Friday, December 4, 2015

Are Martingale Casinos About To Go Bust?

Ellie Ismailidou of MarketWatch reports, Bill Gross thinks Fed, ECB are ‘casinos’ printing money:
Bill Gross has never hidden his dislike for central-bank stimulus. But in his latest investment outlook, the bond guru doubled down, calling central banks “casinos” that “print money as if they were manufacturing endless numbers of chips that they’ll never have to redeem.”

The billionaire bond investor has made the point before that record-low interest rates as a result of ultraloose monetary policy by central banks across the globe are distorting financial markets.

In his December investment outlook for Janus Capital Group Inc. released Thursday, Gross drew parallels between today's global monetary policy and a foolproof betting system known in gambling circles as the Martingale.

Martingale theorizes that if you lose one bet, you just double the next one to get back to even; but if you lose that one you do it again and again until you win.

“Given an endless pool of ‘chips’, the theory is nearly mathematically certain to succeed, and in today’s global monetary system, central bankers are doing just that,” Gross said.

“I used to call it ‘double up to catch up’ at my fraternity’s poker table where I was consistently frustrated (loser)—not because I used Martingale but because I wasn’t a good bluffer. Today’s central bankers use both tactics to their success—at least for now. They bluff or at least convince investors that they will keep interest rates low for extended periods of time and if that fails, they use Quantitative Easing with a Martingale flavor,” Gross wrote.

But this is bound to fail, he said.

“As gamblers know, there isn’t an endless stream of Martingale chips—even for central bankers acting in unison. One day the negative feedback loop on the real economy will halt the ascent of stock and bond prices, and investors will look around like Wile E. Coyote wondering how far is down,” Gross said.

As for investors, Gross warned that 2016 is a time to take risk off the table.

“Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money,” Gross wrote.

“Even Martingale casinos eventually fail. They may not run out of chips but like Atlantic City, the gamblers eventually go home, and their doors close,” he added.

Gross left Pacific Investment Management Co., or Pimco, last year in a cloud of acrimony, setting up shop at Janus where he runs the Janus Global Unconstrained Bond Fund. He’s subsequently struggled with a volatile performance and outflows.

In October Gross sued Pimco for at least $200 million for the damage that was done to his reputation in the year before and after he was fired from Pimco.

Last month, Pimco asked a California court to throw out the lawsuit saying the complaint is “legally groundless” and a “sad postscript” to a storied career.
Jennifer Ablan of Reuters also reports, Bill Gross urges investors to gradually de-risk portfolios:
Bill Gross, the closely watched bond investor, on Thursday said low interest rates are keeping alive "zombie corporations" that are unproductive and warned investors to de-risk portfolios into the new year.

Gross, who oversees the $1.4 billion Janus Global Unconstrained Bond Fund, has said since earlier this year that the U.S. central bank should raise interest rates to more normal levels as zero-bound levels are harming the real economy and destroying insurance company balance sheets and pension funds.

"The faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets," Gross wrote in his December Investment Outlook. "I would gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money."

Gross warned that the negative feedback loop from the real economy "will halt the ascent of stock and bond prices and investors will look around like Wile E. Coyote wondering how far is down." Wile E. Coyote, the famous cartoon character, was forever leaping across wide chasms in pursuit of the Road Runner, flying long distances in thin air, but then looking down and falling off a cliff.

Gross likens central banks to casinos. "They print money as if they were manufacturing endless numbers of chips that they'll never have to redeem. Actually a casino is an apt description for today's global monetary policy."

"Japan for years has doubled down on its Quantitative Easing and Mario Draghi's statement of several years past, 'Whatever it takes' – is a Martingale promise in disguise," Gross said. Martingale is a gambling system of continually doubling the stakes in the hope of an eventual win that must yield a net profit.

The "Martingale promise" vows to get the Euroland economy back to even and inflation up to 2.0 percent by increasing QE and the collateral it buys until the Euro currency declines, the euro zone economy improves and inflation approaches target, Gross said.

Artificially low interest rates have kept alive "zombie corporations that are unproductive" and destroy business models such as insurance companies and pension funds because yields are too low to pay promised benefits, Gross said. "They turn savers into financial eunuchs, unable to reproduce and grow their retirement funds to maintain expected future lifestyles."

Economists Kenneth Rogoff and Carmen Reinhart label this "financial repression," Gross said.
Indeed, as central banks try to save the world from a deflationary disaster, historic low rates have pretty much forced pensions, insurance companies and retirees to take on more risk to achieve their rate-of-return objective.

Ironically, and I think this is what Gross is arguing, all this risk-taking behavior isn't based on solid fundamentals but on chasing after yield at all cost which is doomed to end badly and usher in exactly what the Fed and other central banks are fighting against, namely, a prolonged period of global deflation.

Now that the U.S. economy added a solid 211,000 net new jobs in November, Bill Gross can breathe a little easier as most economists expect the Fed to start hiking rates in December. Interestingly, the big ECB disappointment on Thursday which sparked a selloff in U.S. and eurozone bonds was what led me to believe the Fed is now ready to go in December.

As I argued last month, the surging greenback was my main concern and it wasn't at all clear to me the Fed would start hiking rates in December as the U.S. dollar kept rising. Mario Draghi took the wind out of the greenback and Sober Look was absolutely right, the short euro trade was crowded and the euro was primed to rally if the ECB disappointed in its quantitative easing targets.

Of course, none of this really matters to me. I continue to recommend shorting the euro on any pop and think Mario Draghi's worst nightmare is now a step closer to becoming a reality. The Fed will raise rates but it's far from clear what the future path of rate hikes will look like given that inflation expectations in Europe and the U.S. remain very low.

In fact, have a look at the 5-year, 5-year forward inflation expectation rate courtesy of the St-Louis Fed (click on image):

This chart hardly bolsters the case for runaway inflation but if you ask Goldman, JP Morgan and Blackrock, inflation expectations remain 'unrealistically low' and the bond market has it all wrong.

In fact, some elite funds are preparing for reflation betting that higher inflation ahead will force the Fed to start hiking rates more aggressively next year. I'm not buying the runaway inflation scenario and willing to bet if the Fed makes the monumental mistake of lifting rates too aggressively to nip any perceived threat of inflation, long bond yields in the U.S. will plunge to record lows and deflation will spread to America.

One thing is for sure, there's still plenty of liquidity to propel risk assets much higher and central banks aren't running out of Martingale chips (never mind what Bill Gross and Ray Dalio think). Also, the divergence between the Fed and the ECB isn't as high as some perceive but there will be more global financial turbulence ahead which won't bode well for Japan's pension whale and other pensions increasingly moving to riskier assets to meet their obligations.

Having said this, should you follow Bill Gross's advice and de-risk your portfolios going into 2016? Nope, keep dancing for now as the music is still playing in the background. Just make sure you have the right dancing partner by your side and hold them a little tighter because when that deflation tsunami strikes, all bets are off at the Martingale casinos.

On that note, wish you all a great weekend and please remember to kindly subscribe or donate to my blog at the top right-hand side. The comments are free but that doesn't prevent any of you, especially institutional investors who regularly read me, from kindly donating and/ or subscribing to the blog. I thank those of you who have contributed and recognize and value the work that goes behind these comments.

Below, Bloomberg View's Mohamed El-Erian discusses the U.S. jobs report and Fed and ECB monetary policies. He speaks on "Bloomberg Markets."

Also, Bloomberg's Lisa Abramowicz and Michael McKee report on ECB and Fed policies. They speak on "Bloomberg Markets" and explain why Mario Draghi handed Janet Yellen a gift.

Third, on Friday in New York, ECB President Mario Draghi reversed course stating "there is no limit to its tools in regards to monetary policy," sending markets up. CNBC's Steve Liesman has the details.

Lastly, Ken Moelis, founder and CEO of Moelis and Company, explains why deflation trends are here to stay. "If we're in a technologically driven deflationary market, I think you'll see it last longer than people think. And that's why I think you'll see rates stay low for a long period of time," he said on CNBC's "Closing Bell."

No comments:

Post a Comment