Wall Street Icon Warns The Fed's Balance Sheet Unwind "Is Very Dangerous For Markets"
Blackstone’s market maven Byron Wien warns that stocks are in danger of suffering a setback. But he also explains why investors should keep their calm and weather the impending storm.
To expect the unexpected is the key to success in investing. That’s exactly what Byron Wien has built himself a unique reputation on: For more than thirty years the living Wall Street legend publishes a yearly list with ten surprises that will have a meaningful impact on the global financial markets.«People all over the world are aware of it and identify me with it», says the Vice Chairman in the private wealth group of Blackstone. «What they seem to like about it is that I put myself at risk by going on record and hold myself accountable at the year end», he adds.So how accurate are Wien’s predictions for 2017 so far? Which developments could surprise investors during the rest of the year? And first and foremost: Where does the experienced market maven see the biggest risks and opportunities right now?
Mr. Wien, everybody on Wall Street knows you for your yearly prediction of ten surprises. What is for you personally the most astonishing development so far this year?
I would say I’m having an average year where I get five or six surprises right. Everybody calls them forecasts or predictions but they really are surprises. To me, a surprise is an event that the average investor would only assign a one out of three chance of taking place but which I believe has a better than 50% likelihood of happening. I never get them all right but I don’t do it for score. I do it to get people thinking.
Which surprises did you get right so far?
I said that the S&P 500 would go to 2500 this year. It’s close to 2480 now and we are at the end of July. So I’m pretty optimistic about that one. I also said the price of oil would be lower than people thought and it is lower than people thought. So those are some of the highlights.
And what took you by surprise?
The drop in interest rates and the weakness of the dollar were the big surprises to me. I said interest rates would rise and they fell and I said the dollar would be strong and it’s been weak. So I definitely got those two wrong. The same is true for Donald Trump. I said correctly that he would soften his positions and he has reversed himself on a number of issues. But I didn’t think he would get so little done. So far he has gotten nothing done, nothing to show for. He spends way too much time on Twitter and he hasn’t even gotten the affordable care act revised. That’s a disappointment....
...What’s your explanation for this discrepancy between Wall Street and Main Street?
The earnings of US corporations are increasing and that’s driving the stock market. Companies are doing everything possible to increase profitability. Also, there’s a certain amount of financial engineering going on. Many companies are using the cash on their balance sheet to buy their own shares back and to pay higher dividends....
...And what’s the second thing you’re worried about?
Central bank liquidity has been an important factor driving the market. But now, the Federal Reserve is tightening. They have already tightened twice this year and they are talking about shrinking the balance sheet, starting in September. Also, the European Central Bank is talking about being less accommodative as well. So we’re going from a very accommodative monetary policy around the world to a more restrictive policy and that’s going to put a damper on the market.
But if monetary policy is getting less easy isn’t that also an encouraging sign that central bankers are having more confidence in the resilience of the economy?
The Federal Reserve has two mandates: low inflation and full employment. Right now we have full employment and low inflation. So the Federal Reserve is doing its job. They are achieving their mandate and the economy is not overheating. They have no reason to raise rates. But the Fed has allowed its balance sheet to growth significantly. Since the creation of the Federal Reserve it took 95 years to growth the balance sheet to $1 trillion. But because the banking system was in danger of melting down in 2008 they went to $2.5 trillion basically overnight and now they’re at $4.5 trillion. So the Fed feels guilty that it has expanded money too fast and they feel they have to shrink the balance sheet back.
What does that mean for the markets?
The Fed will shrink the balance sheet by letting the treasury bonds and the mortgage backed securities that are on its balance sheet mature and redeeming them. But that will take money out of the system and that’s very dangerous for the markets.
There is a significant congruence between the expansion of the Fed’s Balance sheet and the performance of the S&P 500. They are roughly congruent except for now because the market is running ahead of the Fed’s balance sheet. That makes me worried of a kind of Wile E. Coyote-Phenomenon where the market is running off the edge of the cliff and it doesn’t know it doesn’t have any land below it to support it. In this case, the missing ground would be the withdrawal of money from the system because not only is the Fed thinking about doing it but the European Central Bank is thinking about doing it as well. So naturally, the market is vulnerable to a 10% correction at any time.
Could that mean the end of the bull market?
I emphasize a correction, not a bear market. I don’t think a bear market is in store. The only thing that really creates sharp downturns is a recession and I don’t see a recession before 2019.....MUCH MORE