Category: people

The bear crying wolf

A perennially bearish hedge fund manager with an Austrian economics bent recently appeared as a guest on the Tom Woods Show.  Tom Woods opened the discussion with:

What do you say to somebody who says, “The trouble with you Austrian-influenced financial guys is that you’re always bearish, so of course you’re going to be right when things go wrong.  Why should I listen to you now?”

Great question.  Are we Austrians eventually right, but always early?  Is this one “big, fat, ugly bubble” that, when it bursts, will vindicate all of us?  Are we just flat wrong?  Is Austrian Business Cycle Theory (ABCT) out of touch with reality?  Or are we stopped clocks, right twice a day, but miss out on a lot of opportunities the rest of the time?

For the full article by Kevin Duffy, see here.

Where are the ominous headlines?

Biotech Index - 140413

 

The momentum stock bubble burst last week, with highflying stocks showing significant declines from their February/March highs:

  • brokerage stocks: -10.8% (high set on March 20)
  • housing stocks: -9.4% (February 27)
  • Internet stocks: -17.1% (March 4)
  • biotechnology stocks: -21.1% (February 25)
  • Tesla Motors: -20.0% (March 4)
  • Netflix: -28.2% (March 4)
  • Twitter: -45.4% (December 26)
  • 3D Systems: -50.1% (January 3)

Yet a brief scanning of the financial headlines shows little concern:

  • MarketWatch.com – “Stocks fall as volume rises, but here’s why not to worry”
  • The Wall Street Journal – “Stock-Market Jitters Put Investors at Ease; Recent Turbulence Is Seen as a Healthy Sign”
  • CNBC – “Last week’s big selloff ‘probably over': Pro”
  • MarketWatch.com – “Don’t let these stock market gyrations scare you; It’s likely that we’ve seen the end of recent declines”

The common theme among pundits is that the momentum bust is isolated, contained, healthy, and even predictable.  CNBC quoted Jonathan Golub, chief U.S. market strategist at RBC Capital:

“I think the selloff is probably over.  If you look at the economically sensitive stuff in the market, it’s not really selling off. It’s tech. It’s bio-tech [which makes up about 10 percent of the market.]  The other 85 to 90 percent is in perfectly fine shape.

This weekend Barron’s patted itself on the back for predicting the tech bust several months ago:

In November, when pundits began to natter about a stock market bubble, we pointed out in a prescient cover story that it was a tech bubble, not a market bubble.  Our advice has paid off handsomely.

Barron’s quoted perma-bull Jim Paulsen, chief investment strategist at Wells Capital Management:

My guess here is that we’re having a valuation adjustment in one small part of the market, in the highflying momentum stocks that got ahead of themselves and are now correcting.  I think this is more of a buying opportunity.

The article concluded:

All this suggests that despite some ominous headlines, the stock market’s health is still good. [emphasis added]

Where are the ominous headlines?  We don’t see any.  We see complacency as far as the eye can see with the assuredness that the momentum stock bust is “contained.”  We heard these same words in April, 2000 after the dot-com bust and March, 2007 after the subprime bust… early warning signs that were overwhelmingly ignored.

 

 

Greenspan sees no bubble

The Maestro’s crystal ball is the gift that keeps giving.  With an uncanny knack for completely missing most of the major inflections points in financial markets over the past five decades, Greenspan added this gem to his resume in a FOX Business News interview yesterday:

“There are a lot of things that can go wrong, but to say that the market is bubbly and in a position where it could conceivably create a serious problem, I think is overstating it.”

Let’s put this prediction in perspective by filling in some of his resume…

“It’s very rare that you can be as unqualifiedly bullish as you can now.”  ~ Alan Greenspan, The New York Times “Economic Survey”, January 7, 1973

1973 and 1974 turned out to be the worst years for economic growth and the stock market since the Great Depression.  (as noted in Jason Zweig’s commentary in The Intelligent Investor)

On October 2, 1990, then Federal Reserve chairman Greenspan made this prediction:

“At the moment it isn’t raining.  The economy has not yet slipped into a recession.”

It was later revealed that a recession had actually begun three months earlier, in July.

In April 2000 (one month after the NASDAQ peak), Greenspan was asked if rising rates would prick the stock market bubble.  His response:

“That presupposes I know that there is a bubble…  I don’t think we can know there’s a bubble until after the fact.”

From The Age of Turbulence (2007), Greenspan recounted his thoughts on the 2003-2006 housing bubble:

“I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.”

The December 26, 2005 issue of BusinessWeek confirmed his complacency:

“The view of most economists, including Fed Chairman Alan Greenspan, is that a national home-price bust is highly unlikely.”

Greenspan also whistled past the subprime lending grave:

“With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . . As we reflect on the evolution of consumer credit in the United States, we must conclude that innovation and structural change in the financial services industry have been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. . . . This fact underscores the importance of our roles as policymakers, researchers, bankers and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers.”  ~ Alan Greenspan, from a speech given April 8, 2005

Housing prices peaked in Q1 2006 and by Q4 were in full retreat, yet Greenspan was unconcerned:

“Most of the negatives in housing are probably behind us.  The fourth quarter should be reasonably good, certainly better than the third quarter.”  ~ Alan Greenspan, October 26, 2006

Even as late as Q2 2008 he thought the worst was over:

U.S. financial markets, roiled by the collapse of the subprime-mortgage market, have shown a pronounced turnaround since March. The worst is over for the credit crisis, or will be soon, and there’s now a reduced possibility of a deep recession.  ~ Alan Greenspan, June 13, 2008

The S&P 500 plunged nearly 45% over the ensuing five months.

Alan Greenspan is a stark reminder that central bankers have only one productive use: as contrary indicators.

Bears feeling the pressure

During manias, the pressure to conform becomes… well, unbearable.  Yesterday, CNBC reported that noted bear Doug Kass put an end to the scorn he constantly received on Twitter:

Doug Kass has had it with the haters and declared his intent Monday to leave Twitter and his 62,000 followers behind.

He has been consistently bearish during the current market rally and has taken substantial heat for his position that stocks are overvalued and headed for a fall.

But he said he’s tired of the constant procession of personal attacks and is packing it in.

This reminds us of the pressure to conform during the housing and credit bubbles from 2004-2007.  Prominent bear Fred Hickey wrote the following in the October 4, 2007 issue of his monthly newsletter, The High-Tech Strategist:

Fellow contrarians, it’s gut-check time.  As a standard bearer of the camp that believes that the Federal Reserve is not omnipotent, I can tell you that this moment is as difficult as any that we have had to endure in many years.  I speak to many of the most hard-core stock market bears (our circle is a small one) and it is clear that their confidence is on the ropes.  I’m not sure if I can characterize it as despondency, but it sure is close.  I can hear the depression over the phone.  Their tone is subdued and there’s an air of despondency.

I’d be lying if I said I wasn’t feeling the pressure.

Someone left me a message this week whining that with the housing market in a total collapse, the Fed will never allow the stock market to fall because the consequences would be so awful.  It was his conclusion, therefore, that stocks were destined to go higher.  Resistance was futile.

It is the notion that the Federal Reserve is in complete control of the markets that is propelling this latest bout of insanity.

History doesn’t always repeat, though it often rhymes.  The near extinction of the bears is perhaps the best sign that the investment winds are about to change as the Fed-induced economic storm clouds build.

Fred Hickey compares today’s central banks to 19th century patent medicine factories

Fred Hickey, editor of The High-Tech Strategist ($150/year, thehightechstrategist@yahoo.com), grew up in Lowell, Massachusetts, known as the “Birthplace of the American Industrial Revolution.”  In his latest HTS he discusses the genesis of the patent medicine industry in his hometown during the mid-1800s:

For a time, Lowell became America’s largest industrial center…  In addition to the textile factories, other industries grew up in the city around the same time, including patent medicine factories – Father John’s Medicine and J.C. Ayer & Co. among them.

Dr. J.C. Ayer founded J.C. Ayer & Co. in Lowell and his factory became one of the largest of its kind in the world.  Advertising was the key to success…, with the company distributing millions of copies of its free “almanac” (propaganda) annually around the world – in eight languages, including Chinese.  A sample from the almanac:

“The skillful pilot steers his ship through all dangers and guides her safely to port.  So the skillful physician pilots his patient through the perils of sickness to perfect health.  In cases of General Debility, so common at present day, he recommends the use of Ayer’s Sarsaparilla, because of its superior efficacy in aiding the formation of pure and vigorous blood, thereby restoring the normal condition to every fibre, organ, nerve, and muscle of the body.  It cures others and will cure you.  This standard remedy is compounded of the best tonics and alternatives known to science, and its superior qualities as blood-purifier and invigorator have stood the test of nearly half a century.”

Ayer became fabulously wealthy, amassing a fortune of some $20 million – quite a sum for the time.

Though Dr. Ayer never practiced medicine, the cover of each J.C. Ayer almanac was decorated with classical engravings such as one showing the Greek physician Hippocrates standing atop the earth declaring: “Heal the sick.”  What was not to believe with such evidence coming from a great doctor?

Hickey goes on the draw the parallel to central banking:

 Today, we look back and laugh – how could these people be so gullible?  Yet, the world is currently under the spell of its own modern-day quacks – known as central bankers.  Central bankers are touted as having the cure for all of our financial problems.  Their tonic, with the scientifically-sounding name of “quantitative easing,” or QE for short, is guaranteed to restore our financial health, to cleanse us from all our ills.  Whether the cause is spending beyond our means (perennial trillion dollar deficits and gigantic debts), making entitlement promises we cannot keep, building a gigantic welfare state of dependents, having a dysfunctional (and sometimes corrupt) government, constructing a byzantine tax system, tying up our businesses in a web of regulations, enabling “too-big-to-fail” banks to grow monstrously bigger – all can be cured with the magical elixir called QE.

Our skillful physician pilots (brandishing their doctorates from Princeton and M.I.T.) have discovered a miracle cure to be sure – at least that’s what one hears all day long from the talking heads on CNBC…  The media dissects Bernanke’s every utterance for clues as to whether he will supply more of the miracle or not.  The cameras are always on – even when he’s just laying out lame jokes at a Princeton commencement ceremony.

The QE medicine is seductive and addictive…

The best part yet – the QE medicine that he and other central bankers around the world are ladling out tastes so good… With QE, stocks will never fall on Tuesdays (20 straight up Tuesdays in a row), stock markets will never again have a 5% “correction,” (nearing 200 days without a 5% decline), investors can lever up with margin debt to record levels ($384 billion and counting – exceeding the 2007 pre-crash level)…  Investors have become so addicted to the QE wonder drug than even the merest hint of a lower dosage (tapering) sends up cries of anguish from the financial world.  Stock prices wobble; interest rates soar and CNBC anchors throw hissy-fits.

Other than the hallucinogenic effects, is the drug working?

Despite an additional $6 trillion of deficit spending, 0% interest rates and trillions of dollars of newly-created high-powered monetary reserves by the Federal Reserve (QE) that has driven asset inflation sharply higher (stocks, bonds, farmland, art and gold); over the past 4+ years we have experienced the slowest economic recovery in post-war history…  Last month investors celebrated a pathetic 165,000 jobs created, when 278,000 of those jobs were part-time.  In other words, we lost another 113,000 full-time jobs.  The U-6 unemployment rate (including part-time workers unable to find full-time work) ticked UP to 13.9%… With jobs hard to get and real inflation-adjusted incomes falling, the average American consumer is under pressure.  Witness the fairly miserable first quarter sales results from America’s largest retailers reported last month.  Same-store sales fell year-over-year at Wal-Mart, Target, Kohl’s and Sears…  Yesterday we received the Institute for Supply Management’s (ISM) report for May which, at a reading of 49.0, showed the biggest contraction in American manufacturing activity in four years – since the “Great Recession” of 2009…  I’ve been going through scores of first quarter earnings reports and conference calls from the largest technology companies.  The numbers and commentary were consistently gloomy – it was the worst batch of results I’ve seen since the end of the Great Recession.

At this stage of recovery something is terribly wrong.  Let me clue you in on a little secret – money printing doesn’t work.

The Japanese chugged plenty of this medicine…

Japan was the first to try “QE” to resolve its problems (though it was certainly not the first to try money printing).  They’ve been attempting to lift their economy out of a decades-long recession for many years.  The Bank of Japan (BOJ) tripled its balance sheet but did nothing to address the real underlying causes of the disease.  They did not address their lifetime employment system that hobbles business flexibility.  They did little to correct the ridiculous rules and regulations that suffocate the agricultural, medical and retail industries.  They raised taxes.  They massively increased government spending, wasting trillions of dollars and causing a debt pileup (235% of GDP and still rising) – the likes of which the world has never seen from a developed country.  As one would expect, the attempt failed spectacularly.

Yet the American snake oil salesmen claimed they didn’t drink enough!

Dr. Bernanke, and other high priests of central planning (including Paul Krugman) lectured the Japanese that their problem was they weren’t swilling enough of the QE tonic fast enough.  For a decade the BOJ resisted, always citing concerns over inflation.  Finally, Shinzo Abe was swept into power on the campaign promise of more licorice for everyone! After eliminating the key inflation-phobes (Masaaki Shirakawa) from the BOJ and replacing them with Bernanke-like clones (Haruhiko Kuroda), the new era of “Abenomics” was on…  The BOJ announced a plan to double its monetary base (high-powered money) within two years.  In other words, they opted to chug the whole bottle of medicine at once.

After discussing the post-WWI German experiment in money printing gone awry (Weimar hyperinflation), Hickey sees the American experiment ending badly:

Despite this horrific central banker record, U.S. investors still want to believe that Father Ben’s QE medicine will eventually work.  But just because the crowd believes this fantasy, doesn’t mean I have to.  As long as the Fed continues to print tens of billions of dollars a month, stocks can continue to climb higher, but the gap between the economic reality (poor) and the stock valuations (euphoric) widens to ever more dangerous levels.  Another crash is coming and I intend to avoid it – once again.

In conclusion, Fred Hickey offers an antidote to the QE drug:

Throughout history, the antidote to money debasement has always been gold.

Bring in the clowns

On May 3rd the DJIA hit 15,000 for the first time.  Right on cue, Ralph “Make ’em Poorer” Acampora predicted Dow 20,000 by 2017 on CNBC in an interview with Maria Bartiromo.  She heaped praise on Acampora’s recent bullish prognostications while conveniently hitting the delete key on his past, which included this blooper from the top of the credit bubble on July 18, 2007 (also on CNBC):

“I’m predicting Dow 21,000 by 2011. It’s only 40% from here [actually 51%, but who’s counting]. It’s a lay-up.” When asked about recent credit jitters, he responded, “Bad news is good news; never fight the tape.”

USA Today: Bull market on solid footing

“The dizzying 2013 stock market rally was reignited Tuesday by multiyear highs in home prices and consumer confidence, a sign the bull run reflects a healing economy and not just the Federal Reserve’s easy-money policies.”  The front page USA Today article quotes two popular permabulls: Brian Belski…

“The economic numbers we’re seeing are confirming what the U.S. stock market has been telling us all year: The economy is on a stronger footing and improving longer-term.”

… and Jim Paulsen:

People are having trouble understanding why the market is going up when the economy is growing slowly, jobs are hard to find, and corporate profit growth is slowing, and they are left with the idea that the rally is just a sugar high from the Fed.  My take is that rising confidence is driving the stock market higher, [adding that investors now believe the worst-case fears they’ve harbored since the 2008 financial crisis won’t be realized].

So there you have it: the 2008 meltdown in the stock market and economy was simply a technical malfunction caused by credit locking up.  The Fed diagnosed the problem correctly, applied some anti-freeze to the credit radiator, and got the economic engine back up and running.  Mission accomplished.  The Fed’s mechanics can now do a victory lap and go back to their auto repair shop and watch paint dry. But what if the sugar high metaphor is more appropriate?  Could the recovery in housing be artificial?  Consumer confidence baseless?  The economy on quicksand?

Does a bull on the cover of a popular mainstream newspaper signal misplaced optimism and impending doom?

Yield-chasers line up to buy Bolivian bonds

Under the You-Can’t-Make-This-Up category of sovereign debt insanity, the May 17th Grant’s Interest Rate Observer files this report:

Many these days are picking the poison of foreign places – Bolivia, for instance.  Last fall, the scenic, private-property expropriating, contract-abrogating and formerly hyper-inflating South American nation issued its first international sovereign debt since 1920.  And the Bolivian 4 7/8s of 2022 this year have rallied by 57 basis points, “the most among sovereign bonds with BB-minus ratings tracked by Bloomberg.” [according to Grant’s analyst Evan Lorenz]

The Great Bond Bull Market began in September, 1981 (over 31 years ago) with U.S. T-bond yields over 15%.  Yields on the 10-year now stand just a shade below 2%.

Precisely 2 years ago, Jim Grant was quoted in an Associated Press interview:

I think it’s useful to imagine how things might look ten years hence.  What will one’s children, heirs or successors think about a purchase  today of ten-year Treasurys at 3.25 percent? They’ll look back and say,  “What were they thinking?”  The (federal deficit) was running at 10  percent of GDP, the Fed had pressed its interest rates to zero, it had  tripled the size of its balance sheet, and they bought bonds?  Treasurys  are hugely uninteresting, as is similar government debt the world over.

Today the Bolivian government can borrow for 9 years at 4 1/2%.  Have bond investors completely lost their minds?

Fed officials give their imprimatur to stock market bubble

greenspan-bubble

Last Friday former Fed chairman Alan Greenspan gave support that the 4-year bull market in stocks has room to run:

And right now, by historical calculation, we are significantly undervalued.  The reason why the stock market has not been significantly higher is there are other factors compressing it lower.  But irrational exuberance is the last term I would use to characterize what’s going on at the moment.

On March 4, Fed vice-chair Janet Yellen assured investors:

At this stage, there are some signs that investors are reaching for yield, but I do not now see pervasive evidence of trends such as rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would clearly threaten financial stability.

And on February 26, chairman Ben Bernanke gave stocks his stamp of approval:

I don’t see much evidence of an equity bubble.

Not to question these all-knowing masters of the universe, but there does seem to be a trifle of evidence to the contrary, that perhaps their zero interest rate policy (ZIRP) has stampeded savers into anything hinting at a yield.  Exhibit A: Over $1 trillion has poured into bond funds over the past 4 years (out of money market funds).  Exhibits B and C: Junk bond yields are at record lows and margin debt near record highs.  Exhibit D: Total credit market debt is a record $56.1 trillion (352% of GDP) compared to $49.8 trillion (also 352%) at the top of the credit bubble 5 1/2 years ago.

After the tech bubble burst, The Maestro admitted that when it came to detecting bubbles investors were on their own:

We at the Federal Reserve considered a number of issues related to asset bubbles–that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact–that is, when its bursting confirmed its existence.  (August 30, 2002)

Five years later those words proved prescient (one of the few times) as the Fed-heads missed the housing bubble and failed to recognize how it had metastasized into a full-blown credit bubble.  While still at the helm of the Fed, Greenspan weighed in on his 6-year experiment to contain the bursting tech bubble (which he failed to see coming):

Most of the negatives in housing are probably behind us.  (October 26, 2006)

Right before the subprime bubble burst, Janet Yellen was oblivious to any impending trouble:

I’m waking up less at night than I was [over the slowdown in housing].  So far, there’s been remarkably little effect on the rest of the economy.  (February 21, 2007)

After taking the reins at the Fed, Bernanke did his own Alfred E. Newman impersonation:

We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.  (May 17, 2007)

The Federal Reserve’s crystal ball does not do asset bubbles.  When its wizards begin to feel they possess such power (that is, denying the presence of a bubble), contrarians take notice.

How Will Japan’s Largest Pension Fund Find Room To Maneuver?

The WSJ is out with a short piece about new rumblings coming from Japan’s $1.43T public pension fund, Japan’s Public Pension Weighs New Investments. If I may be so bold as to impersonate the Japan deflation-blogger Mish for a moment, let’s take a look at a few of the dynamics at play as reported by the WSJ. I’ll provide some commentary along the way:

Japan’s public pension fund—the world’s largest with assets totaling 123 trillion yen ($1.43 trillion)—is weighing the controversial idea of investing in emerging-market economies as a way to gain higher returns as it faces a tsunami of payout obligations over the next several years.

The conservative Government Pension Investment Fund, which alone is larger than India’s economy, has a staggering 67.5% of its assets tied up in low-yielding domestic bonds. The fund plans to sell off a record four trillion yen in assets by the end of March 2011 to free up funds for payouts to Japan’s rapidly aging population. By the year 2055, 40% of Japan’s population is expected to be over the age of 65.

There’s a lot to discuss but before I do I want to clarify an error I believe the journalists who wrote this piece made.

The comparison between the size of the GPIF and the size of India’s “economy” is not a meaningful one because the GPIF is a “stock” while the aspect of India’s economy being referred to, GDP, is a “flow”. At $1.235T (2009 estimate, Wiki), India’s GDP is supposed to measure the total monetary value of output of all goods and services for a particular period of time, in this case one year. Meanwhile, GPIF’s asset base is a static measurement of current asset valuation. I’ll avoid the bath tub analogy and instead refer to public company financial accounting: GPIF’s asset size is like examining an entry on the asset side of a company’s balance sheet; India’s economic “size” is like examining an income statement for the revenue or earnings generated in the period in question.

One other minor quibble– the “2055” statistic is completely irrelevant to telling this story because the GPIF is not going to last that long, at least not in its present form and at its current levels of funding.

With the fur out of the way, let’s dig into the flesh of the matter. First things first: the GPIF is another Ponzi-finance scheme, much like the US Social Security Administration system. I think Takahiro Mitani, president of the GPIF, explained the predicament all Ponzi-finance schemes eventually find themselves in best in this recent WSJ interview:

Mr. Mitani: Baby boomers are now 60 years old or older, and have started receiving pension. In the meantime, the number of people who pay a pension premium is smaller. What’s more, pension premium is determined by wage, which has been on decline. So, pension special account overseen by the health ministry is having a tough time.… More outlay than income in the pension system means that they need to tap into the reserve we have. [emphasis added]

Long-term, the GPIF and SSA will always be running up against a potential demographic problem like this, where the amount promised to past generations of present retirees is greater than the amount being contributed by present workers. Therefore, there will come a time in every Ponzi-pension fund’s life during which the managers of the fund will be forced to go out on the risk curve in a search for yield. And as luck would have it — or rather, as generations of inflationary central planning schemes would have it — the very time these demographic trends reach an apex, so, too, do long-running financial trends on which the fund’s internal rate of return projections have been built. In other words, the perfect financial storm, a “liquidity event” of colossal proportions, metaphorically and literally-speaking.

Unfortunately for Mr. Mitani and his loyal horde of investment management professionals (you did know that scams like the GPIF also serve as lucrative government-sponsored subsidies to investment banks like BlackRock, Morgan Stanley and State Street, Mitsubishi UFJ Financial Group and Mizhuo Financial Group, didn’t you?) there’s more than just wind and noise coming out of those storm clouds in the form of macro demographic and economic trends, though they are all related in a way. Another problem facing the GPIF is political and is tied up in the composition of the GPIF’s portfolio:

The GPIF holds the lion’s share of its assets in low-yielding Japanese government bonds. (The yield on the 10-year JGB is currently a paltry 1.07%.) Roughly 67.5% of its assets are parked in domestic bonds, including government and corporate bonds; the rest are spread among Japanese stocks, overseas shares and foreign bonds.

The GPIF is a Ponzi, wrapped in a Ponzi, inside an enigma. If you take a look at the investment results for the first quarter of fiscal 2010[PDF] provided by the GPIF, you’ll see that the “domestic bonds” portion is split roughly 76% into “market investments” (JGBs of varying maturities) and the remaining 24% into “FILP bonds”.

FILP bonds, issued by the Japanese Ministry of Finance’s Fiscal Investment Loan Program, are similar to agency debt and municipal/public works bonds floated by US state and federal government agencies (think FRE/FNM, FHLB, New York MTA bonds, DOT/highway bonds, public school and university bonds, etc.). According to the Japanese MoF’s own online resource page, which I encourage you to click and skim-read in its entirety for yourself, FILP bonds can be issued to fund nearly anything the Japanese government might deem worthy of funding, including “housing construction, small and medium-sized businesses, roads, railways and subways, airports, water and sewerage [sic], education, medical care and social welfare, agriculture, forestry and fisheries, industry and technological development, regional development” and let’s not forget “international cooperation.”

Like I said, nearly anything. And with Japan’s bubble-fueled reputation for being a corrupt, greasy-handed place to get business done, you can bet that at least one of almost everything in Japan’s economy (and other countries’ economies!) has been funded exactly this way. The FILP is like a giant government-sponsored slush fund for amakudari, Japan’s version of the “golden parachute” for its fascistic, entitled union bosses-cum-career public servants[PDF].

Back to the Ponzi within a Ponzi. One reason that Japan’s central government has been able to issue so much debt ($10.55T and rising as of the end of June) without blowing yields sky-high is due to the phenomenon of captive finance, an ugly cousin of vendor financing, of which government managed pension funds like GPIF are a facilitator. It works like this: the Japanese government issues debt, the Japanese worker is forced to contribute to a government pension fund such as GPIF, and the GPIF buys the Japanese government’s debt because it’s “safe”. Hopefully you can see it now. The Japanese government must keep rolling over debt into new debt just to stay afloat which is purchased by the GPIF, while the GPIF must keep milking workers to pay off the retirees. Ponzi within a Ponzi.

Something’s gotta give. But there’s the rub– it can’t. According to the WSJ article, 67.5% of GPIF’s funds are committed to JGBs and FILP bonds (the allocation as of the Q1 investment results[PDF] linked to above was 68.14%) with the remaining portion divided up approximately 9% international stocks, 8% international bonds and 11% domestic stocks. It can’t easily touch that 67.5% allocation without experiencing stern consternation from Japanese politicians who see their Ponzi-scheme unravelling before their very eyes.

That means the search for yield will have to come from elsewhere in the portfolio, and anywhere else it might come from means potential pain for the supplier. Think the Nikkei can’t go lower? Think the US Treasury has enough problems? Think the S&P 500 has been beat up enough already? Think again. Meanwhile, wherever the GPIF potentially re-places the funds could see a nice little second-wind. Good-bye SPY, hello EWZ!

I’m being facetious but hopefully my point is clear. Of course, where government is concerned, “can’t” doesn’t always mean “won’t”:

Regarding its four-trillion-yen selloff this year, Mr. Mitani said: “We won’t only target [selling] domestic bonds. It could be [Japanese] stocks or foreign-currency-denominated securities or stocks,” depending on market conditions.

At the end of the day, Japanese politicians can kick and scream but the GPIF has to meet its liquidity needs and one way to do that is to suck it up and kick some JGBs and FILPs out the door. Again, this is a problem and it will be chronic until it is terminal. Pay attention those of you long JGBs.

John Vail, chief global strategist at Nikko Asset Management, echoed that sentiment. “They need to take on more risk. As a long-term investment, equities will nearly always outperform JGBs,” he said “Global equities are a wise investment for the GPIF—especially with equities being so inexpensive.”

Mr. Mitani said he is aware of such opinions, but his mandate is to invest in “safe” assets with a long-term view. “In 2008 after the collapse of Lehman, while we posted a negative result we were relatively better than overseas pension funds thanks to our conservative, cautious stance. We posted only single-digit [percentage] loss while others posted double-digit loss,” he says.

In the U.S., the California Public Employees’ Retirement System, known as Calpers, is the nation’s largest with assets of $200 billion. Calpers reported a 23% slump in the year ended June 30, 2009, marking its worst year ever. Some of the biggest hits were from private or alternative investments such as real estate. Calpers has since begun pulling back on such exposure. In comparison, the GPIF reported only a 7.6% slump in the fiscal year ended March 31, 2009.

That list bit about comparative slumps should clue you in as to where the GPIF is going to want to go to first when it comes to meeting liquidity needs. Why sell volatile equity securities and potentially lock-in another loss when you can sell some ultra low-yield JGBs and FILPs, perhaps even turning that ROI-frown, upside-down in the process?

A special thanks, by the way, to John Vail of Nikko Asset Management, for providing some much-needed “useful idiot” stock-jobber equity permabull nonsense encouraging the GPIF to go out on the risk curve a bit more. Over the long-term, equities will “nearly-always” outperform JGBs… except for the past 30 years (image pulled from Mish):

Dang, looks like the long-term can be very long, indeed.

Meanwhile, Mr. Mitani seems fairly confident that the Ponzi-scheme will be kept up a bit longer:

Mr. Mitani expects the 10-year JGB yield to mostly stay below 1.5% for the next two to three years, though it may break above that point temporarily. He added that he isn’t too concerned about the risk that JGB prices will plunge due to fears about increasing JGB supply, creating a Greek-style fiscal crisis.

“If financial firms keep receiving ample funds from [the Bank of Japan], if companies remain reluctant to borrow, and if individuals keep savings at banks, there’s no choice but to purchase government bonds,” Mr. Mitani said.

Maybe. Hayman Capital Advisors’ Kyle Bass doesn’t seem to think so. Either way, it’s not a popularity contest. Just keep in mind that that’s a lot of “Ifs”. The other thing to remember is that the GPIF may be the biggest fund facing this kind of problem, but it is far from being the only one, in Japan and around the world. As discussed above with the Ponzi within the Ponzi, there are a lot of moving pieces in these deadly contraptions and this type of intertwined financial structure has been rigged, Rube Goldberg-style (you’re going to have to click the link and watch the 2min vid to the end to see just how ironic a choice it was given the subject matter at hand), across the world’s pension and financial systems as well as governments.

I know not when it will end, but I do know this– when these things end, they don’t end well.

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