As 2018 drew to a close, global central bank liquidity flipped from net positive to net negative for the first time in a decade. Danielle DiMartino Booth joined Real Vision to explain her thesis that share buybacks have created positive momentum in US equity markets that until only recently have moved away from historically low volatility. The question is, can that volatility be contained as liquidity withdraws? Filmed on November 14, 2018 in New York.
DANIELLE DIMARTINO BOOTH: Hello, I am Danielle DiMartino Booth.
Happy to be back on Real Vision.
Since the last time I was on, I have founded a new company called Quill Intelligence.
We produce a daily newsletter called The Daily Feather and it’s already garnered a cult following.
Rolled out right after Memorial Day, and we are looking to truly launch a research revolution
that is based on my many years inside the Federal Reserve when I did research on behalf
of President Richard Fisher of the Dallas Fed that was unbiased and had absolutely no
agenda and wasn’t trying to sell anything.
And believe it or not, investors really enjoy that.
They appreciate that.
So how did we get here?
Well, it started on August 11, 1987, and unlike Jerome Powell, who had no days in office before
he was greeted with a crashing stock market, Alan Greenspan had a few months as chairman
of the Federal Reserve before he was greeted with the crash of 1987 when stocks fell 23%
in one day, which hasn’t been matched since then.
We might find out in the coming years what it feels like.
But in the days and the months that followed, Alan Greenspan did something extraordinary
that set up where we are today and where we’re headed.
He actually leaked information to bond trading desks ahead of Fed moves to inject liquidity
into the system.
This was fully sanctioned, and he had the New York markets– open markets desk as his
compadre to do this.
And that was when in the current era of monetary policy-making, moral hazard was introduced
into the system.
So following 1987, every other hiccup in the markets, whether it was the tequila crisis
in Mexico with the peso, whether it was the Orange County bankruptcy, a few years later,
we had long-term capital management blow up– famously, obviously, Jimmy Cayne refused to
write the check to bail out that big academic run hedge fund– but every single time there
was a liquidity event in the markets, the Fed would come riding to the rescue.
So fast forward, I’m going to bring Jay Powell back into this discussion.
Fast forward to the fall of 2012, what did we learn on January 5, 2018.
Well, we had the transcripts released.
We actually got to hear Jay Powell in Jay Powell’s words– because he’s a very quiet
man– we got to hear what Jay Powell thought about this era of unprecedented moral hazard
and how it had woven its way into investors’ psyches.
And he basically said, I’m reluctant to vote for this final round of quantitative easing.
It has become habitforming to investors, and by all appearances, we are blowing a fixed
income duration bubble across the credit spectrum.
I just got goose bumps, because look at where we are today.
Look at where risk lies today.
But the point is, every single time the Fed had to pull out extraordinary measures, it
had to pull them out for longer than the prior episode.
When the internet bubble crashed in 2000, we had to take interest rates even lower.
We had to keep them even lower for a more protracted period of time.
And that served to blow the housing bubble up.
Obviously, there were many other players, credit rating agencies, investment banks,
crooked mortgage brokers, delusional home buyers, but the Fed was right there keeping
money cheap, lower for longer.
In the current episode, call it the past decade, we took one step beyond– one step further
into the abyss of this grand experiment by keeping money lower for longer and engaging
in quantitative easing.
There’s a name for it.
It was designed in 2007.
It’s called the Bernanke Doctrine.
But Bernanke took a few people into a quiet room in Jackson Hole, a few of his closest
advisors– which is questionable on an ethical level itself– and they laid out the fact
that the Fed would have to get to the zero bound first– that was a critical step one–
before it could then launch into quantitative easing.
It was designed in private, and the game plan was laid out for what was to come.
So what is quantitative easing, and how does the current era of lower for longer differ
from its prior episodes.
So we haven’t– I still have pronoun challenges as a former Fed insider– how did the Fed
conceive quantitative easing?
They basically wanted to synthetically produce interest rates that were lower than what they
could get them to on a numeric level, the zero bound as we called it.
So in order to do that, they decided to go out into the open market and purchase securities.
In fact, inside the Fed, they never called it quantitative easing.
They called it large-scale asset purchases, because that’s what people inside the Fed.
Do they put big fancy labels on things so that people are confused and don’t know what
the hell they’re doing.
So these large-scale purchases were rolled out slowly, one wave after another.
It started with the United States.
It started with Ben Bernanke, but it was as contagious as the clap.
I mean, it went global.
It went viral.
It went everywhere.
And eventually, we had obviously the Bank of Japan.
We had the Bank of England.
We had the European Central Bank.
We had the People’s Bank of China.
One of the biggest quantitative easing programs in existence was very quietly undertaken in
So at the end of 2018, at the end of this year, which is very close to us, for the first
time in a decade, we will go net negative.
We will flip on a global basis to quantitative tightening.
To explain the– to explain how dramatic this is consider the furor of the Federal Reserve
letting Lehman Brothers fail and within the blink of an eye rescuing AIG, $85 billion
By the end of 2017, global quantitative easing was running at a $2.12 trillion annual run
It was as if we were bailing out AIG every single month and then some.
And then started 2018.
By October, the European Central Bank had tapered its purchase program, its QE program.
It had tapered it down to 15 billion euros per month.
On December 31, excuse me, that goes away.
January 1, 2019, the European Central Bank will stop expanding the size of its balance
sheet, and globally, we will for the first time, once again, go net negative on liquidity.
And the implications have already been– they’ve already been gleaned by the markets, right.
Deutsche Bank has already observed that 89% of asset classes worldwide are– they’re sporting
negative returns for 2018.
You can’t make this stuff up.
So the world has already figured out what negative liquidity feels like, what the drought
could feel like.
US equity investors maybe not so much.
We’ve had something else going on here in this country this year called share buybacks.
So what differentiates the United States from the R.O.W.– from the rest of the world.
Why has it been so awesome to be a US stock investor in 2018.
Well, I’m afraid I’m going to be a broken record here, because it is one word– and,
boy, does this get– it just gets people so mad.
Because they want to talk about fundamentals and earnings, and in a monopoly society, mind
you, we have just a few great big companies that are making everything and collecting
all the profits.
But what makes the United States the place to be, the it girl for investors?
Liquidity is global.
Liquidity is fungible.
Liquidity is agnostic.
But liquidity also has a home or had a home here in the United States in 2018.
The tax bill that was rolled out, according to JP Morgan, brought an additional $300 billion
in share buyback power into the equity markets.
That’s on top of last year’s $550 billion or so.
So estimates suggests that we’ll get to the $850 billion dollar mark by the end of this
Maybe GEs buybacks don’t have the same bang that they once did.
Maybe apples don’t either.
That might be heresy.
But the fact is, we had something the rest of the world didn’t, and we benefited greatly
Because the mother’s milk of markets was still flowing through the United States in 2018,
unlike our international counterparts.
So that’s what made this one heck of a year.
So here we sit at the precipice of what we believe to be the next rate hike at the Fed’s
We’re looking to go to 2.5% on the Fed funds rate.
But we know from what Jay Powell has told us that that is still three rate hikes shy
of what he considers to be neutral– a neutral fed funds rate where that it’s the Goldilocks
Where the economy is not overheating or slowing down, he considers to be 3%.
Unfortunately, his predecessor, Janet Yellen, is on record as having implemented the slowest,
most prolonged, most painstakingly painful tightening in US history under her leadership.
In other words, Janet left Jay with a lot of work to be done with not so much time,
as the economy was heading into, as we know, June 2019 will mark the longest expansion
in US history.
It’s really hard to tighten into an expansion that’s lasted as long as it has, but that’s
exactly what Jay Powell inherited.
It was interesting that most in the media when Jay Powell’s name was rolled out said
he’s a Yellen clone.
This is it.
We’re in good shape.
This guy is going to be our next best friend.
He’s the market’s BFF.
And what did Jay Powell say after his first day in office when the Dow was down by four
Let me think.
He said nothing.
And what did he say at the end of February as the risk parity trade unraveled in bloody
I’ll borrow from another Real Vision guest, Christopher Cole, Artemis Capital out of Austin,
Texas, good friend.
And the way he explains it is very simple.
The world was basically betting– there was a crowded trade that was betting that volatility
would never rear its ugly head approximately forever.
So into this comes the beginning of the liquidity withdrawal, which the markets didn’t like
Into this steps somebody who’s not a Yellen clone who’s going to tighten monetary policy,
who’s going to be tougher, who’s not going to say a peep when markets get upset.
So what we saw was the resurrection of the long dead volatility in the month of February.
And this is typically how cycles end, by the way.
It’s just– they’ve never been this protracted.
We’ve never had a year on record like we had in 2017 when the VIX, the Volatility Index
on the Standard and Poor’s 500, when the VIX was south of 10 for 50 some odd days in 2017
wiping, I mean, any other year in history– there’d been one or two or three days, but
the VIX was south of 10.
And it was always assigned to run for the exits, but not in 2017– not when you have
$2.12 trillion of quantitative easing flowing through the capital markets worldwide, which
creates this great reflation trade.
When only one country’s manufacturing sector was contracting– that was South Africa–
the rest of the world was booming, floating on the sea of liquidity.
Again, once that became– once that started to be extracted from the markets come February,
once Jay Powell said a whole lot of nothing in reaction to the stock market’s hissy fit,
then people got really upset.
You ended up having an exchange traded fund shut down that was based on this short volatility
The stock market felt that the worst had come to past.
An exchange traded fund, ironically enough, named XIV, the opposite of the VIX had to
So was this the reserve, breaking the buck, money fund moment after Lehman fell.
Could we all breathe a sigh of relief and walk away and say, boy, thank god February’s
only 28 months.
Can we get back to the market going up again?
Please and thank you.
Well, companies got back to the business of buying back their shares, and the tax bill
And you have this gigantic surge of fiscal stimulus and liquidity going into this economy.
What could possibly go wrong?
Well, not a whole heck of a lot– not until the liquidity once again started to run dry.
What happened on October the 1st?
What two things happened on October the 1st– actually, October the 5th?
October the 1st, the ECB reduced its taper to $15 billion a month from 30.
So one more– one more whisk away of liquidity.
On October the 5th, according to Goldman Sachs, 86% percent of companies in the S&P 500 were
in buyout blackout.
It was too close to earnings.
It was this two week period around when companies report earnings that they typically are not
in the market buying back their shares.
So this double whammy of this liquidity being pulled out of the markets, lo and behold,
set off– I won’t use that word storm– in the markets.
There was a big sell off.
It was not related to being short volatility.
However, there’s something called the smart money flows index.
And it basically gauges– you can look it up on your Bloomberg SMFI Go.
It basically gauges institutional investors who trade in the first 30 minutes and the
last 30 minutes of trading every day.
We all know that the last hour of trading the stock market is the most important.
Well, this index peaked in January.
And after this unwind of this risk parity, short volatility, trade happened.
A lot of people came running back into the market, especially corporate America.
The smart money stayed out.
Smart money was at the lowest level since 1996 in October.
It never came back.
It never put its trust back into what it was looking at.
And lo and behold, it was not the unwind of a trade in October.
It was managers selling their biggest holdings.
It was managers taking their profits.
There are moments in every cycle.
I remember in 1999 some sell side strategist analysts came out and said price line’s going
to $1,000, baby.
And these moments stick in your mind.
And every day when you’re turning on bubble vision and they’ve got a little countdown
to a trillion dollars for Apple or Amazon, that was kind of my moment.
That was my priceline.com moment in the current cycle.
And sure enough, Amazon managed to trim $200 billion of market capitalization off in the space of a few days, because it disappointed on its earnings.
And what we saw in October was the beginning of the end da, da, da of the passive investing trend in this country.
I’ll share something on a personal investing level.
When you spend nearly a decade inside the Federal Reserve, you get a little bit freaked
out about how the sausage is made.
You get a little bitter about basically monkeying with price discovery, unfettered price discovery.
I was raised as a young whippersnapper on a trading floor up here in New York, and I
learned about bid, ask, spread, price discovery.
That was how the world was supposed to work.
Don’t fight the Fed is the antithesis of price discovery.
Don’t fight the Fed has turned into a passive investing revolution, this great renaissance
where investors can pat themselves on the shoulder and they can say, wow, I am paying
0.25%. Look at my low fees.
Well, what October taught investors, passive investors was that momentum that is awesome–
I mean, great, momentum is wonderful– when these huge market capitalization stocks are
going up, the fangs.
But it works the same way in reverse.
So at Quill, we ran a little analysis that showed that the S&P 500 was down 10%, and
then these mega caps were down 12% in October.
So I think the rude awakening that so many investors have– 45% of equity funds right
now are in some passive strategy.
So let’s say almost half of US equity investors have a rude awakening, because they’re going
to find out that you can actually lose more in capital than you save in fees.
And they’re not going to like it.
They’re not going to like it one bit.
But that is what don’t fight the Fed fostered.
There was no reason to study a company’s fundamentals, as long as liquidity was flowing through the
All you had to do was buy the market, whatever that market was.
And it ended up feeding into a lot of the unintended consequences that we have.
The fact that you have the death of innovation in America– if you’re a big company and you’re
doing well, you used to stick around for your own initial public offering.
That’s no longer the case.
And it ties back to don’t fight the Fed.
If I’ve got a trillion dollar market cap and I see any form of competition in front of
me, what do I do?
I just buy it and get bigger, because you know what?
I can bet the farm.
I can use– just like Americans use their home equity to cash out during the housing
boom years, corporations can use their stock equity right now.
But they use that.
They’re borrowing against their net worth effectively to buy any competition that gets in their way.
And then we wonder why the people in the beltway in Washington DC are all a twitter.
Well, maybe somebody should have reined in the Fed and made them stop this lunacy a long
time ago before we had actual macroeconomic consequences that are going to take down the
baby boomers, by the way.
So where is the economy headed in 2019?
So my good friend, David Rosenberg, he was one of the few people to along with me get
derided in 2005 for calling the housing bubble what it was.
I learned something as we’ve become friends over the years, and that is that there’s one
critical sector that flags a slowing economy and that is housing.
Housing leads economies into recession.
Housing leads economies into recovery.
So the beauty of housing is it’s unbroken.
It leads economies into recoveries.
It leads economies into recession.
It’s got a nice sidekick called autos, and it is another uber cyclical industry that
also flags when we’re getting to turning points, when we’re getting to economic inflection
points. And what we know is that the delta matters.
The change matters.
I get a kick out of a lot of the punditry that says, you know what?
Back in 1981, and I only had a 16% mortgage.
And I just get a kick out of them, because I just– I sit there at the television making
a triangle sign going it’s the delta, you moron.
It’s the starting point that matters.
It’s the fact that mortgages were 3%, and now they’re over 5%.
The tightening that the Fed has undertaken is starting to bite.
Starting points matter, especially when it comes to housing, especially when it comes
to anything cyclical.
So if you start off with a 3% handle on the mortgage and you end up with this 200 basis
point move that we’ve seen and now we’ve got mortgage rates that are at seven year highs
and they’re north of 5% for 30 year– 30 year conforming mortgages, it makes a huge difference.
Housing prices have been going up very fast– had, I need to use my verbs correctly.
Housing prices had been going up.
All of the increase in average monthly mortgage payments in 2017 was due to home price appreciation–
homes becoming prohibitively expensive, intuitive enough.
In 2018, it has been a pure mortgage rate story.
If you can imagine, as low as mortgage rates are today, the average monthly mortgage payment has increased by 20% this year.
That is enough to stop a housing market in its tracks, and that’s exactly what it’s done.
The danger that I see– the real danger that I see that the game changer that housing can
be is if we have sustained declines in stocks, if this takes the wind out of the baby boomer
generation, if their IRAs and 401Ks are depleted– and God knows what’s going to happen to their
bond holdings, which they should be watching much more closely– if this happens, there
is a logical place that baby boomers are going to turn to look for liquidity.
It’s like the L word.
I just– I carry the liquidity banner everywhere I go.
Baby boomers will look for liquidity.
And if there’s one message I’d like to convey, it’s that hollowing out an entire generation
of first time homebuyers, the millennials putting off setting up house and home for
a decade is going to have real true ramifications for the boomers.
They’re going to look to sell their homes, and they’re going to realize that there is
a yawning gap, a vacuum underneath them.
Because the first time homebuyer a millennial who should have bought their first home 10 years ago and didn’t and waited 10 years, they’re in their first home now.
They’re not doing what they were supposed to have done.
They’re not moving up to their middle home in the buying cycle of life.
They’re not moving up to that move up.
And who is going to buy baby boomers homes?
It’s the move up crowd that can afford to trade up to the McMansion.
But they’re not there.
So as badly as baby boomers are going to need the liquidity from that home equity that they
have to fund their retirement, it’s not going to be there.
We’re going to see more dramatic home price declines than anybody’s anticipating, because
of this demographic divide.
Thank you, Federal Reserve.
I think investors have been engaging signposts in trying to figure out which direction the
wind is blowing.
I think investors have had their eye on the wrong target.
They’ve been watching stock market volatility.
They’ve had their eagle eye trained on the VIX index.
I’m not watching the VIX index.
Because nothing becomes unglued– or as Chris Cole explained to me, February was just a
flirtation with the unwind of this massive risk parity trade.
We don’t find out what unhinged looks like until we see volatility in the bond market.
That is where the gogo juice is.
If you’re not following the MOVE index, put it on your radar– M-O-V-E.
Get rid of the VIX, follow the move.
Because it’s the credit markets where damage can truly be done.
Going into the last crisis, we had $170 trillion of debt globally.
Today, we have over $250 trillion of debt.
A lot of it’s toxic.
I am watching more closely than anything.
I’ve done more writing over the past year.
I was in front of the Wall Street Journal.
I was in front of Bloomberg.
Even though I write for Bloomberg, I was in front of everybody in writing about triple
B rated investment grade bonds.
You must put investment grade in quotes.
That is what I’m following the most closely.
General Electric, I will remind you, was a triple B rated company.
Its bonds traded like junk.
This is the sector that has grown to be a $3 billion monster– $3 billion.
Think about that.
Where’s the parallel?
Oh, I don’t know.
Subprime mortgages circa 2007 peaked out at $3.2 trillion dollars.
The triple B segment of the investment grade bond market is now $3 trillion.
It is larger than every other investment grade rated bond combined.
Morgan Stanley did a recent analysis.
I’ve gotta agree with it.
They think that we will see a third– a third of this $3 trillion downgraded.
They call them fallen angels.
And I think we will see angels falling from the firmament in this next downturn, because credit rating agencies have actually done something remarkably similar to what they
did during the last run up, during the last credit boom.
Their analysts, believe it or not– I mean, I hate to convey such shock– but their analysts
have been strong armed by management that’s paid by the companies they rate to maintain
their investment grade ratings.
Because if they’re not maintained, then big institutions fiduciarily cannot hold these
And so they have bent.
And who will pay?
That would be grandma and grandpa, because their local neighborhood broker has told them that it is an investment grade bond fund and you’re going to be just fine.
There is something worse.
There is the leverage loan market, and this came right out of the mouth of one of the
high yield strategists at a credit rating from a few years ago.
Remember, this the next time somebody tells you about the virtues of leverage loans in
a rising rate environment, again, capital losses– capital losses.
Leverage loans are basically issued by companies that cannot access the junk bond market. They are junkier than junk.
So what do they do?
They go off to their friendly neighborhood investment banker, and they syndicate a big
That market is bigger than the high yield bond market.
That’s another benchmark that we’ve seen in 2018.
Follow leverage loans.
Follow investment grade.
There’s a reason investment grade has been so much bloodier than high yield.
It’s with good reason.
So if you don’t have an account at Merrill Lynch, let’s say, maybe you should get one.
Open a money market fund.
Get access to weekly fund flow reports, because they tend to be– the first signal that you’ll
ee is funds flowing in and out of any given asset class.
And they’re what I follow the most closely to see where investment grade, where any asset class for that matter is headed.
I think the most difficult question to answer in today’s environment is where do you put your money?
How do you protect yourself?
Again, this is a vestige of being a Fed insider for as long as I would– excuse me, for as
long as I was– and what we learn in downturns is the hard lessons of correlations.
And unfortunately, asset classes tend to move in tandem when price discovery has been eradicated, when central banks prolong the business cycle artificially.
So there really are so few places to hide, but I may as well share where I’m hiding.
I have a lot of money in cash.
It pays a lot these days.
It actually pays more than inflation, so that’s technically a lot.
And it’s an option for the first time.
In my investing career, cash is an option for the first time.
And believe it or not, I own a lot of short dated municipal bonds.
I like to say that there is no such thing as a Prexit.
We weren’t able to get rid of Puerto Rico.
It was against the Constitution.
But by the same token, we have a lot, a lot of states and municipalities that will have–
they’ve got growing mushroom clouds over them, Chicago, Illinois, New Jersey, California.
We will have municipal bonds that go belly up, and we will have serious pension crises
in the years to come.
But that being said, there are a lot of well-run states and municipalities.
So I have found myself a great manager who doesn’t buy funds at all.
Individual bonds that you do your true due diligence on– it’s one of the last standing
asset classes where you can truly do your homework and find out if you are going to
get paid back your principal.
Capital losses, preserve your money.
So I’m in very few places.
I own a gold fund.
Because if we’ve learned one thing from lower for longer and from overly intrusive central
banks, it’s that there’s exactly one asset class on planet Earth that is negatively correlated
to pretty much everything else when the peanut butter hits the fan.
And that’s gold.
Am I a gold bug?
Are we going back on the gold standard?
No, we’re not.
It’s not practical.
But that being said, if you want to hedge your portfolio, it’s a really good place to
But if there’s one irony I will leave you with, it’s Janet Yellen.
This is a woman who said that we’ll never have another financial crisis in our lifetimes.
She attributes this to the fact that the banking system in the United States is cleaner than
it once was, recapitalized, kumbaya, cue the birds and the butterflies.
Just have them fly on screen.
Does anybody– can somebody tell her where the capital markets are?
Can somebody tell her where the growth has happened?
And once she appreciates that and the fact that under her leadership the Fed prolonged
an economic cycle beyond where it should have been and prevented companies from defaulting
that should have defaulted, that her second statement that this is going to be a plain
vanilla, shallow, not bad recession, it’s just going to be another walk in the park
what we have coming up.
Well, we’ve got to clean up the last cycle, which we never did clean up because QE prevented
And we’ve got to do the next cycle that’s even bigger.
So will it be plain vanilla?
Will it be short and shallow?
I don’t think so.
But I am happy that Janet Yellen is on the record saying that we would have a kind recession,
and that we would never have another financial crisis.