Fed inaction: Economic Risks


A lot of investors breathed a sigh of relief on Thursday after the Fed decided to hold interest rates steady. While it will happen eventually, a number of financial experts say an increase in rates could derail global markets.

With our world more intertwined than ever before, what happens in America could impact the rest of the world. Conversely, a further slowdown in China or political upheaval in Europe could impact the U.S. and other international markets.

While the global economy is still projected to expand by about 3.3 percent this year, according to the IMF, there are several risks that could impact the global economy and its stock markets.

If anyone’s been paying attention to the news lately, they’ll know that China has been in a heap of trouble. Its stock market is wobbly, people aren’t sure whether its growth projections are accurate, corporations are carrying loads of debt, and the list of issues goes on.

To Eric Lascelles, chief economist at RBC Global Asset Management, what’s happening in China presents the biggest risk to world markets and, more specifically, its debt issues.

This year the country’s corporate debt levels hit 160 percent of GDP, which is twice as high as America’s corporate debt levels, while Standard & Poor’s estimates that China’s corporate debt will climb by 77 percent, to $28.8 trillion, over the next five years.

Much of that debt has been concentrated in the country’s booming housing market, said Lascelles, and while the government is helping out local governments and companies, non-performing loans on Chinese banks have grown by 57 percent over the last year, he said.

It’s still a low base—only 1.5 percent of loans aren’t being paid, he said—but those growth rates are rising. If this does become a larger problem, then economic growth could slow even further, which, with China being the second-largest economy in the world representing about 16 percent of global GDP, would have an impact on all of us, Lascelles explained.

While most people expect the Federal Reserve to raise rates before the end of the year, a move in the overnight rate could still create volatility on a global stage, said Lisa Emsbo-Mattingly, Fidelity’s director of research for global asset allocation.

A lot of people think that the base rate will simply be increased by about 25 basis points and that everything will look like it does now. However, bond rates bounce around and aren’t as stable as people may think, and that could cause uncertainty.

As well, the U.S. government balance sheet is “extremely large,” she said, and any rise in rates will impact the bonds it holds.

“The technicalities of this may be more complex than what we’ve seen in the past,” she said. “We’ll see how the market reacts to a little more uncertainty in the Fed funds rate and short-term rates.”

One of the consequences of a rising Fed rate could be an illiquid global bond market . Why? Because when rates rise, bond prices fall, and who wants to buy a security that’s falling in price?

That’s one of Jeff Mortimer’s concerns. The director of investment strategy for BNY Mellon Wealth Management is worried that when people try to sell their bonds into a rising rate environment, there won’t be any takers.


Regulation, he said, has already pushed traders out of the bond market, so there aren’t as many people buying and selling fixed-income instruments as it is.

“We know that there are less people taking the other sides of trades, so how will the bond market handle selling pressure?” he questioned.

An illiquid market could impact global markets in two ways. First, bond prices will fall even farther than they should. And second, if people can’t sell their bonds, they may start selling other assets.

“If you can’t sell bonds, then what are you going to sell?” he asked. “You’ll sell equity—that’s a lot of what transpired in 2008.”

Over the last year, the greenback’s value has steadily climbed. It’s up 20 percent against the Canadian dollar, 14 percent against the euro, 10 percent against the yen and so on.

There are multiple sides to the U.S. dollar story, said Lascelles. Some countries, like Canada, Europe and Japan, like having a weaker currency as it helps exports, but emerging markets countries do not.

Many of them use American dollars to fund day-to-day operations, and if buying those dollars gets pricier, then they could find themselves strapped for cash.

As well, a too-strong dollar is bad for the U.S. It reduces its global competitiveness, and that ultimately limits economic expansion.

It’s also bad for multinationals who make money in other countries and have to convert those dollars back to American bucks.

“There’s no debating that a stronger dollar is negative for growth,” said Lascelles.

Politics is always a risk, but Lascelles has been seeing greater shift to far right and far left politics than he has in the past.

Some of it may be just rhetoric, such as Rand Paul’s “audit the Fed” bill, but with Greece’s rebuff of the IMF and more right- and left-leaning parties getting into power, people have to wonder if the right economic policies will ultimately be put in place.

While he can understand why more populous ideas are being bandied about—rising unemployment and continued economic challenges is causing citizens and governments to think differently—rejecting sound economic policies will slow growth and make it difficult to ultimately reform, he said.

“A healthy does of skepticism is appropriate,” he added, “but in the end these are mostly unwelcome and can jeopardize an economy.”

The Bear Market Has Just Begun


Today the narrow-minded canyons of Wall Street are littered almost entirely of trend-following bulls and cheerleaders who don’t realize how little there is to actually cheer about. Stock values are far less attractive than they were on that day back in 2009 and this selloff has a lot longer to run. There are hordes of perma-bulls calling for a V-shaped recovery in stocks, even after multiple years of nary a downtick.

Here are six reasons why I believe the bear market in the major averages has only just begun:

1) Stocks are overvalued by almost every metric.One of my favorite metrics is the price-to-sales ratio, which shows stock prices in relation to the company’s revenue per share and omits the financial engineering associated with borrowing money to buy back shares for the purpose of boosting EPS growth. For the S&P 500 (INDEX: .SPX), this ratio is currently 1.7, which is far above the mean value of 1.4. The benchmark index is also near record high valuations when measured as a percentage of GDP and in relation to the replacement costs of its companies.


2) There is currently a lack of revenue and earnings growth for S&P 500 companies. Second-quarter earnings shrank 0.7 percent, while revenues declined by 3.4 percent from a year earlier, according to FactSet. The Q2 revenue contraction marks the first time the benchmark index’s revenue shrank two quarters in a row since 2009.

S&P 500
  • Virtually the entire global economy is either in, or teetering on, a recession. In 2009, China stepped further into a huge stimulus cycle that would eventually lead to the largest misallocation of capital in the history of the modern world. Empty cities don’t build themselves: They require enormous spurious demand of natural resources, which, in turn, leads to excess capacity from resource-producing countries such as Brazil, Australia, Russia, Canada, et al. Now those economies are in recession because China has become debt disabled and is painfully working down that misallocation of capital. And now Japan and the entire European Union appear poised to follow the same fate.

This is causing the rate of inflation to fall according to the Core PCE index. And the CRB Index, which is at the panic lows of early 2009, is corroborating the decreasing rate of inflation.


But the bulls on Wall Street would have you believe the cratering price of oil is a good thing because the “gas tax cut” will drive consumer spending – never mind the fact that energy prices are crashing due to crumbling global demand. Nevertheless, there will be no such boost to consumer spending from lower oil prices because consumers are being hurt by a lack of real income growth, huge health-care spending increases and soaring shelter costs.

4) U.S. manufacturing and GDP is headed south. The Dallas Fed’s manufacturing report showed its general activity index fell to -15.8 in August, from an already weak -4.6 reading in July. The oil-fracking industry had been one of the sole bright spots for the US economy since the Great Recession and has been the lead impetus of job creation. However, many Wall Street charlatans contend the United States is immune from deflation and a global slowdown and remain blindly optimistic about a strong second half.

Unfortunately, we are already two-thirds of the way into the third quarter and the Atlanta Fed is predicting GDP will grow at an unimpressive rate of 1.3 percent. Furthermore, the August ISM manufacturing index fell to 51.1, from 52.7, its weakest read in over two years. And while gross domestic product in the second quarter came in at a 3.7 percent annual rate, due in large part to a huge inventory build, gross domestic income increased at an annual rate of only 0.6 percent.

GDP tracks all expenditures on final goods and services produced in the United States and GDI tracks all income received by those who produced that output. These two metrics should be equal because every dollar spent on a good or service flows as income to a household, a firm, or the government. The two numbers will, at times, differ in practice due to measurement errors. However this is a fairly large measurement error and it leads one to wonder if that 0.6 percent GDI number should get a bit more attention.

5) Global trade is currently in freefall. Reuters reported that exports from South Korea dropped nearly 15 percent in August from a year earlier, with shipments to China, the United States and Europe all weaker. U.S. exports of goods and general merchandise are at the lowest level since September of 2011. The latest measurement of $370 billion is down from $408 billion, or -9.46 percent from Q4 2014. And CNBC reported this week that the volume of exports from the Port of Long Beach to China dropped by 10 percent YOY. The metastasizing global slowdown will only continue to exacerbate the plummeting value of U.S. trade.


6) The Fed is promising to no longer support the stock market. Back in 2009, our central bank was willing to provide all the wind for the market’s sail. And despite a lackluster 2 percent average annual GDP print since 2010, the stock market doubled in value on the back of zero interest rates and the Federal Reserve ‘s $3.7 trillion money-printing spree. Thus, for the past several years, there has been a huge disparity building between economic fundamentals and the value of stocks.

But now, the end of all monetary accommodations may soon occur, while markets have become massively over-leveraged and overvalued. The end of quantitative easing and a zero interest-rate policy will also coincide with slowing U.S. and global GDP, falling inflation and negative earnings growth. And the Fed will be raising rates and putting more upward pressure on the U.S. dollar while the manufacturing and export sectors are already rolling over.

I am glad Ms. Yellen and Co. appear to have finally assented to removing the safety net from underneath the stock market. Nevertheless, Wall Street may soon learn the baneful lesson that the artificial supports of QE and ZIRP were the only things preventing the unfolding of the greatest bear market in history.

Michael Pento produces the weekly podcast “The Mid-week Reality Check,” is the president and founder of Pento Portfolio Strategies and author of the book “The Coming Bond Market Collapse.”


End The Greek Ponzi Scheme: Cut Greece Loose


Now come Greeks bearing the gift of confirmation that Margaret Thatcher was right about socialist governments: “They always run out of other people’s money.” Greece, from whose ancient playwrights Western drama descends, is in an absurdist melodrama about securing yet another cash infusion from international creditors. This would add another boulder to a mountain of debt almost twice the size of Greece’s gross domestic product. This protracted dispute will result in desirable carnage if Greece defaults, thereby becoming a constructively frightening example to all democracies doling out unsustainable, growth-suppressing entitlements.

In January, Greek voters gave power to the left-wing Syriza party, one third of which, The Economist reports, consists of “Maoists, Marxists and supporters of Che Guevara.” Prime Minister Alexis Tsipras, 40, a retired student radical, immediately denounced a European Union declaration criticizing Russia’s dismemberment of Ukraine. He chose only one cabinet member with prior government experience — a leader of Greece’s Stalinist communist party. Tsipras’ minister for culture and education says Greek education “should not be governed by the principle of excellence … it is a warped ambition.” Practicing what he preaches, he proposes abolishing university entrance exams.

Voters chose Syriza because it promised to reverse reforms, particularly of pensions and labour laws, demanded by creditors, and to resist new demands for rationality. Tsipras immediately vowed to rehire 12,000 government employees. His shrillness increasing as his options contract, he says the European Union, the European Central Bank and the International Monetary Fund are trying to “humiliate” Greece.

How could one humiliate a nation that chooses governments committed to Rumpelstiltskin economics, the belief that the straw of government largesse can be spun into the gold of national wealth? Tsipras’ approach to mollifying those who hold his nation’s fate in their hands is to say they must respect his “mandate” to resist them. He thinks Greek voters, by making delusional promises to themselves, obligate other European taxpayers to fund them. Tsipras, who says the creditors are “pillaging” Greece, is trying to pillage his local governments, which are resisting his extralegal demands that they send him their cash reserves.

Yanis Varoufakis, Greece’s finance minister, is an academic admirer of Nobel laureate John Nash, the Princeton genius depicted in the movie “A Beautiful Mind,” who recently died. Varoufakis is interested in Nash’s work on game theory, especially the theory of co-operative games in which two or more participants aim for a resolution better for all than would result absent co-operation. Varoufakis’ idea of co-operation is to accuse the creditors whose money Greece has been living on of “fiscal waterboarding.” Tsipras tells Greece’s creditors to read “For Whom the Bell Tolls,” Ernest Hemingway’s novel of the Spanish Civil War. His passive-aggressive message? “Play nicely or we will kill ourselves.”

Since joining the eurozone in 2001, Greece has borrowed a sum 1.7 times its 2013 GDP. Its 25 per cent unemployment (50 per cent among young workers) results from a 25 percent shrinkage of GDP. It is a mendicant reduced to hoping to “extend and pretend” forever. But extending the bailout and pretending that creditors will someday be paid encourages other European socialists to contemplate shedding debts — other people’s money that is no longer fun.

Greece, with just 11 million people and 2 per cent of the eurozone’s GDP, is unlikely to cause a contagion by leaving the zone. If it also leaves the misbegotten European Union, this evidence of the EU’s mutability might encourage Britain’s “Euro-skeptics” when, later this year, that nation has a referendum on reclaiming national sovereignty by

withdrawing from the EU. If Greece so cherishes its sovereignty that it bristles at conditions imposed by creditors, why is it in the EU, the perverse point of which is to “pool” nations’ sovereignties in order to dilute national consciousness?

The EU has a flag no one salutes, an anthem no one sings, a president no one can name, a parliament whose powers subtract from those of national legislatures, a bureaucracy no one admires or controls and rules of fiscal rectitude that no member is penalized for ignoring. It does, however, have in Greece a member whose difficulties are wonderfully didactic.

It cannot be said too often: There cannot be too many socialist smashups. The best of these punish reckless creditors whose lending enables socialists to live, for a while, off other people’s money. The world, which owes much to ancient Athens’ legacy, including the idea of democracy, is indebted to today’s Athens for the reminder that reality does not respect a democracy’s delusions.

NOTE: Our Managed Accounts have no Greek Exposure/ no Greek Banks or Bank Accounts – you deserve that attention and ability.

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Gold under pressure as investors await Fed for US rate outlook

Gold bars are stacked in safe deposit boxes room of the ProAurum gold house in Munich

Gold added to overnight losses to hover near $1,180 an ounce on Wednesday as investors waited for a Federal Reserve statement for clues on the timing of a U.S. interest rate hike.

Spot gold had eased 0.2 percent to $1,179.01 an ounce by 0655 GMT after dipping 0.4 percent in the previous session. Platinum fell to a six-year low of $1,068.75, while palladium dropped to its lowest since March 31.

All eyes will be on the Fed’s statement due at 1800 GMT after the Federal Open Market Committee’s two-day policy meeting. Fed Chair Janet Yellen’s news conference will also be monitored for pointers to the timing of the coming rate rise.

Also out after the meeting will be the committee members’ latest forecasts for economic growth and interest rates, both of which might be nudged lower.

Bullion has not made much headway in recent months because of uncertainty over the timing of the rate rise, which would reduce demand for non-interest-paying assets.

“Gold may find support at $1,165 if Yellen proves to be unambiguously hawkish tonight,” said Howie Lee, an analyst at Phillip Futures.

“The dollar is likely to be the beneficiary tonight,” he added.

A stronger greenback would hurt the dollar-denominated metal, making it more expensive for holders of other currencies while also curbing safe-haven demand.

The continuing Greek debt crisis is not spurring much safe-haven demand.

Prime Minister Alexis Tsipras accused Greece’s creditors on Tuesday of trying to “humiliate” Greeks with more cuts as he defied a growing drumbeat of warnings that Europe was preparing for his country to leave the euro. [ID:nL5N0Z21I7]

The unrepentant address to lawmakers after the collapse of talks with European and IMF lenders at the weekend was the clearest sign yet that the leftist leader has no intention of making a last-minute U-turn and accepting austerity cuts needed to unlock frozen aid and avoid a debt default within two weeks.

Gold is typically seen as a good bet at times of financial and economic uncertainty, but bids have failed to emerge in a robust way as expectations of a U.S. interest rate rise this year are weighing on the market.

The metal’s technical picture was also bearish, ScotiaMocatta analysts said.

Gold appears increasingly vulnerable to a break towards a recent low near $1,160 reached last month, they said.

Read more on protecting your portfolio profits at http://www.youroffshoremoney.com

JIM ROGERS: The World’s Savers Are Being Wiped Out

English: American investor Jim Rogers in Madri...
English: American investor Jim Rogers in Madrid (Spain) during an interview. Español: El inversor norteamericano Jim Rogers en Madrid (España) durante una entrevista. (Photo credit: Wikipedia)

Jim Rogers decries the growing uncertainty and recklessness of global central planners as the world enters uncharted financial markets:


For the first time in recorded history, we have nearly every central bank printing money and trying to debase their currency. This has never happened before. How it’s going to work out, I don’t know. It just depends on which one goes down the most and first, and they take turns. When one says a currency is going down, the question is against what? because they are all trying to debase themselves. It’s a peculiar time in world history.

I own the dollar, not because I have any confidence in the dollar and not because it’s sound – it’s a terribly flawed currency – but I expect more currency

turmoil, more financial turmoil. During periods like that, people, for whatever reason, flee to the U.S. dollar as a safe haven. It is not a safe haven, but it is perceived that way by some people. That’s why the dollar is going up. That’s why I own it. Will I own it in five years, ten years? I don’t know.

It makes it extremely difficult for the investor looking for acceptable risk/reward, or the saver looking to protect their purchasing power; as in Rogers’ view, all options have their problems:

I own gold and silver and precious metals. I own all commodities, which is a better way to play as they debase currencies. I own more agriculture than just about anything else in real assets because of the reasons we discussed before. We were talking before about the risk-free or worry-free investment. Even gold: the Indian politicians are talking about coming down hard on gold, and India is the largest buyer of gold in the world. If Indian politicians do something — whether it’s foolish or not is irrelevant — if they do something, gold could go down a lot. So I own it. I’m not selling it. But everything has problems.

To Rogers, the bigger danger that concerns him is the hollowing out of the ‘saving class’ resulting from this situation. Central planners’ policies are punishing the prudent in favor of rescuing the irresponsible. This has happened before in world history, and the aftermath has always had grievous economic, social — and often human — costs:

Throughout our history – any country’s history – the people who save their money and invest for their future are the ones that you build an economy, a society, and a nation on.

In America, many people saved their money, put it aside, and didn’t buy four or five houses with no job and no money down. They did what most people would consider the right thing, and what historically has been the right thing. But now, unfortunately, those people are being wiped out, because they are getting 0% return, or virtually no return, on their savings and their investments. We’re wiping them out at the expense of people who went deeply into debt, people who did what most people would consider the wrong thing at the expense of people who did the right thing. This, long-term, has terrible consequences for any nation, any society, any economy.

If you go back in history, you’ll see what happened to the Germans when they wiped out their savings class in the 1920s. It didn’t lead to good things down the road for Germany. It didn’t lead to good things for Italy, which did the same thing. There were plenty of countries where it wiped out the people who saved and invested for their future. It’s usually a serious, political reaction, desperation in some cases, and looking for a savior and easy answers is usually what happens when you destroy the people who save and invest for the future.

Related articles

QE 4 Update/ Review

English: President Barack Obama confers with F...
English: President Barack Obama confers with Federal Reserve Chairman Ben Bernanke following their meeting at the White House. (Photo credit: Wikipedia)

The Big Picture

Link to The Big Picture

  • Our market letter will return in the New Year
What Is The Purpose of QE?

Posted: 25 Dec 2012 02:00 PM PST

As detailed earlier in the month, the Federal Reserve announced more stimulus, otherwise known as QE4, at its recent meeting.

Lots of the discussion thus far has focused on whether or not QE will happen and not on the purpose of QE.

What we discuss below is a good example of economists discussing the probability of QE rather than why QE is necessary or what it will accomplish.

So, what is QE supposed to do?  Bernanke told us in his speech over the summer in Jackson Hole:

“After nearly four years of experience with large-scale asset purchases, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve’s large-scale purchases have significantly lowered long-term Treasury yields. For example, studies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.12 Three studies considering the cumulative influence of all the Federal Reserve’s asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.13 These effects are economically meaningful.

LSAPs also appear to have boosted stock prices, presumably both by lowering discount rates and by improving the economic outlook; it is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC’s decision to greatly expand securities purchases. This effect is potentially important because stock values affect both consumption and investment decisions.

While there is substantial evidence that the Federal Reserve’s asset purchases have lowered longer-term yields and eased broader financial conditions, obtaining precise estimates of the effects of these operations on the broader economy is inherently difficult, as the counterfactual–how the economy would have performed in the absence of the Federal Reserve’s actions–cannot be directly observed. If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economyModel simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.15

This is not the first time the Federal Reserve has laid out this argument.  In a November 4, 2010 Washington Post op-ed, the day after QE2 was approved, Ben Bernanke defended their actions with the following passage:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Federal Reserve Board Chairman Ben Bernanke said Thursday that a controversial $600 billion bond buying plan has contributed to a stronger stock market. “Our policies have contributed to a stronger stock market just as they did in March 2009 when we did the first iteration of this program,” Bernanke said at a Federal Deposit Insurance Corp. forum on small businesses. “A stronger economy helps small businesses more than larger businesses. Interest rates are higher but that’s mostly because the news is better. It has responded to a stronger economy and better expectations.”

To sum it all up:

• The Federal Reserve buys Treasury bonds in order to push down interest rates, making them an unattractive investment (last shown here, page 6) .

• Investors respond by moving out the risk curve and buying assets like corporate bonds and stocks, pushing them higher.  The Federal Reserve believes this happens via the portfolio balance theory.

• But according to the Federal Reserve, moving out the risk curve does not include buying agricultural or crude oil futures, so do not blame them for higher food or gasoline prices.

• Higher asset prices create a wealth effect, which increases spending and confidence and improves the economy. The Federal Reserve believes this has helped create 2 million jobs.

We agree with half of what is written above.

• QE does produce lower interest rates, or at least the belief that rates are too low.  This then pushes investors out the risk curve which is why stocks have such an immediate and positive reaction whenever QE is speculated.

• The Federal Reserve is playing politics in regards to the effect of QE on commodity prices.  There is no reason to believe the risk curve ends at low-rated stocks.  How much QE affects food and gasoline prices can be debated, but to argue there is no effect at all, and will never be an effect under any scenario, merely because the Federal Reserve does not want to answer for these higher prices, is just wrong.

• The argument that higher asset prices produce a wealth effect is only partially correct.  Two conditions must be met for a wealth effect to ensue.  Net worth must reach a new high and it must be perceived to be permanent.  This is why housing produced such a powerful wealth effect before 2006.  Home prices always went up and their gains were perceived to be permanent.  Currently we have a retracement of losses and a widespread distrust of financial markets.  These conditions will not produce any wealth effect and we believe they have not.

QE is great for Wall Street as it produces more volatility (brokers like this), higher stocks prices (fund managers like this) and draws lots of attention (analysts like this).  It is not good for Main Street because it does not create wealth.  QE’s effects are not perceived to be permanent, so it does not lead to higher GDP or job growth.

What Will The Federal Reserve Do?

In Septmber we noted that the median expectation in a survey of primary dealers calls for $500 billion of additional purchases heavily tilted toward mortgage-backed securities.   If the purpose of QE is to push stock prices higher, then the Federal Reserve has to deliver at least $500 billion in purchases.  Otherwise it will disappoint risk markets.

Right now, if we have to guess, we believe the Federal Reserve will announce purchases of less than $500 billion. In January the Federal Reserve adopted an inflation target of 2.0%.  As we detailed in a conference call last month (transcripthandoutaudio), inflation expectations are running well above this target.  One measure of inflation expectations, the 10-year TIPS inflation breakeven rate, is shown below.  Further, in April, when Bernanke was asked if he would adopt a suggestion from Paul Krugman to expand the target to 3%, he flatly rejected the idea (explained here).

The hawks will argue expected inflation is too high to add more stimulus, an argument which will carry some weight.  The compromise will be a program of less than $500 billion in purchases which will disappoint the markets.

Click to enlarge:

Source: Arbor Research







Update on our Bond Position

Grover Cleveland - Series of 1914 $20 bill
Grover Cleveland – Series of 1914 $20 bill (Photo credit: Wikipedia)

Nov. 16

Hedge-fund manager Jack Bass, who made $500 million shorting subprime mortgages during the 2007 crash, said he’s now betting half his firm’s money on a rebound in those assets.

Securities tied to the riskiest mortgages are virtually “bullet-proof,” because even if the U.S. housing market declines by 10 percent, investors won’t take a principal hit on their bonds, Bass said in an interview with Bloomberg Televison’sStephanie Ruhle on Market Makers. The assets offer a “very safe place” to make double-digit returns, he said.

“We have more than half our money in subprime bonds,” Bass said. “You don’t like a pair of jeans at 200 bucks, but when they go on sale for $25 you look great in them.”

Mortgage funds have outperformed as the U.S. housing market rebounds, homeowner refinancing remains constrained and the U.S. Federal Reserve buys government-backed debt to try to stimulate the economy. Dallas-based Hayman, which Bass founded in 2005, managed $1 billion at the end of September, according to a firm presentation obtained by Bloomberg News.

‘Best Investments

Bass said his bullish bets are focused on the top tranches of mortgage securities, which would have to endure a “draconian scenario” of homeowners not meeting their payments before bond investors would be hurt. The assets are the “best investment” at a time when U.S. Treasuries provide no yield, he said.

The European sovereign debt crisis and the so-called fiscal cliff in the U.S. have made the current environment “the hardest period of time to invest in our generation,” Bass said. The fiscal cliff refers to automatic tax increases and budget cuts that will start next year unless President Barack Obama and Congress reach a compromise to reduce spending.

While investors have become less concerned about Europe, Bass said it’s too early to pour money into the region. Yields on bonds issued by indebted nations including Spain and Portugalhave fallen since European Central Bank President Mario Draghi pledged July 26 to defend the euro currency bloc at all costs.

Germany’s Plight

Hedge funds buying assets in Europe “might be picking up a dime in front of a bulldozer,” because they will be crushed if the region falls apart, Bass said. Germany is more likely to exit the euro in the next four years than Greece, which faces mounting debts and is struggling repay bailout funds, he added.

Bass compared the predicament facing the stronger nations in the 17-member euro area to being forced to support struggling relatives.

“Let’s not even discuss relatives,” Bass said. “Let’s discuss 17 people that you might have been fighting with for 200 years.”