DANIELLE DIMARTINO BOOTH: Hello.
Joining us today is Peter Boockvar, Chief
Investment Officer of Bleakley Advisory Group.
I'll introduce him by saying he is as close
to on Wall Street as being a brother from
a different mother.
For me.
We've gotten to know each other very well
over the years.
The work that we started to do together was
done very much covertly.
You fed a lot of the intelligence that went
into the market briefings that I prepared
for Richard Fisher when I was his advisor
working at the Dallas Fed, and I'd like, if
you could, to take us to the culmination of
that relationship of being an indirect advisor
to Richard and how it ended up in a bar, the
King Cole bar, on a cold night.
It was you and me, Arthur Cashin, Howard Silverblatt
of Standard and Poor's, and of course, Richard
Fisher.
Richard came to love your work after you made
a particular outlook for the year and used
the term beer goggles.
It was interesting.
The Wall Street Journal did a retrospective
on all of his speeches.
The number one most popular one that he ever
made was your beer goggles reference.
Take us back to that night and what it was
like to meet Richard in person finally after
having been such a critical part of his understanding
of markets intelligence all those years.
PETER BOOCKVAR: Well, what was special for
me that night was actually getting to meet
him for the first time in person.
Previous to that, through you, and directly
in the occasional email correspondence, the
speech where he gave the shout out to me was
special.
The good thing is that we all had a similar
viewpoint of the way of the world and monetary
policy and how it interacted with the regular
economy and saw things a little different
than the conventional thought process in Washington.
To actually get to meet him in person was
pretty special, just as he was walking out
the door and going off to his next thing,
but one thing that did come out of that was
also a continued correspondence.
I don't think I've seen him since but the
occasional email back and forth is always
special to me.
DANIELLE DIMARTINO BOOTH: I know Richard continues
to enjoy your work.
It's how I start my day as well.
I think a lot of us do.
Take us back for just a second.
What are beer goggles?
PETER BOOCKVAR: Back in the day in college,
when you would have a little too much to drink,
everything looked good.
Everything looked better than it might have
without the beer.
The analogy was when the Fed is conducting
extreme monetary policy, the zero rates for
seven years and multiple rounds of QE, it
puts beer goggles on investors.
It makes that awkward lame investment all
of a sudden look like roses.
It looks at that money losing company.
Well, if we do a little bit of this and that
and give him some money, everything will turn
up roses.
That was the analogy that investors become
much less focused on the risk when they have
those beer goggles on.
There's monetary bill got beer goggles on,
and only focus on where's my upside?
DANIELLE DIMARTINO BOOTH: I guess the CLOs
all look better at closing time.
PETER BOOCKVAR: Exactly, yes, yes.
DANIELLE DIMARTINO BOOTH: Before we go to
where we are today in collateralized loan
obligations, tell us how you think the Fed
got the idea in its head, how policymakers
decided that they had to go to the zero bound
before they could launch unconventional monetary
policy, quantitative easing.
There are examples that Chair Powell uses,
as well as Vice Chair Rich Clarita.
They reference back to the episodes in 1995
and 1998 when the Fed was able to execute
three rate cuts and then gracefully extract
itself from the markets and the economic expansion
and the rally in risky assets continue undisturbed?
Are we there today?
Can he do this?
What differentiates '95 and '98 from where
we are now?
PETER BOOCKVAR: The important thing about
understanding '95 is looking at what happened
in '94.
That's when Alan Greenspan raised, I think,
the Fed Funds Rate from 3% to 6%, 300 basis
points within a year's obviously a rather
short increase.
There were negative side effects from that.
The Orange County pension fund, I think, the
[indiscernible] themselves out.
DANIELLE DIMARTINO BOOTH: The Tequila Crisis
in Mexico.
PETER BOOCKVAR: That as well.
Going into '95, by cutting rates 75 basis
points after he just raised 300 the year prior,
and also you were only four years into an
economic expansion very early on.
That was something that they were able to
engineer.
Then you fast forward to '98 and we have the
long term capital management blow up.
You have the Russian debt crisis.
Well, that was coming together and a sharp
decline in the stock market.
The Fed was more responding to a decline in
markets and a freeze up in markets rather
than an actual deterioration in economic growth.
DANIELLE DIMARTINO BOOTH: Third time Alan
Greenspan ever did that.
PETER BOOCKVAR: Well, exactly.
That's how we became trained that on a market
hiccup, as opposed to an economic hiccup,
the Fed was going to come and cut interest
rate, but we know in late '98, that sowed
the seeds for the greatest stock market bubble
in history.
Saying that '95 and '98 are good reference
points for us as the Fed, I think, is really
not thinking through what went on during those
two timeframes.
DANIELLE DIMARTINO BOOTH: Certainly.
The years that followed '98 were some of the
most-- Alan Greenspan had already said, irrational
exuberance in December of 1996.
We knew that the train has already left the
station and but animal spirits are what animal
spirits are.
Let's jump forward in time a little bit, because
Alan Greenspan and you would agree on something.
When he was still Chairman at the Fed, he
insisted against the protest of Ben Bernanke
and Janet Yellen, he insisted that the ideal
inflation rate was zero percent, what say
you?
PETER BOOCKVAR: I agree, because that's actual
price stability.
When you think about zero, let's just take
that, that means some things are going up
4%, some things are going down 4%, this price
is going up, that price is going down but
in a net way, prices are stable.
Now we take technology, for example, it's
a pretty safe bet since the history of time,
the price of any technological good, whether
it was a car in the early 1900s, or it's a
computer or it's a phone, whatever, that those
prices eventually continuously go down.
Then there are going to be some things where
prices go up, mostly on the services side,
whether it's housing or medical care or tuition
or whatever, but if you can net out that being
around zero, that's actually price stability.
It makes your currency stable, it makes decision
making much, much easier.
Now, if you get into too much debt, and you
sell a commodity product and the price of
that product goes down, well, then you're
going to run into trouble.
Maybe knowing that, knowing that you don't
have pricing power, maybe you don't go into
too much debt to begin with.
DANIELLE DIMARTINO BOOTH: Now, there's a novel
thought.
PETER BOOCKVAR: Exactly.
Now look at, now getting back to the technology
companies, look how successful Silicon Valley
has become when they're selling a product
that goes down in price every single year.
Deflation actually has been a benefit to them,
because it has expanded the market at which
they can sell their products.
I like to give the analogy, so an IBM PC in
1981 which retails for about $3,000, if you
raise that price 2% a year to today, it's
costing you $6,000 for the same exact machine.
DANIELLE DIMARTINO BOOTH: Technology, everything.
PETER BOOCKVAR: Right.
Now, you can go into Best Buy and you can
buy a laptop for under $1,000 instead.
Somehow, technology companies found a way
to make money when the price of the product
goes down.
When you say let's get 2% annual increase,
that means in theory that everything has to
go up 2%.
Now, that's obviously not the case but that's
what they're saying.
The reason why they want 2% is not because
they model that out as being good for the
economy or good for businesses are good for
the consumer, they do it for selfish reasons.
They do it because if the inflation rate is
at 2%, they assume that the Fed Funds Rate
is a certain level above that.
If it's a certain level above that, let's
just call it 3%, 4%, which historically, the
spread was about 200 basis points, that in
the next economic downturn, they would have
ammunition to cut rates, a cushion.
If inflation was zero, well, that would imply
a very low Fed Funds Rate and that would imply
very little ammunition to deal with any economic
downturn.
That 2% target is a central bank self-interest
target, rather than what is economically good
for the rest of us.
DANIELLE DIMARTINO BOOTH: Okay.
The minute Alan Greenspan walked out the door,
Ben Bernanke managed to push through his 2%
inflation target.
How do you think that has changed, not just
monetary policy here in the United States,
but worldwide?
You've written extensively, extensively about
the Bank of Japan, which still has the 2%
target, even though-- you can tell me you've
got the history in your mind.
I know you do.
When the last time they hit 1% was?
PETER BOOCKVAR: Right, the only time they
actually even hit two was only after the VAT
increase.
It was a tax increase that resulted in higher
prices.
Higher inflation is a tax anyway, so whether
it's a government administered hike in the
valuate added tax or it's a central bank generated
increase in the overall price scheme by 2%,
it's the same thing.
It still does the same damage to a consumer.
I think the 2% was just in their minds, their
desire to anchor policy around something.
In their models, while these are very sophisticated
models with a lot of PhDs around it, there's
a lot of simplistic thinking behind it.
It's low rates are good, high rates not so
good.
Well, if low rates are good, even lower rates
are even better.
If you print money, and Bernanke gave the
helicopter speech in the early 2000s, you
print money, well, then you can create inflation,
regardless.
Because the history of the Wyman Republic
and Venezuela and Zimbabwe, you print a lot
of money, you get inflation, but there was
attached to that, at least with the Fed's
experience since '08 was, well, you can print
all this money but if it actually ends up
back at the Fed in Reserves, it's not really
out there.
It's just landlocked back at the Fed.
Japan realized, well, yeah, you can create
all this money but if it doesn't change consumer
behavior, and it doesn't incentivize businesses
to borrow and take advantage of low interest
rates well, then there's no inflation to be
had.
DANIELLE DIMARTINO BOOTH: It's the classic
paradox of thrift.
PETER BOOCKVAR: Exactly.
Now, we're at a point where monetary policy,
I argue, is actually restrictive monetary
policy, particularly in Europe and Japan,
rather than being easing because of what it's
done to the profitability of their banking
systems, which is the transmission mechanism
for their policy.
DANIELLE DIMARTINO BOOTH: Give us give us
a feel for the banking stock indices in Japan
and in in your-- given that, well, I don't
know, our president is calling for negative
interest rates, so just focus us on what's
happened to the banking sector in those countries.
PETER BOOCKVAR: The Japanese bank stock index,
the TOPIX bank stock index, since 1989, when
the Nikkei hit its peak, the TOPIX did as
well, is down 90% in nominal terms over the
past 30 years.
We destroyed the equity of the entire banking
system.
Now, you're at the point in Japan where least
a lot of the regional banks are actually on
the cusp of going out of business.
If you're a big Japanese bank, like Mizuho,
Nomura, you have the opportunity to do some
business overseas.
You can offset the profitability pressures
by having business in Japan.
If you're a regional Bank of Japan, you really
don't have anywhere to go.
They're literally dying.
Then you look at Europe, and since '07, the
Euro STOXX banks index is down 70%.
In particular since June 2014, when Draghi
went down the negative rate route, that index
is down 40%.
Now, they will say at least in Europe that
well, their volumes have gone up, their loan
volumes have gone up.
DANIELLE DIMARTINO BOOTH: Make it up on volumes.
PETER BOOCKVAR: Yeah.
Pets.com in 1999 kept selling more and more
pet products, but because they were losing
money on every product, they went out of business.
Yeah, banks are trying to offset the compression
on their margins by trying to increase the
volume, but they're actually making less and
less because the margins are falling faster
than their loan growth is.
DANIELLE DIMARTINO BOOTH: We know that unconventional
monetary policy was not born in the United
States.
In fact, Bernanke gave a speech years ago
in Japan where he suggested that perhaps if
they wanted to generate inflation, they could
just issue zero coupon bonds in perpetuity
with no maturity at all, which I think you
call cash, at last check, but I think something
happened because the Federal Reserve is the
world's leading central bank.
When Bernanke crossed that Rubicon, he brought
together all of his closest advisors at the
2007 Jackson Hole.
It was there that the Bernanke doctrine was
born, and that the precondition of zero interest
rates getting to the zero bound was necessary
before they could embark upon growing the
Fed's balance sheet.
Do we absolutely have to have and we're finding
out in real time, aren't we?
Was it a necessary condition to go to the
zero bound in order to launch unconventional
monetary policy, whether you agree with QE
or not, was that a necessary condition?
PETER BOOCKVAR: I don't think so.
I think what the Fed did is they turned the
business of banking upside down by what they
did to the yield curve, because on paper,
it was get short rates down to zero and if
that is not enough, then try to suppress long
term rates to encourage people to go out and
lever up whether you're a business or a household.
What they did was they flattened the yield
curve, which then damages your financial system,
and then leads to reduce profitability and
unlimited growth.
I think Bernanke he's mentality was-- and
his learning process was the Great Depression
when Milton Friedman came out and said, well,
it wasn't, because it was not enough liquidity,
and it was all this deflation and they didn't
come to the rescue in the 1930s to save the
day and then Bernanke saw what happened in
Japan.
Even though I think he misread Japan.
Then he thought that Japan didn't act fast
enough and soon enough, rather than saying,
well, maybe what they did was the wrong medicine
anyway.
His idea was, I need to go big, I need to
go fast.
I need to get rates down to zero.
If that doesn't work, then we'll start to
open up the printing press to suppress longer
term interest rates, because he knows at least
back then, obviously, housing was depressed
and mortgage rates are going to be priced
off the 10-year.
Well, how do I get that 10-year yield down?
Well, let's buy as many 10-year treasuries
as we can.
DANIELLE DIMARTINO BOOTH: Once Bernanke embarked
upon unconventional monetary policy, QE, it
seemed like it was some a strange contagious
disease.
Now, we have $22 trillion and growing now
that the European Central Bank is back in
the QE game, now that the Fed is in the not
QE, but still growing its balance sheet game.
What do you think of the idea?
Our mutual friend, Jim Bianco, made the comment,
especially of 2017, when there was what, $2.2
trillion of global quantitative easing, the
same year that the VIX was south of 10 in
single digits 53 times, taking out the next
closest year, which I think was in '93 or
something when they had three days that the
VIX was in a single digit type territory.
What do you think of Jim's idea that QE is
and has become global and fungible that it
knows no boundaries, knows no borders?
PETER BOOCKVAR: Well, it's dead on.
The only border in a sense is your currency,
because every time you go from one border
to another, you take that currency risk, but
putting that currency or risk aside, and assuming
you can account for that currency risk through
any hedging, yeah, it becomes borderless because
it's that gets back to that old 506-- we call
that old, search for yield.
We have the big Japanese pension fund that
is a huge holder of that three letter we talked
about.
DANIELLE DIMARTINO BOOTH: The CLOs, going
there yet.
Going there.
PETER BOOCKVAR: Getting to my point of this
simplistic thinking of a central banker is
low rates are good and lower rates are even
better.
Well, if we cannot just lower rates to zero,
but we thought how we can get that negative,
well, then that's the greatest thing ever
because we want to get you to lever up.
DANIELLE DIMARTINO BOOTH: Right, of course.
Yeah, there have been academic studies that
have come out that suggests that had we just
gone to negative 5% here in the United States,
that the pain of the great crisis would have
been greatly mitigate.
These studies, they even shaved off one percentage
point to account for balance sheet expansion,
meaning, I think a lot of the conventional
wisdom among monetary policymakers today is
that we can go deep into negative territory.
I know you don't agree with that.
I know I don't agree with that.
Talk to me if you will about Mario Draghi's
legacy and what it implies for Christine Lagarde's
future as head of the European Central Bank,
because it would seem to me that if any bank
is going to go way off the reservation when
it comes to delving deeper into negative interest
rates, that it's going to be the European
Central Bank.
Tell us about Draghi's legacy and what Christine
Lagarde faces.
PETER BOOCKVAR: Draghi took the lesson of
Bernanke, which also took the lesson of the
Japanese like, I think everyone looked at
Japan and said that deflation is a Boogeyman
and that the reason why Japan is suffer for
all these years is because they have deflation.
The problem with that analysis is that deflation
was just a symptom, wasn't a cause of their
economic malaise.
It was just a symptom.
It was just consumers wanted to save more,
the banking system and the corporate sector
needed to de-lever, population stopped increasing.
DANIELLE DIMARTINO BOOTH: Aging population,
demographic's [indiscernible].
PETER BOOCKVAR: Actually, the average CPI
rate over the past 30 years in Japan is actually
around zero, so they've actually had price
stability.
When you misdiagnose the patient and think
that deflation is bad, well then you do everything
you can, obviously, to prevent that.
That was the mentality of Bernanke.
That was the mentality of Draghi.
Draghi drank that Kool Aid of just get rates
as low as possible, and print all this money,
and then poof, we're going to create inflation.
I like to the natural, it's like a video game.
You got the joystick, you hit the right spots,
and all of a sudden, you get the outcome that
you think, and that's how we think about trying
to get a higher inflation rate just based
on what you do on the monetary side.
Things don't always work out that way you
don't know where the money goes.
Draghi, in way, followed with the Swiss bank
did, Sweden and Denmark also had gone negative
right around the time when Draghi decided
to take that path with a very simple mentality
of if I scare money away from me as a central
bank, it will then go out into the private
sector and everything will be great.
DANIELLE DIMARTINO BOOTH: Magically create
economic activity.
PETER BOOCKVAR: The problem with that is that
negative rates is a tax that somebody has
to eat.
If it's a bank that has money with me as the
ECB, well on taxing them, and how did they
get that back?
Well, then they actually raise the cost of
financing to their customers.
Soon after he went negative, we saw mortgage
rates in some countries actually go up after
he was going negative.
Now, we're at the point where banks are saying
enough is enough.
Individuals are now going to start eating
this and businesses are going to start eating
this, not through me embedding it in the cost
of a loan, but just I'm going to penalize
you for just having deposits with me as a
regular bank.
DANIELLE DIMARTINO BOOTH: I'm just going to
charge you.
PETER BOOCKVAR: Right.
Now, you're getting into a really damaged
part of this experiment, where you're actually
now taxing individuals.
DANIELLE DIMARTINO BOOTH: This is going to
go beyond the banking sector into the private
sector at a time when European growth is flatlining.
PETER BOOCKVAR: Right.
What no central banker really thought through,
any central bankers, they're so good at getting
into this policy.
This is the asymmetry, but there's no thought
about how to get out.
We're now at a point where Draghi has proven
to be, and now, Lagarde.
They've trapped themselves.
They've created in financial history, the
greatest financial bubble in the history of
the world, in credit and sovereign fixed income
and everything that prices off that.
How do you get out of that?
Just imagine the damage done just by going
back to zero from negative, just that, just
now there's what, 11 trillion of negative
yielding securities.
Imagine that goes to zero, imagine the-- just,
you only need a few basis points times 11
trillion, equals a lot of money.
DANIELLE DIMARTINO BOOTH: Starting points
matter.
PETER BOOCKVAR: Right.
Then that filters through the entire yield
curve, not only in Europe, but Japan and infects
the US.
All of a sudden you get this rise.
Getting out of this is now proven to be impossible.
That gets the Fed.
Jay Powell has a choice.
Do you learn the lessons from what went on
over there?
Do you learn the lessons from Bernanke's experiment
and Yellen where they got trapped at zero
for seven years?
Look, the Fed, the Fed is trapped with QE.
It was so easy to get out of and now all of
a sudden, their balance sheet is almost back
to where it was.
DANIELLE DIMARTINO BOOTH: Right.
You and I were both really excited the first
time that Jay Powell testified to Congress
when he was-- his first day in office, yet
at a four digit decline in the Dow and said
nothing.
Then his first testimony to Congress, he was
like, well, but wouldn't have to backstop
that stock market.
I founded the Jay Powell fan club it and you
were right there with me because it sounded
like he was rational.
He made comments in 2012 that the Fed risked
blowing a fixed income duration bubble across
the full credit spectrum, if I'm getting the
quote right and that QE would become habit
for me.
It seemed, for a while after Powell took office,
that he was determined to get somewhere close
to normalized interest rates.
I think he had 3% in mind on the Fed Funds
Rate, and he was also equally determined to
make good on Bernanke's commitment to truly
exit unconventional monetary policy by shrinking
the balance sheet via quantitative tightening.
Neither of those things happened.
Why?
PETER BOOCKVAR: That 3% was really a magic
number.
He desperately wanted again, too, because
in his eyes, if he was able to get around
2% inflation, the real rate would be 1% and
while it's below where it was pre-crisis,
it still was a positive real rate.
Because the poison in the financial system
has been proven to be when you have negative
real rates so at least 3% was the goal, assuming
the 2%.
Then of course, you throw in the tariff and
trade war, and all of a sudden, Powell's desperately
trying to get there and throws in that December
2018 rate hike and everyone freaks out and
obviously, we know what happened since.
DANIELLE DIMARTINO BOOTH: Watching paint dry
in his press conference.
PETER BOOCKVAR: Right.
With respect to the balance sheet, this is
all new to everyone.
No one knew at what point shrinking that balance
sheet was going to break something, until
something broke.
DANIELLE DIMARTINO BOOTH: Well, we're breaking
countries, but that didn't really matter.
PETER BOOCKVAR: Yes.
Things were beginning to break in the sense
that that contributed to the decline in the
fourth quarter of last year because rate hikes
and shrinking the balance sheet was a double
form of tightening and they're all winging
it here.
That's what this unconventional-- by definition,
unconventional is you're winging something.
You're trying something you didn't try before
and you're in this dark room trying to feel
where the walls are.
Now, we're again seeing an instance where
that like the Godfather, like I tried to get
in, I'm out and then they pulled me back in
and the Fed's getting pulled back in just
as Al Pacino said in Godfather 3, because
they're all now trapped in a policy where
once the market feels like they don't have
that cushion in that backdrop, somehow they
can't figure it out on its own.
DANIELLE DIMARTINO BOOTH: I think we'll learn
a lot more as time goes by, especially as
the yearend approaches and the window dressing
at banks and yearend funding strains start
to really kick in.
I think we'll know more when we have the benefit
of a rearview mirror.
I've spoken with George Goncalves, interviewed
him here on Real Vision and he really does
a good job of explaining that foreign central
banks are parking money at the Fed, currency
in circulation is increasing.
You add it all up and quantitative tightening
ended up being twice its magnitude by virtue
of other factors.
The Fed knew this was happening.
This is money park at the Fed, it wasn't like
parked somewhere where they couldn't see it.
They saw currency in circulation rising and
tack on top of that, they knew once the debt
ceiling was resolved, that the Treasury is
going to have to refill its checking account
at the Fed.
They also knew what Treasury, how much Treasury
had depleted its own funding, and they knew
that quarterly tax payments would be coming
due.
These were all known knowns, to use Rumsfeld's
term, what on earth went wrong?
PETER BOOCKVAR: I think they underestimated
what the response function was going to be
from the dealer community.
You had the bank primary dealers that I think
when you're Jay Powell, you assume okay, if
repo rates rise for whatever reason, then
JPMorgan will say, yeah, I'll lend to you
at 2% or 3% or 10%.
We'll do that trade every day.
I don't think they appreciated the regulatory
constraints and how that handcuffed the primary
dealer community.
Therefore, they didn't foresee the non-bank
primary dealers, how they tried to step in,
well, they don't have the balance sheet like
Bank of America and JPMorgan do, they have
to go into the repo market to borrow to absorb
that Treasury supply.
That's how I think that this went on, is they
really underestimated and didn't appreciate
the handcuffs that have been put on the dealer
community once you cross a certain level of
Treasury supply that all of a sudden couldn't
be handled anymore.
DANIELLE DIMARTINO BOOTH: Then you pile on
top of that the John Williams effect.
You've got a pure play academic who's presumably
a brilliant monetary economist.
PETER BOOCKVAR: He doesn't have a quote machine,
I don't think, in his office.
DANIELLE DIMARTINO BOOTH: Famously, no Bloomberg
machine on his desk.
Are the lights on but nobody's home at Liberty
Street?
That's the sense you get, they have these
extremely quiet announcements with somewhat
regularity that they're going to be extending
out.
They just extended out two operations in November,
December, and another in early December, that's
28 days, 42.
It feels like-- is the Fed throwing spaghetti
at the wall?
PETER BOOCKVAR: They are and they're doing
everything they can at least just to get through
yearend by overdoing it, by overdousing that
fire that went out on the hopes that at least
through yearend, we'll quell it and then we
can always pull it back in January, February,
when some of these constraints get eased,
which we have to see what happens.
We don't know.
The problem the Fed now is creating is this
dependency again.
Where is the Fed going to become the repo
market?
Is the Fed going to become this intermediary
that they were never intended to do and to
be because the market all of a sudden becomes
addicted to them, and can function without
them?
That's the danger that they now put themselves
in going into next year.
Rather than saying you know what, maybe we
overdid it on the regulatory side, now, they're
hamstrung there because of Basel 3, and that's
a whole regulatory discussion that needs to
be had.
DANIELLE DIMARTINO BOOTH: There's been major
pushback by Powell at press conferences.
He said no to easing the regulatory constraints.
PETER BOOCKVAR: Exactly.
That's where they're trying to overdo it and
overcompensate on the monetary side.
Again, like you said, January, February will
be the real test to see whether this market
can actually walk on its own after being handheld
for the last couple of months and certainly
into yearend.
DANIELLE DIMARTINO BOOTH: I have this working
theory that Jay Powell's Boogeyman is this
great big monstrous fixed income exchange
traded fund lurking in the background.
A year ago, fixed income redemptions, fixed
income ETF redemptions went up appreciably.
We saw high yield spreads go up, the yearend
funding strains exacerbated this.
I don't think that Powell's forgotten how
this worked last winter.
I think that it is one of the reasons maybe
that he is actually delving into what he won't
call QE but on October the 11th, they announced
that they were going to be growing the Fed's
balance sheet by $60 billion a month, that's
not too far off the 85 billion QE infinity
rate when the Fed was at its peak level.
Now, we're talking about a $1.6 trillion run
rate on growing the Fed's balance sheet, 40%
of quantitative tightening has vanished into
thin air in the space of two months, what
took them 21 months to put out there.
He's afraid of something.
I think that it may have more to do with more
than to do with bank balance sheets.
Walk us through, if you will, what's happened
in corporate credit in the United States as
a result of this policy that we're all clearly
market participants, corporations alike addicted
to?
PETER BOOCKVAR: I'm going to rewind back to
pre-crisis or actually through the crisis.
If there was one area of credit that performed
rather well, it was the CLO market.
It was these-- and for the average person,
these are senior secured loans, as opposed
to a junk bond, which is mostly unsecured.
It's subordinated to a senior secured bonds.
In the crisis, those senior secured bonds
actually made it through relatively well.
Now, the equity below that, or the subordinated
bond below that may not have done well, but
the senior side did.
People out of the crisis said, wow, this is
an asset class, this is a real asset class,
it survived the Great Recession, therefore,
this is really viable.
All of a sudden, this really small market
became rather big.
If you're a company, and all of a sudden you
have this on the demand side for yield, you
have this crop of investors that want yield,
and if you can sell them debt as opposed to
equity, you won't dilute your shareholders.
You're getting low cost capital.
You think that it's beneficial to you, and
if you can sell it senior secured, well, then
you'll get an even lower interest rate and
if the Fed has rates at zero, and I'm paying
LIBOR Plus and LIBOR is close to zero, I can
pay LIBOR Plus 300 and because LIBOR is so
low, I can afford that.
It's great.
All of a sudden, as the years went on, more
and more, and then you created a bigger CLO
universe, and all these entities that were
created, so for every CLO that's created,
that creates that new demand for these loans.
Then Wall Street and companies see, okay,
there's this huge demand from these loans
and the CLOs, let's feed them more loans to
put into their CLOs.
DANIELLE DIMARTINO BOOTH: Nice feed as well.
PETER BOOCKVAR: It's just back and forth and
it's just a replay of the CDO market in the
mid-2000s.
They kept just creating these new products.
DANIELLE DIMARTINO BOOTH: Right.
I think that the percentage of covenant light
leveraged loans in 2007 was somewhere in the
20% range and remind me, where are we today?
PETER BOOCKVAR: Now, you're north of 80 and
some that you're actually having-- there's
no protections.
Here, you have now the leveraged loan market
that's north of a trillion, you have the high
yield market that is north that.
Now, you're in a situation where regardless
of how much money somebody is going to lend
you, you still at the end of the day have
to make those payments, you still need a growing
economy in order to service your balance sheet.
Now all of a sudden, LIBOR, because the Fed
Funds Rate is not zero anymore and even with
the cuts, LIBOR is still north of two plus
percent.
That LIBOR based loan all of a sudden becomes
more expensive.
If you had sold debt last year, you probably
paid even more.
Now all of a sudden, the economy starts to
slow.
You go from a 3% GDP run rate and all of a
sudden, you're now at a 2%.
Now, that is a one third haircut in the rate
of growth.
For many companies out there that have profit
margin, so let's just say 5% to 10%, all of
a sudden, you lose some of that business and
all of a sudden, your margins get tight and
that loan obligation that you have to pay
quarterly to investors, all of a sudden, becomes
a bigger nut that you have to absorb.
Now all of a sudden, from an investor standpoint,
well, rates are going down so floating rate
bonds aren't as attractive anymore.
There's less demand now for this.
Well, these companies need to refinance so
they're going to refinance into a situation
where there's less demand, credit quality
is now deteriorating, you have a lot of now
a growing percentage of the CLO market that
are trading below 90 cents on the dollar,
because investors are beginning to sniff out
slower economy, crimp on cash flows, difficulty
in paying back that debt.
Now, it hasn't really shown up too much in
the high yield market in the aggregate, but
it's begun to show up in the junkiest part
of the high yield market, the CCC area of
the market.
The CCC yield to worst in the Barclays index.
The yield is back to where it was in January.
Now, we remember January was right after a
pretty rough fourth quarter.
DANIELLE DIMARTINO BOOTH: The world was basically
ending.
PETER BOOCKVAR: Right.
When you look at the depths of credit, investors
are becoming more discriminating in different
credits or beginning to pay attention.
Just like with Lyft and Uber and WeWork and
all of Silicon Valley private equity VC funded
firms, everyone is now beginning to pay attention
more to the balance sheet.
Everyone is now beginning to pay more attention
to cash flows.
Even for investment grade companies, listen
to their corporate conference calls and every
CFO is telling you what their debt to EBITDA
ratio is.
They're telling you what their debt to EBITDA
ratio wants to be by the end of 2020.
Because now, investors care.
One of the characteristics of the fourth quarter
selloff in the stock market last year was
those companies with the highest debt to EBITDA
ratios got hit the hardest.
Now of course, Powell came and save the day,
and there's going to be a China trade deal
any day now.
All of a sudden, those worries went out the
door but I do think, again, in that CLO, that
CCC market, we're beginning to see the impact
of a crimp on cash flows and a more discriminating
investor, that's then going to then spill
over into the Bs and the BBs.
That's really the next thing to be watching.
DANIELLE DIMARTINO BOOTH: Yeah.
We've actually seen cash stores, cash was
almost a $2 trillion, at one point, dominated,
by the way, by the seven largest companies
in the country.
We've seen that come down to about $1.5 trillion
in fairly short order.
I heard a report at one of the big sell side
firms that said, as long as we have growing
earnings per share, we're going to be fine,
this is a high yield strategist, but if we
were to see earnings actually contract, then
that would be highly problematic in terms
of our default rate outlook.
It's convenient that very few now, actually
reference fact set data that's only been around
since what?
September 1978.
Because now, fact set has gone negative for
all of 2019.
It seems to me that Jay Powell's got a growing
challenge on his hand because-- you can fill
in the blank.
If you're Joe Q's CFO, and your investors
are on conference calls telling you to pay
attention to your balance sheet.
What does that preclude you from doing?
PETER BOOCKVAR: Exactly.
You're obviously no longer buying back stock
or you're doing at a much reduced pace.
You're focusing more on your capital expenditures.
You're hiring.
You can imagine that every VC in this country
called every single one of their portfolio
companies after what happened with the IPOs
and WeWork that okay, guys and girls, it's
time to focus on profits sooner rather than
later.
The hiring, let's put a timeout on that and
leasing that extra 30,000 square feet of space,
well, let's work within our existing space.
Because that's what's most important right
now.
To the point on earnings is the problem right
now with earnings is that not only are you
seeing a slowdown in the pace of revenue growth,
theoretically, revenue growth at least for
the S&P 500 should be nominal GDP growth around
the world.
Right now, the IMF has GDP growth this year
at 3%.
Let's just tack on 1.50%, 2% inflation, let's
call it 5% revenue growth.
Now, that's for if you're a multinational.
Profit margins are now receding.
You have the slowdown in revenue growth, and
you actually have now profit margins which
are contracting.
The earnings estimates for 2020 in the S&P
are still like 7%, 8%.
Well, that implies that you'll get an acceleration
of GDP growth, which maybe, maybe not, but
that also improves a real big reversal in
this decline in profit margins.
One of the key reasons why profit margins
are receding is because labor costs are becoming
a bigger portion of the expense pot.
Let's just say the economy does get better,
well, with a labor market that's tight, we
can assume that wages will pick up even further,
will crimp profit margins even more.
Now, it'll be great for those employees that
are getting those wage increases.
If companies then start to resort to layoffs
or whatever reasons try to protect profit
margins, that becomes a problem.
We look at the last 10 years, earnings did
a V bottom, earnings are up dramatically from
'08, but revenues are barely higher.
There are a few things that really goosed
profit margins.
It was the cotton in labor costs where the
labor portion of the profit pie was the smallest
since World War II.
DANIELLE DIMARTINO BOOTH: That's a company's
biggest cost.
PETER BOOCKVAR: You had obviously the stock
buybacks, which I argue that last year was
the peak.
Now, companies focus more on balance sheet
improvement.
You also had a dramatic decline in interest
rates, which goosed or dramatically reduced
interest expense which helped profit margins.
Well, interest rates are low, but from a delta
standpoint, you're not going to get a big
drop in interest rates to goose profit margins.
I think that that story is not going to be
repeated.
This is the profit margin side that people
have to pay attention to at the same time
that revenue growth is slowing.
There's just people are trained to think that
there's always this V inflection higher in
terms of growth, because central bank easing
lifts you higher.
The problem right now is that the whole point
of stimulus, when I want to stimulate behavior
through monetary policy, just trying to convince
you making a deal with the consumer in the
business to say, if I lower your cost of funding
today, will you buy the car today or the house
today, rather than spending the next two years
saving up for it?
If rates are already low, that encouragement,
that incentive is more-- it's more dull.
It doesn't have that same impact because you're
like, you know what, I don't need to rush,
rates are low.
I'm just going to wait.
That's why forward guidance was a fraud policy
because forward guidance actually slowed growth.
DANIELLE DIMARTINO BOOTH: Right, it gave people
an excuse to wait.
PETER BOOCKVAR: To wait, as opposed to encouraging
them to act and you still hear about forward
guidance.
Forward guidance I think is like an effective
tool and it's the exact opposite.
We're in a situation where monetary policy
is no longer stimulative.
DANIELLE DIMARTINO BOOTH: Dot, dot, dot.
I love great central banker quotes, just love
them.
Janet Yellen saying that we will never have
another financial crisis in our lifetimes,
pure speculation, Peter, nobody's going to
hold you to this, I promise, but why don't
we end today by you telling me where, in your
mind, systemic risk might be lurking in the
system if there was to be a geopolitical event
or a financial event, something that triggered
a daisy chain.
Where do you think the weak point is in the
global financial system? PETER BOOCKVAR: I
think it would be an uncontrollable rise in
longer term interest rates that would start
whether it's in Japan because now, Kuroda
wants longer, higher long term interest rates,
or it's the ECB where they finally say you
know what, we got to get out of this negative
rate environment because we're killing our
banks.
DANIELLE DIMARTINO BOOTH: Sweden's already
gone there.
PETER BOOCKVAR: Sweden is dead set on getting
out of negative interest rates this December.
It is uncontrollable rise in long term interest
rates that central bankers cannot control
is, in my opinion, the biggest threat because
that's where the biggest bubble is.
If you get a pop in that bubble, that's to
me, the biggest worry.
Now, they can control the short end, no question.
They'll pin that to zero or negative as much
as they want, but as we saw Italy last year
where rates can rise uncontrollably in a very
short period of time, irrespective of all
those purchases by the ECB, that, to me is
the biggest risk.
DANIELLE DIMARTINO BOOTH: Those CLOs on Japanese
bank balance sheets would be in a world of
pain.
PETER BOOCKVAR: Imagine you get a cost [indiscernible]
in the sovereign, what it does to the whole
corporate world.
DANIELLE DIMARTINO BOOTH: Absolutely.
Peter, thank you.
Thank you so much for your time today.
PETER BOOCKVAR: Thanks, Danielle.
DANIELLE DIMARTINO BOOTH: Great visiting.
