Tags: central bank | liquidity | warning | Singer

Be Wary of Liquidity Trap Set by Central Banks

Be Wary of Liquidity Trap Set by Central Banks

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Friday, 19 August 2016 11:11 AM Current | Bio | Archive

I don’t think it’s an overstatement to say that investors could do well reviewing how much substantial risk is embedded in their portfolios once Fed fund rates will start their long way to normalization.

Believe me, this is easier said than done and making the necessary changes will be painful and rather difficult to make and could need professional trustworthy help. No doubt about that.

Maybe, it could be helpful thinking for a moment what Benjamin Franklin said, now about 300 years ago, “There are no gains without pains” while I’d like to add that as an investor, especially over the short to median term it will be, once again, “Better safe than sorry.”

Of course, everybody will have to decide for him/herself …

In the mean time it's also a fact that warnings abound from a whole range of top investment business professionals that markets are closing in on a very, for not saying historically important inflection point.

In this context, just a couple of days ago, Paul Elliott Singer, head of the $28 billion hedge fund ‘Elliott Management’ and who Fortune magazine described as one of the “smartest and toughest money managers” in the hedge fund industry and whose business model of purchasing distressed debt from companies and sovereign states that has provoked many, but that has resulted in sizable returns (yes, it looks like he knows what he is talking about) warned in his Elliott Management Q2 of 2016 letter of to its (mostly institutional/very wealthy) investors, “ … the state of the global debt market, with more than $13 trillion of bonds trading with negative yields, we are in the biggest bond bubble in world history … Hold such instruments at your own risk; danger of serious injury or death to your capital!”

The letter added that the ultimate breakdown, or series of breakdowns, from this environment is likely to be “surprising, sudden, intense, and large.”

For good reason, many investors are scratching their heads these days and feel lost in the continuous avalanche of still mostly complacent (irrational, at least in my opinion) behavior in broad based markets.

Besides all that, San Francisco Fed President John Williams just gave, especially for investors who are willing to do their homework, a really enlightening and surely helpful prepared speech.

Here are some excerpts:

  • The current pace of job gains is well above what we need, which I put to be somewhere around 80,000 a month, although estimates range from 50,000 to around 100,000… We should expect the pace of job gains to slow, and no one should be alarmed when it does—we should only be alarmed, frankly, if we don’t see that necessary slowdown.
  • There’s a difference between being data dependent and being data-point dependent … No one should get caught up on a particularly bad—or a particularly good—jobs report. Or a month’s inflation numbers. Or even quarterly GDP growth. All the indicators should be examined in their entirety to tell us the state of the economy and where it’s likely headed.
  • It’s useful to look at measures of inflation that strip out volatile prices and provide a clearer view of the underlying trend. Those measures suggest that underlying inflation is in the 1.50 to 1.75 percent range. We’re not quite at our target, but the strength of the labor market should help us along.
  • The economic expansion remains on track. Consumer spending is strong, the labor market is running apace, and household balance sheets are improving. All in all, I see a strong domestic economy … we’re doing a lot better than most of the rest of the world.

In simple words all this means (there is lot more good material in Mr. Williams’ speech that is really worth a read) that bond yields and interest rates at their present extremely low levels are not at justifiable levels in a sound/normal environment and therefore should be bound for moving higher in the not so far future, and, last but not least, better sooner than later.

Once that reversal gets underway, the actual undoubtfully overpriced broad-based markets will have no other choice than adjust to the downside.

The huge unknown is that it is practically impossible to know, or having a more or less good idea, of at what speed the reverse in the broad-based markets will materialize.

As an investor it could be not such a bad idea of being solidly prepared for not tumbling into the trap that the most important central banks of the world, albeit unintentionally, have set up for all of us.

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I don't think it's an overstatement to say that investors could do well reviewing how much substantial risk is embedded in their portfolios once Fed fund rates will start their long way to normalization.
central bank, liquidity, warning, Singer
Friday, 19 August 2016 11:11 AM
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