Visual Proof That Central Banks Killed Active Management

By Heisenberg

I’ve got a love-hate relationship with low-cost, passive investing.

On the one hand, it’s kind of hard to argue with something that’s low-cost and that simultaneously outperforms alternative strategies that cost more. That’s a no-brainer.

But the problem in the post-crisis world is that investors have forgotten why it is that low-cost vehicles that replicate various benchmarks work so well. These strategies’ outperformance relative to active management is attributable to the fact that central bank largesse has been the rising tide that’s lifted all benchmarked boats.

And that’s fine (I mean, it’s not fine that it creates gross misallocations of capital, etc., but it’s fine from a the perspective of anyone who’s ridden the wave since 2009), right up until passive investors forget to what they owe their outperformance. That’s when the epochal shift to passive becomes dangerous. Suddenly, hordes of retail investors start to believe they stumbled upon some magic formula eight years ago and then they kind of rewrite history to make themselves believe that they did something other than simply ride the central bank liquidity wave.

I’ve gone to great lengths to try and disabuse retail of that notion, and not because I want to make people feel stupid. But rather because I want investors to understand that if central banks pull back and markets are allowed to trade in a two-way manner again, suddenly everyone is going to realize they weren’t the gurus they thought they were.

Well on Monday, Goldman is out with a new piece called “An Rx for Active Management.”  There’s a lot to go through in the note, but I wanted to quickly point out two charts that pretty clearly show why it is that active management suddenly stopped finding alpha.

Via Goldman

The current run of active manager underperformance began shortly after the onset of QE.

QE drove real interest rates lower (measured by the yield on 10yr TIPS). This trend towards 0%, and even negative, real rates coincided with the shift from active outperformance to underperformance (see bottom-left exhibit).


Central Bank Intervention for Dummies

By Heisenberg

It’s become readily apparent to me lately that retail investors do not appreciate the extent to which the returns they’ve enjoyed since 2009 are directly attributable to central bank largesse.

Normally, we could just write that off as harmless naiveté, but at this point it’s dangerous. Most investors have no conception whatsoever of the extent to which their performance is in no way, shape, or form a product of their own acumen but rather an inevitable consequence of the rising central bank tide that’s lifted all boats.

This will end in (a shit load) of tears when the punchbowl is pulled away and suddenly, every newsletter purveyor and homegamer-turned-self-described-guru discovers that this was all an illusion.

Well, in an effort to drive that point home, here’s a chart from BofAML which should (and I emphasize “should” because at least half of the people who read this still won’t get it) be an idiot-proof visualization of exactly what’s going on here.

This is credit implied vols annotated with colors (basically) to indicate periods of central bank intervention and periods where they’ve stepped away.


Here’s BofAML to explain that for anyone who still doesn’t understand:

Global monetary policies (tightening or expanding) have a profound impact on the credit implied vol market. Chart 8 clearly illustrates this phenomenon. Every time the Fed embarked on the different phases of its QE programme, credit implied vols declined materially. On the other hand, during periods of no policy or when the market started pricing the possibility of policy removal (tapering tantrum and the subsequent tapering phase) implied vols advanced.

Got it?


It’s the End of the Quarter, Do You Know Where Your Money is?

By Heisenberg

Ok, so it’s Friday. And it’s the end of the month. And it’s quarter-end.

Let’s get some data out of the way first.

We got PMIs out of China overnight and that turned out pretty well. Here are the bullets:


And the more granular breakdown:

  • New orders increased to a nearly three-year high of 53.3 from 53
  • New export orders rose to 51, the highest in almost five years
  • Input prices fell a third month, falling to 59.3 after hitting a five-year high in December. That suggests producer prices may be peaking at an eight-year high
  • Among gauges for firms, the reading for large enterprises was strongest at 53.3 while medium-sized companies stood at 50.4 and small firms at 48.6

“Judging from the NBS PMIs, March activity growth appeared to be solid, and inflationary pressures in the manufacturing sector softened,” Goldman wrote after the data hit, adding the following caveat: “The NBS manufacturing PMI tends to increase in March when the Chinese New Year holiday is at a similar date as this year. We will wait for other indicators such as trade and IP to confirm the trend.” For now, the picture looks like this:


Meanwhile, still on the data front, we got inflation data for the eurozone. That’s important for obvious reasons and is especially interesting in the context of this week’s sudden dovish turn in ECB rhetoric. Here are the numbers:

  • Eurostat reports March flash CPI +1.5% y/y vs Feb. final +2% y/y.
  • Forecast range 1.5% to 2% from 52 economists
  • Eurozone March core CPI ex energy, food, alcohol and tobacco +0.7% y/y; Feb. +0.9% y/y; est. +0.8% y/y


“For the ECB, it’s clearly an argument for the doves,” Frederic Pretet, inflation and rates strategist at Scotiabank said. “Some policy makers will see the data as an argument to justify the ongoing stimulus and suggest that the debate on tapering is premature for the time being.” EURUSD headed lower following the print. Panning out a bit, here’s what the picture looks like going back to one “unnamed” official’s stealth dollar bailout on Wednesday:


Speaking of the dollar and weakness, this wasn’t a particularly good quarter for the greenback. While the Bloomberg Dollar index edged up to the highest level in more than a week on Friday as supporting month-end flows outweighed profit-taking interest after yesterday’s rally, this is still on track to be the worst quarter in a year for the index. By contrast, gold is heading for its best quarter in a year. Have a look at the juxtaposition (note: the dollar is down more against the broader Bloomberg index because emerging markets continued to do well):


Looking out across regional equities, Asian shares were lower as market struggled to reconcile Trumpspeak, conflicting economic signals out of Japan (decent CPI print versus lackluster household spending), and the upbeat data out of China. European shares are mostly red.

  • Nikkei down 0.8% to 18,909.26
  • Topix down 1% to 1,512.60
  • Hang Seng Index down 0.8% to 24,111.59
  • Shanghai Composite up 0.4% to 3,222.51
  • Sensex down 0.02% to 29,640.20
  • Australia S&P/ASX 200 down 0.5% to 5,864.91
  • Kospi down 0.2% to 2,160.23
  • FTSE 7332.01 -37.51 -0.51%
  • DAX 12250.52 -5.91 -0.05%
  • CAC 5075.86 -13.78 -0.27%
  • IBEX 35 10372.90 -33.00 -0.32%

Here’s the econ and Fed speaker schedule for the US:

  • 8:30am: Personal Income, est. 0.4%, prior 0.4%
  • 8:30am: Personal Spending, est. 0.2%, prior 0.2%
  • 8:30am: Real Personal Spending, est. 0.1%, prior -0.3%
  • 8:30am: PCE Deflator MoM, est. 0.1%, prior 0.4%
  • 8:30am: PCE Deflator YoY, est. 2.1%, prior 1.9%
  • 8:30am: PCE Core MoM, est. 0.2%, prior 0.3%
  • 8:30am: PCE Core YoY, est. 1.7%, prior 1.7%
  • 9:45am: Chicago Purchasing Manager, est. 56.9, prior 57.4
  • 10am: U. of Mich. Sentiment, est. 97.6, prior 97.6
  • 10am: U. of Mich. Current Conditions, prior 114.5
  • 10am: U. of Mich. Expectations, prior 86.7
  • 10am: U. of Mich. 1 Yr Inflation, prior 2.4%
  • 10am: U. of Mich. 5-10 Yr Inflation, prior 2.2%
  • Revisions: Industrial Production


  • 9am: Fed’s Dudley Speaks to Mike McKee in Bloomberg TV Interview
  • 10am: Fed’s Kashkari Answers Questions at Banking Conference
  • 10:30am: Fed’s Bullard Speaking in New York

What the World Needs Now

By Jeffrey Snider of Alhambra

What is needed now is not more volume for the mountains of evidence we already have that all uniformly describes central banks as bastions of incompetence

What good would opening monetary policy do? The “audit the Fed” bill has been passed again, this time out of committee and possibly set for a floor vote in the House. Though questions remain about the Senate, with at least President Trump its prospects are better than at any time it passed before. Proponents of the idea want to make monetary policy an open matter, though it isn’t really clear why. They claim that secrecy is a hindrance or too much power, but in truth I fail to see much if any difference if the discussions were given to the public contemporarily.

After all, we have all the material necessary right now without the audit by which to burn the Fed to the ground. The transcripts from both 2008 and 2011 (as well as a good many in the years before and in between) show without any doubt or reservation that the FOMC has no idea what it is doing. That is true when comes to the economy, but more so and more importantly as it relates to the central bank’s primary task of money. Again, we can state unequivocally right at this very moment that the Fed doesn’t know from money. We can further state the consequences of that very dereliction in the same unambiguous terms, and do so, as I did earlier, using Ben Bernanke’s own words:

Countries on the gold standard were often forced to contract their money supplies because of policy developments in other countries, not because of domestic events. The fact that these contractions in money supplies were invariably followed by declines in output and prices suggests that money was more a cause than an effect of the economic collapse in those countries.

As I wrote in another context, simply swap “eurodollar” for “gold” and “offshore” for “in other countries” and the whole last decade is an open and shut matter, which is a particular problem because Economists like Bernanke were supposed to know everything about panics and depressions and we got both anyway. The transcripts already published to this point establish beyond all doubt culpability in both allowing it to happen and then doing nothing productive while it did. There is a reason we have lost and wasted a decade already, and Americans by and large know it without need of further statute.

So what good is it to make Janet Yellen’s “rate hike” discussions in 2017 available to us now? As I wrote in the aftermath of Trump’s election:

It’s not that I disagree with the audit as an idea, I just think it is the wrong direction to take. The problem with the Fed isn’t that it is a central bank that does central bank things, rather the problem is central bankers. It would probably be somewhat helpful to uncover what transactions went to whom and when, but if we are to audit the Fed the investigation should be focused on Janet Yellen and Ben Bernanke (and Alan Greenspan), not what specific orders were given by them to the Open Market Desk by CUSIP.
It is getting lost in details unnecessarily. There is no missing money smoking gun with which to prove beyond all doubt the Fed is a fraud. There isn’t any money there at all, which is precisely the problem. The money went missing in the 1970’s and it was central bankers like Alan Greenspan who claimed that it didn’t matter even though deep down he suspected all along that it did.

What is lacking today as well as the past few decades is not further transparency but the actual physical and political courage to use what we already know and what already has been corroborated. There is an enormous volume of the Members’ own words by which to do just that. We don’t need Fed discussions opened up to easily surmise that all of them over the past especially three years have centered around the words “we don’t know”, “we have no idea”, and “maybe it will be just transitory.”

The whole regime has to be purged not just from government agencies but rather from the public at large. For decades now the central bank has been given a pedestal it simply doesn’t now, nor ever did, deserve. It was a political shortcut convenient to both parties as a means to avoid answering uncomfortable economic and financial questions (particularly asset bubbles). I strongly suspect that more than anything that is why they have endured far longer than would otherwise be reasonable in a reasonable paradigm.

Continue reading What the World Needs Now

The Problem is a Single Central Bank, Not a Single Currency

By Steve Saville

Economically and politically disparate countries throughout the world successfully used a common currency for centuries

The euro-zone appears to be on target for another banking crisis during 2017. Also, the stage is set for political upheaval in some European countries, a general worsening of economic conditions throughout Europe and widening of the already-large gaps between the performances of the relatively-strong and relatively-weak European economies. It’s a virtual certainty that as was the case in reaction to earlier crises/recessions, blame for the bad situation will wrongly be heaped on Europe’s experiment with a common currency.

The idea that economically and/or politically disparate countries can’t use a common currency without sowing the seeds for major problems is just plain silly. It is loosely based on the fallacy that economic problems can be solved by currency depreciation. According to this line of thinking, countries such as Italy and Greece could recover if only they were using a currency that they could devalue at will. (Note: The destructiveness of the currency devaluation ‘solution’ was covered in a previous blog post.)

The fact is that economically and politically disparate countries throughout the world successfully used a common currency for centuries up to quite recently (in the grand scheme of things). The currency was called gold.

The problem isn’t the euro; it’s the European Central Bank (ECB). To put it another way, the problem isn’t that a bunch of different countries are using a common currency; it’s that a central planning agency is attempting to impose the same monetary policy across a bunch of different countries.

A central planning agency imposing monetary policy within a single country is bad enough, in that it generates false price signals, foments investment bubbles that inevitably end painfully, and reduces the rate of long-term economic progress. The Federal Reserve, for example, has wreaked havoc in the US over the past 15 years, first setting the scene for the collapse of 2007-2009 and then both getting in the way of a genuine recovery and setting the scene for the next collapse. However, when monetary policy (the combination of interest-rate and money-supply manipulations) is implemented across several economically-diverse countries, the resulting imbalances grow and become troublesome more quickly. That’s why Europe is destined to suffer a monetary collapse well ahead of the US.

It should be kept in mind that money is supposed to be neutral — a medium of exchange and a yardstick, not a tool for economic manipulation. It is inherently no more problematic for totally disparate countries to use a common currency than it is for totally disparate countries to use common measures of length or weight. On the contrary, a common currency makes international trading and investing more efficient. In particular, eliminating foreign-exchange commissions, hedging costs and the losses that are incurred due to unpredictable exchange-rate fluctuations would free-up resources that could be put to more productive uses.

In conclusion, the problem is the central planning of money and interest rates, not the fact that different countries use the same money. It’s a problem that exists everywhere; it’s just that it is more obvious in the euro-zone.

The Upshot of Inflationism

By Doug Noland

Credit Bubble Bulletin: The Upshot of Inflationism

As a determined analyst, I’m as committed as ever to remaining “fiercely independent.” This must at least partially explain why I’ve tended to consider myself politically “independent.” Political party ideologies undoubtedly engender biases and compromise objectivity. With the two major parties now in such a muddle, an “independent” affiliation almost wins by default. I recall years ago when I was first introduced to the notion of “the evil party and the stupid party” in a discussion about our two-party system. That conversation doesn’t seem as deeply cynical these days.

I’m left to daydream of a party committed to a smaller and less obtrusive federal government, strong national defense, fiscal responsibility, social tolerance and attentiveness to the environment. It doesn’t seem all that outlandish. Yet there’s one more thing – perhaps the most vital of all: I aspire to be associated with a political movement committed to sound money and Credit. Why all the clamor over guns when unbridled finance is so much more destructive?

This election cycle has been a national disgrace. It finally comes to an end Tuesday, when a deeply divided nation heads to the polls. I recall having a tinge of hope eight years ago that there was a commitment to more inter-party cooperation and less partisan vitriol. There’s not even lip service this time around. As an optimist, I would like to believe that a period of healing commences Wednesday. The analyst inside knows things will continue to worsen before they get better.

Our nation and the world are paying a very heavy price for a failed experiment in Inflationism. At this point, economic stagnation, wealth redistribution and inequality, financial insecurity and corruption are rather obvious consequences. “Money” and Credit have inflated, right along with government, securities markets, financial institutions, corporate influence and greed.

Along the way, there have been many subtle effects. To this day the majority still cling to the view that central bankers are essential to the solution – rather than the problem. But they are at the very root of disturbing national and international, economic, financial, societal and geopolitical degeneration.

For close to 30 years now, central bank policies have nurtured serial inflationary booms and busts. It’s a backdrop that has repeatedly forced investors, homebuyers and others into serious harm’s way. Buy or you’ll be left behind. Get aboard before it’s too late. It’s a system that systematically targets the unsophisticated and less affluent to take on a tenuous debt position to buy homes, cars and things in the name of promoting economic growth. It’s a system that devalues the wealth of savers. Somehow it’s regressed into a system with a policy objective to coerce savers and the risk averse, to ensure their buying power instead inflates the value of risky securities market assets.

We’re witnessing the repercussions of a prolonged bad cycle of playing with society’s psyche: inflating untenable expectations, only to see them crushed by the fist of bursting Bubbles. Central bankers then simply press on to the more egregious extremes necessary to reflate expectations. Apparently, big corporate “media” has been fine with all of this. Indeed, the “media” have been instrumental to Washington and Wall Street propaganda campaigns.

Continue reading The Upshot of Inflationism

What is/isn’t a Risk to the Global Economy

By Steve Saville

The real economic threat posed by derivatives is that when there is a blow-up the central banks and governments will swing into action

This post is an excerpt from a recent TSI commentary.

Quantitative Easing (QE) is a risk. Negative Interest Rate Policy (NIRP) is a big risk. Governments using the threat of terrorism as an excuse to dramatically increase their own powers and reduce individual freedom is a huge risk. X hundred trillion dollars of notional derivative value is meaningless.

The hundreds of trillions of dollars of notional derivative value and the associated counterparty risk is a potential life-threatening problem for some of the major banks, but if you believe that derivatives are like a sword of Damocles hanging over the global economy then you’ve swallowed the propaganda hook, line and sinker. The claim during 2008-2009 that the major banks had to be bailed out to prevent a broad-based economic collapse was a lie and it will be a lie when it re-emerges during the next financial crisis.

The global economy could easily handle JP Morgan, Goldman Sachs, Bank of America, Citigroup and Deutsche Bank all going out of business. The shareholders of these companies would suffer 100% losses on their investments, the bondholders of these companies would suffer substantial ‘haircuts’, most employees in the investment-banking and proprietary-trading parts of these companies would lose their jobs, but it’s unlikely that depositors would be adversely affected as the basic banking businesses would simply come under new management. Furthermore, while there would be short-term disruption, Apple would continue to sell loads of iPhones, Exxon-Mobil would continue to sell loads of oil, Toyota would continue to sell loads of cars, and both Walmart and Amazon would continue to sell loads of everything. Life would go on and in less than 12 months most people would not notice that some of history’s banking behemoths had departed the scene.

The real economic threat posed by derivatives is that when there is a blow-up the central banks and governments will swing into action in an effort to keep the major banks afloat. Rather than doing nothing other than ensuring that there is a smooth transfer of ownership for the basic banking (deposit-taking/loan-making) parts of the businesses, we will likely get a lot more of the policies that transfer wealth from the rest of the economy to the banks. That is, we will get a lot more price-distorting QE and programs similar to TARP.

The justification will be that saving the banks is key to saving the economy, but in reality the biggest threat to the economy will come from the policies put in place to save the banks.

Monetary Mountain Madness

By John Mauldin

Turns out, the academic and philosophical underpinnings were laid down there [Jackson Hole] for a radical expansion of the Federal Reserve’s toolbox

“Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”  – John Maynard Keynes

Scientific research says that leaving your normal environment can stoke creativity. This is one reason organizations send managers and workers to off-site retreats and conferences. “Getting away from it all” seems to lubricate our brains.

You would think the effect might have been observable among the central bankers who attended the Federal Reserve’s recent Jackson Hole, Wyoming, retreat. Sadly, however, having reviewed the speeches and the interviews that came out of the gathering, I found few if any fresh ideas, or at least none that would truly be helpful. Even the calls for “reformed thinking” turned out to be just variations on the same old thinking. For instance, rather than targeting inflation at 2%, why can we not think about 4% inflation? Instead of worrying about GDP, couldn’t we worry about nominal GDP? As if such minor variations on old themes would make any real difference to employment or growth.

Indeed, what was revealed in the papers and discussions and then in the interviews that followed the conference alarmed me and in some cases truly outraged me to the point that I was spitting epithets. When the dust settled, I was left with a profound sense of sadness over our global economic leadership’s obvious lack of understanding of the real world.

Jackson Hole revealed things that did not make it into the reporting of the event by the mainstream media. Turns out, the academic and philosophical underpinnings were laid down there for a radical expansion of the Federal Reserve’s toolbox. I guess you could call that creative, but I wouldn’t call it helpful, because the unthinkable policy that I have been warning about since last May – yes, we’re talking negative rates – was not only discussed at Jackson Hole, it was discussed in a positive, even slavishly approving, manner. I am going to share with you my sense of what happened at Jackson Hole and what it really means. I trust that by the end of this letter you will better understand just how bankrupt – and disastrous – what passes for sound economic thinking among the world’s central bankers actually is.

Putting Investors Before Savers

It is hard to know where to start, so let us start with what was most outrageous, an interview that had me muttering multiple expletive deleteds.

Last week Tom Keene of Bloomberg Radio interviewed Fed Vice Chair Stanley Fischer. (Tom is one of my favorite media personalities, because he asks the best questions and helps you say what you really want to say. You have to be careful, though, because Tom will also give you enough rope to hang yourself. When you are sitting with Tom Keene, you need to bring your A game, which is why he’s so popular.) Dennis Gartman transcribed part of the Fischer interview in his Aug. 31 letter. Here it is, with some bold emphasis added.

MR. KEENE: What did you learn about negative rates in the crucible of the markets? What have you learned in the last number of months?

Continue reading Monetary Mountain Madness