I received a lot of great feedback regarding yesterday’s ECB quantitative easing piece. Instead of responding to them individually, I will sketch out my responses in the first half of today’s post.
One of my readers noted the lack of any relationship between the ECB balance sheet size and the performance of the DAX. For my chart I used the Eurostoxx 50, but the DAX is roughly the same.
I agree, by no means is there the same clean relationship like the Fed’s balance sheet and the S&P 500. In fact, you might even argue the ECB’s balance sheet size is slightly negatively correlated.
When the Federal Reserve embarked on QE, they did so under Bernanke’s leadership. Like it or not, you have to give Bernanke credit for never wavering. Methodically, he expanded the balance sheet, and although he did experiment with the rate of growth, Bernanke never threatened to reduce the balance sheet. He would stop a QE program, and then wait to see what happened. When the economy stalled, he would return with another new QE program. This continued until he finally found a formula that worked. The third QE program was unique in that it was open ended. Bernanke promised to continue expanding the balance sheet until the Fed achieved their goals.
I understand many investors’ view that after the initial crisis subsided, these extra programs were mistakes. I won’t bother arguing whether they were or they weren’t. As traders our job is not to figure what should be, but what is.
Let’s contrast Bernanke’s steadfastness with the ECB’s policies. During the initial onset of the crisis, the problem was viewed as an “American credit crisis” and the ECB was reluctant to expand their balance sheet aggressively. Therefore the first round of European QE was most likely smaller than it should have been. But after the most severe part of the crisis subsided, ECB Chairman Trichet, in a complete bonehead move, raised rates. Not just once, but twice! This ushered in the European Sovereign crisis. Within half a year the ECB was forced to aggressively expand their balance sheet to stop their union from collapsing. After a scary year, the ECB’s QE programs had done their job quelling the crisis. But instead of just leaving the balance sheet at this new elevated level (as the Federal Reserve had done), at the insistence of the Germans, the ECB allowed the expansion to roll off. This was another brain dead move. Once again an overly tight ECB caused deflation to firmly take root in Europe. Eventually the pain proved too much. The ECB caved and implemented the current QE program.
European quantitative easing programs have been slow, too small, and most importantly, always either withdrawn or continually threatened to be reversed. I am reminded of PIMCO’s Paul McCauley’s line that a Central Bank needs to be “responsibly irresponsible.” Well, the ECB has been the exact opposite. They think they are being prudent, but it’s like treading water holding an anchor. They are making their lives way harder than needed.
I don’t know if Draghi can emulate Bernanke’s “success.” I am not sure the Germans will let him. But at the very least, expanding their balance sheet and then leaving it alone will be a good start. I would argue these previous failures have necessitated a QE program that is much larger than it needed to be. I still believe all Central Banks will overshoot, not the other way round.
Another one of my readers commented about today’s economic environment being much different than when the Fed was engaged in QE:
Only point I’d add is that the Fed started QE when global growth was accelerating (or at least strong) and after the banks had taken their lumps and done a lot of capital raising. The ECB started QE when global growth is decelerating and the banks have yet to recognize all their losses…etc. This is all a bit simplistic but you get the idea: context/background is very different.
Let’s start with the second part of this point. The Americans were much better at recognizing their losses and “taking their lumps.” This is absolutely true. The Europeans are still hiding stuff in their banks. They did not have the required flush. Ultimately this is causing the velocity of money to collapse. Banks are simply unwilling to lend. The only response I have is this current TLTRO program will be a large transfer of wealth to the banks. Just like when Volcker skated all the banks onside during the Tequilla crisis by keeping the yield curve steep, the ECB is helping to recapitalize the banks with these aggressive policies.
The next part about the Fed starting QE when global growth was accelerating is tougher to counter. There is no doubt global growth has been slowing. The only comment I have is that I believe a lot of the recent slowdown was the direct result of the Federal Reserve’s overly zealous desire to tighten monetary policy. If the Fed can simply allow themselves to fall behind the curve a little, we might get an uptick in global growth.
Also, although the oil collapse has caused short term economic pain, in the long run, it is a huge tailwind at the back of the global economy.
I know everyone is bearish on global growth, but I am hopeful the worse is behind us. The ECB might still surprise us yet…
A VIX trade
My refusal to join the bear camp has frustrated a few of my readers. Although I understand their well founded arguments, I don’t think markets crash when bullish advisor readings are hitting all times lows. Nor have I ever seen hedge fund managers advertise record short positions right in front of severe market dislocations.
Recently, I was especially intrigued by the record amount of VIX ETF creations.
Whereas the author of this graph asked “Can this possibly end well?” with the idea the stock market will crash, I am more inclined to wonder if that many investors can successfully time an increase in stock market volatility. According to Tom McClennen the VIX ETF is a “double-contrary indicator” (not to be confused with double secret probation):
Maybe he is correct, I don’t know. Maybe all this bearishness, found both in retail and hedge fund managers alike, will prove to be the right bet. Maybe the global economy collapses as the doom and gloomers predict. Maybe Central Banks have hit the point where they can do no more, and it all comes crashing down. Maybe everyone will nail the next crash.
But I have rarely seen this happen. So when I look at the record VIX long bets, all I see is the potential to disappoint. The popularity of this trade has steepened the VIX futures curve:
Spot VIX is 14.50, yet August implied VIX is 19.25. The steepness of the curve means for VXX long holders to make money, VIX will not only have to rise, but it will have to rise more than the implied curve. Given the huge speculative long position, it doesn’t take much for me to imagine VIX falling to record lows this summer.
At this point I know a bunch of my readers are hitting delete. I get it, this is not a popular call. It’s much more sexy to talk about the coming collapse. And make no mistake, I understand the bear argument. Stocks are trading at levels that make no sense. Yet as I have repeated too many times, stupid stuff happens when you let Central Banks monetize their balance sheets against risk assets. Stocks at these levels make no less sense than German 10 year yields at 0.12%.
Yesterday I bought some VIX puts for this summer. I am way too chicken shit to actually short VIX, but I respect those with the stomach to put that trade on. If the VIX is merely unchanged, it is a 25% return. I bought some out of the money VIX puts on a flyer the world doesn’t end this summer, and these VXX holders puke it out during the summer doldrums.
Vancouver Real Estate
I asked one of my West Coast buddies for his opinion on Vancouver real estate. He sent me this great reply:
Our real estate is vastly over-valued. I have proof. I call it the locker room indicator. You’re a squash player so you are probably familiar with this indicator. When the squash boys, in the locker room or in the bar, after the game and a few beer, start talking investments, I lean in and listen closely. It is a topic that seldom comes up, but when it does, it is important. Squash players, as you know, are generally not the most sophisticated. They are awesome people, sincere, fit and a lot of other nice qualities. But not financially savvy. I remember back in 2000, everyone was buying tech and telecommunication stocks. “B2B” and “fiber optics” were phrases that became more common than “boast” and “backhand volley drop”. Everyone knew or owned Amazon, Nortel, 360, Juniper, sisco, Palm, etc. It was a fascinating conversation that lasted maybe 3 months. You know the rest….
Right now, the squash boys know, to a dollar, the current value of their own home, of my home, of the guy they played last week’s home, etc, etc. They also know, and this is a certainty, that Vancouver real estate will always go up. “Always”. That is a quote. The shitty neighbourhoods will go up 8% and the good neighbourhoods will go up 11%. Every year. Just ask ‘em.
Chinese buying is definitely a factor here. Chinese (mainland, it used to be Hong Kong back in the 80s) are moving money out of the country. They do not always move in to the houses they buy, sometimes just their kids move in. They have been a factor in this market for many years now. But in the last year or so they have been joined by your average garden varietal Vancouverite. Some of those Vancouverites are selling their homes and buying condos to take some money off the table. Others are buying second and third houses and renovating or renting and holding as investments. And they are all competing with each other to buy whatever comes on to the market. It is more than common for houses to sell above listing price. In fact, I would say it is uncommon for the reverse to happen. Personally I think it is just as much low interest rate driven as it is foreign purchaser driven, but I am no expert. Funny that I am not, given how much squash I play…
Million dollar plus homes are everywhere. $900,000 mortgages are common place. Everyone knows the price of everything and they all openly talk about it. It does not even appear to be crass to do so. Last year it was single family detached, this year it is condo. Who knows how long it can keep going. But the squash players are all-in, and that tells me not much longer.
Hope this rambling diatribe was of some help.
We all have heard the crazy Vancouver stories, but recently another one of my friends told me something that blew my mind. According to my buddy, he knows two different people who sold their Vancouver houses last year. Both times it was a Chinese corporation that bought the house. Instead of moving out, the homeowners leased back their houses from the buyers. Not typical, but not unheard of. But here comes the good part… Both homeowners told my buddy that even though they mail their rent cheques off each month, NOT A SINGLE CHEQUE HAS BEEN CASHED.
I will leave you with one chart, one that has slipped off most investors’ radar, but one that still has a big move ahead of it…
Thanks for reading and have a great week-end,