(Dr. Quest, a California money manager, contributed much of this information).
With Q3 GDP growth tracking 1.6%, according to BofA Merrill’s estimate last Friday, Wall Street strategists – whose bullishness has been deafening, despite realities on the ground – are starting to hedge their bets with some unusually candid analysis.
So today, Jim Reid, Nick Burns, and Seb Barker of Deutsche Bank released “A Nominal Problem,” Deutsche Bank’s 85-page annual Long-Term Asset Return Study. Very predictably, and in line with Wall Street’s addiction to the Fed’s trillions – which the Fed is now thinking about “tapering” out of existence – they clamor for even more QE:
Given the structural issues that we think will continue to hold back growth, unconventional monetary policy may actually need to increase in the years ahead.
But… “Expanding ‘traditional’ QE might not be the answer,” they write. They want a “blurring of lines between governments and central banks.” They specifically mention Abenomics as an example to follow, whose utter monetary and fiscal recklessness rule Japan today, to the benefit of the largest banks and Japan Inc., but practically no one else.
“Globally, the next few years may bring politicians and central bankers closer together,” the authors explain. They even see something no one has invented yet, a “monetary policy that directly targets growth over financial assets.”
Thus, Deutsche Bank admits that the global money-printing binge and zero-interest-rate policies have merely inflated financial assets, causing bubbles everywhere, but have done little for real economic growth. And in between the lines it agonizes over the corollary: if QE caused the assets bubbles, what will happen to them when QE gets tapered out of existence?
Other choice quotes (emphasis added):
We’ve previously been of the opinion that the end-game to the 2008 financial crisis is notably higher inflation at some point in the second half of this decade. We still think this is likely but only if unorthodox monetary policy continues over the next few years.
Overall we think many global assets have been inflated by QE and central banks may need to spend the next few years engineering higher nominal GDP to justify such valuations.
Plaintext: Global assets are overvalued.
They’re saying: To keep these lofty valuations inflated at their current levels, rather than let them crash, central banks must create “nominal” GDP growth – in other words, inflation. Sufficient inflation will drive up nominal GDP but will do nothing for real GDP. For example, an asset class that has been inflated to double its economic value? No problem. Just create 100% inflation over a few years, and everything is back in line – except that that asset lost half of its real value to inflation, but it looks stable on paper. This sort of desperate thinking shows how convinced the authors are that assets are overvalued. They’re struggling to find solutions, other than a crash.
And they’re outright bearish on bonds and stocks:
In a US 60/40 equity/bond portfolio, our mean reversion model suggests 10-year annualized returns of only 2.77% p.a. – the fourth-lowest in the 143 years since 1871
Indeed our mean reversion exercise suggests that projected 10-year US equity returns are back down to an annualized 3.3% over the next 10 years.
Forecasting a 10-year return on US stocks of 3.3% per year, which is about the typical rate of inflation in the US, is equivalent to saying that current prices are substantially overvalued.
The Next 5 Years: Curb Your Enthusiasm
Another report, “Tinker, Taper, Told Ya, Buy,” by Michael Hartnett (Chief Strategist, BofA-Merrill), also released today, hints at the unstated, unexamined alternative that the US might have followed Japan into a slow-growth era. Excerpts (emphasis added):
An unprecedented financial and economic crisis, crystallized by the September 15th 2008 bankruptcy of Lehman Brothers, was followed by an unprecedented monetary policy response, which in turn has been followed by unprecedented bull markets in bonds, stocks, and now real estate. Wall Street has soared, but Main Street has soured. The exceptional “sweet spot” engendered by generous central banks and selfish corporations has been great for owners of capital, but bad for labor….
The Next 5 Years: Curb Your Enthusiasm
Significant monetary stimulus, the end of fiscal austerity, a booming housing market, a cheap dollar, record corporate cash balances – if the US economy does not significantly accelerate in coming quarters, it never will. We assume it will, and….
Asset price will not do as well in the next 5 years, no matter what the “nouveau bulls” say. Central banks will be less generous, corporations less selfish. And when excess liquidity is removed, it will get “CRASHy”. The dollar and (temporarily) volatility will be the last assets to surge as Deleveraging ends and an era of Normalization begins.
Whether or not – or how – these scenarios will play out is less important today than the message in between the lines: These Wall Street bulls are part of the phenomenal hype machine that has, in conjunction with limitless “whatever-it-takes” QE, inflated the very bubbles that they’re now fretting about, and that they’re now trying to figure out how to navigate. The fact that they’re now pointing out some very ominous clouds ahead gives pause. Are they telling their clients in between the lines to run for cover?