Remember the main reason why the Fed should have tapered, namely the illiquidity in the bond market it is creating with its feverish pace of collateral extraction, and conversion of quality collateral into 500x fwd P/E dot com dot two stocks? Here to put it all in context is Scotiabank’s Guy Haselmann: “Through its QE policy, the Fed buys $3 of mortgages for every $1 of origination. The consequence is that secondary mortgage market liquidity has been decimated: it is as bad as when Bear Stearns failed.” That’s just MBS for now. However, since the Fed has refused and refuses to taper, the same liquidity collapse is coming to Treasury’s first, then corporates, then ETFs, then REITs and everything else that the Fed will eventually monetize. Just like the BOJ.
As a post script, here are some other observations from Haselmann:
- Moral Hazard has run wild due to Fed policies. Risk appetite, complacency, and market speculation are at elevated levels. Buyers are scrambling to find assets to buy. As a result, there has been a surge in debt issuance, especially of riskier securities like covenant-lite loans, leveraged loans, and payment-in-kind bonds.
- The Fed does not have an inflation problem, simply because the $3 trillion+ it has created out of thin air has not been lent into the fractional reserve system. In other words, the velocity of money has been falling. The lack of visibility health care costs, the national fiscal budget, the tax code, regulatory rules and economic growth generally (to name a few), is so widespread that it is impossible to assess the financial logic behind potential capital investment projects. When this uncertainty fades, the velocity of money will rise and the Fed’s ability to control inflation with be challenged accordingly.
- IPO’s have also come at a fierce pace, taking advantage of investors scrambling to put easy money to work; and who may not be giving enough attention to valuations and the risks involved. Market pundits seem to fuel investor complacency with daily statements that equity P/E’s are historically cheap. However, comparing today’s “new normal” growth trajectory to the high growth period of the 1990’s seems misguided. Furthermore, the current environment is unprecedented and the “E” is a rapidly moving target.
- The P/E’s of the top 50 Russell 2000 stocks is over 45. The P/E of Linkedin is 755, AOL’s is1278, Chipotle’s is 54. After Twitter’s IPO tomorrow, the stock will trade near 42X revenues (because it has no “E”). Now that is “cheap”- at least relative to where some stocks traded during the dot.com bubble.