The “Insanity Trade:” Where Does It Go From Here?

The CFA Society of the UK, in a poll of its 11,000 “investment professional membership,” put the conclusion into the headline:

Perception jumps of Developed Market Equities as overvalued, as indication of ‘Bond Bubble’ becomes more extreme.

The Fed has floored the monetary accelerator with its steel-capped, lead-lined boot for over six years. Other central banks have followed. They expected, or pretended to expect, that it would create demand, economic activity, and consumer-price inflation.

None of which happened.

Turns out, they didn’t give the free trillions to consumers living from paycheck-to-paycheck – or those living without a paycheck – who’d actually spend this money on things needed or wanted for daily life, to be consumed in a minute or used up over a few years. instead, central banks shuffled these free trillions to their banks from where they flowed in a myriad ways into financial assets of all sorts around the globe, including securities that funded the US fracking boom.

It ended up creating demand for financial assets and asset-price inflation, not consumer demand and consumer-price inflation. It sent stocks and bonds soaring, while yields plunged. Numerous government bonds are now titillating us with near-zero to negative yields.

Investment-grade corporate bond yields plunged too and are now minuscule, if still largely positive. Even junk-bond yields. They average about 3.9% in Europe and 6.3% in the US, though these bonds have an appreciable probability of default and should reward investors for the risks they’re taking.

In the chase for yield, trillions were being plowed into creating supply, such as the US oil-and-gas boom, just when demand was lackluster. Hence, downward pressure on prices, and an environment of low inflation as a consequence of loosey-goosey monetary policies.

“Repeat after me: Easy money is deflationary,” wrote Ed Yardeni, of Yardeni Research, in his Morning Briefing on March 23: Easy money has stimulated supply “because producers overestimated the ability of easy money to boost the demand for their goods and services. Easy money allows ‘zombie’ companies to stay in business, thus boosting supply, even though they are losing money.”

Hence the glorious boom and devastating bust in the US oil-and-gas sector that we’ve been poking at for years.

“Needless to say, the central bankers don’t get it,” Yardeni wrote. They insist that they must continue to provide free money to create demand and inflation “which perversely is deflationary since it is inflating supply more than demand.”

And this, Yardeni explains, leads to the “insanity trade”:

It is widely believed that Albert Einstein said that the definition of insanity is “doing the same thing over and over and expecting a different result.” As long as central banks continue to pour liquidity into the financial markets to boost inflation, the “insanity trade” should continue to work. It’s insane to imagine yields falling much further below zero in the Eurozone, but they do make US bond yields look mighty attractive still, even though they are insanely low too, though still above zero. Global stock markets should continue to rise, and possibly melt up, even though valuation multiples are getting a bit loony in the US. Commodity producers should remain depressed losers, while commodity users should remain manic winners.

But the “investment professional membership” of the CFA Society of the UK, the folks who’ve been plying the “insanity trade” for years, just how insane do they think valuations have become?

In the poll, the CFA UK found that 76% of its 11,000 members considered corporate bonds “somewhat overvalued” or “very overvalued” – an 11% jump from a year ago, and the highest level in the history of the survey. Only a tiny 5% thought corporate bonds were undervalued.

Government bonds fared even worse: 81% of these investment professionals thought they were overvalued, making them the most overvalued asset class. Only 3% thought they were undervalued. I assume those were the folks that accidentally checked the wrong box. There are always a few.

Even stocks, the sacred refuge that you cannot lose money with, as central banks around the world are trying to teach us: the number of respondents that considered them overvalued jumped to 52%, and only 18% consider them undervalued.

Buy low, sell high? So hit the sell button, all at the same time?

In an environment where nearly all financial assets are overvalued, many professionals have become comfortable with them. They know they’re overvalued, but they figure that they can become even more overvalued as long as central banks keep doing what they’ve been doing. But it won’t be easy.

These folks “feel that the prospects for additional benefits from QE may be limited,” explained CFA UK CEO Will Goodhart. They “see the search for returns as becoming even more challenging.” And for pension funds and insurance companies, “the prospect of a long period of low returns will be a concern.”

That would be the optimistic scenario.

And when they do click on the sell button, at first one after the other, and after seeing what the others are doing, perhaps in unison in order to save what they can? It would come at a time when liquidity in the bond market is drying up, when leverage has reached extremes, and equity valuations have become, as Yardeni phrased it, “a bit looney.” It would create some very special fireworks. But not yet – that’s the consensus.

The negative-yield experiment in Europe is triggering the first perversions. This is just the beginning, a new trend that’ll turn into the next craze. Read…  Dumping American Junk in Europe, Draghi Asked for it

Share on FacebookTweet about this on TwitterShare on LinkedInShare on RedditPrint this pageEmail this to someone

  15 comments for “The “Insanity Trade:” Where Does It Go From Here?

  1. Dan Romig
    Mar 24, 2015 at 9:27 am

    Perhaps the central bankers do get it. Most central banks, including the Fed and the ECB, are heavily influenced or controlled by the Rothschild dynasty. Perhaps these central banks want what we’ve seen over the last six plus years.

    The Wall Street elite have seen their power and wealth grow since the housing bubble. They got the Cromnibus shoved through Congress, and signed by Obama to put their derivative Ponzi-scheme of multi HUNDRED TRILLIONS of dollars backed by Uncle Sam and the taxpayers. They have there chosen replacement for Eric Holder waiting to lead the Department of Justice, and protect thieves like Jamie Dimon from any criminal indictments.

    So what if pension funds go bust from ZIRP policies? So what if the working class masses of Europe starve in ‘austerity’? Does that affect those who hob-knobbed in Davos recently? Nope, not one bit.

    The Department of the Treasury should be the only entity that can issue the United States’ fiat currency. Back on 4 June 1963, President Kennedy issued Executive Order 11110, which returned to the U. S. government the power to issue currency without going through the Fed. Shortly thereafter, he was assassinated.

    Until the Fed is terminated, we all live under its control. This citizen would hope that Yellen and company are acting in a benevolent manner, but evidence indicates otherwise.

    Thank you Wolf for keeping us informed.

    • Robert
      Mar 24, 2015 at 5:45 pm

      All good points, Dan. When Yardeni writes ““Repeat after me: Easy money is deflationary”, does he not realize that the Fed is providing money almost interest-free to the very banks that own it- and the recent Senate report clearly demonstrated that they are using a lot of this money to buy real assets: coal, oil, foodstuffs, etc. for their own accounts- and that is anything but “deflationary”. If the U.S. can produce unlimited easy money (and that is what an $18 trillion deficit means), why shouldn’t China? One of the reasons that food prices keep going up and up is just that.

  2. Petunia
    Mar 24, 2015 at 10:06 am

    As the central banks made the banks whole by buying their worthless paper at face value, they shifted the perception of bankruptcy from the banks to the central banks and by extension governments. The peasants can see the holes in budgets and balance sheets, and worse they feel it every day. There is now no confidence in government or financial systems, deservedly. Does anybody think these people have a clue as to what they are doing other than stealing everything they can before the music stops.
    The only thing certain is that it can not continue forever and it won’t.

    • NY Geezer
      Mar 24, 2015 at 11:44 am

      Petunia, I am sure the Central Banks do know what they are doing. Mario Draghi has said in the past, that Central Bankers will do “whatever it takes” to save the banks and their debt holdings. Those debt holdings are vast and the Central Bankers are doing what it takes.

      I suspect the banks are holding much more gas and oil production debt than the US Fed anticipated they would be holding. Oil and gas prices just broke too soon and the bankers did not have time to sell all the triple A rated junk bonds to pension funds, bond funds and other customers.

      Of course, since the banks play in a risk free game they always assume the golden goose will live forever and they continue to feverishly create junk debt even when the goose is in the process of dying. The Central Bankers will have to just do what it takes to fix that problem and pretend they do no understand who they are hurting.

      The central bankers know that the public’s money, which includes but is not limited to, bank accounts, the interest that should be paid on bank accounts, real and personal property, pensions, present and future tax liability, and infrastructure use charges, is the only source from which they can take. So, it is not a mystery who gets hurt.

      • Petunia
        Mar 24, 2015 at 1:15 pm

        I totally understand all of this. My point was that now, as opposed to before the financial crisis, the average person knows they are getting robbed. Back then they knew the bankers were skimming here and there, now they know the bankers are vacuuming up everything. The banking interest want to start a war as a distraction and to increase the demand for oil. Let their kids sign up to fight that one.

  3. Jungle Jim
    Mar 24, 2015 at 11:10 am

    The Fed’s experiment in currency manipulation has been a catastrophe.

    Their ZIRP has had the effect of impoverishing savers and mispricing risk the world around. It has led to enormous misallocation of resources both here in the United States and worldwide. Companies routinely borrow to pay dividends and to conduct share buybacks at high prices rather than low. Funds have been poured into fracking because there is virtually no other place to get a return. Had that money been differently deployed, for instance on repairing our infrastructure, we have something to show for it.

    QE has been known to be ineffective from the first. The Fed supervises the banks and quarterly they receive reports from each bank showing its financial position. All they had to do was to read those reports to realize that the money was NOT going into the economy. The loan portfolios were not increasing, the trading desks were growing, and the remaining funds were being redeposited with the Fed as “excess reserves”. Yet in the face of the obvious the Fed soldiered on pouring money into the banks. Ineptitude or misfeasance ? I don’t pretend to know, but it is no wonder that the Fed is so fiercely opposed to an audit of their stewardship.

  4. James B
    Mar 24, 2015 at 11:25 am

    Look at the velocity of money @ https://research.stlouisfed.org/fred2/series/M2V Time to warm up those printing presses. The problem was that the Fed didn’t throw enough money at the issue ha!

    • mptzl
      Mar 24, 2015 at 3:17 pm

      I used to be concerned about M2 velocity too. Remember we derive it from “base money ” X “velocity ” = GDP X price level. Or something like that.

      Thought #1: since the QE money has just been sitting useless on the ledgers of the banks in their Federal Reserve accounts the M2 number is falling because GDP and price level are about constant and M2 supply has increased. So we’re not measuring the pulse of the economy as much as the other factors in said equation. So you’re seeing a graph of what you measure but it’s not what you think it is.

      Thought #2: I don’t understand how that original equation is calculated if one accounts for M3, that is eurodollar supply, because it’s vastly larger than M2, acts in the same way, and not set by the fed.

      Mostly I think since the end of the gold standard M2 velocity is no longer a reliable measure of economic health but I don’t know of a similar better measure.

      • James B
        Mar 25, 2015 at 8:17 pm

        You’re probably correct, M2 velocity may not be reliable to measure economic health. What do you believe is the best measure for economic health? Is the baltic dry index a good indicator in your opinion?

  5. Mike R.
    Mar 24, 2015 at 11:53 am

    Thanks to the internet and excellent reporting by numerous financial blogs, the picture is clarifying.

    I think we will be seeing a “SNAP DEPRESSION” across the world in 2015. All the moons seem to be aligning and of course it will be worse than what was stemmed in 2008.

    The Fed is impotent and cornered. China is dropping off the charts. BRICs in big trouble. Europe a mess. Japan a basket case and the US, well the US is broke; just doesn’t admit it yet.

    Western developed societies have had a few years to develop retirement shock. Demand for anything but essentials will crater. Central Banks will try and hold price structure up to prevent deflationary spiral. And something will set off a panic.

  6. LG
    Mar 24, 2015 at 2:21 pm

    And those inflated assets like housing became un affordable for the millions! Good luck with that.

  7. mick
    Mar 24, 2015 at 6:24 pm

    One of the best articles I’ve ever read, and I’ve read many. Thanks Wolf.

    • Mar 24, 2015 at 8:37 pm

      Thanks, Mick. Music to my ears!

  8. Justin
    Mar 24, 2015 at 8:11 pm

    I can’t wait to see the pitchforks come out and watch as the kleptocrats get what they deserve.

  9. Julian the Apostate
    Mar 25, 2015 at 9:25 am

    I think the word IS getting out to more and more folks; the contrarian websites are upticking in their readership. But compared to the number of hits for something like Kim Kardashion’s butt it’s a drop in the bucket. What is more important here on the Long Porch is the ability to debate and reason and vent and return refreshed to our own individual challenges. We are all individualists but we can come here to Wolf’s Gulch for a little r & r. Thanks again, Wolf.

Comments are closed.