. Well, credit is clearly overpriced, and it doesn't take a genius to figure out why. It's a search for yield in an asset scarce universe. So if you look at, for instance, the basket of investment grade domestic credit, which is-- I mean, LQD is the ETF. But it's the Lehman Bloomberg-- it's not Bloomberg. It's Lehman Barclays Bloomberg basket of investment grade credits. It's up over 15% this year. They have data going back to 1938. The best year ever was I think about 7%. So there is just an astonishing overpricing of credit in the search for yield. And I wouldn't own any of it there. I think some of this is purposeful. And it's there to push capital and risk into what is a riskier asset class, which is equities. But I would be under allocated to credit here, unless you want to get in and out quick. Because at some point, that party is going to end.