Let’s begin with an excerpt from our August 2012 newsletter – In the classic movie Animal House, Dean Vernon Wormer emphatically announced Bluto Blutarski’s (John Belushi) GPA for his seventh year at Faber College, “Mr. Blutarsky….zero point zero.” To which John Belushi’s character, with a pair of pencils in his nostrils, just shrugged his shoulders. This seven year span is also coincidentally the duration Fed Chairman Ben Bernanke plans on keeping the fed funds rate at an equally impressive zero point zero since initiating that rate in December 2008.
The real story was last week as Ben Bernanke and his marketing team decided the prospect of QE4, 5, 6, or even 7 was just too much to communicate over the next few years. As a result, Ben launched QE3 in the form of QE∞; a commitment to purchase not only $40 billion of mortgage securities every month ad infinitum, but to continue Operation Twist to the tune of another $45 billion. Ben essentially decided that a nearly $3 trillion balance sheet was not enough to remedy our 8.1% unemployment rate and thought an unlimited commitment would be the answer. As a result, the chase for yield marches on. From dividend paying stocks, to bonds to REITs, anything that throws off a dividend is in huge demand. Zero point zero is a huge factor.
To explain the current environment from a behavioral perspective we cite Daniel Kahneman’s recent book, “Thinking Fast and Slow” where he discusses the idea of assessing normality and our reactions to surprises. What we found interesting was how, “Under some circumstances, passive expectations quickly turn active.” Whereby, “we found that we were distinctly less surprised on the second occasion than we had been on the first…Because the circumstances of the recurrence were the same, the second incident was sufficient to create an active expectation.”
So QE1 was shocking, QE2 a little less so, and the recent QE∞ merely expected. While this is the effect Ben is looking for the reality is risk remains; macroeconomic risk, geopolitical risk, regulation risk, interest rate risk, inflation risk, to name a few. The current prices are reflective of the “normality” we have grown accustomed to and our cumulative discounting of risks over the last four years. Unfortunately, zero point zero cannot continue unabated without repercussions.
In the same scene Dean Wormer described Mr. Dorfman’s GPA, “0.2…Fat, drunk and stupid is no way to go through life son.” We have said it before, the “have to buy mentality” and “relative to Treasuries” thought processes will work until they don’t. That is our best fat, drunk and stupid way of suggesting the normalcy we have grown accustomed to may not be so normal.
Yep. That was eight years ago and here we are today. The Fed is now printing $120 billion/month, saying interest rates will be 0.1% through at least 2023, forecasting benign inflation for those years all with a return to full employment without any bubbles anywhere. Kool-Aid baby!!!! Drink up!!! Ok. We recognize their efforts were warranted in 2008 and clearly necessary during the current pandemic. Unfortunately, virtually every day in between has been treated the same way as well. Governments have used that free pass to spend without restrictions and the Fed while attempting to raise rates a few years back has now realized they will likely never stop printing and/or raise rates for years.
So where’s the risk? After all when Chair Powell when asked about bubbles yesterday responded with amazing confidence, “…if you look at the long experience of the 10-year, 8-month expansion, the longest in our recorded history, it included an awful lot of quantitative easing and low rates for seven years. And I would say it was notable for the lack of the emergence of some sort of a financial bubble, a housing bubble or some kind of a bubble, the popping of which could threaten the expansion. That didn’t happen. And frankly, it hasn’t really happened around the world since then. That doesn’t mean that it won’t happen, and so, of course, it’s something that we monitor carefully.” To which our follow up questions would have been then why not print $1 trillion a month? Why do we pay taxes if printing unlimited amounts of money has no negative consequences? But we digress.
So which message is correct? IPOs trading at 100x sales and equity markets at all time highs or the need to keep rates at 0.0% and print money at a rate of $120 billion/month? Yesterday the Fed gave us their clear answer. Their highly passive approach prior to 2008 is now permanently active. Bubbles? Periodic market tantrums? Fundamentals? Moral hazard? Debt fueled buybacks in lieu of investment? Don’t bore us. After all, Chair Powell said everything has been ok. He also said “powerful” eleven times in an hour to describe his current actions. That’s right!!! Eleven “powerfuls”!!! Let’s go!!! Maybe it’s our contrarian view but anytime someone says “powerful” eleven times makes us both laugh and cry. Everything is fine…really.
Still, it seems to us that the Fed is finally recognizing the confidence game they have been propagating is waning. Could it wane for another eleven years? Our guess is we’re going to find out.