Think back to the days before the 2008 credit crisis. At that point no one had any clue about the unbelievable amount of Central Bank balance sheet monetization ahead of us. Since then we have all become numb to the mind boggling numbers Central Banks have injected into the global financial system, but I don’t think this is a good development.
And even more scary than the sheer size of balance sheet expansion is the nonchalance that has greeted Central Bank purchases of other instruments such as equities.
Just for kicks I brought up the Swiss National Bank 13F American equity filings:
The SNB has $42 billion of US equities! 42 f’ng billion! That is crazy. And how much European equities do they own? And what about the other Central Banks? These are only the positions SNB is forced to divulge. It is not always laid out so neatly for us to see. What about all the derivatives?
Or what about the case of the Bank of Japan conveniently upping their JGB purchases at the same time the country’s biggest pension plan announced the monumental asset switch out of domestic bonds into foreign equities? Those equity positions don’t sit on the BoJ’s balance sheet, but they might as well. And don’t think BoJ doesn’t already own equities – they have been buying for years.
My suspicion is Central Banks own way more equities than most realize. To some extent, I understand why. Yields have gone to zero, and everyone is venturing out the risk curve. Why shouldn’t the Central Banks also?
As much as I crap all over the SNB’s equity holdings, have a look at the performance of the S&P 500 denominated in Swiss Francs:
US equities took a big dip in 2008. This was followed by a big rally, but aggressive American quantitative easing programs cheapened the US dollar to the point where, for foreign entities like the SNB, equity gains were given back through currency appreciation. This situation made US equities just as cheap for foreigners in the summer of 2011 as they were in 2008.
Faced with zero rates and the need to monetize their balance sheet, it is understandable how Central Banks drifted into the dangerous precedent of buying equities. Since then, equities have exploded higher, and fear has long left the Central Bankers. Yet they still continue to buy equities… Big time…
Although I understand how it came to this, I don’t agree with Central Banks buying equities. Eventually they will have to sell these positions. Distorting risk markets with Central Bank policy moves is not a good development.
Right now, my opinion is the minority. Stocks have been rising, and these moves by Central Banks appear to have lots of upside with little downside.
But here is something to think about. Investors are always worried about the last crisis happening again. After the 1987 crash, all everyone could do was imagine another 20% down day. Today the fear of 2008 repeating fills everyone’s head. To some extent this is the reason high yield credit is sucking wind. The moment investors get nervous, they lean on what went down last time. Although I am far from a fan, Carl Icahn’s self serving website is a perfect example of a typical hedge funds’ strategy of shorting high yield credit to protect against the next big surprise:
I don’t know much, but I know that the next big crisis will not look like the last one. That doesn’t mean there won’t be similar elements, but markets just don’t make the same big mistake so quickly afterwards.
Few investors are hedged for crises. If they were, there wouldn’t be a crisis.
So Carl Icahn’s website promoting his short high yield credit positions almost guarantees this will not be where the surprise comes from.
The more I think about the actions of these Central Banks, the more I am worried they are playing with fire. And I am not talking about inflation running a little hotter than they expect. I think there is a chance of something really wrong happening to their balance sheet.
Warren Buffett talks about how when the tide goes out you get to see who is swimming naked. Usually this is directed towards private sector entities.
My worry is we will find it is the Central Banks that have left their trunks on the beach.
The last time the Central Banks did some big asset shift was when they determined gold was a barbarous relic that had no place on their balance sheet. Many of them sold it. Of course that proved to be the low, and it steadily rose from $250 to $1900 in the ensuing decade.
What if Central Banks’ purchases of equities is just as ill timed?
My guess is that before this is all through, they are going to wish they could take a mulligan on both trades…
Thanks for reading,