In a few decades, historians will decide whether Quantitative Easing was really useful and necessary to stabilize the world after the Great Recession of 2008. What we can say right now about QE is that it has progressively dried up the intellectual debate and reduced it to a unique form of thought, sometimes cloying. Between 2010 and 2012, the bond vigilantes who claimed that QE would mechanically and immediately lead to hyperinflation left the scene, not only did the consensus towards QE become universal, but the whole debate began to revolve around at the times, the ways and quantities of Qe and nothing else.
All the traditional variables, growth, inflation, productivity, employment, savings, public accounts, profits have ceased to be analyzed in themselves and have become mere input data to establish how much Qe there would be. More Qe equals more room for bonds and shares to party, less Qe means less room. On closer inspection, nothing else has been discussed in recent years. The paradox is that we're not even so sure that QE has worked in the real economy as well as we've been telling ourselves all this time. Qe blew up the monetary base (the money created by central banks), but it didn't translate into a significant increase in the money supply (the money created by ordinary banks).
Qe has certainly contributed to lower rates, but rates are only one of the factors driving firms to invest and households to spend. In addition to rates, there are animal spirits (which depend on the general climate, pro-business or anti-business), taxation and, as Richard Koo has noted for years, the need for private individuals, after major crises such as 2008, to repay their debts sooner to contract new ones to invest. You can go to a private individual and offer him a zero or negative interest loan, but if his priority is to reduce debt, instead of investing, the private individual will try to continue saving as much as possible.
But now it is as if the intellectual pall of Qe is lifting. Qe is at its zenith. The increase in the global monetary base since early 2018 is an optical illusion due to the fact that it is measured in dollars and the dollar, depreciating, makes it appear higher. In reality, in 2018 the world will have to get used to not only the cessation of Qe, but the gradual but increasingly rapid decline of the monetary base. And this leads to two consequences. The first recalls what happens in space. For half a century, since Sputnik, we have been sending everything up there and everything has been fascinating and exciting. Now, for many years, we will have to clear the sky of dead satellites and the debris of exploded ones - an expensive and not at all exciting job.
We have experienced the fun part of Qe so far, now we have to dismantle it, something of which we have no experience in history. The second consequence is that the disappearance of Qe brings to the fore all the issues of the economic and market debate that had hitherto been subsumed in that on Qe. Suddenly the single thought of Qe opens up in a babel of voices in which it has already become possible to hear everything and its opposite again. The difficulty in finding one's bearings is considerable, also because the level of the debate is generally good and the proposed theses are well argued.
First of all, there are the Seventeenth Party, those nostalgic for 2017 who claim that nothing has changed except for those very few extra decimals of inflation which are exactly what has been declared for years by all parties to want. Among them are the mentally lazy (such as some strategists of big houses used to predicting ten percent fixed-rate stock increases under any circumstances), but there are also brilliant minds such as David Zervos of Jefferies, former Fed Trump research office, says Zervos, he wants strong growth and the stock market, a weak dollar and rates that rise without damaging growth and the stock market. If he chose Powell it is because he has guaranteed to go easy on the rate hikes and not to go beyond the four in all already programmed by the Fed for this year and next.
Let's relax, therefore, in essence everything will be fine. On the other hand, there are the Mondonuovisti, theorists of the radical break between 2018 and the previous years. Once we reach and break through the level of full employment that drives up wages, they explain to us, wage inflation starts in a non-linear, but exponential way. To this we must add the fact that a double net supply of securities will weigh on market rates compared to 2017 (due to the growing US deficit to be financed and the Fed's non-renewal of maturing Qe securities). Without on the other hand forgetting (say Goldman Sachs and JP Morgan) that the Fed, between this year and next, will raise policy rates on its own not four times but eight times, a big difference with that single increase that the market it was still discounted a few weeks ago.
Then there are the Radical Mondonuovisti, who push themselves into the apocalyptic. Among these Ray Dalio, the great manager currently short on Europe, claims that there is a 70 percent probability of recession in America by 2020. For his part, the radical Keynesian Koo argues that Qe must be dismantled quickly and fury, because if all the excess reserves of the banks created in these years of Qe were really transformed into loans to companies (as was the intention of the promoters of Qe), we would have at this point an inflationary flare and a consequent monetary tightening that would wreak havoc of bonds and shares.
And alongside the Radical Mondonuovisti, who move over the long periods of history, we also have the Tactical Pessimists, who confine themselves to the short periods of trading. For Andrew Sheets of Morgan Stanley, the 10 percent discount at the beginning of February is just an aperitif. The complete meal will be served during the second quarter, when we realize that the US economy, far from accelerating, will actually show signs of slowing down. And here, we add, we are touching a nerve that is also exposed in Europe. When the market starts to price in dream scenarios, even modest disappointments like the ones we're seeing in Europe's business confidence indicators can feel like a big deal.
On the market positioning, still too long and complacent, Chris Potts points the finger instead, convinced of the inevitability of new corrections in this first semester. Lively differences also on the American public deficit (not so serious for the authoritative Gavyn Davies, ready instead to leap to a fantastic 15 percent of GDP in the next recession for Albert Edwards) and on the dollar (destined to strengthen for Bank of America and to weaken for the market), which is still very long on the euro and the yen, and for the other major houses, which have not changed their forecasts at the beginning of the year.
Not to mention inflation, about which the debate is more heated than ever. Here, instead of reporting the terms, we prefer to refer to the report that the staff of the Fed (the PhDs of the research office) made to the lawyers, entrepreneurs and politicians of the board, balanced and highly esteemed people but, after the recent appointments, all particularly knowledgeable in econometrics and models. According to our calculations, the staff said, inflation should not exceed 2 percent this year. The problem is that the model we use for our calculations is old and works worse and worse. The other problem is that there are no better models out there than ours.
From here we draw some indications. The intellectual debate and the daring speculations that are circulating again are infinitely more stimulating and fascinating than the obsessive discussions on ECB tapering to which we were reduced, but if we want to keep our feet on the ground, the data that we really have available to predict the future are fragile and all to be verified. In addition, it is the first time that a Qe has been dismantled and it is the first time that a hyper-stimulating fiscal maneuver like the American one has been launched in conditions of full employment and a mature cycle.
In other words, we are sailing on sight in a year, 2018, which is more appropriate to define as transitional rather than radical change. We are moving from the over-protected world of QE to the hard world looming from 2019 onwards, but neither inflation nor yield curves will change so much this year as to put our portfolios at serious risk. After all, there is always a cushion of 20 percent earnings growth in America and between 10 and 15 percent in the rest of the world, a cushion that should cushion any drops and the inevitable multiples compression.
Jeremy Siegel, an academic who has always gotten his hands dirty with the markets and has been correctly hyperoptimistic throughout the great rise, already in November began to say that 2018 will end with a rise of between zero and ten percent . It seems to us a reasonable forecast, but we must add that 1987, a year of great economic growth and fresh from an expansive tax reform, also ended with an increase. The index began the year at 217 and ended it at 247, but in the meantime had the opportunity to climb up to 337 and then collapse in two days to 223 (and below 200 intraday).
Sorry to say it, but the condition to avoid a crash of such vast proportions after eight years of increases is to have not just one correction like the recent one, but a series, hopefully interspersed with recoveries. The fact that he has resumed selling volatility after the bloody losses of the past few weeks shows that there is still work to be done to bring the most vocal Seventeenth-devourers back to their senses. Only after having purged the market of its excesses (which are not limited to trapeze artists without a volatility net but involve more or less all portfolios, in any case overweighted by bond or equity risk) and only after having verified gradually that inflation will have remained indeed at reasonable levels the market may eventually venture to new highs.
Knowing that in any case, in December, the American elections could change the underlying picture again. For this reason, for this first half year, it will be better to sell more on increases than to buy on decreases. It's true, that's what everyone will try to do, but to go against the tide it will be better to wait a few more months.
