Negative Mortgage Rates Arrive in Denmark. Yes. Negative Mortgage Rates.

I’m not about to translate an entire news article from Denmark, but here is the headline that hit the wire a little while ago:

Boliglån rammer negativ rente for første gang

Nordea Kredit skal nu føre penge tilbage til enkelte kunder i stedet for at opkræve dem, skriver JP Finans.

Translated courtesy of Google:

Mortgages frames negative rate for the first time

Nordea Kredit must now bring money back to individual customers instead of charging them , writes JP Financial .

Has deflation become so severe in the Eurozone that negative mortgage rates make sense?  Deflation, yes.  Paying people to take out mortgages, no.

If deflation has become such a severe problem that a banking system must pay people to borrow, the global economy is crawling on the razor’s edge.

These are strange times indeed.

Here is the link if you wish to translate the entire piece:

“I watched a snail crawl along the edge of a straight razor. That’s my dream; that’s my nightmare. Crawling, slithering, along the edge of a straight razor… and surviving. ” – Colonel Kurtz

– LL


American (or European) Py

This morning the European Central Bank made some very accommodative moves.  While the details are a little wonky, here is a rough summary (emphasis on “rough”):

  • Targeted Long-Term Refinancing Operations (TLRTO):  These operations are designed to “grease” the monetary policy transmission mechanism so accommodation becomes reflected in the “real” economy.  To make the operation more attractive to banks they may eliminate the premiums charged to banks and lower the benchmark rate.  Today’s announcement lowered the cost of funding to 0.10% above benchmark.
  • ECB to purchase ABS:  The idea here is for the banks to bundle various securitized loans and sell them to the ECB.  Today’s plan includes both new and existing Asset Based Securities and Residential Mortgage Backed Securities.
  • Lowered Rates:
    • Rates on main refinance operations were lowered to 0.05%
    • Rates on marginal lending were lowered to 0.30%
    • Rates on deposit facility were cut by 0.10% to -0.20%.  Yes.  Those little dashes in front of the percentages indicate that banks will be paying interest on the money they deposit at the ECB.

In the wake of this, rates on 2-year paper in eight European countries went negative; with the lowest negative rate being paid to Switzerland (-0.119%) and the highest negative going to Austria (-0.049%).  I think I’d balk at the privilege of paying the Swiss 0.119% to give them the use of my money.  But hey, that’s just me because apparently someone is willing or the rate wouldn’t be where it is!

As I write this, the EUR/USD has fallen 1.60% to 1.2939 – the ECB having (at least for now) the desired impact of hammering down the Euro.

In Europe, reactions in the equity markets were generally positive.  The DAX gained 1.02%, the FTSE gained 0.06%, and the CAC 40 gained 1.65%.

That’s a pretty healthy reaction.  It seems that draconian fixes are considered bullish while the underlying problems necessitating these fixes are ignored.  A money manager has to make his numbers each quarter, so I suppose that’s understandable on some level.

The US markets were generally positive early in the day, but the gains faded after the 159, 648th rumor came out of Ukraine.  This was the most recent of the 79, 824 bad news rumors, and it took the markets fractionally lower.

Early this week I linked an article about “liquidity traps.”  Roughly (again) defined, a liquidity trap is where injections of cash by a central bank into the private banking system fails to decrease interest rates because there is a prevailing belief that interest rates will soon rise.  Similarly, if the cash is not being deployed due to “hoarding” there is little impact on creating inflation (which a few countries could use right now…  Italy, I’m talking to you).  This is described as M * V = Py, where M is the money supply, V is the velocity of money, and Py is the product of price and units.  An increase in Py would be evidence of inflation.

Since there is no question that the Fed and the ECB are ramping up the “M”, and there is little evidence of an increase in “Py”, one could deduce that “V” is the lollygagger.  To wit, here is a quote from the St. Louis Fed’s website:

“During the first and second quarters of 2014, the velocity of the monetary base was at 4.4, its slowest pace on record. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This implies that the unprecedented monetary base increase driven by the Fed’s large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP.”  – Economist Yi Wen and Research Associate Maria Arias in a St. Louis Fed article:

Now, in full disclosure, the concept of the liquidity trap is a construct of Keynesian economics.  The Austrian School would argue that the lack of velocity during these periods of low interest rates is a result of previous mal-investment and the discounting of an assets value at an extremely low rate (time preference).

I wish I definitively knew the cause of the flaccid “V”, but after witnessing 5 years’ of ramping up “M”, I’m beginning to side with the Keynesians on this one.  It would seem that much mal-investment would have worked through the system at this point, resulting in some juicy Py.

Mmmmm.  Juicy Py.



Friday’s Random Thought

My 3 p.m. meeting was cancelled today, freeing up some time for me to catch up on some reading.  While perusing my bookmarked financial blogs, I came across a quote (from a money manager whom I hold (held) in high regard) that made me stop in my tracks.  So much so that I had to re-read the paragraph three times to make sure I wasn’t missing something.  I’ll leave the manager’s name out of this discussion, but here is the quote:

“As a money manager, my portfolio model remains currently fully invested. The problem is that I am grossly uncomfortable with that allocation given the risks that currently prevail. However, as I have stated many times previously, I must follow the trend of the market or I will suffer “career risk” as clients move money elsewhere to chase market returns.”

How can so much “wrongness” be packed into one short paragraph?

  •  “…my portfolio model remains currently fully invested” and “I am grossly uncomfortable with that…”  That’s kind of like a doctor who keeps prescribing a medicine, even though he knows the prescription is elevating the risk of an adverse reaction or death.  I think I’d ask for a second opinion!
  • “I must follow the trend of the market…”  Here’s a tip from one money manager to another:  VFINX follows the “trend of the market” quite nicely; and does it for 0.17%.  What are your management fees?
  • “I will suffer ‘career risk’ as clients move money elsewhere to chase market returns.”  Career risk?  Seriously?  One of the things I learned early on in my career was that longevity was much more likely when you put the clients’ best interests ahead of your own.  Sometimes that means taking a call in the evening or on a weekend.  Sometimes it means driving out of your way when the client needs to meet you at their convenience.  But ALWAYS, ALWAYS, ALWAYS it means treating their money with as much care as you treat your own.  And, unless you’re insane, you are not likely going to invest your own money in a way that exposes it to known or perceived risks.  Besides, I must have glanced over the part of the contract where the clients signed up to be my personal annuity.

Those who know us know we manage money in an uncorrelated fashion with an eye on consistency of returns.  Following the trend is not our thing.  As such, we’ve had clients leave us since 2009.  It started with some of our wholesalers for whom it was easier to replace us with the “hot dot” than to have a serious discussion with the end client about where we fit in terms of risk and reward.  Other clients stayed for a few years more, but ultimately succumbed to the Sirens’ song of seemingly riskless riches.  I maintain friendships with many of those who left, as I understood that everyone is driven by their unique emotional makeup, there was nothing personal about their business decision, and I wasn’t going to change the way we manage money.

Fortunately, we adjusted our business in anticipation of expected redemptions.  We reduced our cost structure, moved our broker/dealer relationship to a more efficient chassis, entered into new market segments, and brought in a second portfolio manager to help insure that our investment process and security selection was as good as it could be.  We also recognized that, in a persistently rising market, we had to strip costs to the client down to the minimum.  So that’s what we did.

Now, five years later, we’re as healthy as we’ve ever been.  Our client base has been diversified.  We learned to be more efficient.  Our clients enjoy lower costs.  We have a new and experienced portfolio manager/business partner.

It’s ironic that, because we chose to embrace “career risk, ” we’ve become a better organization.

Still, it makes me wonder how much of the stock market rally can be attributed to the mentality expressed by that money manager/blogger.  I fear it’s more than a little.  When the fire alarm sounds, there are going to be a lot of people trying to get out of too few exits – not so good for the clients, but at least many careers will remain intact. – LL


The Grateful Dead and Noise Pollution

We started this business in 1992. Back then it was known as Bayfield Financial, then we took on some partners and changed the name to Irvin/Letterio Portfolio Management.   After that, we took on more partners and became Peregrine Advisers, subsequently sold the company to private equity, did a public offering, followed by a management buyback, ultimately becoming Altair Management Partners.

Over those years, we enjoyed the 1990’s tech bull market, endured the tech bubble popping, coasted along with the housing bull market, navigated the Great Recession, and marveled at the subsequent Fed-induced bull market.   We look back grateful that our flagship investment strategy never suffered a decline greater than single digits.

What a long, strange trip it’s been.

In a way, our longevity was helped along by doing our own research, having a distinctively contrarian viewpoint, and (most importantly) being able to glean causality from the events unfolding before us.

Which is what brings me to write this post.

For most of 2014, I’ve been witnessing things to which I cannot confidently attribute causation.   To wit, implied volatility (VIX) sits at 11.65; a full 19%+ below its level just one year ago.   At the same time, the S&P 500 melts upward to low volume all-time-highs.   All of this while the yield on the 10-year Treasury fall to 2.44% (a 15.6% decline in yields since the beginning of the year), and the yield curve continues to flatten.

So, bonds are rallying, stocks are rallying, volatility is practically non-existent, the yield curve is flattening and the Federal Reserve is backing out of bond purchases.   Strange bed-fellows.

I’ve picked my brain for the past few weeks trying to find a similar set of historical circumstances from which to glean some insight.   I’ve also been looking at foreign bond prices and currency pairs to assess the possible impact of the carry trade (which looks pretty possible).   I’ve dug through economic releases looking for inflation, stagflation, deflation, or disinflation (mixed bag, at best).   I’ve read bullish narratives (which sound like talking points), bearish narratives (which always sound too smart by half, which makes me dubious), and conspiracy narratives (for entertainment after reading all the dry material).

The takeaway for me is that I simply cannot explain the coincident movements in these indicators.   They seem counter-intuitive.   On a certain level they seem irrational.   They come across to me as so much noise.

When I say “noise, ” I mean a very specific kind of noise.   Let me give an example.   In instances where we employ third party managers, the dominant reason we terminate them tends to be noise.   It’s that unexplainable change in the way the manager is communicating, researching, staffing, or responding to inquiries.   It’s subtle, it’s often gradual, and it’s far more noticeable through intuition than through dogmatic questionnaires.   It’s one of those things you can’t quite put your finger on, but your intuition hears it.   It’s noise.

Over the past 22 years, we’ve had some luck factor into our achievements; but analysis would show that the single-most important factor was avoiding two major bear markets by our willingness to walk away when we heard the noise.    Simply put, if we can’t understand what we’re hearing we won’t invest in it.

Now, I wish I could provide some awesome technical and fundamental analysis for the reason we’re beginning to flatten out our exposures.   But as I said earlier, I can’t.   I can’t, because I can’t hear very well.   There is just too much noise. – LL


Small Caps Have Dandruff

How do I know this?   The Russell 2000’s head and shoulders just hit my Bloomberg.  


Apparently the malady is contagious, as it seems the NASDAQ has caught it as well:


Now I’m no chartist, but there seems to be some pretty clear support and resistance areas in this classic topping pattern.

Yet, the phenomenon seems isolated to the small caps (Russell 2k) and generally younger companies (NASDAQ).  As the chart below illustrates, there has recently been significant divergence between the smalls and the bigs (S&P 500).  The top chart compares the two indexes while the bottom shows the direction and magnitude of the spread.


A chart of the NASDAQ vs. S&P looks nearly identical, so I omitted it.

These signals by themselves may not be too troubling.  But combined with the momentum stock beat-down, the retail stock beat-down, the bio-tech beat-down, the 10-year Treasury yield beat-down, and a flattening yield curve…

We’re not in the business of predicting short term market direction.  We are in the business, however, of allocating capital.  And while noisy indicators may or may not be precursors of pending market problems, relative value is looking a whole lot better than long beta from where I sit.  – LL