? The Myth of the Infallible Central Bank (w/ David Levine) | Stock Trade Ideas

Oh Welcome to trade ideas. I’m Alex Rosenberg here with David Levine founder of Odin River and also someone know you as the paranoid bull Thank you all for joining us here at real vision great to be back So helped us make sense of these markets here because with so many, you know As we are talking on Monday morning the S&P is up 1% a lot of up 1% down 1% That seems to be the norm these days and people are really trying to figure out what’s driving the market now and what will drive us in the weeks months and Perhaps year or two years ahead So if you were to tell us what the stakes are what the market is trying to figure out right now What would that be? Well, it’s good to put this in context So what’s really interesting if you look at the S&P 500 today? It’s around 2900 last January the end of January 2018 The S&P 500 was higher than it is today last August it was higher than it is today and what’s really interesting is that there’s been a variety of different narratives that have taken over in the first half of this year because we Bottomed in 2018 at the end of December has been quote-unquote bullish. There’s been a lot of confidence volatility settled down What’s really funny though? Is that confidence was based on tweets was based on a back-and-forth trade policy was based on the idea that Donald J Trump will control the markets up and down ahead of the election and get reelected The narrative didn’t really make sense if you think about it So if I look at the last two weeks where the markets are up and down where equity market volatility is up where Treasury market? Volatility is up where the bond yield curve has been inverting? That’s a little bit more normal in my opinion given how volatile the real world actually has been since last January remember last January was the beginning of the end of the top of a bull market We had 90 percent of asset classes globally down in 2018 And so what happened the first half of this year in my opinion is sort of a bear market bounce We had volatility settle we had Correlations go back up. And so a lot of confidence in a narrative that maybe in my opinion wasn’t really justified So what we’re seeing now is more uncertainty We’re seeing that across various different markets and in my opinion that’s more reflective of the fundamentals So I think what’s happening is markets are becoming more normal What we were seeing the first half of the year wasn’t very normal And so what I expect is more the same more volatility more uncertainty And markets beginning to reflect the fundamentals that we know are very volatile in the real world now, which the fundamentals will matter most We’ll see trade war is very important Global slowing in China, very important yield curve inverting important 16 trillion dollars of negatively yielding sovereign credit Important US economy are we in recession import so there’s many different questions Primarily macro related that need to be answered in the coming weeks Those will probably determine the fate of things But I would expect more volatility like this and more uncertainty and maybe even narratives taking hold again Like everything’s going to be fine, or maybe not we’ll see what happens at Hong Kong there’s a lot of uncertainty but in my opinion a little bit more of a normal market in the last couple weeks and what we Saw before so let you play a little dealer’s choice here and of those questions Which one do you think that most investors are getting the most wrong? Where where is the most where’s the biggest problem and investors thinking when it comes to this market? You know, there’s one thesis that have been talking about for the last period of years and I call it the myth of the infallible central banks meaning in order for systemic risk to exist there has to be an assumption that everyone’s making that later is Turns out to be wrong and it’s got to be very very big and most people have to believe it to be true Right. Now that assumption in my opinion is called the myth of the infallible central banks So embedded in a variety of these different assumptions that people are making about the markets is the idea Don’t fight the Fed Don’t fight the BOJ. Don’t fight the ECB in my opinion. That’s just not a good assumption to make meaning Central banks have limits those limits are political. Those limits are legal and in the United States right now We had all the former Fed chairs write an article in The Wall Street Journal just in the last few weeks Questioning the feds very independence right now in the United States. So confidence is also very important for central bank’s so what I would say is what level of confidence is the right level of confidence in central banks is a very important question and How this myth of the infallible central banks kind of becomes unwound in the coming weeks and months Is very important and that could happen in a variety of different ways Two most obvious ways where we see that happening today in the banking system the European financial system European banks we know they’re under pressure near all-time lows Japanese banks under pressure near decade lows and The fundamentals of those have been challenged very much by central bank policy in Europe and Japan the second most obvious places is showing up sixteen trillion dollars in negatively yielding debt Primarily the majority of which is sovereign credit 16 trillion and negative The yielding debt should never exist that was created by central bank’s so we have these very big market signals that are already occurring Which are kind of showing us they’re reaching the limits of central bank power and central bank credibility and central bank effectiveness So as those unfold in the coming weeks, I think those will be very important in two weeks and months actually Those would be very important themes to watch unfold. Let’s just drill down a bit on the negative yielding bonds that something that has sort of crept into the conversation as the Overton Window is being opened about Something that could happen in the US as well I guess I’m trying to understand because to me it seems like a success of central banks that they were able to make people buy negative yielding bonds, you know by setting rates negative but and and you know, Seeing that translate throughout the curve of the risk spectrum as well. I mean people talking about negative yielding mortgages Now what sort of your thesis about why that’s so problematic and what it means for the future of central banking. Oh sure It’s just really really basic. So if I lend you money I need to be compensated for that risk We know for a fact not hypothesis fact systemic risk exists in 2008 it was proven beyond a doubt that if you have a credit bubble You can have systemic risk and that can show up immediately across the entire world We almost had a global financial system collapse beyond repair in 2008. Thankfully we were able to repair it Therefore the risk of lending the risk of participating in the financial market is positive That is why the risk-free rate is always positive whenever you study finance There is a compensation for systemic risk that is embedded in every discount rate And whenever we teach finance, it’s one of the basic fundamental building blocks Now what central bank’s decided was? let’s ignore that what we care most about is stimulating the economy by inflating asset prices and we will ignore systemic risk because we believe don’t worry central banks will be Infallible don’t worry government’s will be able to pay their debts Overlook this very basic fact, which is that systemic risk is positive Therefore interest rates actually have to be positive in my opinion because of the very nature of risk itself systemic risk And so by making the mistake of lowering rates to zero and below The central bank’s forced the system to underprice systemic risk throughout Every single asset class that exists now the concept of negative yields ignores systemic risk It also suggests that you and I are entering a contract where I’m guaranteed to lose money by lending you money That is just not something that people should do in finance. So this goes very deep. It goes very deep and so I don’t believe it is a success to have 16 trillion of Negatively yielding debt actually thinks to sign the systems I should really know a lot of trouble you had the Austrian bond up 50 percent in a month you had You know German government debt up 20 percent in a couple months for what reason in my opinion No other reason than a blow off top quite similar to calm only way bigger way more important because this is government debt government debt is way more central to the financial system than subprime CDOs or any other kind of Credit instrument that’s ever been an issue in the past. So I actually don’t think it’s a success to see the negative yields I think it’s actually really troubling and it’s a sign of how far the system has gone. So going along with that thesis How do you see it playing out from here or you know, this is a blog top if this is a moment of capitulation What does that mean for the months ahead? Well, the two the most important places to look are the the banking system and then the credit markets and Those two things are are both in trouble meaning if you’re bank You have to be able to make money by lending and what negative rates do is it forces? Interest rates negative and it also forces the yield curve to be flat Those two factors make it very very hard for banks to make money So when we look at the equity market prices of European and Japanese banks, not surprisingly They’re near all-time lows in Europe and near decade lows in Japan So my opinion the banking systems of both Europe and Japan are really important because central banks now Especially in Japan are at the limits of what they can actually do to help the situation If the BOJ were to increase their interference or their kind of influence of on the interest rate markets in Japan actually make things worse So there’s really difficult. They’re in a really difficult situation in Japan If the fundamentals continue to remain as bad as they are in Europe similarly, we saw Deutsche Bank already announcing a restructuring So we’re in the middle of the European financial system unwinding now there is a German Court case outstanding that is you know, this is a little obscure, but it’s important thing the German Federal Constitutional Court, which is kind of the equivalent of the Supreme Court right now is reviewing the legality of QE They have never ruled that the QE that was done in 2015 and Beyond is illegal Everyone assumes that the German Constitutional Court is gonna come back in a few months and say don’t worry Q He’s okay the 33 percent rule that the drug. He’s been following if they want to increase it to 50 percent. That’s gonna be okay But it might not be the case. We actually don’t know today nobody in the world Maybe the judges know but I don’t even know if they’ve decided know whether q is legal in Germany Which is just wild to think about if they were to come back and say it’s illegal The point is that there’s a lot of uncertainty in these markets, especially in the financial system So I’d start with you know coming back to your question of what what’s most important the financial system itself Especially in Europe and Japan and the the second point which is credit market volatility I mentioned a little bit about this court case That would be something that would be quite volatile across credit markets and we’re to come back in a negative way But credit market volatility more generally is also very important to watch if you look at the last couple weeks Credit market volatility has picked up Treasury market volatility has picked up even more than equity market volatility now if we start to see that volatility Increase that could be quite dangerous because it would also be a sign that we’re likely starting to see defaults Spreads could begin to widen and we could begin a credit cycle now everything I’ve said so far has ignored the fundamentals remain weak Fundamentals remain very weak China just had one of the worst quarters in 20 plus years industries like automotive And semiconductors and others are weakening and so and not to mention oil and gas like there’s a bunch of industries where fundamentals are weak So if we get credit market volatility picking up while fundamentals remain weak Ignoring whether or not the u.s. Is in a recession We could start to have a default wave we can start to have credit volatility and those two things banking System vulnerability in Europe credit market volatility throughout the system those would be things which they could be quite dangerous in this environment so when it comes to all these Particular issues and I’m glad we talked about central bank’s already because the answer really comes back to central bank’s I mean central banks could save, you know, Georgia make another European banks and central banks could couldn’t You know continue to do things too. So, can I just in a row? Yeah, please Getting this is the key Point right which is the myth of the infallible central bank. And the reason it’s a myth remember in 2008 This is really important to remember in 2008 the actions that the Fed took were not in their authority They were granted to them by Congress They were granted to them by unified front of Democrats Republicans and the White House coming together Locking arms and saying we need to bail out AIG. We need to bail out goldman sachs We need to bail out the financial system because it’s important because we don’t want the economy to go into a tailspin even in the united states Could you imagine today Nancy Pelosi walking into the White House with President Donald Trump and saying hey Let’s bail out AIG and gomen Sachs. I don’t know how all that would go over perhaps in an election year the Democrats might say oh why don’t we make this a tougher negotiation than President would like they may be incentive to make things even more difficult Than they otherwise might given the context of the politics here to Europe where you were going before They actually tried to create a merger between to which bank and another bank in Germany and they failed The reason is that it’s not that straightforward You have union workers on the board of deutsche bank and union work has said no merger. We don’t want to get fired And when you start to think about bailing out banks in Europe, that’s where the laws become really important so one of the key issues in this German case that I mentioned is that the german constitution and the German laws want to make sure That Germany is not financing the deficits of other countries specifically countries like Italy so if you got into a situation where you needed a bank bailout You’d actually need to have the different countries cooperated at the end of the day might that happen I think probably but most likely that would take time And therefore you’d have significant volatility in the near term in other words one of the best things that could happen for a bailout of the financial system in Europe might be significant volatility You know if markets are down 30 or 40 percent and you have a lot of volatility and there’s quote/unquote flood on the streets That’s when maybe there’s a political will to come together and give the central bank The authority it needs to act in a time of crisis which is what happened in a way But the point is that there are limits to what the central banks can do at any point in time And I think we’re nearing those limits and at the very least To paraphrase if there is a central bank put the strike price is much lower than people might currently think of us It’s a great way of putting it. I think that’s right. So given this view of the world that you articulated What does it mean for you when it comes to asset allocation? And so I think what it means coming back to the very beginning of the conversation what our equity markets doing today? They’re much more volatile. Right? We saw we saw VIX as one measure of volatility but realized volatility It’s really picked up in the last couple weeks Valuations on any kind of cyclical adjusted basis are very high The same is true for credit markets bond yields, very low meaning bond price is very high the asymmetry associated with any of the things that I’m talking about Meaning the risk to the downside if any of the things I’m talking about materialize are quite significant both in equity markets and credit markets For me, that means being that short now. I don’t advise that for non-professional investors It’s really shorting is quite dangerous and it can be, you know, very asymmetric to the downside It takes a lot of you know, both patience and things, you know Having a good sense of position sizing risk management and stuff like that in my opinion De-risking is is probably the most prudent thing to do FDIC insured savings accounts where you have, you know, 2% interest and you have a guarantee at least from the government I don’t believe they will let FDIC insurance go even in its systemic type Crisis, it’s pretty attractive You have 2% you know guaranteed in this market where you have negatively 16 trillion and negatively yielding credit including you know the US 10-year below that 2% you know, it’s pretty attractive in my opinion. So maybe not the sexiest trade idea we’ve ever Yeah, I think this is not a time to try to be sexy now I mean, you know you for me You know being short is something that does make a lot of sense and when you say net short stocks bonds Yeah, and so the way that I construct, you know, my portfolio is to be long progress I’m long this conversation like I’m long transparency and there’s a reason why at paranoid bull My Twitter account is is somewhere where I share my ideas I believe very much in the mission of real vision and very much in the modernization of Finance. And so being invested in themes like increased transparency and Finance themes like Increased transparency and media and companies that are benefiting from that post public and private Holding that forever to me is a great thing to do now Being short broader equity markets being short companies that are being disrupted Yes being short credit, which is again something that you know when advise to your average investor but doing these things in the context of portfolio to me makes a lot of sense, especially if one You know constructs it with not a lot of leveraging and some prudence with position sizing. I think it’s the right way to go Well David, I’m along this conversation – thank you so much for joining us here in real vision. Thank you for having me It’s great to be back

21 thoughts on “? The Myth of the Infallible Central Bank (w/ David Levine) | Stock Trade Ideas”

  1. If you believe prices will fall by 8% and the bank offers you an interest rate of -3% it can be perfectly rational for a rational person to deposit their money in such a bank. This man is asinine. Surely, you can find an individual more interesting than this to waste 16 minutes of our lives.

    Negative interest rates are a desperate attempt to encourage expenditures before deflationary expectations saturate the psyche of investors that guaranteed negative returns are a haven against the certainty of even greater financial losses. Have you even heard the name Irving Fisher?


  2. We bail out these banks as taxpayers never receive anything in return. Let these banks fail. They've decided only lending money for friends and family. Why do they have show called shark tank its because will not loan the needed capital.

  3. David Levine !! Hooray!!

    (BTW you are and incredibly lucid & clear thinker! ) Thank you!

    [Portfolio Manager – Brisbane Australia]

  4. The Fed is a private company, profiting from issuing currency. However, the main purpose of the Fed now, is to impose the [fetishised] business cycle. Use austerity to create a downturn so the Uber-rich can buy up bargains, then create boom, to sell the bargains at a profit. Over and over again. How do you think the 1% got that way!

  5. Fascinating the number of people who ignore UAH 6.0 Satellite Data

    It confirms we have had no net Warming last 21 Years

    Sharp Cooling last 3 Years

    NASA confirms our Thermosphere is Cooling and Contracting

    NASA predicts solar cycle 25 will be weakest in over 200 Years

  6. If I am the privileged 10% of richest people I will say: I did a huge money in the last 10 years by investing in equity and surfing in the China economic performance. Now China is over, the demand of consumers in the world is stopping, the recessions are coming. Let accept apply the money even with negative interest rate in the solid countries treasury bonds to protect what I gained. Quicker the better because in the future the interest could be more negative and I may make profit in investing there. Solid countries, Japan and Germany and USA, maybe.
    If I am a Treasury of these countries I know I can guarantee the repayment of my issued bonds once it is issued in local currency and will not assume sovereign risk in a foreign currency. Then why should I pay positive interest in something that the demand to buy is huge and I will use the money to reanimate my weak economy. My opportunity to create such demand by credit to the population is very limited anyway.
    If I am a population I am very worried with uncertainty of job in the future once in the past 20 years the job was all taken to cheaper labour countries and unemployment rate are part of constant real life today. If I am old I need to preserve my saving and will never spend money nor will borrow money in the bank even if the interest rate is low.
    If I am an economist will say that the real economic opportunities is disappearing and it is going into the recession.
    But who cares, I am not exactly interested in being any of the above I. I want to be a big multinational corporation using cheap money for M&A , destroying competition and jobs and being a oligarchy.

  7. I reject your myths about the success of negative yielding debt! Narcissists and psychopaths can drink their own poison.

  8. a lot of talk about market theory. Might as well throw "how things should be" out the window because you cannot overpump credit into the system and expect to keep the bubble inflated, yet anyone who has gotten rich off these massive credit bubbles somehow believe they earned that excess wealth when in reality they are the problem with the current system. If you want to be rich, a lot of other people need to be pushed into poverty for that to happen, unless you just keep inflating the bubble. The slush fund is almost over, all it will take for the whole scheme to collapse is a majority of consumers to abandon fiat currency before the governments around the world can push out cashless systems. That's the panic right now at the top, where the game of Jenga has reached ridiculous levels of precariousness. Anyone not thinking big picture right now is a fool.

  9. Deep thoughts. Great thesis to add into the economic mix to make sense out of chaos. Thinking going ‘the big short’.
    Yipes…. I’m in and out everyday…. Argentina down 50% in a day… oofah. Gold doesn’t even know what to do.

  10. The Fed is a criminal entity. Answers to no-one! Robbing the American people blind & sending them off to one War after the other. Yet the people allow this evil to continue??

  11. The only reason why we had this great bull market was central banks and the Fed. Look at all the troughs in the SP500. They all occured at QE1, QE2, QE3, Operation Twist, Yellen flip flop and Powell flip flop.

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