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I Know Why The Caged Favre Sings

What is Brad Childress, the coach of the Minnesota Vikings, thinking?

It’s a remarkable story this week…in a one-point ballgame, in the third quarter, the coach tells quarterback Brett Favre that it might be better for his long-term health if he takes a seat for the rest of the game, because he’s getting crushed by the defense.

Keep in mind this is Brett Favre, who holds a significant edge in the longest streak of consecutive games in NFL history: 285, equivalent to almost 18 NFL seasons. Odds are good that he has been sacked a few times before and he has a pretty good streak of getting back up. I can imagine the conversation went something like this…

Childress: “You’re getting kinda beat up. Don’t you want to come out?”

Favre: “I think I’m okay. I didn’t even notice the last three.”

Childress: “If you came out now, you’d have some time to get Christmas shopping done. How in the world can you find the time? Go ahead, have a seat.”

Favre: “I want to play. I’m fine. You’re paying me a lot of money to sit.”

Childress: “Let someone else play. Come on, be fair. Tavaris Jackson’s mom is in the stands. Be cool.”

The only thing I can think of in Childress’ defense is the new NFL rules on concussions. For those of you who aren’t fully aware of these rules, essentially they say that if you take a rap on the noggin and tests show you can’t do nonparametric estimation for semimartingale stochastic differential equations in your head, then you can’t play until you can prove you have the power to lift an apple using only telekinesis. If that explanation confuses you, then hit the showers: you have a concussion.

But sitting the NFL’s all-time tough guy at quarterback because he’s getting dropped faster than GM’s market share? That seems to me to be a bad coaching move. As Will Rogers once said, you “dance with the one that brung ya.”

So…then why did I become a secular bond market bear in November 2008 after watching a bull market in bonds basically for my entire career? For years, I scoffed at people who saw the big turn in interest rates, and didn’t respect the dominant trend of our era: the gradual disinflation caused initially by tight money and encouraged later, ironically, by loose credit and suffocating financial and operating leverage. The big trend, which is still technically in force, is illustrated below in a chart I have shown many, many times:

It is hard to fade the Big One.

There is not yet any technical reason to suspect that the grand disinflation is over. But to my mind, the writing is on the wall and it’s time to pull the quarterback. Things are not working as they used to.

The big supporting factors of the Great Disinflation in my view were the spread of globalization, a general trend of governmental deregulation of business, consumer and producer over-leveraging, maturation and synchronization of central bank policies, and (possibly, although the data is pretty sketchy on this and it doesn’t explain why less-connected countries also disinflated) the significant labor-saving developments associated with computerization.

And that is why it is time to be skeptical about the secular bull market in bonds. Globalization seems to have gone as far as it is going to go anytime soon, although I would be loathe to bet that way (it might just be the depression that is giving rise to xenophobia and populist protectionist policies). Government over the last decade has begun to get more intrusive rather than less so. Producers and consumers are starting to de-lever, sometimes gradually and sometimes suddenly (through the bankruptcy code). Central banks are synchronized, but have added too much liquidity worldwide so the synchronization is a negative at the moment. And to be honest, Excel 2007 keeps corrupting my spreadsheets so I’m not convinced the microchip will save us.

That doesn’t mean that the next 25bps are to higher rates necessarily; inflation derivatives markets imply 2010 inflation is expected to clock in at only 0.9% before rising gently thereafter, and this agrees with other models of core inflation I look at. However, as noted here the underlying inflationary trend (ex-Shelter) may already be established. The undertow may be pretty strong already, and to my mind the big picture contributors to the long decline in inflation and rates are turning around. I am not presently a fan of nominal bonds. It is time that old soldier takes a seat.

Today, the Existing Home Sales data was very strong, almost stupidly so, with the annualized sales pace clocking in at 6.54mm units/yr. That’s faster than all of 2008 and 11 of the 12 months in 2007. The price index is now tickling the underside of 0% for the year, threatening to show real stability.

Existing Home Sales - Can it be this easy? (Source: Bloomberg)

The skeptic in me has trouble believing that the housing market is actually repairing itself faster than it broke down, and faster than the bubble built in the first place. Obviously, some of this is pent-up supply hitting the market now that prices have stabilized, and I wouldn’t expect these turnover levels to be sustained even with support from the government tax breaks etc. But at this level, they don’t have to be sustained for a very long time to clear a bunch of the deadwood that is overhanging the housing market.

What that will probably mean, though, is that we’re going to see credit contracting more quickly as folks who have technically had credit (because the bank didn’t care to seize the house) lose it. There is still a huge mess to clean up here, and we’ve not even addressed the commercial real estate market yet. But things have stopped getting worse, at least for Christmas.

Don’t downplay the importance of the yield curve shape in helping to heal things, either. Traditionally, banks have healed themselves by borrowing short and lending long when the Fed has engineered low short-term rates. In this particular episode, that would not be nearly enough, but as we have seen recently banks are also raising tens of billions of equity capital from credulous investors who can’t do math. The finance industry is healing more rapidly than I ever expected, too.

And that means: if these trends continue, it means that just like in 2002-3 we never let the economic rinse cycle complete. If (and it remains a big if) the expansion is already under way and if it is robust, then I fear it is setting us up for another, worse, debacle. I shudder to think of it, but it boggles the mind to think that the horribly bloated financial dinosaurs that were the biggest targets in this debacle might be “allowed” to succeed and thrive.

I am not sold on that yet, but I am open to the possibility.

Categories: Uncategorized
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  1. January 24, 2010 at 9:42 pm

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