TBTF October 28, 2010 - Tell it like it is

Too Big to Flail

October 28, 2010

‘Tell it like it is, Don’t be ashamed to let your conscience be your guide. But I know deep down inside me, I Believe you love me, Forget your foolish pride’ (Aaron Neville – 1966 but I grew up on Don Johnson’s (yes, he of Miami Vice) version – 1989).

And tell it like it is he did. If he was led by his conscious, I doubt that, much more by the smell of money, but boy did he tell it.

Who is he, you will ask? Bill Gross, Chief Investment Officer at PIMCO, the worlds biggest bond investor. And he had this to say:

• Wednesday is the day when the Fed will announce a renewed commitment to Quantitative Easing – a polite form disguise for “writing checks
• We are, as even some Fed Governors now publically admit, in a “liquidity trap,” where interest rates or trillions in QEII asset purchases may not stimulate borrowing or lending because consumer demand is just not there
• Still, while next Wednesday’s announcement will carry our qualified endorsement, I must admit it may be similar to a Turkey looking forward to a Thanksgiving Day celebration
• Check writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme
• Has there ever been a Ponzi scheme so brazen? There has not. This one is so unique that it requires a new name
• The Fed wants to buy, so come on, Ben Bernanke, show us your best and perhaps last moves on Wednesday next. You are doing what you have to do, and it may or may not work. But either way it will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment

There you have it, Bill Gross, a vigorous supporter of the FED, is expressing his doubts about the next round of quantitative easing, and not only about this round but also about the first round. He admits there is not much else Bernanke can do, but it is, in his own words “the most brazen Ponzi scheme ever” and he plans to NOT be the last one out.

He will diversify his way out, move out of Treasuries and into developing/emerging market debt, leaving only the FED and the Chinese to buy this staggering amount of US Government Guaranteed Debt. If the FED wants to buy, he will sell: “Certain Turkeys receive a Thanksgiving pardon or they just run faster than others! We intend PIMCO to be one of the chosen gobblers”

And Bill wasn’t the only one to openly question the sensibility of another round of QE, Peter Orszag (former advisor to President Obama) wrote the following op-ed in the New York Times: Sailing The Wrong Way with QE2? In which he states

“In other words, by perpetuating an artificially low 10-year government bond rate, the Fed may be delaying (even if very modestly, given the modest impact of the action on long rates) the very fiscal policy action that the nation most needs, while doing little to boost an economy whose principal problem is not high long-term interest rates.”

Harsh words indeed.

So after today we have 3 FED governors, the Chinese, the Wall Street Journal, Peter Orszag and Bill Gross vehemently against more quantitative easing. Anyone still believe in a shock-and-awe announcement next Wednesday?

As Abigail Doolittle of Peak Theories Research described in a very well written piece yesterday named QE2: The Bond Bomb? Treasury yields are already creeping up since the beginning of October and if they follow a similar path as after the QE1 announcement, QE2 could very well be the thing to bust the bond bash.

In Portugal the government and the opposition broke off budget talks, ‘agreeing to disagree’, causing yield spreads between Germany and Portugal to widen substantially which in turn had a negative impact on the euro. After Greece’s news yesterday, that GDP will fall by more than expected in 2010, this is the second piece of negative news to come out of the Eurozone. It seems not all is as stable as many had hoped.

As was the case Tuesday we had some strange decoupling within the risk-on/risk-off trade from what we have seen the last 2 ½ months. While the Euro and Yen declined versus the Dollar, Gold/Oil & other commodities fell as expected, the VIX rose, but equities tried and almost managed to rally back to unchanged. Could it be that we were collectively front-running today’s POMO? Something is afoot, that’s for sure.

Dow -0.39% SP500 -0.27% Nasdaq +0.24% EUR$ 1.377 WTI $82.50 Gold $1325.35

Technology and Financials managed to eek out a gain, while Basic Materials witnessed the most severe drop -1.15% as commodities fell across the board.

The yield on the US10yr rose by 8 bps to 2.722%, a rise of 34 bps since October 7^th.

Mid-term elections 6 days away, QE2 7 days!

Happy Hunting & Let’s Be Careful out there!!!