The Bond Market Disagrees With The Fed: So What’s New About That?

The US Federal Reserve through its Chair Janet Yellen has been making clear in recent meetings and speeches that the “federal funds” overnight interest rate (close to zero) is going to be with us for a “considerable” period of time, possibly lasting until 2016, so long as unemployment stays above and inflation stays below the Fed’s targets of “full employment” around 94.5% and “core” inflation of around 2%. Just now both bond market professionals and the Fed know we are below each target by about 100 basis points (1/100th of a percent). But that’s where any agreement between them ends and where the bond market begins its latest quarrel with the Fed. 

Bond traders always seem to think they know more than the Fed about money and the economy. Just listen to Rick Santelli on CNBC any day of the week: nothing new there. What’s new is the bond market seems to waver between two completely opposite assessments of why the Fed is wrong, both of which cannot be true: (1) that the economy is far weaker than the Fed gives it credit for (and is flirting with recession); and (2) that the economy is far stronger than the Fed realizes (and is flirting with inflation).  Just now the first premise seems to be winning out, but the second always lurks under the surface. The combination makes bond prices a spurious guide to equity investors.

Yet commentator after commentator on CNBC and elsewhere keep warning the equity market that “the bond market is trying to tell us something” important. Rick Santelli went so far as to say that the bond rate “yield curve” is forecasting a new US recession. For a while, equity markets seemed to be intensely listening to its schizophrenic financial neighbor: every time the price of ten-year Treasury notes retreated (causing interest rate yields to fall) during the course of recent trading day, the equity market sold off very noticeably.

If the ten-year rallied and yields temporarily fell, equities would broadly rally in price also, even stopping for the moment the precipitous slide in the market value of so-called “momentum” growth companies in biotech and “new tech” areas like social and internet media, cloud computing, enhanced data security and even electric cars. These stocks had rapidly fallen out of favor with the onset of a rash of IPO’s and secondary offerings and insider sales in these sectors, with investors rotating away from them to so-called “value” stocks with far lower P/E ratios (and far lower earnings growth). This is in part under sway of the Fed’s bond market critics who argue that its Quantitative Easing (QE) programs have actually held back a more normal “return” to robust growth and that, as QE finally stops, the emerging strong economy will “lift all boats,” even heretofore growth laggards like Cisco and Intel. Why risk money on the high beta highfliers when you can get more from a quick pop from the “Dogs of NASDAQ” with less downside risk (since they are down so far already).

Sounds logical, but you have to buy both premises: that the economy will be coming back gangbusters, and that the likes of Cisco and Oracle can regain market share leadership from the newcomers like and Workday and that have beaten them in the market during the tough years we have just come through.  And you also have to disagree, of course, with the notion that the current bond market pricing is forecasting a recession, which would be a reason to get into cash, not a Cisco.

The Fed has announced both the tapered end of QE by the end of this fall and its intention to continue, however, with highly accommodative interest rate restraint until late 2015 at the earliest to give the economy the best chance to reach both its healthy employment and inflation targets by 2016. Bond traders seem to think both policies are wrong: that, on “free market’ principles, QE should already have been ended and that short term interest rates should be…here things get interesting….raised sooner  rather than later because credit trading is not yet normalized but nonetheless should for now trade lower because the economy is actually in worse shape than the Fed realizes, at both the short end and the long end. Which makes for the classic ‘flattening of the yield curve” that often predicts recession! In short, bond traders seem to have seen Steve Martin’s “The Man With Two Brains” so often they have forgotten it was a comedy. And these are the folks the equity markets are supposed to pay attention to?

But could it possibly be that the Fed, not the bond market, that has its head straight? That the Fed realizes that the “weather deniers” in the bond pits are wrong to dismiss any relationship of the past winter’s excesses  to December through February shortfalls in retail sales, construction activity and factory orders (all of which interim trends clearly have reversed in March according to actual data)? That the Fed realizes that a flight to Treasuries has been triggered far more by the crisis in Ukraine than by the bond trader mantra that the economic sky is falling in the US? That the Fed, moreover, has been able to pull off the tapered end of QE without the massive run-up in ten-year Treasury rates (that would have killed the slowly-emerging housing/mortgage recovery) feared last summer when QE tapering was first mooted by Chairman Bernanke. Indeed, money has flowed into Treasuries – perhaps more by happenstance (think Putin) than design, but better to be lucky than scared in most aspects of life.

In their defense, bond traders argue that QE has failed because interest rates actually went up during its heyday. But the Fed was not looking to drive down rates.  It understood that longer term interest rates would rise with the economic recovery it was trying to stimulate by holding short-term interest rates down. It simply was using QE III to keep that increase within reasonable limits –-which even bond traders would have to agree it did.

Ever since the Great Recession hit, bond traders’ many apologists have criticized every single move the Fed has made, predicting both doom (rampant inflation) and gloom (a return to recession) – two phenomena that rarely, if ever, accompany each other! Perhaps the equity markets should indeed watch the bond markets carefully, not for ancient wisdom, but for signs of such inherent incoherence, and act accordingly. Maybe the Fed after all has the more correct and balanced view –  that the economy is getting better, but needs more help to get really well, and the bond traders just need to get over it.

By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University

Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.













April Showers Hit Markets: Bring An Umbrella To Trade

Previously published on The Huffington Post

Forces at work from Tokyo to Kiev have been roiling the US stock market for a couple of week. But the financial sushi that is now on the menu in Japan, and Russia’s “Crimea of the Century” are only part of the story.

Japan is trying at long last to revive its moribund and literally “deflated” economy by a combination of easy money (to spur needed domestic inflation, weaken the yen and grow exports), structural reforms and a major sales tax increase to reduce the overwhelming level of government debt brought about by decades of fruitless “stimulus” overspending on unneeded infrastructure. Sounds good. But traders in the US have come to fear that Japan’s Fed is not pumping out easy money fast enough to offset the tax increase, which in turn will slow rather than stimulate the Japanese economy and cause the yen to rise undermining the traders’ so-called ‘carry trade’ – borrowing cheap yen to convert into dollar equities thus boosting US equity prices. If everyone unwinds the “carry” at once – as has been occurring recently – equities fall hard, especially while the US Federal Reserve is slowly but surely unwinding its own extraordinary quantitative easing program. The whole scenario also threatens the positive outlook for enhanced global economic growth that we started this year with, further undercutting equities.

The Russian invasion and annexing of Crimea has gradually added to global growth worries and equity jitters, but obviously not because of any financially strategic characteristics of Crimea. With a US president facing political pressure to prove he can ‘stand up to Putin’ from a public that nonetheless has utterly no stomach for military intervention in Ukraine, the only “weapons” available are economic sanctions of the “this will hurt me more than it hurts you” variety. The “personal” sanctions against Putin’s oligarch cronies are not the equity traders’ problem. But moving to the next level of sanctions on trade with Russia, ultimately including energy products like oil and gas, would impose pain for the entire European economy, which has enough troubles of its own from the Eurozone crisis hangover.

Other sources of energy imports, including from the US, can’t possibly come through fast enough to spare Europe a recession if Russia further destabilizes the eastern Ukraine or even invades and the West is forced to go to “DefCon 4” level trade sanctions. As a result, nervous traders are watching the Ukraine/Russia border even more closely than the CIA. (Why didn’t they borrow some of NSA’s tricks and snoop the Vlad-phone before Putin made his move?)

In the midst of these growth-threatening circumstances, along came 60-Minutes worth of Michael Lewis’ latest exposure of Wall Street excess (“The Flash Boys”) undermining confidence just when confidence is what investors need most. Lewis revealed in plain English the millisecond advantage high-speed, computer-driven traders have enjoyed –- with the profit-related connivance of the major stock exchanges and the unwitting assistance of SEC market reformers – allowing them to jump ahead of buy or sell “market” orders from you or me or the biggest institutional traders to make gazillions of risk-free penny profits by forcing us to pay more than what our computer screens tell us is the “market’ piece. Simple, computer-elegant, virtually un-measurable and probably legal front-running.

While the Lewis book no doubt caused some 60-Minute retail investors to pull their money out of stocks, professional traders haven’t really been moved to dump equities by the notion that their customers are being nano-skimmed. They are more concerned by Lewis’s reminder of the power of computer-driven trades set to algorithms that can trigger massive and sudden market sell orders based on momentary and even accidental extraordinary price changes in single stocks or ETF’s.

The famous “Flash Crash” a couple of years ago was just such an event. The Lewis book effectively underscores the fact that we can’t get really get to the bottom of the chain of events that actually caused that sudden market collapse because our trade monitoring devices can’t get down to the millisecond level. The ‘pings” of such trades simply are undecipherable with current market-policing technology – they are effectively lost in the vast Indian Ocean of dark- pool private exchanges that sprang up in response to the regulatory reforms designed to open up the stock exchange oligopoly to more competition and thereby lower “spreads” between bid and ask prices. It did so, but to so a fine degree of fault that traders can’t really tell that their pockets are being picked. (By the way, the flash crash happened in May, so no surprise that equity traders start to get nervous memories in April.)

Finally, the “rotating correction’ – from bio-techs to cloud computing to big data and finally to anything with a high P/E multiple – that has rolled through the equity markets in the first week of April was triggered by a couple of oddly interpreted events. First, Congressman Henry Waxman of California (a retiring but not shy Democrat) and a couple of his Party colleagues wrote a letter to Gilead asking why the company was charging $1000 per pill ($84,000 per full treatment) for the newly approved and highly effective Hepatitis C drug. Note Waxman is a Democrat and thus virtually impotent in the Tea Party dominated House of Representatives. But never mind. Traders dumped Gilead like a failed Phase III trial and took the whole biotech world down with it purportedly on fear that there was a serious threat to drug pricing going forward. Nonsense – at least from the government. But when the largest pharmacy benefits manager, Express Scripts, took up the same cause this week, the threat at least looked a little more real. No doubt many biotechs were trading in bubble-land — but not particularly Gilead.

Then a couple of high-flying technology and biotech companies had the gall to do a secondary offering in the midst of a great run for IPO’s in the same sectors over the first quarter and into early April. Our beloved equity traders are supposedly strong free-market capitalism advocates, who urge our politicians to keep the tax breaks in place for the venture capitalists who deserve the rewards of their successful investment because they are such prolific ‘job creators.”

But when the VC’s have the nerve to cash in those chips with secondary offering of their own shares that dare dilute the sleepy traders by surprise — somehow they didn’t notice those stocks were also at bubble-land prices – there is hell to pay for the rest of the shareholders, as those traders joined the secondary sellers in unloading their own inflated shares, taking profits and continuing to sell down if only to preserve capital for a later run.

Many market commentators broadly praised this “multiple correction” as portending an overall return to a more “normalized” trading environment without the extreme multiple expansion of the last couple of years that some prominent voices believe is more attributable to the Fed’s money than the companies’ revenues or even their profitability (which for some as yet is non-existent). But more than a few healthy babies have been thrown out with this bath. Warning to the commentators: be careful what you wash for!


By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University

Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.

Anatomy of A Market Lie: CNBC Misquotes Yellen, Misreads The Fed And Helps Out Short Sellers

Recently published by The Huffington Post

Going into the Federal Reserve Board’s Open Market Committee meeting of March 18-19, market expectations had coalesced around the expectation that the Committee would begin to change its “highly accommodative” monetary policy – i.e., increase its target for the overnight “federal funds” inter-bank borrowing rate from its current level of zero to one-quarter percent – not before the second half of calendar 2015. Any change in direction toward an earlier increase from this expectation on the Fed’s part, which was the distilled product of the statements and minutes of the last several Committee meetings through January of this year as well as the published views of incoming Chair Janet Yellen, would accordingly be viewed as an unwelcome surprise by the bond and stock markets, sending bond yields markedly up and prices of both bonds and stocks significantly down.

The markets reacted tamely at first to the Committee’s end of meeting statement that reiterated their intention to maintain for a “considerable period” its highly accommodative monetary policy after it completes its “measured” tapering of its bond purchase program. It also noted that both the tapering and any subsequent rate increase decision would be dependent on both incoming data and forward outlook for multiple factors including progress toward maximum employment and a 2% interest rate, as well as overall economic conditions. There was no express or even implied hint in the statement that was seen off the top as altering market expectations for a rate increase sooner than the second half of 2015. 

However, during Chair Yellen’s first post-meeting press conference, a Reuters reported asked her to clarify what she meant in response to an earlier question that the tapering would be on course to be concluded by “next fall” if the Fed’s current consensus estimates of near-term economic activity were realized. The Chair first made clear that “next’ actually meant fall 2014, not fall next year 2015. The reporter than went on the press Yellen on what exactly the term “considerable period” meant when the Fed used it to suggest the period of time it would wait after tapering was completed before starting to raise the federal funds benchmark interest rate target.

 After first asserting that the term was hard to quantify, Yellen went on to say that it would be like “six months”’ or some such but that in any event any such decision would depend on the economic circumstances at the time, consistent with the Committee’s (unsurprising) post-meeting statement .

 Despite Yellen’s evident caution and discomfort in expressing any specific quantitative definition of “considerable period,” the stock and bond markets chose to take Yellen ultra-literally about the six months and turned suddenly and violently downward, with equities down over 200 points within just a few minutes. In short, Yellen was interpreted – against all evidence to the contrary in the Fed’s statement and in all the rest of her answers – to mean that the Fed would start raising interest rates in the spring of 2015 – many months earlier than the markets expect.

 For short sellers, Yellen’s modest “Biden moment” gaffe – bending over backwards to help out a reporter – was a gift from the gods.  It morphed into another weapon with which to panic shareholders and thereby drive market prices quickly down to where they could score later profits buying back at those lower levels and reaping the rewards when the broad markets come to their senses about Yellen’s remarks.

 After the markets stabilized (but distinctly in the downside) and closed for the day, CNBC gave their short-seller friends yet another biased boost by posting a story that actually led with a headline that the Fed had changed interest policy and “embellished” (some might say misquoted) Yellen’s actual words to the effect that she “said interest rate increases likely would start six months after the monthly bond buying program ends.” The CNBC story went on drill home the short-sellers point by specifying that “if the program winds down in the fall, which would put a rate hike in the spring of 2015, earlier than market expectations for the second half of the year.”

To reach this explosively short-friendly conclusion, the CNBC story, besides just twisting Yellen’s words, had to also ignore some basic math. Since the Fed is committed to a “measured” tapering program of $5 million decrease in each of its mortgage and Treasury securities purchases per meeting, it will clearly take until the Fed’s December 2014 meeting at the current pace to fully announce the wind-down of monthly purchases over the remaining six meeting – namely the end of fall, not the beginning (the October meeting). The tapering then would actually end only in January 2015, and six months from then would be in the second half of 2015 – no change in interest rates, no change from market expectations.

 Yet CNBC chose to ignore this math and hear Yellin as meaning early fall (the October meeting), the only way to get to its “Spring Interest Rate Increase” scare-line. CNBC’s one reliable Fed reporter, Steve Leisman, even pointed out this math on the air the first chance he got in an effort to debunk his own network’s emerging story line. But CNBC went ahead with its false headline and story anyway.

When a network ignores its best Fed reporter’s conclusion and publishes a contrary story that also fails basic math, one has to assume that there are considerations other than objective journalism at work.

We have seen this distorted, pro-short playbook from CNBC before. Last summer, the network led the charge for the ‘taper tantrum” that took stocks down several hundred points into when it interpreted Chairman Bernanke’s late springtime intimation of the start of tapering “later this year” as meaning at the Fed’s September 2013 meeting (rather than December, actually more consistent with both market expectations and the data the Fed was reviewing). When September came and went without a taper, those who took the market down and then bought into the manufactured market swoon made fortunes.

Let’s be clear. Higher interest rates are coming in 2015, and most certainly if the economy performs better than expected. A majority of Fed officials forecast a 1% rate level by the end of 2104. But even that only assumes three second half increases of 25 basis points each. It strains credulity to assert, as CNBC did, that the Fed really changed its interest rate policy on March 19 away from what markets were expecting.

Even CNBC seemed to realize its initial story was beyond the pale. It rather quickly took it off its website and found an outside commentator who agreed with its “policy change” conclusion to quote along the same lines. The Internet, however, has a photographic memory, and the familiar CNBC theme that there is yet another cause for a market “correction” was now afloat in the market waters.  Even the NBC nightly network news picked up the faulty CNBC assertion that the Fed had changed policy toward a quicker increase in interest rates.

 When you want facts, listen to Yellen herself, and tune in to Leisman. Otherwise, proceed at your own risk with CNBC.


 By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University

Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.





Putin’ On The Ritz: Why Western Business Undermines Sanctions To Put Profits Ahead Of Patriotism

Content previously published on The Huffington Post


Putin’ On The Ritz: Why Western Business Undermines Sanctions To Put Profits Ahead Of Patriotism


Want to put the squeeze on the outlaw Putin by dialing back the offshore shenanigans of his pals among the Russian super-rich? Wait just a minute, Mr. President: what might that do to the London real estate market? Let’s see which side Prime Minister David Cameron ultimately takes on the question of whether to punish Vlad the Invader or protect the City of London’s offshore ATM machine.


Want to double-down on sanctions that would dial back the Russian gas and oil supply contracts for most of Europe? Hold on. Who wants to bite the hand that heats us in the midst of this cold winter, which, after all, is America’s fault? Let’s see just how forcefully Chancellor Merkel uses her recent re-election and de facto queenship of the Eurozone to leverage her “good cop” chit-chats with the Russian President into a threat he might take seriously to undermine the 50% of his economy that comes from energy exports.


President Obama’s problem isn’t whether President Putin will listen to him, as so many U.S. commentators harp on. The question is whether our NATO allies in the Western end of Europe will put their money where their mouths are when it comes to drawing a red line in favor Ukraine sovereignty. These countries are not in the vulnerable position of our NATO allies in Poland, Latvia, Lithuania and Estonia, or even Slovakia, the Czech Republic, etc., on the Russian border. These countries have plenty of ethnic Russians on their side of those borders. And they are rightfully concerned about Putin’s version of the George W. Bush/Dick Cheney “pre-emptive war” doctrine – namely, that he can march troops (with or without identification) across the borders to preemptively prevent alleged abuse of such Rethnicsussian.


Of course, if the British, French and Germans continue to waffle and wobble on whether to become more dependent on potential U.S. energy resources rather than their Putin pipelines, the U.S. idea of sanctions will have to be replaced by putting some anti-missle defenses back on the table, on the Russian border of those former Soviet states. But this resort to a militarized rather than economic action against Putin would only serve to escalate the threat of unintended warlike consequences further. We would not need to do so if the leading European states would be willing to share the pain of tough sanctions on the Russian economy. Not bloody likely!


The same goes for American big business with major investments in the Russian economy. Are the mining equipment companies, oil and gas drillers, pipeline suppliers, investment banks, and other U.S.-based exporters of goods and services to Russian countries joining the Republican hawks in calling for tough sanctions on Russia’s economy?  Conspicuous silence. Except for their lobbyists, of course, who are fiercely lobbying the Administration against such sanctions.


And what about the supposedly easy solution to Europe’s energy dilemma of simply lifting American prohibition on exporting American oil and natural gas (which, by the way are not Obama decisions but acts of a previous Congress which can only be changed by Congress)?  Let’s see how soon – if ever – Congress gets around to taking action to lift those bans in the face of the opposition from U.S.-based chemical and utility companies (how many Congressional districts don’t have a power plant)?


It turns out our own devotion to liberty and international law only goes so far when somebody’s profits and dividends and executive compensation are put at risk. Talk is cheap, but patriotism is expensive, as it turns out. Too expensive for American and European industries with close economic ties and dependencies on Putin and his own somewhat Soviet version of “crony capitalism.” Right now, for many of our “Western” business people, it’s a matter of protecting their Russian partners, at all costs – particularly to Ukraine.


China may hold our debt, but it’s Putin who has England’s equity, Germany’s furnaces, and France’s keys to Iranian contracts.  And while sanctions against Iran have precluded only potential business for law-abiding U.S. businesses, sanctions that really bite the Russian bear would hurt existing U.S. business interests. Let’s see if the Congress – so vocal about “doing something” to stop Putin – will actually vote to hurt the U.S. chemical and utility industries by allowing oil or gas exports to Europe. Maybe if Putin threatens to “liberate” the ethic Russian population of Brooklyn from New York’s “stop and frisk” practices. But more likely by then we’re back to missile crisis time anyway.


The fact is that it is not the American President but rather American, English, German and French businesses that won’t lift a thumb off their profit scales to save Crimea or even the whole of Ukraine. And why should we be surprised? U.S. businesses refuse to hire until it gets more tax breaks and lobbies ferociously against any increase in the minimum wage to protect their bottom lines and “shareholder values.” Just watch and see over the next week or so how many business commentators start to talk about how sanctions against Russia will hurt “American jobs.”


Their apologists in the business media, particularly the so-called “reporters” on CNBC (apart from Steve Leisman) spread blatant untruths about the demographic makeup of the minimum wage workforce to protect the de facto wage freeze on low income Americans. One CNBC anchor confidently observed that those on minimum wage were just teenagers who don’t deserve a raise – while the facts any true reporter would find are that only 16% of minimum-wage workers are under 20. The average age of all such workers is actually 35 and most of them are women of child-rearing age.


When CNBC’s “free market advocates” have to stoop to economic fraud, that couldn’t survive in an SEC prospectus review, to protect their patrons’ profits, we should pay attention to how far some business leaders will now go to stop the President and Congress from imposing truly effective sanctions against Russian invasions of a sovereign state, which ironically would prefer to adopt some form of capitalism.


Just watch and see over the next couple of weeks how many of CNBC’s business “experts” start talking about how imposing sanctions on Russian interests will hurt the U.S. economic recovery and of course, “American jobs.” Russian contracts are as sacred it seems, as private equity’s “carried interests”– which are truly carried by all other U.S. taxpayers.


In short, some of America’s most influential capitalists can live without a free Ukraine, but can’t seem to survive without their friends in the Kremlin.  Profits, like politics, make for strange bedfellows.




By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University


Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.








Finally, The End Of The Five-Year Armageddon Trade?

For the past several years, beginning with the collapse of the US housing finance market in 2008, debt and equity markets worldwide have been subject to periodic shocks and jolts that have given rise to what’s now known as the “Armageddon Trade.”

Reminiscent of the market positioning that occurred in advance of “Y2K” at the turn of the new century, a bevy of commentators took turns predicting that the market crashes that were triggered by the collapse of the securitization market for mortgage debt were about to be triggered again by various “black swan” (i.e., odds of happening conventionally, perceived like winning Power Ball) events either in America or overseas. This would lead to gigantic losses for security holders with “long” positions, and, of course, tremendous gains for short sellers who would have two ways to win. One, if those black swan events actually occurred, and two, if they could convince enough people that they would, so that they would dump their stocks and bonds in a “pre-fire” fire sale into the willing hands of the shorts when the alleged “crisis” was seen to have passed.

Of course, the Armageddon Trade talk was buttressed by actual occurrences that nobody predicted in their scope and impact.  The near death experience of the American mortgage banking and investment banking industries really did happen, along with the fall of Lehman Brothers, the distressed sales of Bear Stearns, Merrill Lynch, Countrywide Mortgage, Wachovia Bank, and Washington Mutual, the resignations of the heads of Citibank, AIG, Bank of America and other financial giants accompanying their bailouts by US taxpayers, and the bailout/bankruptcies of GM and Chrysler.

If all this destruction of wealth could happen in the world’s most important economy with its global reserve currency, then was it so hard to believe that Greece would default? Or that Germany would abandon the Euro? Or that the Euro would collapse to arithmetic parity with the US dollar or worse? Or that the European Central Bank would prove too weak to act decisively? Or that Italy, Spain and Portugal would follow Ireland and Iceland into virtual receiverships along with their banking institutions? Or that France would finally succumb to its excesses? Or that China would collapse into recession? Or that the US would default on its outstanding debt as a result of the new political Tea Party mistaking the so-called “debt ceiling” law for a credit card limit? Or that the US government would actually shut down for weeks to satisfy the same minority Tea Party and their talk radio sponsors?

As it happened, however, none of these confidently predicted Armageddon events actually happened, dealing a blow to the credibility of the “Chicken Little” school of market sentiment. Instead, US stocks climbed 20-30% in 2013, depending on your choice of scoreboard. Yet as the new year began, the bad news bears put together a new disaster scenario to encourage the investment winners of the past year to take advantage of the “selling opportunity” while they still could, thereby driving down stock prices and rushing money into Treasuries, which were increasing rather than decreasing in value despite the Fed’s December decision to begin tapering its own debt securities purchases. The bears had of course positioned themselves in Treasuries in advance of their latest Armageddon call.

This time around, however, the doomsayers had to weave a much more complex and interrelated, cumulative case for the end of the world as we know it. This included pointing to the following. China was slowing toward a hard landing, based on one month’s PMI data in advance of an earlier than usual Chinese New Year, which always depressed economic activity temporarily. Another imminent “Lehman moment” collapse in China of their “shadow-banking” trust loan finance sector because the collapse of coal prices would not support repayment. A slowdown in US hiring (by some but not all measurers) and retail sales (for some but not all vendors), obviously temporarily impacted by unusually severe winter weather in two-thirds of the country. The potential for a rolling emerging market currency collapse brought on by runs against the Argentinian, Turkish and Hungarian currencies, which in global GDP terms do not amount to a hill of beans, plus a new Italian government crisis. And finally a protracted fight in the US Congress over the extension of the debt ceiling through the 2014 election cycle brought on by the Tea Party caucus in the House and Ted Cruz in the Senate.

This 2014 doomsday scenario succeeded initially in driving a “semi-correction” of 5% in equity values and concomitant rally in ten-year Treasury note values. The cable TV financial networks rallied to the correction cause (if only because they had been calling for one all during 2013 to no avail), bringing on a host of guest commentators predicting a 20% correction (S&P down to 1480), a new bear market, and even a return to recession negative GDP growth this year with the impending collapse of global finance and all commodity markets except gold. Many of them saw it coming in the supposed “weak volume” recovery of 2013 – it would prove a false dawn, as one prophesized.

But as the old prophet Bob Dylan put it even in his Super Bowl commercial, “things have changed.” The markets got smart. They looked under the hood of the global economy found problems, but not crises that couldn’t be handled by the powers that be. China bailed out a weak trust bank, proving they learned the Lehman lesson. That country’s trade figures improved in January, presaging stabilization in manufacturing while the government pursues economic reforms to reign in excess lending – good things that will help prevent crises. Italy had a relatively smooth transition to more energetic and popular leadership (learning the Berlusconi lesson). The House and Senate extended the debt ceiling, no strings, no filibusters (learning the Gallup Poll lesson) and the merging market central banks acted quickly to face reality of currency runs, proving they learned the Thailand lesson.

In short: plenty of worry for the famous wall that markets often climb, but no Armageddon’s on the horizon. Maybe we can get back to “normalcy” after all, even with increased market “volume” more to the upside. Even with that supposed crisis sign, low volume proves to be a fraud.  As Bloomberg has reported, trading volume measured in shares has indeed been down over the past five years, by 27%.  But the average price of shares is way up for the same period (from $24 to $77, well over double!). So volume measured in total market value has actually grown by a third over that period.  Score one for grade school arithmetic. Chicken Littles, it seems, just can’t do the math!

By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University

Previously published on

Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education

Tinker, Taper, Forward Guide: The Fed Confronts The “Coldilocks” Economy

Content originally published on The Huffington Post

Once upon a time in a century far, far away, the US economy was perceived by one and all as in a “Goldilocks” state: not too cold, not too hot, just right.” Just like the porridge at the Three Bears’ house – or so it appeared – conditions in the latter half of the 1990’s were optimal for both bond and stock investors, consumers and producers, traders and investors, buyers and sellers, even mortgagors and mortgagees. There were no walls of worry for mountaineers to climb, no debt ceiling crises, no fiscal deficits. Greenspan was in heaven and all was right with the world of finance.

Well, that scenario turned out to be a fairy tale indeed, fueled by conventional Federal Reserve monetary largesse and conventional wisdom favoring deregulation of financial engineering. The worst economic debacle since the 1930’s Depression followed the fable of financial nirvana. Clearly not everything was “just right.”  There were severe imbalances in the world of leveraged finance, especially in terms of the hidden costs of genuine risk that would emerge as interest rates were finally forced to rise, too late to halt the free-market excesses that had their way with Goldilocks while the Fed looked the other way.

Understandably, then, few observers of today’s US economy would dare to suggest we are anywhere near a Goldilocks moment, despite the recent (though much delayed) emergence of relatively benign data suggesting that a recovery from the great Recession is truly on track. Vito Racanelli of Barron’s, just this past weekend observed that “The longer view is that some 150,000 to 200,000 jobs are being created monthly, on average; inflation is low; the Fed remains accommodative; and the quality of earnings is good.” But he went on to note that, while these facts were good for the stock market, it was not a pretty story for 20 million un- or under-employed households. No Goldilocks economy yet. But maybe “Coldilocks” would be more apt description, especially considering the confusing jobs picture that confronts the new Fed Chair, Dr. Janet Yellen.

Perhaps buoyed by her now two degrees of separation for the discredited Greenspan, she nonetheless faces markets that may be pulling and tugging her to follow up the famous Greenspan and Bernanke “puts” that have been perceived to underwrite the rallies in both stock and bond prices (though obviously not bond returns) since 2009 that have put our generation of three “bears’ to rout – until very recently, when the jobs creation data turned much too cold.

Speaking of cold, the disappointing job numbers – adding up to  just 188,000 for December and January combined compared with the 194,000 one-month average since last January  – have been blamed on the unusually cold and snowy weather affecting two-thirds of the US land mass. The same goes for declining auto sales, disappointing retail sales over the year-end holidays, and the softening in housing sales and prices over the same period. But multiple commentators rushed dismiss “weather effects” as lame excuses and rushed to predict a 20% “correction” in stock prices (i.e. a 1480 S &P) and even a turn toward recession unless the Fed reverses its tapering course for its monthly bond purchases, or even if they do that.

The renewed Armageddon trade worked for about a week or two with a little help from some overdone panic about the Turkish lira and the Hungarian whatever, giving the TV folks’ friends in the hedge fund community ample opportunity to buy in cheaper (after missing the 2103 market rally) before the markets came to their senses. Or as Racanelli’s Barron’s piece put it: “despite Soft Jobs Data, Stocks Edge Up on Week.” Perhaps, at least the stock market seemed to be thinking, there is something to the “Coldilocks” story. The economic recovery is real and will only be deferred, not derailed, by the bout of cold weather, Groundhog Day predictions be damned!

Stock market bulls have indeed been playing a game of “whack a mole” for a couple of weeks as the prophets of doom spun TV tales that some combination of China, Argentina, Hungary and the “Polar Vortex” (no, that’s not a new derivative instrument) were forming a perfect storm of currency and consumer collapse that would bring on recession risk and put the new Fed in a classic bind: either dramatically reserve course on tapering (and thus lose credibility) or keep on course and risk killing the recovery.

A few bullish market participants might well have bought in to the idea that the Fed would flinch on tapering (the new “Yellen Put”), but most seemed to discredit the often-wrong monthly jobs creation data in the so-called “business establishment” Labor Department survey, and put more faith in the accompanying “household” survey, which actually showed a monthly employment gain of over 600,000. This figure is much more in line with the private SADP survey, which showed nearly 400,000 new private sector jobs, almost double Labor’s “establishment” report. There was even some other, intrinsically good data amid the chill in the Labor report: new declines in under-employment and increases in labor force participation, both of which suggest even more “Goldilocks” turns in the recovery despite the weather.

A more pressing matter for Chair Yellen as she enters the 2014 bears’ domain will be to finesse the Bernanke ”forward guidance” legacy –namely, a 6.5% unemployment rate “threshold” when the Fed would start thinking about raising short-term interest rates. Yellen helped create that legacy herself, but was also instrument in the Fed’s push to fuzz it over last month by saying the Fed will find it appropriate to keep rates low “well past” the time – maybe even next month  – when unemployment drops to 6.5%.

Both the bond and the stock market, of course, now want to know what “well past” means. Yellen will be testifying in Congress on February 11 and 13, but would be highly unlikely to get out ahead of her Fed colleagues on any specificity, since she has not even chaired one meeting yet. We are more likely to get clarity at the next Fed meeting (just about the time of (you guessed it) the Ides of March!


Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.








The American stock market has been beset by a spike in volatility and downward pressure since the beginning of the year. Some of the riptide declines began with the unexpectedly light employment report for last December, issued early in January. While private research reports had documented net job increases well above the 200,000 or so that had been reported by the Labor Department over recent months, the government estimated only 74,000 were added. For those market speculators waiting all 2013 for the oft-predicted 10% downward correction in stock prices that would give them a chance to get in to the market after missing its 30% increase over the year, the disappointing jobs report offered their first chance to send their minions onto cable TV to promote the well-worn “sky is falling” thesis that would lead investors to quickly “take profits” and get out of the markets “while they still can.”

This ploy amounted to just another well-promoted renewal of the “Armageddon trade” that spooked investors – and opened doors to speculators to buy stocks cheap before the inevitable snap-back when Armageddon forgot to happen in 2009, 2010, 2011, and 2012 (based on doomsday scenarios for the Euro, the European “PIIGS” states, China and even the US).  This time investors – fooled not just once but four times by the chicken-little game –didn’t swallow the jobs report whole and refused to panic.  This was  largely because the dismal report was found to be based on statistics collected for only one week in December, and the coldest one at that – which artificially held down all sorts of employment but only temporarily.

But the speculators soon got another gift that keeps on giving – this time from the always volatile “emerging market” sector overseas – specifically in this case, the rapid depreciation of the currencies of Argentina and Turkey, which had been living beyond their means for years but only recently exposed as such by the Fed’s December decision to begin “tapering” the monthly money-printing that had found its way to the hot-return markets like those two countries, among others. Black market rates for exchanging the Turkish lira and the Argentine peso into dollars spiked precipitously, their Central Banks rushed to raise local interest rates and adjust exchange rates to counter the panic in the streets. Then speculators rushed in first to the currency markets to pressure the country authorities further to test where even more tumultuous – and profitable –breaks could be triggered! But the speculators also quickly saw that there was an even bigger game in play, and one they could play on a very low-cost/high returns basis – namely, playing the whole US stock market against itself for a quick buck on the short side with a relatively very small investment, just like in the good old days of the Euro-panic of 2010 through 2012.

The initial US market reaction to the Argentine-Turkey tango – which gave the speculators their renewed opening – was a flight to the quality of treasuries, which took the ten-year note up to levels that reversed the ‘normalizing’ price decrease (and rate increase) expected in the wake of the Fed’s tapering and mimicked a pattern usually associated with the onset of recession fears. Then came multiple 100+ declines in equity markets as they picked up the ‘all is not well” scenario laid out on cable coverage starving for something that looked like dramatic change. All this manufactured doom and gloom has created a perfect scenario for the speculators’ favorite playbook. Here’s how it works:

A big problem in a really consequential market, like a collapse in Chinese growth, would merit a drastic equity market response, more than even the 10% correction that short sellers and the many hedge funds that missed the 2013 rally altogether because of their antipathy to any “Obama’ market or whatever. But that’s reality; speculators deal in fantasy. Chinese GDP is equal to a large percentage of US GDP, more than the top ten US states combined. But Argentina, Turkey, Hungary – that’s a whole other story. Argentina’s GDP is just the size of Arizona and Missouri combined; Turkey’s is the same as Virginia’s and North Carolina’s combined.  And Hungary is supposed to be an earth-shaking currency problem? Its GDP is the same size as Kentucky’s.  But these global minnows allow the speculative whales to play an ultra-efficient market manipulation game at very low cost.

The “sky is falling” speculators just briefly “invest” a relatively small amount of their dollars to take a market position that drives down these little countries’ currencies even farther, take a mega-short position in the Dow or S&P averages. Then like the Armageddon psychology promoted by the cable TV “experts”, do the rest of the work for them, driving down equities to return big and quick short-position profits that more than make up for the losses incurred on currency manipulation, and opening the opportunity to buy favored equities – which they know will not be hurt by a Hungarian devaluation or whatever – on the cheap for 2014.

They played the same game back in the day when Greece or Spain were going to bring down the Euro, or the world: a few bucks pushed to spike the rate for “Credit Default Swap” insurance on Spanish debt, for example, could be relied on to drive down the entire global equity market, at least for a few days. Panicking equity investors gave up perfectly good positions as the TV folks quickly marshaled their forces to cover the coming global market calamity (which of course never happened), the speculators sold out their CDS positions at a loss but reaped a harvest of short-sale profits and then bought in cheap to reap the later equity rallies of 2010, 2011, 2012 and 2013.

Spain and Greece, however small in their own right, were at least tethered to a really significant currency and the Euro-bloc economy. But Turkey, Argentina, Hungary – they are really the tail that now wags the global equity market dog.

Market suckers have been taken in by these speculative games for four years running; why should 2014 be any different, especially with CNBC cheering them on by not explaining what’s really going on? Sure Armageddon talk ups the ratings, but maybe CNBC should ask itself: when we succeed in scaring everybody but the speculators and hedge funds out of the market, who’s going to be left to watch us?