Moving The Goalposts
In Kaoboy Musings 5 (10/3/19), I posed the question: “Is ‘bad’ once again ‘good’?” I was referring to the notion that “bad” economic data might be interpreted positively by the market on the notion that a once hawkish Fed might be convinced to become accommodative in the face of economic weakness. After last week’s FOMC meeting on 10/30/19, I opined in Kaoboy Musings 11 that the Fed overtly tied its future policy stance to a 2% inflation bogey, which I thought was significant. On the one hand, Powell showed his cards already with respect to his “downside playbook,” after 3 cuts to the Fed Funds rate year-to-date; ergo, “bad” is “good.”
But what was most significant about last week was that Powell also revealed his “upside playbook” by dispelling the converse theory that “good” is “bad,” that strong economic data would lead to a hawkish response and a swift return to tightening. In fact, by this line of reasoning, when the jobs number came out last Friday (11/1) and showed a whopping 128k addition to payrolls versus the 85k consensus (lowered due to the GM strike), not to mention strong upward revisions of previous months, one might have expected a negative market reaction over fear of a Fed policy whipsaw. Instead, the market ripped to new highs. By moving the upside goalposts to an inflation target rather than, say, strong employment numbers or GDP growth, Powell all but admitted to a patiently accommodative Fed policy stance and summarily exorcised the “good”-is-“bad” bogeyman. So now, at least from a Fed policy perspective, “bad” is “good” but “good” is also “good.”
The two charts below show the current state of inflation in the U.S., or lack thereof. The left shows the CPI (Consumer Price Index), and the right shows the PPI (Producer Price Index); both are popular barometers for inflation rates. Both indicators display strong downtrends in the short-term – despite strong concerns that the tariffs would result in higher consumer prices. While tariffs have impacted certain industries, they are just not causing inflation in the aggregate. My hunch is that this is the strong USD at work, “importing” weakness from abroad, which is why I am supportive of the Fed easing – if only to arrest the relentless surge of the USD.
Over the long-term (see chart below), we have not had significant, sustained CPI increases (>5% per annum) since Blondie had the top song (“Call Me”) on the billboards in 1980 (technically, the CPI didn’t break down below 5% until almost 1983, but 1980 marked the peak)!
Clearly, something else has kept inflation subdued for decades. Most would point to technological innovation as the secular culprit, and I would agree – we have seen this before. Paraphrasing Mark Twain, “history may not repeat itself, but it often rhymes.”
One of the books I am currently reading is the fascinating biography of Andrew Carnegie by David Nasaw (hat tip to Bob Lesko for the great recommendation). On the one hand, this “rags-to-riches” tale extols the virtues of the “American Dream” made possible by capitalism: how a poor immigrant boy from Scotland began his career as a “bobbin boy” in a cotton factory and stair-stepped his way from industry to industry, eventually becoming one of the most prominent industrialists and philanthropists of America. On the other hand, it also paints a dark side to the fully unregulated capitalism of the day, showing how a complete lack of government protections against trusts/price-fixing led to rampant crony capitalism and a very uneven playing field, often causing violent clashes between corporations and unions.
Most interesting, however, was the fact that throughout Carnegie’s lifetime, technological innovation was the one constant that kept exerting a deflationary force on the economy. The widespread adoption of the power loom cost Carnegie’s father (a handloom weaver) his job and forced the family to emigrate to America. Throughout Carnegie’s steel career, inexorable advances in steel-making technology like the Bessemer process constantly created efficiencies that increased productivity but exerted downward pressure on wages. If this happened over 100 years ago, imagine what is happening today in a global, cloud-connected society with AI/machine learning advances every other day.
Ergo, “good” is now “good” from a Fed policy perspective now that the goalposts have been moved to “sustained inflation above 2%.” Good luck with that, Jerome. I’m guessing other economic measures will run hot before this measure -- I believe that this will be a concern at some point, but I think we have a ways to go due to all of the aforementioned reasons in past Kaoboy Musings for why this economy still has slack in it, despite an ebullient and arguably overbought stock market in the shortr-term.
UFC 245: Cooperman vs. Warren?
Talking about Andrew Carnegie and the “American Dream” is a perfect segue to the current war of words between Democratic hopeful Elizabeth Warren and retired hedge fund manager Leon (“Lee”) Cooperman on the topic of wealth inequality – an issue as germane today as it was back in Carnegie’s day.
While I’m generally going to steer clear of politics in this newsletter, I am a truth-seeker at heart and have enclosed a copy of his recent open letter to Warren, because I think Lee does a phenomenal job of cutting through the political snarks and offers a well-reasoned defense of our successful, capitalism-based economy. I have known Lee a long time and have always respected his thoughtful, balanced views.
In particular, Lee’s distinction between “income opportunity” vs. “income inequality” on page 4 of his letter resonated with me. His list of countries with the lowest Gini coefficients (measures of income equality – the lower, the more “equal”) included Afghanistan, Albania, Algeria, Kyrgyzstan, Moldova, Romania, Slovakia, Slovenia, and Ukraine. To quote Lee:
”Yet despite the relatively high degree of financial equality implied by their numbers, none of these countries can boast booming economies or generalized income and wealth-creation opportunities. It would therefore appear that their citizens may be more aligned than those of most other countries in the fair distribution of wealth, but that does not translate in any meaningful sense into widespread prosperity.”
In my opinion, this letter is worth a read no matter what your political persuasion is, because it not only invites thoughtful two-way, bipartisan discussion (is this even possible anymore?) on the hot topic of wealth inequality, it also offers pragmatic, viable solutions versus some of the blatantly confiscatory ideas floated by politicos that are more pandering than practical.
Our society has come a long way from the “Wild, Wild West” of Carnegie’s day – we have antitrust laws, we have securities laws against trading on inside information, we have regulations in all kinds of industries that protect both the consumer as well as the employee. Yet our economic system stands almost uniquely in the world in terms of the widespread creation of opportunity and wealth because we’ve managed to preserve the “secret sauce,” which in my opinion, is the capitalistic impulse that says if you create a product or service that is deemed valuable by society, there is (almost) no theoretical limit to where you can go with it. I believe we must never lose sight of that – no matter who is in the Oval Office.
GSE Update: Calabria at American Action Forum
GSE Preferreds (see Kaoboy Musings 1) have been drifting lower in recent weeks, likely due to lack of near-term catalysts. There is some truth to this, although I’m somewhat inured to this given my 11-year hold so far.
FHFA Director Mark Calabria spoke today at the American Action Forum. Here are some quick soundbites which I found interesting.
- Calabria emphasized that staying in conservatorship is NOT an option and that exit from conservatorship does NOT depend on Congress. On this last point, he called this dependency on Congress a “myth” and said he “won’t wait for Congress to authorize him to do something he’s already been authorized by Congress to do.”
- Rather, it is FHFA’s statutory mandate to EITHER 1) get the GSE’s out of conservatorship, OR 2) put them into receivership. Significantly, he followed up with this comment: “I want to emphasize that the conditions for receivership are not here today.” This is exactly what I conjectured in Kaoboy Musings 9 after so many news outlets latched onto Calabria’s comment that “receivership was still an option.” Sure, it’s an option, but it’s no longer a relevant option.
- He worries that a certain “complacency” has developed around conservatorship and hopes to keep the momentum going on “administrative and regulatory reform,” saying that “hopefully this time around we can do this before a crisis.” Channeling JFK, he quipped, “The time to repair a roof is when the sun is shining.
- I thought it was interesting that he said that getting the GSE’s out of conservatorship and back into private hands would “depoliticize mortgage finance reform.”
- He summarized the recently released Strategic Plan from FHFA as having 3 main objectives:
- Have the GSE’s foster a liquid, competitive mortgage finance market
- Remind the GSE’s to operate in a “safe and sound condition,” making sure no “conservatorship complacency” sets in
- Prepare the GSE’s for exit from conservatorship
- With the breathing room of the recently relaxed Net Worth Sweep requirements to allow for $45 bn of capital buildup (vs $6 bn previously), they now have 4-5 quarters of time to restructure the agreement with Treasury
- This gives them time to get the GSE’s ready for exit
- This gives them time to get the FHFA ready to be the post-conservatorship regulator
- Mentioned that the exit is process-driven rather than calendar-driven (this may be why the market may seem disappointed at a lack of near-term catalysts)
- Perhaps most significantly, at the end of the speech, he said that if he were a future creditor to the GSE’s, he’d want to see “a whole lot of equity beneath him” and said that that is exactly what their goal is.
And herein lies the crux of my thesis: if the goal is to have a “whole lot of equity” in the capital structure, can you accomplish this by eviscerating the old equity and then tell would-be investors to trust them? I say no.
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