Lord Make Me Chaste ... But Not Yet
December 24, 2018·Money
Back in 2013, when I was just starting Epsilon Theory, I would go around and give talks to institutional and professional investors about the power of narrative, particularly the narrative of Central Bank Omnipotence. In plain terms, that’s the idea that markets were up, up, up in largest part because everyone believed that everyone believed that monetary policy determined market outcomes. It wasn’t that central bankers are all-wise and knew the answer to everything. It’s not a narrative of Central Bank Omniscience. No, it’s that central bankers are all-powerful, Omnipotent, and their actions (or inactions) make the market go up (or down). That’s the narrative.
The most common reaction to my talk?
You’re nuts.
Only five years ago, soooo many institutional and professional investors did not believe that a faith in the Fed (the Jupiter of the central banker pantheon) was the Why for a bull market. Particularly among value-oriented investors and old-school hedge fund managers like Lee Cooperman and Stan Druckenmiller, I heard a very different refrain – the US economy was now in “a self-sustaining recovery”, and that was Why stocks were up.
Sure, these Masters of the Universe followed the Fed closely and didn’t deny its importance in setting the broad parameters of real-world business cycles. Sure, they read every word that this Jon Hilsenrath fellow over at the Wall Street Journal would write about Fed intentions, and sure, they went to Big Bank X, Y and Z’s small group dinners with Fed governors A, B and C, and sure, they understood that Europe was safe now that Mario Draghi was adopting the Fed playbook, but being influenced by such as that was for lesser mortals. No, no … what I had to understand, dear boy, is that they watched certain infallible market and macroeconomic signals, coupled that with a bevy of analysts and PMs doing “deep fundamental dives” into individual stocks, and THAT was why they were Masters of the Universe.
Fast forward to 2018. The infallible market and macroeconomic signals have, in fact, failed. All those buy-side analysts and PMs finding “alpha” from their 30 worksheet-long FCF models and their oh-so sharp questions posed to management at 1x1 meetings and their oh-so observant site visits to this facility or that facility have, in fact, been fired. All of these Masters of the Universe like Lee Cooperman and Stan Druckenmiller have turned their hedge funds into “family offices”. Not because they WANTED to. Because they HAD to.
I’m not picking on Cooperman and Druckenmiller. Really I’m not. This is a story that’s been repeated a thousand times over the past five years, in both big and small ways. But both Cooperman and Druckenmiller, for whatever reasons, have kept themselves very much in the public eye and the public discourse since winding down their firms, trying to Master of the Universe-splain what happened.
Lee Cooperman and Stan Druckenmiller say it’s the machines’ fault, that “algorithms” have taken over the markets they loved so much and understood so well. It’s those darn machines. That’s why they can’t beat the market any more. That’s why their infallible signals failed and why they had to fire all those brilliant analysts.
That’s why, with the fervor that only a religious convert can possess, these old school Masters of the Universe now pray to their Fed gods, because only the Fed can control the machines. Only the Fed can say the right words and do the right things to make the machines behave.
How do these prayers manifest themselves?
In forms like every Missionary appearance on CNBC last week, much less Jim Cramer’s rantings and ravings, beseeching Jay Powell and the Fed to show mercy on our portfolios and stop the madness of ... {checks notes} ... 2.5% short-term interest rates.
In forms like last Sunday’s op-ed in the Wall Street Journal from Stan Druckenmiller and former central banker Kevin Warsh, saying that awkshuallly, 2011 was the time to exit QE, and an economy with >3% growth and an unemployment rate <4% is just too “fragile” to withstand the “double-barreled blitz” of higher interest rates and a rolling-off balance sheet.
Honestly, it’s embarrassing, especially for self-styled Fed critics like Druckenmiller, who has railed against QE and extraordinary monetary policy actions for YEARS.
It’s like St. Augustine, who prior to his conversion to Christianity in his early-30s, was quite the ladies man. As he recalls his prayers from those wayward days: Lord, make me chaste. But not yet.
The Druck equivalent: Lord, give me QT. But not yet.
I thought there was a good chance that Jay Powell would answer those prayers.
He didn’t.
All Powell needed to do was say the magic words: “we are watching carefully”. Watching US-China trade negotiations carefully. Watching the strength of the dollar and the weakness of commodities carefully. Watching EVERYTHING that Mr. Market is oh-so worried about carefully. Because if the Fed is “watching carefully”, then the Fed has got our back. And there’s nothing better for an investable rally than knowing that the Fed has got our back.
But Powell didn’t say this. He didn’t say anything close to this. In Fed-speak, he came pretty darn close to saying the opposite of this.
Powell told you on Wednesday that the Fed does not have your back.
Will the Fed be there for us in the End Times, when things get REALLY bad? Of course they will. That's THE job of any central bank, to provide emergency liquidity to markets when the Four Horsemen of the Investment Apocalypse come galloping into town.
But will THIS Fed have your back in the way that everyone from Druck and Cramer and Trump and every other Wall Street rich guy has come to expect over the past 9 years?
Will THIS Fed define the health of the US economy by whether the stock market is up bigly or not?
Will THIS Fed do "whatever it takes" to outlaw the business cycle and prevent a recession from ever happening again?
Powell said no.
Good for him.
But if the Fed does not have our back, then we are well and truly stuck in a game of Chicken between Trump and Xi ... hell, we're stuck in a game of Chicken between Trump and the world.
You have no edge in this game. You don't know the odds of this game. Not because you're not smart enough and not because you're not trying hard enough, but because the edge and odds in a game of Chicken are unknowable. And anyone who tells you otherwise is lying to you and/or lying to themselves.
The problem for markets today is not the Fed.
The problem for markets today is the guy in the White House.
Maybe his game of Chicken with the world ends up great for the US. Maybe it's a necessary game to play. I don't think it will and I don't think it is, but no one asked me. I'm along for the ride, like it or not.
Not.
What I can do, though, is refuse to play along with the narrative charade. What I can do, though, is put my faith in my pack and my own actions. What I can do, though, is step back from the market casino while these games of Chicken play out.
You can, too.
