KEN GRANT - Chaos Theory: A Random Walk Through Current Events
Chaos Theory: A Random Walk Through Current Events
September 16, 2018
It was quite a sloppy (Jewish) Holiday shortened week, which nonetheless played out about like I expected it to. It is followed, of course, by what we members of the 12 Tribes consider our Big Enchilada Ritual (Yom Kippur), so I’m anticipating more of the same over the next few days. Last week, the macro data was, on balance, pretty tepid, with CPI, PPI and Retail Sales all coming in as disappointments. However, in spite of this, equities were up a pretty solid ~1%, while global treasuries sold off – to a point where the U.S. 10-year is pounding on the door of 3.0%, and Swiss bonds of the same maturity are poised to breach the unambiguously usurious level of 0.0000%.
As of now, the only major equity markets showing a positive ytd return are those in the U.S. and in (Pearl Harbor perpetrators) Japan.
It is, in short, the kind of environment where one must look for invisible strings, those opaque, counter-intuitive interconnectivities that fall under the heading of Chaos Theory, and its corollary: that the flapping of a single butterfly wing in Nebraska can unleash a hurricane in the Sea of Japan. Market participants have for 150 years referred to this dynamic as the Random Walk, where prices move at their own discretion, and those seeking to generate returns must struggle to connect the dots.
Care to take the stroll with me? If so, let’s begin. Speaking of hurricanes, like everyone else, I have been watching in fascinated horror the umpteenth pounding of the Carolina Coast, this time as brought to us by a stubborn mule of Tropical Storm named Florence. It looks pretty nasty down there, and I feel for everyone affected. But I join others in wondering if would be too much to ask of the media to desist the tasteless practice of filming breathless updates from reporters, who, by all accounts, appear at any minute likely to be swept away like the house of the Wicked Witch of the West? Friday night, I was watching one such segment (I won’t reveal which network, other than to disclose that it wasn’t The Weather Channel) where the poor slob at the mike was literally hanging on to a telephone pole at an angle parallel to the ground, and perpendicular to a power pole that looked like it was to be dislodged by the forces of nature at any instant. I feel that all of this unnecessary sensationalism, while undoubtedly boosting ratings, adds nothing to our erudition. Hence the term: Storm Porn.
And speaking of Porn, many of you may have encountered a news item about a rapidly fading (but currently ubiquitous) hero of mine – Paul McCartney, in which he recounted an erotic bonding session with the (even-higher-in-my-esteem) John Lennon, from about 60 years ago. I won’t elaborate, and the sensitive among you can feel free to shove this one into the “too much information” file. But there is a bright side -- insofar as the episode enabled favorite newspaper (no joke): The New York Post, to reach new heights with its signal skillset: clever headlines. So we awoke Wednesday morning to an edition featuring a pic of the youthful John and Paul, as accompanied by the following headline: “Beat the Meatles”.
You gotta love the Post, and I’d put this masterpiece right up there with such timeless efforts as 1983’s “Headless Body in Topless Bar” (no explanation needed), and 1996’s “It Works!!” announcing the successful reattachment of a certain body part severed from the person of one John Wayne Bobbit, as the result of a romantic dispute with the estranged wife of his bosom, Lorena.
And, speaking of problems in the realm of “L’Affaires de Coeur” it now appears that the love match between James Dimon and Donald J. Trump has run its course. In response to the former’s spit-balling about his ability to beat the latter in a presidential election, the Leader of the Free World could not resist throwing back some infantile, ornithological shade. I. Wish. He’d. Just. Stop.
And speaking of Jamie, he now remains as the last man standing in a corner office of a Major U.S. Financial Institution in the wake of the 2008 crash, which began in earnest 10 years ago this past Saturday, with the final collapse of Lehman Brothers. There were two, but then Lloyd announced his retirement, so now there’s one. Jamie won’t probably be around for much longer, but he’s still here, and he’s alone. Wonder if he ever misses Sandy, Stan, Dickie Fuld, Ace/Jimmy, John Mack or Angelo?
And speaking of the 2008 crash, while there has been an ocean full of commentary about whether the government’s response was appropriate, I nonetheless feel compelled to weigh in. While we won’t probably know the full effects of the episode for at least another decade, for me, the results to date merit an unambiguous “thumbs up”. Yes, we bailed out the banks and fat cat bankers with taxpayer dollars, and no, none of the thousands that perpetrated what maybe modern history’s most massive financial fraud were ever prosecuted, much less went to prison. But the banking system needed the bailout, and I, for one, was happy to contribute my tax dollars to the cause. Because I am completely convinced that the counterfactual: one that would’ve allowed our then-tottering financial institutions to fail, would’ve had unspeakable consequences. All forms of debt would’ve gone into serial default. Asset prices – including housing – would’ve collapsed to Absolute Zero. Everyone with a mortgage would have lost their home and probably their job. There would’ve been blood in the streets.
And speaking of bailouts, perhaps the most controversial issue being bandied about, 10 years after, is whether or not the Feds were wise in failing to come to the rescue of Lehman. On balance, I think they made the wrong decision here, but I do have some sympathy for those who made this call. Lehman had been given many months to source a capital injection, but didn’t like the prices it was offered, and so, out of greed and hubris, it allowed the window of salvation opportunity to close. In addition, I believe that what really tipped the scales against them was the near-contemporaneous decision to bail out Fannie, Freddie and (the week before the Lehman moment of truth) AIG. The government had NO choice with respect to these institutions – particularly AIG, which had written hundreds of billions of credit insurance to the likes of Goldman, Citi, Credit Suisse and countless others. Had they gone down it would’ve been, like an old boss of mine used to say, “Katie bar the door”. I think virtually every levered institution on the planet would have been transformed into a tumbling domino.
But the depths of AIG’s woes were not widely known untill the need for a bailout became apparent, and the timing was – shall we say – unfortunate for Lehman – which again had so arrogantly squandered its months-long recapitalization window. I think Paulsen and Bernanke felt that they had expended all available political bailout capital, and allowed Lehman to go toes up.
So it goes, and so they moved on. It was then time to inject some adrenaline into the comatose financial system, and hence QE became a permanent part of the financial lexicon. Was it a mistake? I hardly think so. After pumping several trillion dollars of new money into the system, finance companies – at least in this country – got well and started doing business again. Historically low interest rates socialized a recovery in the financial, housing and (eventually) jobs markets. And I ask you this question: if, say, in the spring of 2009: the depths of the crisis, I would have told you that a decade later, the SPX would be a 4-bagger, that housing prices would reach new highs, and that unemployment would achieve record lows – all without a hint even to this day of real inflation (much less hyper-inflation), would you have taken it? I bet you would’ve. Yes, there were other factors that contributed to the astonishing recovery, and yes, somewhere down the road we may end up paying a bigger price for a bank bailout/money printing strategy that I must allow goes against everything I hold as holy with respect to economic theory. Somehow, though, at least thus far, they were right. So I’d like to take this opportunity to salute those crazy kids at the Fed and Treasury for having the courage and political will in terms of monetary policy to try something that shouldn’t have worked but (at least thus far) did work.
And speaking of politically counter-intuitive monetary policy, I think we should pause a moment to salute the kamikaze move last week undertaken by the heretofore entirely anonymous Murat Cetinkaya – Director of the Central Bank of Turkey, who responded to that country’s strongman Recep Erdogan’s diktat not to do so by jacking up overnight rates by 650 basis points -- to an eye-popping 24%. I mean, what could possibly go wrong for MCet? But as of the point of this correspondence, I’m happy to report that: a) the move stemmed the free-fall of the Turkish Lira, as well as that of b) its benchmark BIST 100 Index (now down only a modest 50% year-to-date); and c) according to published reports, Mr. Cetinkaya is still able to fog a mirror. But my advice to him is to watch his back – particularly given that in addition to his status as supreme leader of the Turkish peoples, Erdogan has, and as evidenced by the attached holy parchment, appointed himself CIO of that country’s Sovereign Wealth Fund:
He may be OK with paying 2%/month vig for short-term borrowings, but I’m not gonna lie: all of the above is making me quite nervous, or my name isn’t Cetinkaya. We’re stuck in a data vortex for the next several weeks, with only the possibility of happy news from Washington, Ottawa or Beijing to catalyze any sort of a rally, and I’m not holding out much hope in any quarter.
So expect a bumpy ride, and whatever else you do, pay attention to the principals of Chaos Theory. Butterflies may at this very moment be causing future tidal waves. A stray bullet can catalyze two world wars. Friendly fire took out Stonewall Jackson, and god knows where we’d be had that not taken place. 500 hanging chads in Dade County, FL turned the 2000 election, and arguably changed the course of history -- in dramatic fashion -- for the next generation. A microsecond’s worth of a bad data feed can trigger catastrophic quantitative sell programs.
Under the circumstances, who’s to say that a missed beat in a Neil Peart drum solo couldn’t take down the entire continental power grid, or that perturbations in Saturn’s third moon wouldn’t destroy five years of earthly cotton crop?
Not me, because I am prepared to continue my Random Walk through the Theory of Chaos.
And speaking of Chaos Theory, I’d urge caution in its shadow. With all of these strange goings on, it is wise to play the probabilities, but to do so with a realization that what takes place in the tails often determines the outcome. However, one holy blessing remains to us,the one that marks my sign-off each week. Timshel: Hebrew for “thou mayest”, bestows upon all of humanity the opportunity to reach the heavens or to die trying. Thus, in advance of this year’s cycle of repentance, I can only offer you a heartfelt…