In de Crash course extra’s geven diverse commentatoren, zakenlieden en andere deskundigen hun commentaar op de gedachten die door Chris Martenson in de Crash Course zijn ontwikkeld.

Saxo Bank’s CIO Steen Jakobsen predicts a 15%+ market correction soon

Engelstalige transcriptie

Chris: Welcome, everyone to this Peak Prosperity podcast. It is March 13, 2018 and I am your host, Chris Martenson. Today, we’re going to be discussing the global economy, inflation, interest rates, trade wars, things like that. Now, this is really a tale of two narratives. One goes like this: the global economy is hitting on all cylinders; U.S. equities just keep powering higher; corporate earnings are up; and both business optimism and employment are up. Okay, that’s one narrative. The alternative one is that the risk of recession is high and climbing. Financial conditions are deteriorating, and both interest rates and inflation are rising. So which narrative is right?

Returning with us today to help us make sense of all this, one of my very favorite guests, Steen Jakobsen, Chief Investment Officer and Chief Economist of Saxo Bank. He has many years of experience within the fields of proprietary trading and alternative investments. He travels widely, he reads and writes constantly, he thinks very broadly about the world and where it’s headed. Steen, real pleasure to have you back with us today.

Steen: Thank you for having me, Chris. Always a pleasure to be here on your program.

Chris: Well, thank you. Now, listen, we last talked a little less than a year ago, and two major topics then were the declining credit impulse and the related risk of recession. Now the credit impulse, it’s a slow-moving beast. It requires many months of lagging to get it to align with economic growth or recession. Can you please bring us up to date with that story?

Steen: Yeah. And I think your last point is the important point. So basically, what we know about the credit impulse, which for the listeners that doesn’t know it, is the change of the change to credit. So the marginal change to credit in the world. And what we talked about shy of a year ago was, of course, that China has seen a dramatic drop on their activity, the second largest drop ever, only exceeded by what we saw in 2008 – 2009.

What we do know from empirical studies is that with a nine to ten month lead we then know the economic activity level with 60 percent explanation value. In other words, mathematically we have what we call and R square of 60. So 60 percent of the activity level is known nine to twelve months ahead. Of course, that still leaves a good 40 percent unexplained, and here you can throw into the equation Central Bank policy, how active are they, but also certainly regionally in the USA a fiscal imbalance that’s an increase over the tax cuts, and of course, the constant talk of infrastructure, which I think, Chris, we have been discussing among ourselves for the last ten years. But the overall activity, basically, is the credit impulse.

And fast forward to today. What we’re actually seeing is that we expected China’s imports as we look forward to actually reach a trough in March and November. Meanwhile, the US credit impulse has gone negative. So there we expect, basically, the global information we have right now is that Q3, Q4 this year is going to be very, very negative for growth unless the 40 percent, which is unexplained, picks up dramatically. And there we go back to your narrative. You know, it’s a clambake in tax credits that happened, or the tax help to the rich that happened. Is that actually going to push the median interest of the growth outlook? What will it do to inflate and the likes.

But basically, the credit impulse is telling us we’re still on route to have a slowdown in the US economy. Some people will like to call it late cycle activity right now. And classically, in a late cycle, business cycle, we do see inflation pick up, and we see that the companies on the corporate earning sides are doing extremely well. But that, you know, if it’s late cycle, of course, it coincides really well with the credit impulse.

Chris: In looking at this chart that I found of yours that’s on – it was prepared by Saxo Bank – but it’s on the trading site, the last time we saw negative credit impulses were, of course, declining, and then tipped negative in about 2007, early 2008. Also, around 2000. So these things are fairly highly correlated with negative growth. But as you said, just 60 percent. So what about that other 40 percent? I have a question for you here.

You know, we had a little bit of a volatility scare in early February and, of course, a lot of people started passing me a chart showing that the US Federal Reserve balance sheet was shrinking. But I kind of think of this as a global story, as we’ve talked about, and I’m looking here now at the ECB balance sheet. I can’t see – it’s actually just hit a new record over 4.5 trillion euros, just an astonishing amount. Bank of Japan, their balance sheet is up 7.8 percent from a quarter a year ago. The ECB is up 4.4 percent from a quarter a year ago. The Fed’s balance sheet is down 1.0 percent. Isn’t it all three that we really have to look at?

Steen: Absolutely. And Bank of England, as well. So what we’re seeing in terms of – I think the consensus right now, Chris, is that the impact on the G4 Central Banks will be the end of this year, which is kind of ironic that it coincides with my credit impulse signal. But basically, the net withdrawal of balance sheet over all four of the major Central Banks will start to happen as we enter into 2019. So the consensus, and I think a lot of the Goldilocks optimism that’s building to the marketplace right now, is exactly the people who look at that say, oh, hang on a minute, we know there’s going to be withdrawal of credit liquidity, but that withdrawal actually in nominal terms will only start in 2019.

What you and I have talked about with the credit impulse, of course, is the first of everything the marginal change, and in my opinion, everything in life happens at the margin. But the negative margin changed, not actually negative, but the momentum of the actual increase in balance sheet will continue on until the end of 2018.

Chris: All right, so last time we talked there was some risk of recession baked into that. I recently saw that there’s been other talk of recession risk out there by the leading economic indicators, all this and that. Where do you stand on the idea of first, US recession, and then secondarily, maybe global recession?

Steen: Yeah, so I led my prediction of recession being led by the credit impulse because if I had 60 percent explanation value, I actually think that’s the way to go. Where I’ve seen it recently is the number of papers that look at the term structure of the U-curve in the US. And if you use that, we’ve seen a significant increase over the course of this year, of course, from less the 10 percent to 25. I think the consensus in the marketplace is probably 10 to 16. I think the math is about 25, and in our estimation, we are still north of 50 percent recession exactly because we think the credit impulse is happening because we believe we are late cycle, and because, if you look at the expectations for 2018, what’s interesting is that the AB expectation for this year in terms of the earnings for companies is higher than any actual earnings have ever been in the S&P 500.

In other words, the expectation, even if met, will you know, will not be a phenomenal result at all, but it will be the highest ever. So not even having the highest earnings ever would actually be a big deed on the expectations. So where, in other years, when we started talking this time of the year, as we come into the tail end of the year, normally we will see a revision to the downside. This time we actually start with very high expectations. It’s like the market is priced for perfection right now. We have a benign policy out of the White House, according to the market. We have a benign set of terms in terms of the interest rates according to the market. And in terms of recession, the market is saying, well, you know, we have enough fiscal imports to carry over for another period.

And finally, on the monetary policy, again, benign because really 2019 it will start to withdraw the liquidity, but 2019 will have much higher growth to pay for that. So that is sort of the Goldilocks setup that we have right now. And I’m not one to say that you should absolutely go short anything. But our quantitative models, it’s very interesting that this spike in volatility we did see in early February has meant that our quantitative models, which are very dynamic in nature, they’ve gone through the highest cash levels we’ve seen.

Chris: Now, I’m intrigued by this idea – let’s go through that Goldilocks policy piece by piece that this idea that we have on the fiscal side it seems pretty relaxed. And, of course, Trump is talking about in the United States infrastructure spending and all of this and that. What I’m looking at here, though, is the spike in the deficit is already pretty extreme, and that’s going to require floating and I guess another trillion of new borrowing over the next year, if the numbers are right. How does that get absorbed, and what’s the impact on the dollar here?

Steen: Yes, so there is a theory, which I actually think works, that the more supply base the more net demand there is. So in every society, in order to deal with the debt, what we’ve classically seen is that supply created its own demand which of course is safe law, probably one of the few laws in economics that works. So basically by increasing the amount of issuance there will be a net demand for it because for every marginal change, higher interest rate right now, guided by the Federal Reserve, there will be pension, assets and liability managers buying it.

So I think in a mathematical point of view I don’t think it’s an issue, that the issue is increase. And I think that’s what the market prices in. I do think credit impulse is negative because the decrease to the credit leverage is smaller. So unless you increase the leverage, so leverage times the amount of credit that you need, then you have an issue. And I think that’s clearly what’s going on. I think the leveraged ability of society is going down. I don’t the think the net issuance, per se, will be an issue. There will be enough demand for every marginal ten basis point higher. Interest rates will go up. Don’t forget that a lot of pension funds and insurance companies will actually make money as interest rates goes up because they’re net liabilities will decrease significantly.

Chris: Right. Great point. Of course, the pension funds, in many cases, are so far behind the eight ball it’s – I’m not sure exactly…

Steen: But that’s a different story. The fact is isolated in trading-wise as long – as interest rate is rising you actually very beneficial for pension funds and insurance companies.

Chris: Well, sure, I could see that, particularly for the corporations that have to set aside and put money into their pension funds. That absolutely makes sense. But let’s talk about these rising interest rates for a second because this seems to be potentially a pin in this story, something sharp and pokey. So here’s what I’m looking at, Steen. I’m looking at the LIBOR chart, and it’s positively spiking here, faster even than the 2011 mini crisis. It’s at a pretty high level here. What’s going on with LIBOR right now?

Steen: Yeah, so the LIBOR rate, of course, is interbank, uncollateralized lending as well. So when you look at the tech spread, so both the LIBOR on its own but also the tech spreads are increasing significantly. And that actually shows you that there’s a less amount of credit available. Of course, I will argue that it’s due to the credit impulse in the world lending contraction of overall credit. And I think every banking system is unprepared. I mean, I don’t think they have the net funding going on in the banks anymore despite the fact that net lending is not increasing significantly. I think the balance sheet is actually very stretched in the risk-rated and all of the compliance that they need to do.

Don’t forget the maximum leverage on US banks has come down from an indicated [unclear] fifty times value to leverage to now less than ten with the new Federal Reserve regulations. So I actually think that there is too little capital going on.

Chris: Too little?

Steen: Too little? Too little capital, spread free capital. People are changing and using the money is other, like ETF, in passive risk parody [PH] and others. So I should think the available full credit to credit is significantly decreased. And I think there’s, to some extent, there’s distrust between certainly across borders and the recent regulating in the US, of course, has also made it more difficult for foreign banks to go to the Fed window to borrow money.

Chris: Interesting. I don’t know if you saw it, but Roland Paul of Real Vision TV put up a very interring chart on Twitter a couple weeks back, and it showed the stock price of Deutsche Bank inverted against the LIBOR OIS, and it seemed to be a pretty tight match. He was suggesting that maybe Deutsche Bank is exposed here as part of this dynamic. Is that a possibility?

Steen: Yeah, but probably the explanation of that is also pretty clear. So what happened with the tax yielding US, of course, was that the US company was about to repatriate capital to the US. I don’t think that – that wasn’t actually for a major and medium size company any tax advantages. But it does sort of screw up the money market system because don’t forget this money was always is dollars anyway, but they were sitting in an Irish bank or in a French bank or a Luxembourg bank as euro dollars. Not in euro dollars the currency, but in euro dollars.

Now that the US companies are then repatriating the capital from the European side of the bank and putting into US banking system, actually the money goes from being available to the global market that goes into the domestic US market. So part of the fueling of the stock market is actually, in my opinion, come from this increase in the credit domestically. And what we’re seeing, on the other hand, is that cross currency swaps and, as you say, correctly LIBOR rate between banks and Deutsche Bank and other European major banks have actually had to pay up to get the funding of US dollars.

Chris: Interesting. All right. Well, let’s keep on this US interest rate bandwagon for just a minute. I’m looking at corporate yields here. Investment grade also rising, highest level in years. Pretty interesting here. So even if that liquidity is sloshing back in to the US, it’s looking a little bit like funding costs are still going up here at a fairly highly indebted moment in time. Aren’t these rising interest rates – what are these telling you? It looks to me like there’s less liquidity in the system which is why I made the comment about financial conditions. But maybe there’s another explanation.

Steen: I think every single product that the investor looks at has less liquidity than is perceived. I think one of the biggest gaps between perception and reality right now is the ability to actually exit the portfolio you’re in right now. Whether that is and ETF, whether that is credit or whether that is even some of the small cap stocks. And I think we already have a proof of this because the spike in February, think about it, it was just about a five percent move in terms of price, but it created almost ten thousand percent increase in volatility. If a five percent move creates that sort of noise in the system, it shows that we, again, and I think I used this on your program before, but we are playing musical chairs. And when the music stops we’re not missing one chair, but we’re going to be missing three chairs in a ten-chair race.

So I think it’s pretty clear that the liquidity side is a concern, and I can tell you this afternoon an unnamed Central Bank called me up, and they wanted to talk about liquidity in ETFs and the bigger risk of the market itself beating itself in terms of the way we have structured the market today. So I actually think that liquidity is the norm now. And if you look at the breadth of the stock market over the last couple of weeks, it’s very, very, very narrow. So we are chasing the same investment, we are chasing the same themes. We are not concerned about that, as I said before. Everything is benign when we talk about the incoming risk, but I’m very concerned. And that’s certainly par for me, and I’m always wrong pretty much, but at least my model, my quantitative model is now supporting me saying we really have to be in the mode of capital preservation now. This is the capital preservation mode.

Chris: So I’m interested in that comment about the market structure, you know, I’ve done a lot of interviewing with people over the years about the rise of the machines, the algorithms, all this and that. And of course, we saw in that February volatility that liquidity and volumes just absolutely evaporated, as one would expect in a market structure that’s dominated by computers, algorithms that they are very, very rapid and quick to pull the bid when they need to. Was that part of the discussion and if so, how does that feed into ETFs?

Steen: Yeah, so first of all, people treat ETFs like it’s a stock, like it’s a homogeneous entity. A lot of the ETFs have specific rules in market making, specific rules in end of the day pricing. If you have a leveraged ETF it’s a total different, you have a counterpart at risk. But the thing is that the market now has been so used to using ETF they think everything is the same, everything has the same standard. There are a number of standards involved in just the ETF side. And then you have your derivative made and the like.

In our estimation, there’s about $4.5 trillion worth of ETF and related products right now in terms of active investments, and that’s a significant jump. And most of this is interest bearing. Not interest bearing because the ETF is not declaring properly, but because investor doesn’t read that declaration of what happens. And a good example, of course, being these two, three times leveraged ETFs that you saw. So as usual, I think we are all taking the easy choice and the easy way out in terms of just, you know, we like a theme, and then we buy the theme. We forget to look at the actual counterpart in this. We forget to look at the liquidity involved. And don’t forget, every single person that ever gone bankrupt in history, they went bankrupt not because they were stupid, not because they did something wrong, but because there was no liquidity.

Chris: Interesting. And what about the market structure being so dominated by algorithms now?

Steen: First of all, if we just step back, why is algorithms so big, and why is it pretty much for 98 percent of it really short term based? Because if you are using artificial intelligence, if you are using algorithms, you need deep data mining. But deep data mining actually has a preregistration of at least 60,000 data points. And although you and I, Chris, combined are very old, I don’t think you and I have any databases with 60,000 data points, right. So you’re any mathematic, we could not do a deep mining of our data.

But imagine you then instead of doing daily data or weekly data or minute or seconds data, then usually you get 60,000 data points. So what I’m really trying to say here is that the reason why we have so much algorithmic and liquid trading and short-term trading is that’s the only way you can actually fulfill one of the mathematical, minimum requirements which is 60,000 data points. But it also means that almost all of the activity is in between intra-day really. So 90% of the flow intra-day is driven by algorithm, but that leaves the rest of the market, like over the weeks, over the months, to be end users of real risk.

So I think the distortion is really in the short term. But back to your point, which is that is the reason why it’s so dangerous. Yes and no. I think there’s plenty of liquidity in the system, but day by day these algorithm traders can disrupt and can switch off the engines that actually provide liquidity. And that is the bigger issue, and especially in the ETF space where you have so many creations of EFTs. Don’t forget, if you’re an institutional investor you don’t go buy HYG [PH], for instance, but you go to a provider or your bank, and they will issue you a tailor made HYG out of the stock components, right. So you tailor specialize these features. And of course, that liquidity disappears.

You were on in 2008. You probably knew a lot of people who were [counting] on failure. And when they needed a bid it was pretty much the same price where they bought it, right? So the spread went from one percent, two percent, to sixty percent spread.

Chris: Right. And by the way, I can’t get to 60,000 data points because as I add one I kind of lose two at this stage of life. So what are you going to do? I’m interested now in looking at really what’s going on with these trade wars and this idea, it’s really on everyone’s mind, a lot of rhetoric flying around, but, Steen, should a trade war evolve here, what’s at risk?

Steen: It’s big. It’s massive. And I think, of course, being a foreigner I’m not the spoke expert on US politics. But I did know for a fact that the only point, the only issue, on which Donald Trump has been consistent, even before becoming political, has been on this bashing of China and early on of Japan in the late 80s. I think it’s a central part of his appeal to the voters. I think he’s playing a midterm election game right now. And I think the whole political narrative that they’ve created is that after World War II the Marshall Plan, which was put to work to help the Europeans, the 2001 WTO inclusion of China was also a lending hand for the US to help China to democratize and move on. And now I think Trump want to undermine all of this.

So the narrative piece of advice is to use this to say, well, now we first helped Europe, and now we helped China, and they have not been kind to us. Now we want to reverse it. Of course, the practical side of this, of course, is that even if Trump was able to create all these manufacturing jobs that he dreams of, they would be unproductive and uncompetitive, and they would increase the inflation process in the US. And this is bad inflation, not coming from increasing activity but actually coming from taxes going up.

So the great irony is, I think, the hardest hit on this I think would be the US consumer. They will get higher prices for all products, but mostly only from an economic point of view, if you think about the US, you’ve been running a current account deficit for many, many years, courtesy of being a reserve currency. If you run a current account deficit, you’re actually spending more money than you have. So let’s presume that Trump is successful, he reverses the trade deficit to a surplus, and in the process the current account, that will mean that the US consumer would have to be living below his means for a long, long time to come back to a norm.

So it’s extremely complicated, but I do know that people are underestimating this. Look through the history of America First as a slogan, Pat Buchanan, second World War. I mean, the whole concept is this dream about yesteryear, and a time past, where American cars and everybody was happy in the 50s and 60s, and it’s not the reality of the world. On the other hand though, you know, it’s pretty clear that China and the other countries are violating property rights and other things. So you need to clamp down. But this escalation out of trade twitters and the likes is not the conducive way. And I think the single biggest risk, if we all combine everything we talked about, to growth, to a recession, is actually the gentlemen who borrow and those in the White House. I think those two advisors are directly, probably culpable on seeing US growth go lower, especially to implement some of these trade sanctions against the rest of the world.

Chris: Well, I guess there’s two ways to sort of get what Trump says he wants in terms of trade policy. One would be to have that trade war. The second would be to have a much weaker dollar. China’s probably going to have to respond at some point beyond rhetoric. And I’m looking here now, killed or abandoned under Trump, a list of things of companies that have been blocked in terms of takeovers in the United States since Trump took office. This Qualcomm one that just got blocked, the would-be acquirer of Broadcom based out of Singapore. The next country that got blocked after that was China. Then China, then China, then China, then China, China, China, China, China, China, then China, and the last one on the list is Germany. So it’s really beginning to look like Trump’s got a point to make here. How could China respond beyond allowing the dollar to weaken?

Steen: To expand into one belt, one road. Don’t forget, since we talked we’ve had the Communist Party conference, and the Chinese then said, we’re no longer aspiring to number one, we want to be number one. And as you know, aspiring to something and expressing that you want to be something, it’s very different. So I think what we will see over the next ten to twenty years is a very clear, de-dollarization from the Chinese and the Asian region. The first step in that is actually the Shanghai Commodity Exchange, which in March will introduce a crude contract. China is the biggest importer of crude in the world. Why would they want to go through a US based contract to do that when they can’t have a third party involved?

China wants to get their currency to be stronger, so it can be a reserve currency. They will probably have to build up their reserves in gold to match what is already in place with the IMS in Europe and the US, about ten to fourteen thousand tons. So I think China’s policy is pretty clear. They’re going for the long haul. The long haul is that they have ability to create infrastructure and strategic alliances all the way through Asia and the Middle East. And using their leverage and their purchase and net demand leaves them in a better negotiation position as seen from Being relative to the US.

So I think very shortly, and maybe even in this year, a lot of people will have to – a lot of countries, a lot of Prime Ministers – will have to decide: are you with the US or are you with China? And unfortunately, I think a lot of people will be with the Chinese in this situation, partly because of the policy implemented by the US, but also because the pure mechanics of this. Think about it, there are about four billion people in Asia, and if we are very nice to North America, there’s about six hundred, seven hundred million clients, right. So the companies that’s going to be built and produce and sell in Asia will have an audience which is at least four times, five times, as much in size bigger than the ones that is in US. So that’s your response, Chris.

Chris: Very well thought through. And I’ve been astonished noticing that because of all the anti-Russia, if I dare say, hysteria, but the focus that seems to be pretty outsized right now in the West, we saw Exxon back out of a Rosneft deal, but China’s energy fund, CFT, stepped right in and bought a big piece of that.

Steen: I see life when I’m travelling, so in Moscow I stay in a specific hotel which is used by diplomats. Last time I stayed, the King of Saudi Arabia was there. First time ever in Russia. I went to – where did I go – I saw that Chinese Foreign Minister was there. In fact, all around the world there’s new alliances being built. And what American companies will say right now, we’re not going to be allowed, as per your definition as well, we’re not going to be allowed to compete in China, but then we can certainly compete in India, right. So India, being soon the most populous country in the world. But hang on a minute. If you look at the history of India, who does India have the highest common denominators with? Where is most of the bureaucrats in India educated?

Chris: I wouldn’t know. England?

Steen: Russia.

Chris: Really?

Steen: So Russia and India have been very, very close. Russia has always, by India, been seen as a close ally. So Russia and India are very, very close. So of course, if you lined the countries up along the sort of the split world that I gave you before you would say, well, but China is, you know, we can’t do it, the Chinese can’t do the US. So then there is Europe left which, of course, we’ll always be in the middle. But India is sort of the up and coming country that everybody wants to be a piece of. They have already achieved their alignments with Russia. And they have also ultimately found alignments there with China.

So what I see is, unfortunately, Chris, is that down the line we’re going to have a split world where Europe is in the middle, and then you’re going to have the Eastern countries where we’ll pretty much buy Chinese economy, and you have the rest of US part that is becoming increasingly isolated. And in between all of this, I think, the cryptocurrencies that’s going on, I think, one day pretty soon we’ll have an IMF currency. We’ll eradicate all the currency rates, and then the government will use proxy and cryptocurrencies to control us even more including global tax and the likes.

I know I’m getting depressive now, but I really think that this is what people are trying, the policy makers, are trying to achieve and which they can’t get away from. So the response is pretty clear to me. China is going for five billion people plus its own market, and they’re not going to be too worried about the US as an import market because I think they know it’s already over in terms of their ability to be a big exporting nation into the US.

Chris: Yeah. It certainly seems to be something that’s maybe hit its peak at some point in time. But to me, cracking the energy markets and watching what happened with that delegation from Riyad that went to Moscow, but also went to Beijing and watching that whole realignment, it really feels like the United States is living in a prior era strategically. I’m not really clear what our strategy is there, but if it’s alienate the world’s top oil producers, we’re doing a great job. We seem to be proceeding a pace on that one.

Steen: I really don’t think it’s, per se, it’s a strategy to upset people. I just don’t think they understand how the world has evolved. I think China is so misunderstood by Westerners, especially English-speaking Westerners. But that said, we underestimate the tenacity and they ambition of China. China really wants to be the number one country in the world in every sense of the word. And you know, [phone fades out] They did the first quantum telecommunication satellite recently. I mean, there’s a lot of areas where actually China is superior to the US in research and its ability. So it’s not all just stealing IPs. Also a very, very grand and ambitious plan to be number one in the world in technology because their technology is the way they can maintain high growth rate for increase in productivity.

Chris: Well, and they certainly also understand resources and how they play out and where they are in the larger energy story. And they’re making what I consider to be rational moves, given what I see in the data.

Steen: Yeah, the electrification. I mean, that’s a big story since we also talked last year. They’re going to be flowing more money into battery and battery storage over the next twelve months than they spent in the last 120 years. So you know, on the positive side, I think we’re going back to fundamentally not doing apps but doing more mechanical engineering and combining the biggest big data, all the stuff that we learned over the last ten years not to be on Facebook, but actually for energy and for energy consumption storage of energy.

And I really think there will be – think about China wants, by 2020, all cars to be electrical. You can think about that what you want, but it’s the government that says it should be, so it will be, right. A country with an even bigger pollution problem is India, you know. Five, ten years from now they’re also all will be going to electrical cars. So the world is changing, and the electrical car is just a battery, right. I mean, don’t get me wrong, it’s sophisticated, but you will not have, like German industry. It think that German… They don’t have investment in electric cars. They don’t have… industry [Phone fades]

Chris: Well, now I’m interested, let’s turn back to Europe for second. I can’t wait to get your views on this. The Italian vote. It’s certainly seemed that the Italy vote, from this end, it looked like the Euro skeptics gained some measure of power. The Italian banking system looks like a mess to me from over here. How does the Italian vote change any of the calculus now for Europe?

Steen: So again, there are two narratives. There is that: did you really expect anything different to happen? And the second one is that you know, it’s late in the cycle for Italy. To some extent, the less diplomatic person in me would say that Draghi whole policy at the ECB is executing the Italian banks to live. And as Draghi should be by March 2019, I think Italy basically has a year left on its ability to change. And with this election I think what unfortunately transpired was that Italy is as far as it’s ever been from actually sitting down and figuring out how they do reforms and how they get the banking system in order. So to me I think the Italian banking system is a ticking bomb. I don’t think its an immediate bomb that will explode because as long as Draghi is at the ECB he’s going to continue to support and have a very loose monetary policy in Europe, pretty much based on the fact that they will keep Italian banks alive.

Chris: Well, with twenty percent nonperforming loans, let’s be clear, they’re already zombies.

Steen: Absolutely. But there’s some pieces at a very low level of interest rates. So when you pay zero in interest rate it’s not a big deal. But if the bullish crowd on interest rate are right, and we’re going to be a four hikes on the Fed and then I think it will be – and as you said already earlier with the LIBOR and the tax break and overall the interbank lending being somewhat drying up, I think these banks need funding, and you can’t get funding from ECB and from the system.

I recently travelled to what I say is the three most leveraged countries in the world which in Norway, Dubai and what was the third one I was thinking about – anyway, but both Dubai and Norway is two countries where you see the real estate market come down dramatically, ten, fifteen percent. I mean, Dubai, despite the fact the have the World Cup thing coming up, and that’s because they’re the most leveraged societies that I know. These are high-risk taking countries. And all of them are actually reflecting the same story.

And Italy, again, it’s not a high leveraged risk because, of course, the domestic savings is very high in Italy and most of the issued bonds they have is actually sitting with pensioners and pensions systems and the investors in Italy. But the fact is that actually the problem will show up first in Italy in Dubai and in countries marginally like Norway where we have some small, open economies which are very dependent on the global trends. And I think we are seeing cracks in the surface, but again, ECB Central Banks, I think are still ready to take another dance with Asian monetary policy if the Goldilocks scenario unlocks.

Chris: I want to talk very quickly then about this idea of where this inflation might come from because certainly inflation will push on rates. We’ve seen a tick up in inflation here in the United States. Consumer price inflation at 0.50 percent, that annualizes out at six percent. Don’t know it that’ll stick, but very interesting chart – commodities versus equities, that ratio at one of the lowest points in decades. In your mind, is there any danger that commodities, which would actually push through more consumer inflation, that those might actually begin to go up here?

Steen: I think the two asset classes that has a positive return expectation over the next two years are the American market and agriculture and commodity overall. So I actually think they will push up. But for reasons not related to inflation I think simply because the extraction price, and then energy consumption is decreasing. So I think there is a good deal to be done there. And I think overall as a proxy tangible versus intangible, so you’re actually right. They are extremely dirt cheap relative to any assets that you compare with. I think that over a five to ten period these are the assets that will do well.

In terms of the inflation story, I think both goldman is also pointed to the fact that the interest rate rise we’ve seen, if you decompose that, 80 percent of that is actually increase in, not if inflation but in growth expectation, so 80 percent is actually people predicting higher growth and only 20 percent has been higher inflation expectation. Personally, I think the whole upside of inflation is extremely overblown. To me, inflation comes from velocity of money. Velocity of money in the US is still poor. And if you look at volatility of money as a definition it’s actually net lending demand from the banks. And as you know, Chris, the net lending from banks in the US has just gone negative.

So I don’t understand how we’re going to get high inflation in an environment where banks are lending out less money. The multiplier is working slower, and velocity of money doesn’t seem to be picking up. Oh course, what could change that would be infrastructure. It could be capex expenditures, so interest funding. But what we’ve seen so far in 2018 is that companies are still buying back stocks to a tune which is bigger than the net issues of bonds. And the infrastructure, I think it’s very difficult to implement in the US, certainly because, as you know, most infrastructure investment actually happen to happen at state level. And state level tax issuance is not something people like to do in a midterm election cycle.

Chris: No, absolutely not. Hey, I have a quick question I’m hoping you can answer. I don’t have a good answer for it here. I’m looking at the ECB balance sheet here at their website. I’m looking at – it lists a variety of subcomponents, of course. I’m interested in two. The first is gold and gold receivables. What exactly are gold receivables, and is there anyway to find out how big that component is?

Steen: I’m assuming it’s gold swaps. So they have lent out their gold to create liquidity in the marketplace.

Chris: Yeah. So same thing over here. I just can never find any information on it. That’s where the inquires end. They just say no, we have gold receivables.

Steen: I tell you, I don’t think they actually want to be seen to be lending out their gold, but I’m pretty sure they do. And as you know, there’s huge amounts of conspiracy theories on how much gold is actually in the world and what quality. But in terms of the accounting, I’m pretty sure it’s gold swaps. So the ability to actually lend against the stock in vaults.

Chris: Yeah. Interesting. I’m still trying to unpack that. It’s very tricky to get any good info on that. The second category is other assets. I love that. Other assets listed at 254 billion euros. Seems like a big number to me. What might be in that other bucket?

Steen: Well, technically things that is not a normal bracket, and it could also be – and I know where you’re going with the question – so I do think that could be some equity in other stuff and swaps related to. So may not be buying directly stocks, but they could have been buying return on the swaps and other things on what they do. Plus, of course, they could have bought some protection on some of the bonds they had, the risk they’ve taken on.

Chris: Yeah. You know, our own Chicago Mercantile Exchange lists proudly on their website a Central Bank incentive program. They’re the highest volume players out there, so they get really special pricing. But nobody, not one Central Bank, will list that they actually own any CME products, but they all have this giant “other” bucket. So I’m just interested.

Steen: I think the Swiss National Bank is the exception to the rule. The Swiss National Bank, of course, is a big stockholder in Apple, so you can see their actual positioning.

Chris: Yeah, on direct stocks, but they never admitted that they owned a CME future or put.

Steen: True. True.

Chris: I haven’t seen that.

Steen: And I don’t think we will see that change either.

Chris: Yep. Probably not. So I’m just curious. All right. To wrap up. Steen, what are the biggest risks you see for the remainder of this year, and how does that have affected your hedging or your positioning of your portfolios?

Steen: So I think the external factor is what is now coined the trade war. I think the market is totally unprepared for the severity of the fallout from that. I think in market terms, it’s the market itself. I still think that the February, you know, quick rally we saw in volatility is only a precursor to what could be coming later. I think the market is really priced to perfection, and I don’t believe in perfection after a long life in trading. So the market itself.

And I’d say overall how it really concerns me, and I’m not sure or not, but if China and the US is going to split the world in two, we really stand if front of a very difficult time to reengage because at least in climates like this we have a global market for better or worse. But this time we could have two version of the same thing, and I think – I don’t think China will back down. I don’t think the US will back down.

Chris: Interesting. And so in terms of positioning portfolios, is it time to lighten up here? Go to cash?

Steen: So I said a few times we are in what we call a preservation of capital mode, which means that you should definitely still keep your exposure to the market, but you should do it in a way which is unleveraged, and you should certainly increase the cash proportion to have some ammunition, should there be opportunity in the year. And I think there will be opportunity this year. I think the magnitude of the fall is going to be five, ten, fifteen percent, I don’t know. But I do know if the five percent can set off the alarms as it did if February, god forbid, we get a ten or fifteen percent move down for the marketplace. But having said that, I think the incoming changes to capex in terms of electrification and better uses of these new technologies, I’m pretty positive. I think five years from now we could store energy at one tenth if not one hundredth the price that we do today. And imagine what that can do the world in terms of cost and capability of alternative energy sources.

Chris: That would change everything.

Steen: That would change everything, and I think it will change, and we need a change. And I think there’s a higher order, Chris, and maybe I’m being a little bit philosophical, but I think if this is the world we should be depressed. If this it how the world looks, but I actually think over the next ten years we’re going to go to higher order of things. I think computer power, energy, as we just talked about, starting to educate again and understanding the IQ in investment in education is everything. I think we’re getting it very slowly, and there’s a lot of noise politically, but I think the winning companies of today are knowledge company, social intelligent companies, and I think this drive will be away from digitalization and stupidity towards quality and service. So I’m very optimistic about the future. But I do still think, unfortunately, that we’re going to have this reshape sell off before we can start anew.

Chris: Well, as you know, us Americans can always be counted on to do the right thing after we’ve exhausted all the other options.

Steen: Exactly. But that’s not just Americans, Chris, to be fair. That’s everybody.

Chris: I know. I’m just quoting one of my favorite curmudgeons of history. So hey, with that, Steen, thank you so much for your time today. tell people how they can follow you and your excellent work.

Steen: We have a research webpage that is called tradingfloor.com, tradingfloor.com. And if anyone ever wanted to follow what I specifically write, just put a note on my profile there, and I’m very happy to share my thoughts.

Chris: Fantastic. Well, Steen, thank you so much for your time and your insights today.

Steen: Thanks for having me, Chris.

---

Duur:  45:54

Publicatie: 19 maart

---

De gehele Crash Course vindt u hier.