Mr. Bassman knows some stuff.
His mini-bio follows the jump....
First though, our boilerplate introduction to Mr. Bassman:
...Wall Street loves to make convexity sound complex (I suppose it’s so they can charge higher fees?). We speak Greek (calling it “gamma”), employ physics as a metaphor (analogizing to it “acceleration”), and use mathematical definitions (since it is the second derivative of the asset’s price change)."Pish. Posh." is a technical term only used by market professionals for those situations where one has decided to go full Alinsky rule #5:
Pish, posh. An investment is convex if the payoff is unbalanced for equally opposite outcomes. So if there’s the potential to earn a profit of two on a bet versus a maximum loss of one, the bet is positively convex. If you can lose three versus making two, it is negatively convex. That’s it. The rocket scientists are called upon to help (fairly) price the cost (value) of such possible outcomes. This is why the expansion of derivative trading in the 1990’s resulted in a hiring spree of physics PhD’s....
#5 Ridicule is man’s most potent weapon. It’s hard to counterattack ridicule, and it infuriates the opposition, which then reacts to your advantage...And from Macro Voices the transcript of a conversation on September 26.
The participants are fund manager and Macro Voices host Erik Townsend and Harley Bassman, the Convexity Maven:
Erik: Joining me now is Harley Bassman, operator of Convexity Maven, a macroeconomic website. And of course Harley is very widely credited as the inventor of the MOVE Index, which is essentially the volatility index, or VIX, for the bond market.
Harley, I want to start with that point, actually, not just to credit you as the inventor. But I interviewed Danielle DiMartino Booth earlier this week and her comment was so many people are like, oh my gosh, is the economy about to fall over into recession? Let’s keep an eye on the stock market and watch for signals.
Her comment was, forget the stock market. Watch the MOVE Index. She thinks that what’s about to happen, if something is about to happen, it’s going to happen in the bond market.
Now, since you are the guy who invented the MOVE index, how useful is it as far as a leading indicator or a predictive signal that might tell us that something is wrong?
Harley: I think that she’s spot-on right. The bond market is going to be where all the action is and that will be where to keep your eyes focused because central bank intervention is the key driver right now.
But looking at the MOVE per se as an indicator, it’s more of a coincident indicator than forward-looking. So it will basically confirm movements in the bond market. Because there’s a whole group of hedge funds out there that operate as ball sellers to go reap profits. So they kind of keep the MOVE in line with realized volatility. So as realized volatility, realized activity, realized risk expands, the MOVE will go with it.
Erik: Okay, so we can use the MOVE Index – I think the way Danielle was describing it – as a confirmation indicator. If it feels like shit’s hitting the fan, and the MOVE is going crazy, it’s a good indication that it really is hitting the fan. But probably not a predictor.
Is that a good summary?
Harley: Oh, yeah. That sounds great.
Erik: So let’s back this conversation up to the much bigger picture of the bond market.
For a while, we had everybody and their brother (except you) saying, okay, look, as soon as we get past 3.12% (or whatever the magic technical number was on the 10-year yield), that’s it, baby. It’s all over. The bond bull market, it’s history. It’s going to be the end is nigh for the bond market.
You were quite outspoken last time we had you on the show. You said, look, this is mostly about demographics. We’re not going past (I think you said) 3.50% on the 10-year. It’s just not going to happen.
Needless to say, you got that one right.
But what I don’t remember from that interview, I don’t think that you had anticipated this reversal in yields all the way back down to almost that 2016 low.
Is this consistent with what you expected? And what do you see coming next?
Harley: I would love to say that I was brilliant and predicted the market to rally this much. But, no, that wasn’t in my playbook.
But when rates were 3-and-change, did I think we could go higher? No. I haven’t changed my mind in a few years now. We’re not going to go above 3-1/2% until 2023 at the earliest.
And it’s purely a demographic concept. The boomers are retiring. And as they retire they are selling stocks and buying bonds. You can see this on almost any large firm’s flow of funds. Retail people have been sellers of stocks for a decade now – the only buyers of stocks have been corporate buybacks.
And they’re moving their money into bonds because they need fixed income. They need retirement income. And they know social security ain’t going to cover it for them. So you have this massive flow of money out of stocks into bonds from real boomers.
And the other side of the coin is the millennials forming households. They get married, they have their first child much later than the prior generation. So it’s taking a little time for these people to enter the workforce, become productive, and demand goods and services – cars, baby strollers, houses, whatever it might be.
That mismatch is going to basically flip over in 2023, more or less. ‘23–‘25. And that’s going to go and drive rates higher the same way in the ‘70s and the ‘80s the boomers drove rates higher.
Erik: Now let’s touch on the stock market, since you mentioned it.
I agree with you that boomers are selling stocks and buying bonds. Now, before this happened, a lot of people predicted this is going to happen. Boomers are going to sell stocks and buy bonds. Therefore the stock market is going straight down.
Well, oddly, we’ve seen the confirmation. In fact, boomers are selling stocks and buying bonds. But those corporate buybacks have been a big part of it. And it seems like there is also a lot of international flows. Even though global stock markets are definitely rolling over around the world, the S&P is right on the verge of all-time highs as we’re speaking.
What the heck is going on? You mentioned corporate buybacks, but that’s not enough by itself is it, to keep us at these crazy elevated levels?
Harley: I think so. The numbers have been huge for corporate buybacks. And with rates down here, it’s all the more reasonable. I mean, if you’re a corporation and you’re trying to work on your balance sheet, there is a tradeoff between debt and equity. This is MBA 101.
And with rates down here, issuing debt and buying back stock is not nutty. As a matter of fact, you can borrow money at less than the dividends that are being paid by the S&P.
Now, it does have a negative corollary as you’re levering the company up and you’re making it less able to ride out a storm, as we saw in ‘07–‘08–‘09. Investment banks levered 20 to 1. And when things got rough, down they went.
So it’s not all fun and games. But, realistically, buying back stock at these prices is not nutty, relative to bonds.
I know the CAPE says that stocks are crazy hot, and there’s lots of other analysts out there that think stocks are rich. And Shiller says that there is no correlation of rates to the CAPE. I just disagree. That just sounds crazy to me.
If you have money in your pocket and you want to invest it, you’re going to make a decision based on all of your available opportunities, which is stocks, bonds, commodities, art, housing, whatever it might be. And if rates are 1%, 1-1/2%, stocks that yield 2% and have a P/E of 18, 19, that’s not bad.
Stocks are not cheap. Let’s be clear. Stocks aren’t cheap. But they’re not crazy rich. I call them on the higher side of fair.
Erik: Okay, Harley. So if the argument is that basically what’s going on here is retail really is not buying stocks. It’s not the usual retail craziness that is pushing stocks to higher and higher prices. But it’s all about corporate buybacks.
And, clearly, we’ve got low rates and a lot of people think lower rates still to come. There aren’t too many headwinds that are going to get in the way of this.
Are there other factors? I mean, obviously the corporations can’t buy back all of their stock with money that they get from selling bonds. Otherwise there wouldn’t be any stock market at the end.
Is there a point at which you reach an absorption level where this corporate buyback trend stops providing a bid to the market overall? Or is this something that could go on for years and years to come?
Harley: I don’t think it goes on forever. And there is a limit, clearly, to how much stocks you can buy back and be a prudent manager of your corporation.
But I think you were right before with the point you mentioned about international buyers. To quote an old boss of mine, we are the cleanest dirty shirt. We have growth, we have a solid economy, dividend is nice. It’s not that bad.
And if we have lower rates, QE going on in Europe and Japan, moving money to the US is also not crazy. In fact it’s quite reasonable. So I think, as much as the Fed might want to go and not be lowering rates, QE in Europe and Japan is positive. It’s fungible money going into the system seeking out diversified assets that are kind of safe.
So I think there is money coming there.
The question is: Europe and Japan cutting rates and doing QE, is that good for the global economy? As a public policy concept, is this good? Or are they just basically jumping ahead of us in a currency war? That’s a different question.
Erik: Harley, let’s continue on the bond market direction. Here we are now, seeing at least a temporary backing up of rates. We got below 1.50% on the 10-year.
Is there a potential that this is a trend reversal? Or was this just a little hiccup and we’re still headed lower in yield?
Harley: Rates are still dramatically lower than they were six months ago. Could rates back up 50 from here? Sure, why not? We’re at a big range. And could we go lower in rates? I suppose so.
But I think that, at these interest rate levels, bonds become somewhat unappealing just because it’s basically a zero real yield at this point. To the extent you want to buy low-rated bonds over here, you buy them because you have an actuarial problem. You are an insurance company or a pension and you have to buy them by regulation.
But going up the curve at this prices, I’m not a buyer. I’d rather invest in 2-years and have powder to burn.
Erik: Harley, the big debate that’s been going on in finance between a lot of people is, is the US going to follow Europe into negative rates? What’s your take on it?
And if it were to happen, what’s the significance? What would it mean? What would the consequences and knock-on effects be?
Harley: Well, my stated opinion for quite a while is we will not have negative rates in the US. I haven’t changed my mind on that. I think we have a different society, different politics than Europe and Japan. And I also think that if we were to get negative rates that the politicians would be assaulted by the populace. I just don’t see it happening.
I don’t think it would be effective at all.
But negative rates in the financial capital of the world, you’re talking about pulling up the foundation of the banking situation. Which was kind of the idea of QE1 to begin with, was to go and solidify that.
So I don’t think it happens here. I think they’ll find other measures. And as I’ve written about recently, it’s going to be fiscal policy. That’s where you go next........MUCH MORE
And here is the podcast, if interested.
MacroVoices #186 Harley Bassman: Volatility Does Not Equal Risk
