When he speaks, the Fed minutes are revised.
When they're planning Davos, they check his schedule.
Bernanke has him proofread his remarks.
) changed the color of the iPhone because he did not like it.
He is "The Smartest Man in Global Capital Markets." Or, "TSMIGCM."
And he is our anonymous guide to the markets ahead. (See also:
The Smartest Man in Global Capital Markets on When the
Music Will Stop
Among the salient events TSMIGCM has predicted for us:
- Last July, he predicted a massive run in equities on the
heels of QE3, and his timing was perfect.
- He predicted the emerging markets slowdown in China to the
month, basically (April 2013).
- He told us in March 2013 that the banks would raise equity
exposure from 40% to 50-60%.
- And many, many other things. Our only access to him is
through Mischler's Global Head of Syndicate, Ronald Quigley. So
foremost, again, I offer special thanks to Ron for providing this
I am very happy to bring you all Ron's latest exclusive interview
with TSMIGCM, who has been hard at work for us and for
from his humble abode in the municipality of Saanen in the canton
of Bern, Switzerland. He's freshly back from whirlwind tours across
the globe with finance ministers, the heads of global think-tanks,
the CEOs/CFOs of the world's largest pension funds, corporations,
supra nationals, agencies and sovereigns. His views are respected
by them all, and his "views" are based on relationships that dwarf
the mere North American-European focus of the Bilderberg Meetings.
TSMIGCM is an international banker/billionaire, high-net worth
client of the firm, and one of the world's most sought-after seers.
Part I - The Fed (as told to Ron Quigley)
Well now, it has been several months since I told all of you what
would happen… and it happened!
It's quite amusing to listen to all the bantering on American
television; I suspect people there just need to live perpetually in
fear of something. They particularly love market carnage. They must
have nothing better to do with their time.
Let us now try and set the record straight, and provide some
The Fed has lived in fear of essentially three things: 1)
deflation, 2) a "redux" of 1994, and 3) severe and unrelenting
policy "backlash" from abroad as it regards the impacts of
quantitative easing (QE).
Deflation, not unemployment, has been at the core of what all the
central banks are doing. They fear deflation with good reason: It
is immensely difficult to solve for in a short to intermediate
timeframe. Witness Japan. The banks are all trying to "reflate."
They have been nervous since all the reflationary mechanisms have
just about been exhausted, and most reliable gauges of future
pricing pressures are not registering a heartbeat. Commodity prices
across the board, precious metals, industrial metals -- everything
that is supposed to move up has been moving down. The inflation
numbers are more important than the employment numbers. As I have
said before, "structural unemployment" in the US is arguably at 6%
(this versus the 4% to 4.5% level Alan Greenspan quoted more than
15 years ago).
A "Redux" of 1994
I was writing about 1994 way before the madding crowds. When
pressed on this topic, Greenspan and his NY Fed President William
McDonough always suggested it was their singularly largest
disappointment at the central bank. They were convinced they had
winked and nodded enough times to sufficiently "suggest" to markets
that a rate hike was coming. But in February 1994, after a 1993
credit cycle that remains the most superior analogy to 2012 through
April 2013, upon raising rates, emerging markets spreads gapped
500+ basis points, Mexico imploded under the weight of massive
capital flight, and the financial markets seized up. Let there be
no mistake about it -- current Fed Chairman Ben Bernanke, much more
an advocate of an efficient, transparent, and consistent FED
communications strategy than Greenspan, knew this and knows this.
Augustin Carstens, Governor of the Bank of Mexico, has been warning
the Fed that he has been seeing significant speculative capital
flows into his country, which is reminiscent of 1994. Asset bubbles
were manifesting themselves everywhere, including in Japanese
commercial real estate and J-REITs, Southeast Asian banking
centers, emerging markets local currency funds/assets, emerging
markets FX rates, MLPs, and REITs in the US.
Six plus weeks ago, Bernanke did nothing wrong in his Congressional
testimony. He hesitated one or two times and suggested that QE
would, by definition, have some unintended consequences if
prolonged in perpetuity. This was enough. We should be thankful he
did that. Money supply was going up, however, given the new and
confused regulatory environment, and the financial system was
unable to act as an efficient transmission mechanism to augment the
velocity of money; henceforth, the likely legacy of QE could be the
harmful long-term consequences it would have on savers (of all
kinds), pension funds, retirees, and insurance companies.
Therefore, what Bernanke was in fact doing was intentionally
letting some air out of the bubble.
All of this near term repricing of many asset classes has been
overdue and necessary, and it will likely assist in full-year 2014
being a rather constructive one as opposed to another 1994, 20
Severe and Unrelenting Policy Backlash From Abroad
Regarding the Impacts of QE
Mexico has not been the only country challenging the US Fed on its
policies. From Brazil to China, and from Russia to Germany, this
was fast becoming a well-rehearsed chorus of angst. This has
happened in an environment that can best be described as a "Buy
America" one. Many smart money managers and foreign companies have
increasingly been advocating the purchase of US assets of all
kinds. When traveling the world, this can be heard everywhere; it
is the trend today.
The idea that the US Fed is the cause of everyone's problems has
become quite the rallying cry. Take Brazil as an example. They have
advocated capital controls more times than I can count to protect
their currency from rallying against the dollar and infringing on
exports. But the Fed has barely made a left turn in the road, and
the Brazilian reais has collapsed to an exchange rate of 2.27 reais
per US dollar. The problem with Brazil is that it is an emerging
market, and not an emerging superpower. It has a poor and
marginally competent government; labor costs have skyrocketed, as
have commercial real estate prices -- that is, when it can be found
in the Faria Lima district of Sao Paolo, it is way too expensive;
labor unions have vast power; the state immerses itself in every
aspect of production; and the country is vastly overregulated. I
have met dozens of emerging market debt and equity investors and IB
clients during these past weeks, and for the most part, they were
negative on Brazil. A country that should by all accounts be
growing at a 6-7% annualized GDP is growing below 1%. So, the Fed
will migrate away from QE; the US dollar will strengthen. Then who
will the Brazilians blame? As can be seen by recent social unrest,
they have finally gotten it right -- themselves!!
Summation of Part I
To sum all this up, I recently had a lunch with a hedge fund
manager I have great respect for. You would all know the name, but
I can't reveal it. I outlined my view that the "liquidity unwind"
would create 1994-like distortions in credit and fixed income
markets. Upon finishing, I was told that my guest was in complete
agreement with me but for one thing. What I was missing, so he
said, was that there would be "no exit strategy." The Fed, he
suggested, viewed QE as binary; it would go on for a very long time
precisely out of fear of another 1994 at a time when EMEA banks
were still weak, Japan was dancing on the periphery of irrelevance,
China was slowing down, and most importantly, the central banks had
no more arrows left in their respective quivers. "Forever," I was
Give Bernanke and the Fed credit; they see and know all of this.
They very meticulously -- almost forensically -- orchestrated a
"correction" that amounted to 5% in equities, 5-10% in select US
Credit Products, and 15%+ in emerging markets-related asset classes
and currencies. This was necessary! Central bankers have maintained
for years that they should not manipulate and manage asset prices.
Today, that is exactly what they are doing. There has been no
coherent US fiscal policy to assist the Fed in its quest to salvage
US growth and reflate. History will prove this true.
Part II - GEOGRAPHIES (Select Thoughts on Countries of
QE will fail in Japan. Unlike the US, which has awesomely flexible
labor markets, lots of transparency, reasonable immigration
policies, and few subsidy-related distortions in its economy, Japan
is subject to many rigidities that do not set the preconditions for
QE to succeed. Virtually no one of consequence in Washington, DC,
thinks that the Japanese will succeed. But as I have said before,
there are a couple positive signs.
- Major exporters likely to benefit from a collapsing yen
appear to voice a fiduciary responsibility to increase overseas
direct investments with the profits windfall they will get.
- The companies most reliant on domestic sales are also
advocating cross-border acquisitions, and there are some signs
that consumers are modifying their savings and spending patterns.
Regrettably, in the absence of substantive deregulation and
structural reform, Japan is not capable of having a sustained QE
equate to anything but trading opportunities.
The country recognizes that the current demographic trend does
create a sense of urgency regarding the exporting of business
models to other jurisdictions and increasing foreign direct
) across the globe, preferably where demographic trends best offset
what's happening at home. As an example, Japanese multi-national
companies have been very reticent to increase FDI in India for many
years. India is an integral part of the US-China containment
strategy, and it has been an imperative of US policy wonks to
encourage Japanese FDI in that country. Having recently spent a
full week there, it is clear that this is now happening. Japanese
policy banks -- like the Japan Bank for International Cooperation
and the Development Bank of Japan -- are providing almost $8
billion in guaranteed loans to help construct the Mumbai-Delhi
Corridor Project, all in an effort to illicit more FDI. Japanese
Prime Minister Shinzo Abe has targeted another $45 billion in
Japanese FDI for India in this year alone.
So corporate Japan is on the move, as it should be. The real
bottleneck to QE will be the consumer and the country's inertia in
terms of agricultural reform, immigration policy changes, and other
issues. These things will hold Japan back. The likely result will
be an over-reliance on the things they are comfortable with; thus,
there will arguably be much more FDI in global emerging markets.
The target list for this investment includes Vietnam, Thailand,
Indonesia, The Philippines, Myanmar, India, Brazil, Mexico,
Poland/The Czech Republic, Germany, and the US.
As I have written before, the real issues in China are excessive
credit, volatility in policy prescriptions to deal with market
dislocations, and the margin of safety between the equilibrium
level of GDP growth (ELG) and the "actual" GDP growth rate. As my
good friend Seth Klarmen wrote years ago, "Margin of safety in
value investing is the 'key.'" This rule should also apply when
analyzing sovereign credits. It is not possible to know the exact
annualized GDP growth rate below which China would be unable to
absorb all the new workers coming into the system each year; it is
equally difficult to ascertain what China's actual GDP growth rate
is in real time. What we do know is that the margin of safety (the
delta between the two) is too narrow for comfort. I assume the ELG
is currently 6.5% (down from 8.0% more than five years ago,
primarily due to China's changing demographics) and the actual GDP
rate is approximately 7.0% (not the 7.7% the PRC suggests). Thus,
the margin of error here is very narrow.
It is precisely this narrowing delta that pushed policy makers to
make abrupt modifications to policies and regulations. China is
very fixated on being perceived as an adult on the global stage.
Having to choreograph a massive spike in Shibor to "punish"
speculators is inconsistent with the image they want to cultivate.
As the Japanese migrate new FDI away from China to Myanmar, India,
Indonesia, Thailand, Vietnam, and The Philippines, and as China
slowly loses its labor cost advantages versus other key emerging
markets manufacturing economies, the risks of a real China slowdown
will grow over time. The impact on Latin America will be severe,
most notably on Brazil where we are already seeing signs of social
I do not see China slipping below its ELG this year, but if and
when this does occur, it will unleash more deflationary forces
around the globe. In
my last article
, I argued that the
(SHA:000001) would have to breach the 2,000 level, and this has now
happened. It may, in fact, have to go lower in order to persuade
the authorities to increase the liquidity taps once again. China
is, at the end of the day, a bit of a shell game economy. The
government meticulously arranges share sales between institutions
(corporates, banks, etc.). I do not see this ending well. We may
not get the conflagration prophesied by
, but it is likely to be close. It won't happen this year, though.
One of the benefits of massive market dislocations is that they
tend to enhance transparency in terms of the true or intrinsic
value of credits, asset classes, and countries. This is true of
Brazil, where we are now seeing social unrest.
Brazil's President Dilma Rousseff's solution is to increase
spending and social outlays; this will only be a very near-term
solution, if that. The currency will remain under pressure; it may
trade as low as 2.5 reais to the dollar. Some well-situated hedge
fund managers have actually asked me recently to what extent I felt
Brazil would have a real crisis -- for example, a run on a bank. I
do not see that happening, however, current events are constructive
in that they point the finger at over-regulation, excessive
government at every level, and antiquated labor laws. Now that the
US Fed is no longer the "bad guy," we can get sufficient
introspection there that leads to substantive change. I have been
very negative on Brazil versus Andean/Mexico for several years.
Now, however, it would appear to me that Brazilian equities -- for
the first time in several years -- are fairly priced relative to
those alternative markets. Some very smart and agile equity
managers are increasing Brazilian exposure purely on that basis.
Consequently, I do see Chile, Colombia, and Peru as having gotten
somewhat expensive. This will not deter the Canadian pension funds
from continuing to prioritize infrastructure assets in those
geographies, but it will make it more difficult to monetize the
equity of locally domiciled businesses, in my view.
Carstens has gotten his way in so far as the Fed has at least
suggested that QE will not be a permanent policy. Hence, some
speculative capital flows have departed Mexico, relieving pressures
on the peso/dollar cross currency rate near term. To the extent
that the PRI government can keep the cartels at bay and continue
its commitment to deregulating the inertia inherent in the Mexican
economy, I still like the investment thesis there and still see
tangible evidence of increasing FDI flows that could add 1-2% to
Mexican GDP estimates going forward.
I spent some time in Argentina recently as well. The government is,
as you all know, not competent and failing its people; this is a
very widely held view. Many producing assets are trading at levels
below replacement value. To the extent that we see a shift away
from President Cristina Kirchner in the upcoming October elections,
I am of the view that asset prices can improve. Well-placed private
equity professionals across Latin America are circling some
producing assets in that country. They view it as one of the very
few opportunities to increase an initial investment fourfold or
fivefold in several years, assuming the electorate wakes up. This
merits watching for anyone fixated on alpha generation,
notwithstanding the current emerging markets fallout we are
witnessing across the globe.
- Recent comments by the Fed and pursuant deterioration in
markets will very likely help prevent another 1994 market
dislocation. There was abundant evidence of asset bubbles
everywhere. QE cannot be deployed in perpetuity (it was/is very
dangerous for any money manager or hedge fund manager to adhere
to that view), and letting air out of these bubbles in a
quasi-managed manner is vastly superior to February/May 1994,
which is when we saw emerging markets spreads widen 500+ basis
points. I feel a bit better about full-year 2014 as a result of
these past few weeks.
- I stated in
my last missive
that the major US brokerages had approximately 40-42% of total
private banking assets invested in equity securities (versus 70%
in the '80s-'90s). At mid-year 2013, some of those brokerages
report aggregate equity allocations in the range of 52-58%;
therefore, the "wealth effect" of higher equity prices is more
prevalent now than it was six months ago. Of course, the opposite
holds true as well. We need -- and we will (in my view) -- get
higher equity prices by year's end.
- Market structure will remain a problem. Fewer major banks are
holding less inventories; feeling as though they are not
sufficiently compensated to provide liquidity in times of market
stress will only serve to exacerbate those stress points. The
fact that those banks are also doing increasing amounts of their
business across asset classes with the top 50 money
managers/hedge fund managers does also not bode well for
stability in my view.
- FICC: The stability of China and the risks of flawed policy
there is a real danger to most emerging markets, particularly the
commodities-based countries that have been at the forefront of
the 2010-2012 rallies. I like the Shanghai Index at 1800 or lower
(we are headed there), and I like Brazil (finally) relative to
emerging market alternatives long term. I do not believe nominal
US Treasury rates will continue to spike; we will find
equilibrium very shortly. A 3% 10-year note is still very low,
relative to any historical norm. Longer duration US Treasury and
credit products will come under pressure in the fourth quarter in
my view as most FICC clients will assuredly look to shorten
portfolio durations meaningfully given the recent volatility we
have seen. I see no compelling need to rush into REITs, MLPs, et
- Metals: There is no question that many of the gold producers
are looking at asset sales and/or consolidation within their
Industry. Any price point below $1200 per ounce will present a
real challenge to an industry whose average cost of extraction
essentially equates to that price point currently. We said gold
could get to $1200 -- and here we are. The market can over shoot
to the downside (as it invariably always does); I would not at
all be surprised to see something between $850-$1,000 as a
bottom; therefore, if you currently own none and fundamentally
believe portfolios should have a 3% or so allocation to gold, now
is not a bad time to start laddering-in positions... slowly. The
miners have totally underperformed the underlying asset; that is
unlikely to be the case over the next three plus years.