The End Of The Invisible Hand And ‘The Hunt For Red October’

For years – actually, for the better part of a decade now – the usual suspects parroted an at best naive and at worst profoundly dishonest line about the impact trillions in central bank liquidity had on asset prices.

By “the usual suspects”, I mean anyone who became caught in their own reality distortion loop in an era where logging outsized returns was as simple as buying an ETF and watching the money roll in.

To be sure, nobody with any sense of the market actually believes that central bank asset purchases played no role in inflating the value of financial assets in the post-crisis world. As I’m fond of putting it, the idea that central banks deliberately gave everybody a free ride after 2008 is the furthest thing from a “conspiracy theory” there is. I’ve used the following passages before, and I’m just going to quote myself (and Ben Bernanke) because over the summer, I finally perfected my exposition of this topic. To wit:

There has of course been an ongoing, coordinated effort by developed market central banks to inflate the prices of risk assets since the crisis. As I never tire of reminding you, that is the furthest thing from a conspiracy imaginable. It’s how QE works and for anyone who was unfamiliar with the mechanics, it was explained very explicitly in a 2010 Op-Ed in the Washington Post by Ben Bernanke called “What The Fed Did And Why.” That Op-Ed contains this passage:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

If central banks driving stock prices higher and deliberately suppressing corporate borrowing costs is a “conspiracy theory”, well then Ben Bernanke is a “conspiracy theorist”. And if, to take the other side of the argument, this was supposed to be some kind of a closely-held secret that only central bankers knew about, well then Ben Bernanke is the worst co-conspirator in the world. I don’t know about you, but I don’t want to be in a “conspiracy” with a guy who writes an Op-Ed for the Washington Post called “What We Did And Why.”

The point is, “yes” there has been an ongoing effort on the part of central banks to inflate stock prices and catalyze a global hunt for yield that ends up driving everyone down the quality ladder with the effect of leaving everything priced to perfection in fixed income. But “no”, that is not a conspiracy. Again, it’s literally how accommodative policy works.

That is rhetorical perfection, courtesy of yours truly. You will not find it expressed as succinctly and incisively anywhere else.

Unfortunately, legions of newly-minted market mavens lost track of just how self-evident all of the above really is, and who can blame them? After all, just because the gains were engineered from on high doesn’t make those gains any less real (assuming you actually realized them by selling).

Now, the dynamics that led to those gains are reversing. The global hunt for yield is giving way to the exact opposite scenario: Rising rates on USD “cash”, which serves to suck the life out of risk assets the world over. The unwind began in emerging markets and, along with the trade war, conspired to cast a pall over European risk assets which, if they haven’t snapped already, are on the cusp, with the final blow likely to be the end of ECB asset purchases from December.

It’s against that backdrop that BofAML’s Barnaby Martin is out with a characteristically entertaining new note, appropriately called “The Hunt For Red October”.

“Despite a late rally into month-end, October 2018 still proved to be an ugly time for markets and ‘crashes’ are becoming more common in a world of vanishing QE support, and — importantly — rising real interest rates in the US”, Martin writes, reiterating everything said above, before noting that “just 23% of markets have managed to record positive total returns in ‘18, a number usually seen in times of either financial or debt crises, or just plain old recessions.” Have a look at this:

(BofAML)

It won’t surprise you to learn that Martin attributes this, at a kind of 30,000 foot level anyway, to the “the end of the ‘invisible hand’. To wit:

Last month wasn’t unique, though. We think it reflects a bigger picture theme…namely that assets are now struggling to produce meaningfully positive returns in an era of less central bank liquidity. The “invisible hand” that once propped-up market prices is now significantly smaller. Chart 1 shows that there are precious few assets that remain above water this year. In fixed-income land, US leveraged loans have produced total returns of around 4%. In Europe, many government debt markets — with the exception of Italy — are up for the year, albeit only by a modicum. But note that the biggest loser of all during the QE era, namely cash, has turned into one of the best performing assets of 2018 (1.5% total returns).

There is of course a ton more color in the full note, but really, there’s nothing left to say for our purposes here. This just “is what it is”, so to speak, and it should surprise exactly nobody.

For nearly a decade, investors have enjoyed a backstop from a never-ending, price insensitive bid emanating from a buyer armed with a printing press. That buyer is now pulling back (collectively speaking).

The results will be predictable as legions of investors who long ago confused the generosity of their benefactors with their own supposed market acumen, will be forced to fend for themselves.

Good luck – you’re going to need it.