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Authored by Brooks Ritchey – MD, K2 Advisors – via Beyond Bulls and Bears blog,

What do quantum mechanics and the theory of relativity have to do with global central bank policy? Years of aggressive central bank policies haven’t resulted in the type of accelerated global growth one might expect, so Brooks Ritchey, Senior Managing Director at K2 Advisors, Franklin Templeton Solutions, wonders if there is an alternate universe where that is in fact the case. He breaks down the role of monetary and fiscal policy in generating growth, and what investors need to think about when such policies aren’t delivering it.

The current and prevalent view among some modern theoretical physicists is that our universe is not the only universe, but rather there are many parallel or multi-verses that likely exist alongside or in tandem to ours. In the book The Hidden Reality: Parallel Universes and the Deep Laws of the Cosmos, author and physicist Brian Greene makes a compelling case for this remarkable possibility. Greene describes that “the mathematics underlying quantum mechanics … suggests that all possible outcomes happen, each inhabiting its own separate universe. If a quantum calculation predicts that a particle might be here, or it might be there, then in one universe it is here and in another it is there. And in each such universe, there’s a copy of you witnessing one or the other outcome, thinking—incorrectly—that your reality is the only reality. When you realize that quantum mechanics underlies all physical processes, from the fusing of atoms in the sun to the neural firings that constitute the stuff of thought, the far-reaching implications of the proposal become apparent. It says that there’s no such thing as a road untraveled.”

Bizarre. Greene goes on to describe that in addition to quantum theory, cosmological theory supports this freaky notion as well.

So what purpose the Cliff Notes lesson in theoretical quantum physics? It suggests that there could be a universe, maybe multiple among the multi-verses, where the outcome to all of the central banks’ quantitative easing efforts post-2008 has been sustained growth. One where the Federal Reserve’s (Fed’s) Keynesian plan has worked accordingly, GDP growth is firmly and organically established, and everyone is living happily ever after. Just next to that universe there may be another in which qantitative easing (QE) also worked to jump start the economy, but then an asteroid smashed into the Northern Plains of North America and all of humanity was destroyed—truly unsettling. Fortunately for us there has been no asteroid, however growth has not yet taken hold either—and that is decidedly unfortunate.

The Universe of Economic Growth—or Lack Thereof

According to statistics from the International Monetary Fund, the G20 in aggregate appeared to be growing at a respectable 3% in 2013, but when examining the developed world’s portion of that data, the “reality” that emerges is much less optimistic. The European Union (EU) grew 0.1% in 2013 and looks to be on a similar trajectory this year. The United Kingdom and United States saw growth of 1.7% and 2.2% respectively in 2013. Growth in France was near 0% and this year France, along with Japan and Germany, could be flirting with possible recessions.

Putting these statistics into perspective, despite the developed world having engaged in what is likely the most comprehensive monetary stimulation effort of the last 200 years, growth can best be described as middling. Without the fortunate shale revolution in the Northern Plains of the United States (and thankfully not the asteroid) growth there likely would be much lower, probably not much ahead of Europe today.

The good news about the universe in which we find ourselves, at least according to Modern Portfolio Theory, is that a truly diversified portfolio of uncorrelated and negatively correlated strategies/assets is still of value, in our view. Unsustainable fiscal and monetary imbalances often leave in their wake alpha capture potential—alpha being a measure of performance on a risk-adjusted basis—so we’ve got that going for us. The bad news is that there is no easy solution to the many problems and structural headwinds the developed economies of the world face, and without change I think our global economy could likely remain stuck in a long gray plod of disappointing economic growth for who knows how long … infinity???

Two Schools of Thought

Before we imagine a universe that provides a path out of this economic quagmire, let’s take a closer look at what got us here in the first place.

The arguments for QE and against QE can for the most part be distilled down to two very distinct schools of economic thought; schools that have served as the framework for the majority of modern economic and market theory taught in academia today. On one side we have Keynesian economics, theory based on the ideas of British economist John Maynard Keynes. On the other we have Austrian economics, based on the ideas of a collection of academics—some of whom were originally citizens of Austria-Hungary (no surprise). At the risk of over-simplifying what are without doubt two extremely deep and detailed theories, to help structure our discussion I thought I would attempt to summarize each:

Keynesian Economics

 

In the simplest of terms (and we do mean simple), Keynesians argue that private sector business decisions may sometimes lead to inefficient outcomes, and therefore government intervention is occasionally needed to step in with active monetary policy actions. These actions may be coordinated by a central bank. Generally, the Keynesian view believes that spending is what drives economic growth, and that deficit spending in a recession can be offset via fiscal surpluses in an expansion (and therein lay the rub).

 

Simplifying even further, let’s consider Keynesian to be “the school of short-term economic planning.”

 

Austrian Economics

 

Austrian theory on the other hand argues for very limited government intervention in the economy, particularly in the area of money production. Indeed, the Austrian school believes that central bank manipulation of economic cycles with artificial stimulus does more long-term harm than good, ultimately creating bubbles and recessions that are far worse than would be experienced in a natural economic cycle. This then would be “the longer-term school.”

Who’s Right?

To summarize, the Austrian school suggests that markets are self-correcting mechanisms that follow fairly smooth cycles, and that it is better to let nature run its long-term course (so to speak) as opposed to intervening when things may be less than optimal (i.e., recession). Keynesians on the other hand believe economic cycles can be smoothed with tactical short-term government monetary intervention, and that fiscal policy may be modified occasionally to better guide market cycles. So which view is correct? Is it better to ease aggressively—and then ease some more when things are still not improved, or should the Fed simply remain on the sidelines and let the markets sort themselves out on their own? As they say, there are two sides to every story—and then there is the truth. Put differently, we do not live in an “either-or” world (or should not anyway), and the optimal application of economic theory?in my humble opinion of course—probably lies somewhere in the middle of these two diametrically opposed views. Perhaps in some universe out there this utopian equilibrium has been established, but clearly not in ours—at least not yet.

In practice, Keynesian thinking has generally guided most of the Fed’s policy decisions post-World War II, and has certainly been front and center in the aftermath of the 2008 Lehman Brothers bankruptcy. Most would agree that the exceptional measures introduced by central banks around the world at that time – most decidedly Keynesian in nature – could be deemed appropriate in that they succeeded in restoring financial stability, while also preventing a full-blown global depression.

Subsequently, as the financial system stabilized, the justification for further QE became more rooted in the belief that such policies were again required to restore aggregate demand, particularly after the sharp economic downturn in 2009.

With each successive round of easing, however, the effectiveness of such policies in stimulating sustained growth is increasingly questioned, while the potential for longer-term negative consequences increases. Murmurs from the Austrian table in the back of the room begin to resonate.

So here we are with a global economics engine that has never really fully kicked back in, despite QE’s one through three, and now the policies of Japan’s Shinzo Abe and the ECB’s Mario Draghi dubbed “Abenomics” and “Draghinomics.” Where does it all end?

Armchair Quarterbacking

I do not presume to know more than those running the Fed in terms of economic policy making, however this of course does not preclude me from offering opinions on the matter.

While monetary weapons can be a good first step to remedying an economic crisis, they are clearly not enough on a standalone basis to return an economy to stability and growth. Monetary medicine cannot heal fiscal ailments in the areas of budgeting, regulation, taxation and related policies. To return any economy to stable and organic growth the aforementioned fiscal roadblocks need to be addressed—sounds Austrian I know (more likely I’m somewhere in the middle).

My concern is that there has been an almost total academic capture of the mechanism of the Fed and other central banks around the world by neo-Keynesian thinking and hence policymaking, while the executive and legislative branches of the government have turned a blind eye to the necessary reforms.

So while the plan has thus far worked brilliantly for Wall Street, what central bankers have succeeded in doing is preventing, or at least postponing, the hard choices and legislative actions necessary by our politicians to fully implement a sustainable and prosperous future for our children—and theirs.

When I allow my thoughts to run in these directions it can naturally be distressing at times. I remind myself then that I can only focus on the variables in my life that I can control, and among those are investment portfolio positioning. I often use a vehicle metaphor when discussing markets with friends and colleagues. When things are “risk-on” it is okay to take the red convertible sports car for a lively jaunt. When things are “risk-off” perhaps the solid sedan is a better option.

Today I view the world as “risk-uncertain,” and in these instances I recommend the armored vehicle. That is a suitably diversified portfolio of alternative strategies, one that is focused on capital preservation and non-directionally driven market gains through strategic and tactical strategy allocations.

Alternative investments cover a varied set of asset classes and strategies that go beyond traditional stocks and bonds. Alternative investment asset classes include real estate, real assets (e.g., commodities, infrastructure) and private equity, while alternative strategies primarily consist of hedge strategies, including use of derivatives. Hedge strategies typically have the ability to utilize short positions (i.e., seeking to profit on a decline in value of an individual security or index) in contrast to traditional mutual fund strategies which typically permit only long positions.

I believe the prudence of such an approach to investment management is underscored given the current environment. That is unless you find a way into another universe.

via Zero Hedge http://ift.tt/1wzSjz6 Tyler Durden

Take precautions…

Source: Cagle via Sunday Funnies

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Submitted by Jim Quinn of The Burning Platform

Christmas In October – Desperate Measures

The desperation of retailers grows by the day. I head to Wal-Mart and Giant in Harleysville every Sunday morning at 7:00 am. to do my weekly grocery shopping. I go to Wal-Mart at opening to avoid the freaks we see weekly on the People of Wal-Mart post. The workers at Wal-Mart are only a small step above the customers. They can barely communicate, rarely look you in the eye, and generally act like they are prisoners in an asylum.

I’m in winter/bad times ahead prep mode. I had a load of fire wood delivered yesterday which I wheelbarrowed to the back yard and stacked with my already decent sized stack. Last week I took an empty propane canister back to Wal-Mart to replace it with a full canister. That would give me three full propane tanks. I left the empty tank outside next to the propane cage and went in to pay. The old lady cashier with the gravelly smoker voice told me she would call for someone to get me a new tank.

I went over the cage and patiently waited for a Wal-Mart drone to come out, unlock the propane cage and give me a full tank. Two minutes, five minutes, and eventually ten minutes go by with no one coming out to help me. The cashier pokes her head out the door and shrugs her shoulders and says no one is responding to her calls. What a well oiled machine they have at Wal-Mart. Eventually the old lady abandoned her cashier post and in a painstakingly slow manner proceeded to unlock one bin after another until she found a full tank. I’m sure a line of unhappy customers were piling up at the only register in the garden center while she spent ten minutes getting me my propane tank.

A transaction that should have taken five minutes from start to finish ended up taking closer to twenty five minutes, with another five or six customers also dissatisfied with their extra long wait. This is a perfect example of how not to do business. Maybe Wal-Mart’s problems are bigger than households having less to spend. They are attempting to maintain their profit margins by reducing staff hours, hiring low quality people, and paying them shit wages. In the short run it may keep profits higher, but in the long-run customers will go elsewhere. Except most of the elsewhere stores closed up years ago when Wal-Mart arrived and underpriced them into bankruptcy.

My shopping experience at Giant is generally pleasant. The staff are nice, competent, and have been there for years. They know what they are doing and serve you with a smile. But their store is part of a worldwide conglomerate, so things have changed for the worse over the last four months. They renovated the entire store, creating bigger aisles and moving stuff around. That’s annoying, but after a while you figure out where they moved the stuff you want. The real negative change was the dreaded “Everyday Low Pricing”. This weasel phrase means you will be paying more. This is what the Apple idiot CEO – Ron Johnson – did at JC Penney. It put them on a rapid path to bankruptcy.

The weekly sale items at Giant have virtually disappeared. This has coincided with the drastic increase in beef, pork and fresh produce prices. Since “Every Day Low Pricing” went into affect our weekly grocery bill has gone up 20%. And I am buying far less beef and more chicken. In the past I would stock up on sale items and put beef, pork and whatever was on sale in our storage area freezer. Now I am stuck buying what we need that week. No bargains, just fully priced food items. Be forewarned, whenever you see a store announce “Everyday Low Pricing” you are getting screwed.

The Boos Begin in August & Bells Start Jingling in October

The desperation of Wal-Mart and most of the other mega-retail chains is no more clearly evident than in their relentlessly ridiculous acceleration of holiday marketing displays. I was flabbergasted when I saw Halloween candy, decorations and costumes in row after row BEFORE Labor Day at my local Wal-Mart. Selling Halloween candy two months before Halloween is idiotic and a sure sign of desperation. Retailers have run out of merchandising ideas. I wouldn’t even consider buying Halloween candy until the week before Halloween. Do Wal-Mart freaks of the week actually buy Halloween merchandise in September?

Holidays used to be special occasions that lent a sense of sales urgency for retailers for a week or two, to pump up sales. Now Wal-Mart and the rest of the dying retailers have Christmas, Easter, Fourth of July, and Halloween displays up for 80% of the year. There is no sense of urgency to buy. From September 1 though October 31 there are rows and rows of bags of corporate produced chemicals disguised as candy. I suppose the obese masses buy this crap in anticipation of Halloween, tell themselves they’ll only take one, and then shovel the entire bag down their gullets.

So last week, still a full two weeks before Halloween, Wal-Mart had already converted their entire garden center into a Christmas wonderland of cheap mass produced Chinese cookie cutter Christmas decorations and lights that will blow out after three hours of use. They had also converted aisles at the front of the store to Christmas displays. Who the hell shops for Christmas crap in October? There is nothing like having cheap Chinese Christmas crap available for over two months to create a sense of urgency to buy. Wal-Mart and the rest of the mega-retailers have got nothin. They have no original merchandising ideas. They don’t even try anymore. They source low quality goods from China and compete solely on price. I can’t wait for the Easter candy to appear on Wal-Mart’s shelves in late December.

Black Thanksgiving

Black Friday is dead. Long live Black Thanksgiving. The riots and stampedes by the ignorant masses for toasters and HDTVs on Black Friday are now being replaced by retailers and malls across America opening at 6:00 pm on Thanksgiving. It actually seems fitting. How better to give thanks for our mass consumption, debt financed, materialistic, iGadget addicted society than to open stores on Thanksgiving. Spending time with family is overrated anyway. If you had to spend six hours with cousin Eddie and aunt Bethany, you’d be looking forward to an early opening at Macy’s.

The bullshit message from the mega-retailers is: “We’re not opening on Thanksgiving out of desperation or greed. We’re doing it simply to satisfy the demands of our customers”. It’s a racist national holiday anyway. We should be going to an Indian run casino on Thanksgiving to make up for our past sins. Opening stores and forcing workers to work on Thanksgiving is pathetic, disgusting and a truly desperate measure in this consumer empire in decline. The law of diminishing returns has been invoked upon the mega-retailers that dominate our suburban sprawl paradise.

These retailers can start holiday merchandising three months before the actual holiday. They can open their doors on Thanksgiving, Easter and Christmas. It’s nothing more than shuffling the deck furniture on the Titanic. We’ve allowed bankers, politicians and corporate titans to financialize our economy, gutting the once thriving middle class, sending manufacturing jobs overseas, and convincing the clueless masses that consumer goods purchased with debt is equal to wealth. But, we’ve reached the point of no return. There are 248 million working age Americans and 102 million of them are not employed. Of the 146 million working Americans, 82 million of them make less than $30,000 per year.

While retailers have added billions of square feet since 1989, real median net worth is 5% lower over 24 years. Retailers are attempting to get blood from a stone. The stone is in debt, approaching retirement with no savings and dead broke.

We have one entity that deserves the most credit for destroying the American Dream. Real median household income is lower than it was in 1989. The 2008 collapse was caused by the easy money bubble machine at the Federal Reserve. We had the opportunity to hit the reset button, implement rational economic and monetary policies, take our lumps, and make the banking culprits pay for their crimes. Instead, the easily manipulated masses believed the Wall Street storyline and allowed the Federal Reserve and feckless politicians to save the banking cabal with extreme money printing and debt creation. This has pushed the middle class closer to the breaking point, while further enriching the oligarchs. The Federal Reserve saved their owners and lured the masses further into debt.

The Fed, Wall Street, and Washington DC have successfully driven consumer debt to an all-time high, blasting through the $3 trillion level. Declining real incomes and rising debt are a sure recipe for success.

Our entire economic paradigm is built upon desperate measures. Zero interest rates, $3 trillion of QE, systematic accounting fraud, fudged economic data, and doling out subprime loans to auto renters and University of Phoenix wannabes have failed to revive our moribund economy. Delusions don’t die easily. But they do die. We are reaching the limit of this delusionary dream built upon debt, denial, and deception. Make sure you wolf down that Thanksgiving feast before 5:00 pm. There are HDTV’s to fight for at 6:00 pm.

via Zero Hedge http://ift.tt/1oKTH2Z Tyler Durden

via Zero Hedge http://ift.tt/1nGUcdI Marc To Market

As was leaked on Friday, when the market surged on news that some 25 banks would fail the ECB’s third stress test (because in the New Normal more bank failures means more bailouts, means the richer get richest, means more wealth inequality), so moments ago the ECB reported that, indeed, some 25 banks failed the European Central Bank’s third attempt at collective confidence building and redrawing of a reality in which there is about €1 trillion in European NPLs, also known as the stress test.

The ECB’s results as summarized by the central bank:

• Capital shortfall of €25 billion detected at 25 participant banks
• Banks’ asset values need to be adjusted by €48 billion, €37 billion of which did not generate capital shortfall
• Shortfall of €25 billion and asset value adjustment of €37 billion implies overall impact of €62 billion on banks
• Additional €136 billion found in non-performing exposures
• Adverse stress scenario would deplete banks’ capital by €263 billion, reducing median CET1 ratio by 4 percentage points from 12.4% to 8.3%

The central bank’s punchline: “[the] Exercise delivers high level of transparency, consistency and equal treatment. Rigorous exercise is milestone for the Single Supervisory Mechanism starting in November.”

And this is what it’s all about from Vítor Constâncio, Vice-President of the ECB. “This unprecedented in-depth review of the largest banks’ positions will boost public confidence in the banking sector. By identifying problems and risks, it will help repair balance sheets and make the banks more resilient and robust. This should facilitate more lending in Europe, which will help economic growth.” Or, as Bloomberg called it, “The ECB has staked its reputation on Monday’s stress test results“… what reputation?

As for the 25 bank failures in question, they are shown below, with failures concentrated among Italian banks, with nine banks unable to “pass”, and Greek and Cypriot banks, with three apiece. Among the largest is Banca Monte dei Paschi di Siena, Italy’s third-largest lender, which faces an outstanding capital hole of about €2.1 billion. While the ECB would have loved to have Monte Paschi pass, the bank has been far too many times near death to credibly squeak by on whatever “reality-bending” terms.

Amusingly, some 18 months after the entire Cypriot financial system collapsed and the country’s banks had to be bailed in, the Bank of Cyprus which failed the test as per the above, said it passes ECB stress test assessment following its EU1b share capital increase.

“The positive result of the Comprehensive Assessment reaffirms the solid capital position of the Bank, even under the most extreme, severe theoretical stress conditions. It also reflects the pro-activeness of the Group in raising adequate capital in advance of the Comprehensive Assessment”: Dr Christis Hassapis, BOC Chairman says in statement.

Remember: confidence… confidence…. confidence…

Some quick observations: not a single major bank failed the stress test and the cumulative capital shortfall among the 25 failures is precisely €25 billion, less than the €27 billion shortfall reported during the 2011 stress test when 20 banks failed, and when Banco Espirito Santo, Dexia and Bankia all passed with flying colors. Oh, and just in case it was lost the first time, the Bank of Cyprus supposedly passed.

According to the WSJ, the number of failures, and the depth of the cumulative capital shortfall, was slightly larger than what analysts and investors expected European regulators to identify during their “stress tests” of 150 of the continent’s leading banks.

The ECB said the banks that failed have taken steps this year to substantially boost their capital buffers. Twelve of the 25 failing banks already have covered their capital shortfalls, raising a collective €15 billion this year. That leaves another €9.5 billion that banks still need to come up with.

 

Banks that received failing marks, and which haven’t already filled their capital holes, now have two weeks to explain to regulators how they plan to overcome the deficits.

 

As part of the exercise, the ECB also reviewed the quality of bank assets to determine whether they were accurately valued. That process resulted in banks being forced to reduce the value of their assets by a total of €48 billion, the ECB said. The central bank also identified a total of €136 billion of troubled assets, known as non-performing exposures, sitting on the balance sheets of the eurozone banks.

More amusing, among the banks that failed, one after another are already lining up to comment that they already are “fixed.” Some examples:

• BCP Says No Need to Plan Capital Increase, Forced Asset Sales. The board is confident that measures already decided in 2014 fully cover the capital shortfall resulting from the adverse scenario of ECB’s stress test, Banco Comercial Portugues says in regulatory filing. So nothing more has to be done.
• Muenchener Hyp has aggregated capital shortfall for the Comprehensive Assessment of 229 million euros. Muenchener Hyp raised 351 million euros of capital instruments eligible as CET1 capital in the year to Sept. 30. So nothing more has to be done.
• Caisse De Refinancement De L’Habitat had adjusted common equity Tier 1 ratio of 5.74% in the ECB’s asset quality review, versus a pass mark of 8%, the Bank of France says. CRH has already raised sufficient capital to make up the shortfall, Bank of France says.  CRH is case of “shortfall but cured,” Bank of France Governor Christian Noyer says. So nothing more has to be done.
• Polish lender Getin Noble says has already filled capital gap after tests. Getin Noble says needs no capital increase after AQR tests as it has already filled capital deficit shown in asset review tests, Chief Executive Officer Krzysztof Rosinski speaks with reporters by phone today. So nothing more has to be done.
• HSH Nordbank, the world’s largest maritime lender with EU20b shipping portfolio, has CET1 ratio of 6.1% in adverse scenario of ECB’s stress test vs pass mark of 5.5%. HSH says results boosted by guarantee provided by owners, states of Hamburg and Schleswig-Holstein, which was raised to EU10b from EU7b in 2013. So nothing more has to be done.
• Axa Bank has aggregated capital shortfall for the Comprehensive Assessment of EU200.2m, ECB says. Axa Bank raised EU135m of capital instruments eligible as CET1 Capital in the year to Sept. 30, ECB says. Axa Bank also issued EU90m contingent convertible notes to parent Axa, for total capital increase of EU225m, Axa says in separate e-mailed statement. So nothing more has to be done.

And the punchline: while the three Greek banks failed, they all passed… on a dynamic basis. In other words, if one excludes reality, and replaces it with this curious state known as dynamism, all is well. So nothing more has to be done.

So if none of the major banks were impacted, and if the vast majority of failures don’t have to do a thing, what was the point of the stress test? Here is WSJ’s take:

European officials say this year’s tests are the strictest yet. They were preceded by ECB officials combing through the balance sheets of 130 banks, trying to gauge whether they accurately valued loans and other investments and forcing some banks to write down problematic assets such as overdue mortgages and corporate loans.

 

European Union officials and economists hope the publication of the test results, as well as the release of more than 1 million financial data points about the banks, will improve confidence in the industry. That, in turn, should make it easier for banks to issue affordable loans to household and business customers, spurring much-needed economic growth.

Wait, the complete collapse in demand for bank loans in Europe (at least those loans that won’t soon be purchased by the ECB), is a function of banks not having confidence in each other? So all that was preventing Europe’s record unemployed consumers from levering up had everything to do with fear that their lender would go insolvent tomorrow and nothing with the youth having no employment prospects, and negligible income for everyone else? Got it.

And now with bank confidence all restored and stuff, watch as this chart of European loan creation goes vertical, right?

via Zero Hedge http://ift.tt/1oKDZVD Tyler Durden