Brewster's Trillions And The Week Ahead

By: Michael Ashton | Mon, Nov 1, 2010
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Well, at long last the week we have been waiting for has arrived, and with it we can expect a degree of volatility that has recently been somewhat rare. Monday's range on the S&P, for instance, was a smidge more than 18 points. Since the beginning of September, there have been only three days with a range more than 20 points (one of those was the 31.58-point range seen in the launch off the bottom on 9/1), so we are already seeing volatility which, though far from extreme, is more life-like than what we have recently seen. To be sure, both stocks and bonds closed near-unchanged, but there are definitely some volatile undercurrents. Investors by now should have their positions squared away for the election, FOMC meeting, and Employment, but some of these investors will discover that their positions are wrong.

I admit that I am surprised that the squaring-away of positions didn't seem to involve much selling. Certainly most indications are that investors are quite long stocks as well as bonds, but apparently the risk of not being long enough heading into this week was taken to be greater than the risk of being too long. Investor and analyst surveys both show very high levels of bullishness and low levels of caution; while the VIX has risen to 22.3 (the highest since September), in the context of the event calendar that doesn't seem to signal much nervousness to me.

I, for one, am nervous about a lot of things. I am not particularly nervous about the general outcomes. It seems clear that the Republicans are on pace to secure major victories in the House and Senate, although they will probably fall short of taking control of the Senate (considering that 40 seats held by Democrats were not even up for reelection in this cycle, that's not terribly surprising. Democrats would have to lose 28 out of 37 races to cede control of the senior body, and occasionally incumbents do, you know, win). It seems clear that the Fed will announce some form of QE2; although "how much" and "when" remains in doubt, the market seems to be generally discounting "a lot" and "soon", and will have some trouble being measurably surprised. The Payrolls number on Friday should be up in the ballpark of 50-75k; how much we care about a miss will be determined by the first two events and the market reactions thereto.

There is considerable resistance to the notion of QE2. I am pleased to have the company of such august market observers as Bill Gross of PIMCO and Jeremy Grantham of GMO. We all seem to dislike QE for different reasons.

Gross in his latest monthly letter describes QE as a "brazen" "Ponzi scheme." I don't agree with many of the things Mr. Gross says in this letter, but he surely isn't far off in that description.

I agree with much more of what Jeremy Grantham says in his quarterly note that has the classic title "Night of the Living Fed" and a cover page that is already a classic. Grantham is a great strategist, even if he gets a little wacky with the whole global warming/climate change thing. His conclusion is basically that "Fed policy [is] a large net negative to the production of a healthy, stable economy with strong employment." And he argues it extremely well. Readers of that piece will see some arguments similar to ones I have made in this space. Another useful summary as QE pertains to inflation:

"Thus, the Fed falls back on its last resort - quantitative easing. This has been used so rarely that its outcome is generally recognized as uncertain. Perhaps the most certain, or least uncertain, is that the eventual outcome will be inflationary or, at best, that it will be inflationary unless precise and timely countersteps are taken."

My own objections to QE2 are less strident; I simply believe it will be ineffective and is therefore a waste of time. I am much more animated by the wasting of taxpayer dollars by the ridiculous fiscal policies we have pursued for several years now (like, 20). Damage done by quantitative easing can in principle be reversed, but now that the IRS has grabbed our legs and shaken us upside down to get at our loose change, so that the Congress and Administration can incinerate it faster than Richard Pryor in "Brewster's Millions" (about 4 times as fast, come to think about it. Brewster had to spend $30mm in 30 days and have nothing to show for it; we've spent $3 trillion in 2 years with almost nothing to show for it), I doubt very much that we will ever see that money again.

Here is a quick summary of my own arguments about QE2:

M2 Rates-of-Change
Don't really need QE2 when M2 is recovering so well.

In summary, I think QE2 is going to happen, and I don't think it will do much; if I am wrong, I believe I am mostly in agreement with Grantham when I say I think the errors will all be on the side of higher inflation. We have waited patiently for this week, but that doesn't mean we have waited anxiously for it. Are we better off than we were two years ago? Three-quarters of the country in a recent poll said that things are going badly in the country, the highest such proportion in a few decades. But the poignant question will soon be "are we better off now than we were last week?" Let's hope we can say so, but I have my doubts.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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