04 17 20 WOWS Listening In - Jim Bianco - We Won't Easily ... 17 20 WOWS Listenin… · was a big...

Good to hear from you, Jim. Thank God for modern communications capabilities so I can welcome you while sitting just down the road from Covid-19 ground zero in Suffolk County, NY. We’re very much shel-tering in place.

JIM BIANCO: Did you see the story in The Wall Street Journal a few days ago calling COVID a rich person’s disease because the technology of trans-continental air flight used by wealthy people flying back and forth all over the place that has been spreading it faster than anything else.

Yes, quarantining cargo ships for 40 days no longer cuts it, as pandemic protection. JIM: The black plague actually took 40 years to run through Europe and this has taken 40 days to run through the world. The WSJ talked about how there was a big ski event popular with wealthy Mexicans in Vail* [an earlier version placed the event in Aspen, we regret the mistake] in early-February — and the entire outbreak

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We Won’t Easily ForgetJim Bianco Sees De-Globalization, Risk Aversion Surviving PandemicDazed and floundering amid headlines crammed with awful news and wishful thinking about a swift return to normalcy, whatever that is now, I turned for this issue’s interview to one of the most hard-nosed guys I know — and I mean that in the very best of ways — Jim Bianco. Jim, the well-known macro strategist who quite practically named his Chicago-based firm Bianco Research way back in 1990, is the kind of straight-shooting, no-nonsense guy who’s always made the Midwest special. My Hoosier and Chicago roots don’t make me at all biased!

Able to chart his own analytic course for 30 years now, Jim is reliably iconoclastic but gimlet-eyed, way savvier than most on the intersection of stocks, bonds and the government, and not about to fall sway to passing fashions of thought. And he’s long paid painstakingly close attention to even the most esoteric of money market foibles. For all of those years, Jim has reliably guided clients through the long bond bull’s feints and frenzies, and since the Great Recession, has mostly been bullish on stocks, too. But no more.

The bond bull is over, Jim declares, though he sees no immediate run to the upside in rates. As for stocks, this bear has just begun to run. And while he doesn’t fault Washington for birthing the Bank of Uncle Sam amid this crisis, Jim has serious reserva-tions about what may come next. We covered the waterfront, when we spoke last Friday. Listen In. — KMW

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in Mexico can be traced to it. Also, that the actor Idris Elba caught it in Italy at the same event where Justin Trudeau’s wife got it. And they traced other big events where the likes of Prince Charles and Boris Johnson were exposed. Their point was everybody keeps looking at medical technology, but transportation technology has actually had a bigger impact on the pandemic’s spread.

And could compli-cate the recovery — JIM: Air transportation and mobility can spread it faster than medical technology can tamp it down.

Especially with a diabolically clever virus that can make asymptomatic people highly infec-tious. JIM: Oh, I know. Now they’re talking re-infec-tion, too.

The gaping holes in our ability to even get people tested are mind-boggling. JIM: The problems with governments have been exposed. It seems like they’re just incapable of doing anything, when push comes to shove.

Competence is a really rare commodity. JIM: And not just here. Pretty much everywhere.

Only the likes of South Korea, Hong Kong, Singapore and Taiwan took the threat seriously nearly quickly enough. JIM: Yes, they took it seriously — because they’ve only been flattened by three or four of these things in the last 25 years. Nothing makes you take it seriously like experience.

An unfortunate human trait. Tragic, now. JIM: A little while ago I was on the internet and I was horrified by the pictures of mass graves on Hart Island. That there’s actually an event in the

United States that has come to that point. It’s almost surreal.

Where did the last several centuries go? Space is always at a premium in NYC. But this is sickening. And may change things. JIM: It depends on whom you talk to. Everybody

kind of uses this thing to push their own agendas — and not just political types. I got a call from a wealthy New York real estate guy who listened to my recent conference call for clients. His mes-sage was, “Oh no, you’re wrong. There’s not going to be a need for less commercial real estate; there’s going to be a need for more real estate. You’re going to go from 80 square feet a person, on average, in Manhattan to 200.” So real estate companies are going to have to dou-ble their holdings. I’m like, “Yeah, okay. The real estate guy thinks that the pandemic means that he’s going to sell more real estate.”

More office space? Older commercial properties were going begging before the pandemic. And residential was soft-ening. JIM: I know, both my 25-year-old and 23-year-old daughters have been

living in Manhattan. One on the Lower East Side and one in the West Village.

My old stomping grounds — JIM: Well, they’re home now. My oldest had just gotten a new job — the kind of career move she’s been angling for since getting out of school three-and-a-half years ago. She started March 15 and they shut down March 16. So she worked at it one day and got laid off last week. She didn’t renew her lease, which is up at the end of May, and if her company fails she might not go back. I’m just won-

“The question really is what happens after

this is over and we go back to work? What long-term changes

are there going to be? Some think that once we get past this pan-

demic, we’re going right back to the way we were... But it’s

much more likely there will be changes — ones that result in us being less aggressive than we were in the past.

And de-globalization is going to be a big one.”

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dering how much the population of New York City is going to be like that — if people just aren’t going to go back — then all of the sudden the demand is going to be severely reduced. There’s going to be more of that than your real estate guy wants to contemplate — JIM: I was trying to tell him that. In the space of three weeks, my daughter went from “This is the job I’ve been working for,” to “I’m not renewing my lease and I might just stay here in Chicago.” She must be just crushed. JIM: She is, but they’re hoping — the company she’s working for is rather small, and is applying for a Paycheck Protection Program loan. She works in the arts — she was going to be a man-ager for opera singers and the guy’s trying to keep everybody on staff, if he gets the loan. But that only works until what? The end of June? It’ll likely be extended — JIM: So I told her, but she was like, “Yeah, but when are we going to get big crowds back at the Met? Remember, it’s old people who like to go to the opera. How long until they’re willing to pack into the Met with 3,000 people again? Can we hang out that long?” She was telling me last night about whole opera companies that might fail. The second-largest opera company in London might file for bankruptcy. The New York City Opera, not the Met, but the second-largest one that Roy Niederhoffer runs, also might not make it.

They can’t wait months and months. They’ve already got operas scheduled for ’21 that are can-celling at this point. So she doesn’t know. She still is kind of in a state of shock and we’ll see. She’ll have a great story in 30 years, but that doesn’t help now. JIM: Exactly. Even though it will hardly be a unique story. It’s going to be repeated tens of thou-sands of times, if not hundreds of thousands of times, in New York City alone — let alone the rest of the country or the world, for that matter. The spike in unemployment statistics has been breathtaking. Albeit entirely predict-able when we’ve hit pause on the entire

economy. The big question is how can we safely get the gears turning again. JIM: That’s the question nobody wants to answer. I’m thinking about folks all the way from Chairman Powell to most of the money managers I talk to daily. Most want to talk about how bad is it going to get in the second quarter and then what kind of rebound are we going to have in the third or fourth quarter. So I say, “I can answer both those ques-tions appropriately. It’s going to be really bad in the second quarter and it’s probably going to be less bad in the third quarter — I don’t think you need to go much beyond that.” No one has a crystal ball — JIM: The question really is what happens after this is over and we go back to work? What long-term changes are there going to be? Some think that once we get past this pandemic, we’re going right back to the way we were. To put this in market par-lance, they expect we’ll go back to the January highs and we’ll go back to all the attitudes that we had pre-pandemic. They’re smoking something — JIM: Well, there’s an argument to be made — that’s possible. But it’s much more likely there are going to be changes — ones that result in us being less aggressive than we were in the past. And de-global-ization is going to be a big one. I don’t doubt it.

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JIM: People already have started talking about how we’re going to have to take back the manufacturing of strategic products, like pharmaceuticals and medical equipment, from China. But it’s not going to stop there. I think there’s going to be a general de-risking and a more conservative attitude. Mohamed El-Erian has got a great line about it. He says we’re going to move from efficiency to resil-iency. “No longer am I going to be excited, Mr. Cook, to hear about how you’ve expanded the Foxconn plant in China, so that you can make more and cheaper iPhones. I now want to hear what you are going to do the next time we’re shut down for three months. Do you have enough cash? Do you have enough capacity in facilities around the world that you can shift production among them and keep making iPhones in the next crisis? That’s not as efficient as the way you’re doing it now — but it is a lot more resilient than what you’re doing now.” Margins will be hit, big-time. JIM: Among other things. Companies are going to have to hold more cash; they’re going to have to hold more reserves. Goldman has said that the buybacks might go down by 50% from here for-ward. That makes sense to me. But buybacks have been a big underpinning of the stock market rally of the last 10 years. Huge. JIM: It’s been $5-plus trillion of buying. So if you believe that those are going to be some of the long-term consequences, then the S&P is not going to make it back to the highs for a while. I suspect that’s an understatement. JIM: There are other things that will change. I saw Steven Major [global head of fixed income research] at HSBC doing a TV interview the other day, and he was saying, “I wonder if the handshake is gone? I wonder if we’re going to keep elbow bumping or something like that forever?” Maybe culturally, the handshake never comes back. He might not be wrong on that. I mean, after something can’t be done for a while, then it’s no longer a habit, and it might be gone forever. And I guess what Steven was arguing was that if we’re going to have that kind of a change, then we’re definitely going to be having more of a de-risking attitude, as we move forward. Can air kissing from six feet apart be a thing? JIM: Right. My real estate friend that I was talking about was assuming — as everyone was when we

were two or three weeks into it — that working from home was — to use a technical term — a shit show. “I can’t get my computer to work and I don’t know why the printer isn’t doing this and I can’t connect to that.” But now, if you ask most people working from home, they say, “It’s okay, I got everything working.” I think that by mid-May — once we’ve had a good six weeks of everybody working from home, then everybody is going to say, “Okay, working at home is functional.” So, when we can go back to work in our offices, we’re going to look at pretty much every service sector job — Outside of health care, and things like res-taurants, in the main. JIM: Right. Yours is a service sector job, Mine is a service sector job — office workers are going to say, “Our jobs could be generally defined as doing two things: One part is creating intellectual property of some kind — writing reports, creating PowerPoint presentations, updating spreadsheets or something like that — all things we could do from home. Go on — JIM: Then, the other part of our jobs is where we are collaborating with employees, attending meet-ings, meeting customers — those are things that are often best done in an office. Although the pandemic is giving everyone a crash course in collaborating via things like Zoom. JIM: True, but also in its downside. So I suspect that, given the option, most people will still prefer in-person collaboration in the office. Maybe we will see a shift to service economy workers doing one or two days a week from home and then three or four days in office. If so, why couldn’t we do that with only 80% of the office space we’re using now? Maybe sharing a desk with someone else as the staff rotates through the office? After all, now that everyone has set themselves up with a work station at home, why not just keep working there, at least one day a week? All kinds of reasons. Maybe you’ve had to commandeer the dining room — JIM: That was my friend’s argument for why he was going to sell more commercial space. “They’re realizing that working from home is terrible.” But that was just at first. Now, people are adjust-ing. And I’m not saying we’ll work at home five days a week when this ends, just one or two. We’ll






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still need to collaborate and stuff. But not eight hours a day, five days a week. If that attitude were to develop, it could really hurt the commercial real estate market. What about the rest of the economy? JIM: The reason that I bring up commercial real estate — one of the things I’ve been pointing out is that, if you look at the fixed-income markets, the one that is getting hit the worst and under the most pressure is commercial mortgages. The commercial mortgage market is getting hit bad because that business model relies on people meeting in large groups. That’s true whether the property being mortgaged is for a restaurant or a hotel or a mall or a large office building — and that’s what we’re not having right now, large groupings of people. That makes the commercial mortgage market really ground zero for all of this. And I guess you’ve got to ask — When the recovery comes, do we go all the way back? Or do we keep all the tables six feet apart in the popular restaurants? Do we spread our-selves out a little bit more in hotels? If so, that would mean that hotel occupancy levels are never again going to approach their previous highs. Do we spread ourselves out in malls? If so, that means the foot traffic for retailers is going to drop —and the trend to online shopping will just accelerate further. It would be hard to be any more “socially distant” than the few shoppers I’ve seen in rare trips to malls in the last year. JIM: Exactly. You could really spread yourself out in some of the malls even before the pandemic. They are half-dead at this point. Look, I don’t know what all of the changes will be, but I’m pretty confident that there are going to be a number of changes coming down the pike in this economy, as it struggles to recover. And here’s a final thought on that. I saw Rick Scott, the senator from Florida, being interviewed a couple of days ago on TV. He got visibly angry and declared, “Anybody who buys anything made in China is immoral.” Full stop. Now, 60 days ago, he would have been roundly mocked for that. People would have said he’d lost it. You might even still argue that he’s lost it, despite being in the middle of the pandemic. I don’t think finger pointing is particularly helpful when everybody needs to focus on surviving — and beating this virus.

JIM: Point taken. But really, what I’m thinking more about is two things. One, who’s going to push back against Rick Scott? 23,000 dead Americans and you want to make the case for China? Good luck doing that right now. Politically, no one is going to make that case here, now — and nobody is going to make it in Europe, either. And second — I’m just thinking back to the Great Financial Crisis — the Tea Party movement, Occupy Wall Street, the political polarization — all of that comes after the crisis is over. When we’re in the middle of it, we don’t think about those things. But when it’s over, we start getting angry. That’s when people start getting angry at govern-ment responses and they get angry that, say, “I had a perfectly legitimate business and the govern-ment forced me to close and it failed and I lost my life savings.” This time, Congress at least seemed to have learned something from mistakes made in 2008 — focusing more on bailing out people, salvaging paychecks. JIM: Maybe we’ve put together all these bailout pro-grams now, but the relief is not going to reach every-body. They’ll get angry and when they get mad, the easy deflection is going to be “Well, it’s not my fault: it’s the Chinese’s fault. Blame the Chinese.” That’s why I think we could really see a move towards de-globalization and, especially, towards punishment of China; it’ll accelerate. That would open another whole can of worms. But POTUS revels in deflection, God help us. JIM: I’m probably wrong about some of these things and I’m probably not wrong ion others. But what I think is the real long shot is the bull case: “Oh, Americans will just forget. We’ll just go back to work. And we’ll go about the business of going back up to S&P 3400 — and wondering whether or not Apple is going to hit its numbers.” You’re determined to be a killjoy. JIM: Somehow, I think we’re not going to go quite back to where we were in January any time soon. Now, we’re not going to go into a Great Depression, either. But we’re definitely not going right back up those record levels. It’s actually surprising how quickly we could slam the brakes on the economy to accomplish social distancing — at least in






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most places — but it’s not going to be like flicking a light switch when we want to get it back up to speed. JIM: Not only is it not going to be like flicking a light switch, it’ll be a protracted process. Yesterday [4/9] Dr. Anthony Fauci was saying that based on their latest modeling, they’ve revised their projec-tion of how many Americans may die from Covid-19 to 60,000, down from the 100,000 - 200,000 that they’d previously estimated. Models, models everywhere. Good data, no. JIM: But getting better. What I thought were really interesting were some additional comments Dr. Fauci made. One of the things that has gotten the estimate down to 60,000 from 100,000 is that we actually have social-distanced, washed our hands and done the things we were told we needed to do — as he said, in amounts and with discipline that they never expected the American public to exhibit. And that is paying off with a severe flat-tening of the curve — even more than they thought possible just 10 days ago. You expected more of a cowboy response? “They can’t tell me what to do!” JIM: That we got so much cooperation says to me that we’re not sitting around waiting for Trump to tell us, or Mnuchin to tell us, or Andrew Cuomo to tell us, it’s okay to go back to work. We’re not? The governors told us to stop. JIM: No, I think we’re going to go back only when we’re ready to go back to work — not when they tell us it’s time to go back to work. Or to be more specific, they’ll tell us it’s okay to re-open busi-nesses and they’ll be re-opened, but — Who’s going to patronize them? JIM: What I’m thinking is that we’re going to sit down with our boss and say, “Okay, we’re going to come back into work on Monday, but here’s what we are going to be willing to do. And, when we open the doors, our customers are going to come back when they’re ready to come back. They’re not going to be lined up in front of the door 10 minutes before we unlock it. Because, they haven’t been sitting at home ready to crowd into the popular res-taurants or crowded into the Apple Store — or whatever image you want to use. They’ll come back slowly.” In fact, we saw that in China. True enough. JIM: I know that Apple was one of the first com-panies to reopen their stores in China, back in late-February/early-March. Basically for the first

three weeks or four weeks they virtually had no customers because people — and I’m talking about people in areas that weren’t locked down in China — they just weren’t ready to go back just yet. Now, I’m not saying we’ll never go back. I’m just saying we’re going to go back at our own pace, and really what you just said was, “We’re not waiting for Trump to tell us it’s okay to go back. We’re waiting for the availability of testing for antibodies; we’re waiting for masks and gloves and Purell and all that kind of stuff, so we can safely go back.” You bet. As well as effective treatments and maybe even a vaccine. JIM: Well, ultimately a vaccine. The reason that I left a vaccine off that list is — if you believe everything I’ve heard, and that you’ve heard, too — that’s likely to take until late next year. Alas. JIM: We’re not going to wait around until late next year to start reopening for business. I’m talking about what we could do before that. But ultimately, yes, we’re still going to hold out for the vaccine before we can really start talking about returning to normal. And what does “normal” mean? JIM: Exactly. Then — if we get a vaccine in 18 months — the question is what is normal? After you’ve gotten me into a habit, or you into a habit, for 18 months, how do we undo that habit? Maybe we don’t quite undo it. What I’m trying to say is there’s going to be some-what less risk-taking, more emphasis on resiliency, a de-globalization — and that is not going to get us to the aggressive earnings numbers, 20 forward P/Es, and low interest rates, that it would take to take to get the S&P 500 back up to 3400 soon. Eventually, we’ll make it back there, but not soon. “Eventually” can be quite a long time, as you know as a student of the history of markets. I mean, this is a bear market, I don’t care how you want to cut it — JIM: Oh, of course. It’s already met the definition of a bear market. Completely. And it’s not over, just because we’re having a bear market rally. JIM: Well, the thing about bear market rallies — I am a chartered market technician, so I’m going to put my technical analyst hat on and say that as of last Friday [4/9] we closed at 2789 — I’m looking at my Bloomberg right here in my home office —

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and that’s like literally 2 points away from a 50% retracement — so let’s call it a 50% retracement. Sounds zippy, unless you know history. JIM: Right, if you look at the history of bear mar-kets, rallying to a retracement of around 50% to 66.6% of the entire decline is something that tends to happen two or three times during a bear market. In 2007, the first move down from October to November of 2007 [1406.07] was just an 11% cor-rection — and we then retraced 75% of it [to 1523.57, in December]. But then the market fell down to the Bear Stearns low [1256.98] of March of ’08 — and we retraced 40% of that [by mid-May]. Then we went down to the Lehman low, which was a lower low [741.02]. Yet we still retraced 50% of that the whole move before we finally sank to the March of ’09 low [666.79]. It was a devil of a time for investors. JIM: But not really out of the ordinary in a bear market. We saw the same thing in 1973/’74. The first move down was January to August of ’73 — then we rallied to retrace two-thirds of that move before we made a lower low in the spring of ’74 — followed by a 41% retracement of that move. Then the market made a lower low in October of ’74 and then a double bottom that December, which finally signalled the end of that bear. And you could say the same things about the 1929 crash. There was a two-thirds retracement — or 61.8%, technically, from the October 29 crash low into the spring of 1930. Then the bear re-emerged. Killed everyone. JIM: Right, we didn’t take out the October 29 low for almost a year — but we eventually did. Long story short, Right now, the market has done a 50% retracement — Ho hum. You’re not impressed. JIM: Yes, that’s what happens in bear markets. The first retracement is usually the biggest retracement along the way. So, for the moment, this just looks more like a bear market rally. And as you said, it could take a long time to get out of this bear. Which will be quite an adjustment for many, many investors. JIM: So I’ll give you a stat here — in fact I’ve got it up on my screen and was looking at it as you were calling — the Federal Reserve puts out their finan-cial accounts — The Z.1 report, at Federalreserve.gov —

JIM: Yes, and in there they break out wealth by age cohort in the U.S. If you group some of them together, you can see that 58% of the nation’s wealth is held by baby boomers; 18% of the nation’s wealth is held by Gen-Xers; and something like 5% of the nation’s wealth is held by Millennials. Now baby boomers were born as recently as 1964, so the youngest baby boomer is 56 and folks that age and older hold well over half the wealth in the country. Life expectancy is somewhere around 77 years in this country — let’s call it 80 or so if you want to just round it off. Well, the average baby boomer is in their early-60s — owns over half the nation’s wealth — and they’ve got 18 to 20 years left to live. If they need more retirement income, they can’t wait 10 years for a bear market to run its course and then maybe start a secular bull market. That would be half their life expectancy. Rub it in, why don’t you — JIM: My point is that their attitude with regard to the majority of that wealth is going to be a lot more conservative. I’ve always said that a bear market is about time not price. And how long does it take to recover? The problem is that most wealth is usually held by older people and so a bear market is devas-tating to them. If you’re 35 years old, and I tell you, “Okay, this bear market — I don’t know if it’s going to last 10 years, but just use that number — it’s going to take 10 years and then when it is over, we’re going into another 20-year secular bull mar-ket.” Your reaction is probably, “Fine, I’m 45 then, and if a 20-year secular bull market takes me to 65, I’m fine with that. I’m not going to change my asset allocation. I’m going to ride this whole thing out.” That might actually be a prudent strategy. But if you’re 63, it is a different story altogether. “You mean that at 73, I’m going to be at the same point I was in January of this year? I can’t do that. That’s half of the time I’ve got left. I want to retire in three or four years and I want to start living my retirement as I envisioned it just 60 days ago. I don’t want to wait.” No kidding. JIM: I know the bull story is, “Well, stocks always go up.” Yes. But you don’t always live forever, and that’s a problem that becomes acute when a bear market happens. And this one is happening with the majority of the wealth held by the cohort we know as baby boomers — Naturally, enough. Boomers are the largest cohort and this time around have had the most time to accumulate that





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wealth. This is the opposite of ’73-’74, when we were just getting out of school. JIM: Right, my point is that in contrast to during earlier bear markets, this time, with even the youngest boomers in their mid- to late-50s, there’s a new urgency among boomers not to risk what they have. “Yes, the stock market always goes up, eventually, but where am I in the demographic cycle? The market has all the time in the world to wait for the next bull — but I don’t.” Clearly, you’re expecting older investors to pull in their horns, not to turn into river-boat gamblers to try to make up ground? JIM: Yes, and the other problem I think boomers are going to face is — let me say it this way — I have been an unapologetic bond bull for two decades — Amid a 30-plus-year bull market. JIM: Right. But I now think that the bull market in bonds has ended. It ended last month. Maybe we retest the lows in the next month or two or six. But I think the next secular move in interest rates is now going to be up. And I suspect that the large driver of the next secular move in interest rates — higher — is going to be inflation. Because? JIM: All the stimulus that we’re pumping into this economy — it was $6 trillion: $4 trillion by the Fed, $2 trillion from the stimulus package, until Friday. Then the Fed threw another $2 trillion on top of that, so now we’re up to $8 trillion. That is $14,000 per person — that’s what you get if you divide $8 trillion by 327 million Americans. If you divide by the number of U.S. taxpayers, it’s about $40,000 a taxpayer. Inflation? In an economy stopped cold? JIM: No. We’re not going to get inflation now. We are going to see Great Depression-type economic statistics in the second quarter, maybe set some all-time records — I think the all-time record is 23% unemployment — and we could very well take that out in the second quarter. We could see a 25% decline in annualized GDP in the second quarter — that would be about a 6% decline over-all just in that quarter — and a 25% annualized decline in GDP would be the worst in American history. We won’t know until July. But there was no quarter that bad in the Great Recession. There was no quarter that bad in the Civil War, according to some studies I’ve seen. In the Great Recession of 2008, real GDP, from peak to trough, only fell 5%. That was it. And

think of the pain and stress that caused. We’re going to drop 6% in just the second quarter, as I said. Now, peak to trough, the Great Depression was worse, but so single quarter was as bad as the second quarter is likely to be. So, okay, we’re not going to see anything resembling inflation over the next couple of quarters because of that massive contraction. Then inflation is your long-term forecast? JIM: Yes. The virus will peak, it will recede, it will go away, there will be a vaccine in 18 months. And there will be behavioral changes that will get us back to work and stuff like that. But all of this sti-mulus — as I like to jokingly say — if this doesn’t produce inflation on the other side of the V — we should delete the word from the dictionary. The V? You see a V-bottom? JIM: I do think it will look like we’re having a V-bottom, but that we’ll come up short on the upside — and that’s where the bottom will start to look like an L. So I’ve been arguing that we’ll have both a V-bottom and an L-bottom. How so? JIM: We’ll have a really bad second quarter, and then the economy will start to get less bad — that’s the part that will make my V. But won’t bounce all the way back to the peak and that’s what will make my L-bottom. But like I said, if we don’t get infla-tion on the backside of the V, then we should delete the word from the dictionary. Because if this doesn’t do it, nothing will. But — JIM: I know that Jay Powell made the argument yesterday [4/9] that, “Well, that was the argument that we heard after all the QE started in ’08 — that it would cause inflation — but it didn’t. Yes, that argument actually was wrong. Yet it’s still argued in some quarters. JIM: That’s true. And it was wrong. But boy, what we’re doing now makes that look like child’s play. And we’re not done. They’re talking in Washington about another stimulus bill. So we’re not done pil-ing up stimulus on top of stimulus. And I do think that we will eventually see inflation coming on the other side of all this stimulus. There’s nothing wrong with a bit of infla-tion. The Fed has been trying to gin some up for a while. JIM: Right — We’re presumably not talking anything like


WOWS 2020 Issue Dates

January 17 February 14 February 28 March 20 April 17 April 17 May 8 May 29 June 19 July 24 August 21 September 4 October 9 October 30 November 20 December 11





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1979’s runaway 13.3% annual CPI inflation — JIM: No. But look, you and I are old enough to know that there is a thing called inflation, even if we haven’t seen any to speak of for 20 years — we’ve talked about it, but it really hasn’t arrived. I’ll just be happy with, “Hey, look at that. It’s actual inflation.” Happy to see inflation numbers actually rising not just because crude oil prices are going up but because of a general rise in inflation. It doesn’t look like rising oil prices are in the cards any time soon — JIM: Right again. But what I think causes inflation to come about is all this stimulus — $600 a month from the Federal government in unemployment checks —on top of what you get from your state. That will keep demand to buy stuff artificially high. Not much, when it’s going for food basics and maybe to pay rent or mortgage bills. JIM: Now, I’m not talking about extra unemploy-ment benefits spawning conspicuous consumption — not when it’s going for rent and car payments, mortgages and basic necessities. Nonetheless, a lot of businesses are going to go under during this pause, so the available supply of stuff to buy will shrink. And that’s where we’re going to get our inflation from. We’re stimulating people to keep the demand coming, but we’re not really stimulat-ing to keep the supply moving. Look, Congress passed a paycheck protection pro-gram but what’s it designed to do? It’s designed to help some businesses continue to pay their employees — even though those businesses aren’t producing their products or services anymore. So the workers keep getting a paycheck so they can keep paying their mortgages, buy stuff. But they’re not working to produce anything. Supply isn’t increasing. Yes, demand is falling, but it probably falls less than supply. That’s where the inflation starts — and the bear market in bonds kicks in. The virus is killing the invincible bond bull? JIM: I expect we’ll not only have some rising prices, but higher interest rates. Again, baby boomers don’t want to hear that, at all. Many are only finding solace in their bond portfolios at this point. “Don’t worry. I’ve been in this 60/40 portfo-lio and the 60% in stocks crushed me — but the other 40% is bonds.” That’s not going to help them if we start seeing higher interest rates as well — and when the cost of capital goes up, the multiples on the stock market contract — Contract? From here? Say it ain’t so!

JIM: Sarcasm noted. But people still think, “Multiples don’t contract.” Yes, they do. If infla-tion drives interest rates higher, then you can’t be thinking about the S&P’s earnings times 20. It’s more like, what’s the S&P’s earnings times 15, or even times 12, in a higher rate environment? And earnings contracting at the same time as multiples equals misery — JIM: You bet. It’s just it’s been so long since we’ve had to worry about contracting multiples, as well. So there is another issue I think we’re going to see on the backside of all this. More immediately, on the downside here, we’ll still have sub-1% long-term interest rates — and we might even go back down to 30 basis points on the 10-year Treasury one more time, which is what we hit on March 9 — but that’s about it. What makes you so sure this is finally the end of the mighty bond bull market? JIM: What I’m arguing is that this pandemic is a contractionary event that will last no more than 18 months — because that is when a vaccine kicks in. At that point, and maybe even sooner as anticipa-tion builds that the vaccine is coming, we’re going to see a lot of focus on the stimulus effect of the coronavirus response producing inflation. So you’re talking about a broad bottoming of interest and inflation rates, nothing on the order of a spike or V-bottom. And the bond bull market has been pointing in that direction for some time. JIM: Yes. It really has. And we might well have ended it with a spectacular blow off move when we saw the bond market going to 99 basis points on the 30-year and 30 basis points on the 10-year at that March 9 low in yields. That was like a 100-basis-points-drop in like three weeks. Breathtaking, for bond types. JIM: It was stunning. Everything that’s been hap-pening in the bond market has been stunning. I remember, we were passing charts around of the long bond’s price, and saying, “In a normal period, if I showed you this chart of a price going from 100 to 130 in three weeks, you might have asked me ‘What tech stock is that?’ But the chart was actually of a U.S. Treasury.” U.S. Treasuries don’t rally 30% in less than a month. But from late-February to mid-March they did — and then reversed a lot of that, as well and are trying to do a double top, too. It’s been truly





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unprecedented. There’s nothing of its kind in the classic book on the history of interest rates in the United States — I’m having a senior moment — JIM: You mean the Sidney Homer, Richard Sylla book, A History of Interest Rates. In the last couple of years, when I’ve given speeches about what’s going on in the bond market, I’ve actually brought it with me. I hold it up and say, “710 pages and 5,000 years of history of interest rates. Do you know what there is not one word about in this book? Negative interest rates. That was never a thing until 2015.”

Another new thing is that late last year, with the combination of negative interest rates and the virus — Austria has a 100-year bond — and in the space of 6-to-8 months — from late-summer until March — it rallied 80%. Now, the reason I mention that is it’s a triple-A security. That may be the only triple-A-rated secu-rity in history that rallied 80% in less than a year. That’s not what they do. That’s why they’re triple-A. They’re not supposed to be volatile like that. So we’ve turned a lot of things on their head here in this market. No argument. The repo market’s distress — and the Fed’s response — starting months ago were a red flag to anyone pay-ing attention. JIM: Right. It was the whole “not-QE” thing. “This is not QE.” There definitely was something wrong, but it took the virus crisis to find out what the problem was. Which was that regulators and cen-tral bankers are like generals: they’re constantly fighting the last war. When they looked at 2008, they said, “What was one of the problems? Too much leverage. The banks and the brokers were too aggressive.” Okay, that was an accurate description. But what happened? They spent the last 12 years putting together rules to prevent banks and brokers from leveraging. And not just one regulator did it. All of them did it. It’s the Fed, it’s the ECB, it’s the FDIC, it’s the European Banking Group, it’s Basel III, it’s the Bank of International Settlements, Bank of Japan and Bank of England and the Financial Securities Association — in the UK — Total groupthink. But for good reason. JIM: But what happened in September was that we

started to hit the limits of the amounts that banks can leverage themselves. So they could not expand the repo market to meet the ever-expanding overnight financing demands of ever-burgeoning securities markets. That’s where the Fed had to step into the repo market. Then, when we got into the pandemic crisis in February and March, it became increasingly clear that the banking system was impaired. All protests to the contrary, notwithstanding — JIM: Let me explain what happened in the banking system in February and March. Please do — JIM: Today’s stock market and the futures markets are largely, to use the modern word, “platforms.” You put in a bid, you put in an offer, in the stock market — and you just sit there and wait for some-body to come in with the other side of your trade and match it. But the fixed-income markets are still largely dealer markets. If you want to buy or sell something, you call a bank or a broker and they typically will buy or sell it out of their inventory. Right. Bonds still largely — but not exclu-sively — trade the old-fashioned way. JIM: Well, in late-February/early-March when this thing hit, all of the fixed-income accounts called up all the dealers and said, “Sell. I want out. Sell to you.” So by mid-March, the dealers’ balance sheets were bloating and bloating with more and more inventory — To the point that they ran up against lev-erage limits. JIM: They couldn’t buy anything more and that’s when the markets became dysfunctional. Early on in all this, the Fed was saying, “We’re going to offer a trillion dollars a day of repo financing.” They were trying to get the dealers to expand their balance sheets more. The problem was that the dealers were taking down the repo in that size, while saying to the Fed, “I’m regulatorily con-strained from doing this.” And the Fed said, “Okay, forget my rules.” But the dealers said, “You don’t understand. It’s 15 agencies around the world that are telling me that I can’t do this. You’re just one. You need the other 14 to change their rules.” At that point, one large dealer said to me that — now let’s be clear, the Fed did not tell them this, but kind of suggested to them, “Just ignore the rules and do it anyway.” That dealer’s retort, I thought, was really good. They said, “I remember JPMorgan in 2008. The Fed kind of told them the same thing. ‘JPMorgan, we need you to buy Bear






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Stearns.’ ‘Oh, but I need to do all this due diligence and I’m worried about this and that.’ ‘Just do it.’ ‘JP Morgan, we need you to buy WaMu. Just do it for the greater good.’” And they did. And lived to regret it. JIM: Exactly. When the crisis was over, it turned out that Bear Stearns and Washington Mutual were very bad actors, so we saddled them with billions of dollars of fines. But since JPMorgan was then the owner of those companies, the fines flowed through to JPMorgan, which wound up getting screwed on those deals. JPM didn’t go into those deals with blinders on — JIM: Still, this time around, the dealers were under-standably cautious. “You’re asking me to do you a favor now. But what we do know is that some day the virus will pass and then you’ll come back and be astonished and disappointed that we violated all those rules — and you’ll punish the hell out of us. No thank you. I’m not doing it unless the Justice Department sends me an indemnification letter.” So what the regulators have been spending the last three or four weeks doing — all of them — is try-ing to tear down the rules that they’ve spent the last 12 years putting together. But they can’t tear them down fast enough. Which is why the Fed jumped in and said, “Okay, if I can’t get the dealer commu-nity to buy this stuff, then I’ll do it.” That’s why you’ve had this massive expansion of QE and the Fed has been buying bonds at a rate of $200 billion — or $300 billion — a week. The numbers have been just incredible. But I have to agree with Paul McCulley. Only the “Bank of Uncle Sam” — the Treasury plus the Fed, authorized by Congress — has the firepower to keep not just the markets, but the economy, afloat amid this crisis. JIM: What I question is what this does to the econ-omy and markets, long-term. They’re getting into buying corporate bonds. They just said they will buy munis. And junk — or at least fallen-angel junk. There are two quick points I want to make about that. Since the middle of March — I’ve got the chart [above] I’m looking at — the Fed has bought almost $1.25 trillion worth of securities in the space of a month. Yet interest rates haven’t done anything. To me, that speaks volumes about the end of the bull market in bonds. That a buyer spending a trillion-plus dol-lars hasn’t moved the needle?

JIM: Precisely. If, in normal times, I told you there was buyer in the market looking to spend a trillion dol-lars plus in less than a month, you’d expect the entire yield curve to be at zero right now. But it’s not. And that’s because there’s massive liquidation going on everywhere else. So the Fed has not been only a trillion-plus dollar buyer of Treasuries, but it has now made all of these announcements that they’re going to buy munis and corporate bonds — and bond ETFs. But, by the way, they haven’t started buying any of that stuff yet. Again, they’re a slow-moving bureau-cracy. They need to put together operational rules and they need to put together understandings about how this is going to work. They’re writing these as fast as they can and they’ve told us that they hope by mid-April that they would be able to start buying them. I think mid-April is the 15th — that’s next Wednesday — so let’s see if they actually start get-ting into these markets by Wednesday. I know that they’ve hired BlackRock to buy corporate bonds and I know that they’ve hired PIMCO to run their com-mercial paper program, but they have not started that yet. [Still no sign as of Friday afternoon.] Execution is always the trick. JIM: Actually, I think it’s more than that. If you asked me the question, “But is the Fed allowed to buy ETFs? Is the Fed allowed to buy corporate bonds? Is the Fed allowed to buy commercial paper? Is the Fed ALLOWED to buy high-yield fallen angels, or asset-backed securities, which they’re also getting into — or lend against those securities?” My answer would be no. They are not allowed to do that. According to my understanding of the Federal Reserve Act and its amendments that came along with Dodd-Frank, they’re only allowed to buy stuff that has a government guarantee — Treasuries, or agency-backed mortgages, which are Fannie and Freddie guaranteed, because they’ve got an implicit guarantee by the government, or any debt that Fannie or Freddie issue. You could maybe make an intellectual argument that the Fed is also allowed






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to buy munis, but we’ve never really gone that way. That’s precisely why Congress had to authorize the Treasury to do the buying — and let the Fed then leverage its actions. JIM: Yes. My argument has been that the Fed isn’t doing all of this stuff. The Treasury is doing it. The way that I’ve been explaining it is that what is hap-pening is for all of this alphabet soup of programs — the CPFF, the TALF, and all of the others — the Treasury is putting together funds, known as Special Purpose Vehicles. The Treasury puts money into those funds that’s either given to it directly by Congress or through the Exchange Stabilization Fund. Then, what the Fed does is just provide financing (leverage) for that fund. And it can do that, because as a Treasury fund, the SPVs are guaranteed by the Treasury. The fancy language that the Fed uses to describe this situation is that the Treasury will fund the SPV at X billions of dollars and be in a first-loss posi-tion. What does that all mean? I know what that means. That the Fed is going to leverage the hell out of the Treasury’s “equity” in the SPV. JIM: Yes. Because, for instance, I own Bianco Research, that means if my company generates losses, I take the hit as the owner. In essence, the Treasury will be the owner of all the SPVs, buying fallen angels, or corporate bonds, or ETFs. Which means the Treasury, all of us taxpayers, will be tak-ing the losses on those transactions. The Fed can only provide the financing or the leverage for all those SPVs purchases, because the Treasury owns them, so they are government-guaranteed. Three times during the presentation Jay Powell made on this on April 9, he reiterated that any-thing they do in the alphabet soup programs, the Fed needs to get the Treasury’s permission on. That did stand out. The Fed traditionally asks no one’s permission. JIM: There are two things to understand about that. One, the Treasury is buying all of that paper. And two, the Fed is effectively giving away its indepen-dence: The Fed is now merged with the Treasury. So when it comes to these programs — and I hear all my friends on Wall Street talking about “When the Fed decides that it’s time to pull back from these programs.” Uh-uh, the Fed doesn’t decide when to do that anymore. The Treasury decides when to do that. Donald Trump will decide when it’s time to stop doing this.

Pretty scary when you put it that way. JIM: Right. What was Trump saying, pre-virus? “Oh, if the Fed would have only done the right thing,” — basically, meaning print money like mad to lower interest rates, “the Dow would be 10,000 points higher.” Well, we just gave Donald Trump the ability to run the printing press, that is what we’ve done in creating your “Bank of Uncle Sam.” I think it’s a bit more complicated. The Fed, the Treasury and Congress had to cooperate to do it — JIM: Right. And I hear my friends on Wall Street say, “Well, in three or six months, when the Fed decides that they’re going to pull back —” Time out here. The Fed, through the Treasury, is going to buy cor-porate bonds, buy municipals, buy corporate bond ETFs and buy commercial paper. So this is going to ramp the stock market higher. And around September 30 — five or six weeks before the elec-tion, the Trump Administration is going to say, “Sure, now is a good time for you to pull back all this liquidity, even though we might be risking making some waves in the stock market, or even a sell off.” No way! Trump is going to tell them, “No way, you’re going to turn on the printing presses even faster.” That’s what we’re going to wind up doing. Maybe. The Bank of Uncle Sam concept does assume rational decision-making behind shifting through a cycle between independence and cooperation among fis-cal and monetary authorities. Trump could certainly challenge that if it comes time to shift gears before November. But that’s probably a very optimistic statement, on multiple levels. JIM: My belief is that the reality is that it will be politicians deciding this. Now, the Fed guys will say, “Well, we did something like this in 2008, and we were able to withdraw the liquidity support.” But maybe, if they’re honest, they’ll admit that all the QEs they did then, added together, still amounted to doing it on a much smaller scale. And I’ll make two further points. When they put together all of their SPVs in 2008, the whole idea was new — no one really understood it. The second point is that back then we had a White House — in both the Bush administration and in the Obama administration — with Tim Geithner as the Treasury Secretary. In other words, the Treasury






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Secretary was the former head of the New York Fed, and he pretty much deferred in making those decisions to the Fed. “Ben Bernanke, you decide what we’re going to do with this. We’ll go along, at Treasury, with whatever you say.” Maybe we were lucky in retrospect. But historically, anyway, this country has found ways to surface competent leaders amid the crucible of a crisis — even if, as Churchill may or may not have observed, only after trying every other alternative. JIM: Call me more hard-nosed. This is 2020. We’ve had 12 years to understand these programs, we have a much better understanding of what’s going on with them. We have a better understanding of what their power is — and we didn’t really under-stand that 12 years ago. Most significantly, we have an administration that has a hostile relationship with the Federal Reserve. What’s more, that hostile relationship is all about the fact that the Fed has not been printing money like mad; that the Fed has not gone to negative interest rates. Trump has wanted the Fed to be far more aggressive than the central bank actually has been — and now we are giving Trump the ability to make the Fed do his will. At least through the election, there’s no way that this Administration is going to stop the flood of money. And what if Joe Biden wins? Who knows what the Democrats’ attitudes are going to be then? Yet Wall Street loves this thing. Wall Street is think-ing that it is just brilliant that the Fed is being aggressive in pumping all of this money. Of course, because much of the money is being pumped through the Street. But that was even more true the last time we were in a crisis. JIM: Well, Bob Michele — he’s the Chief Investment Officer of JPMorgan Asset Management — and its head of Global Fixed Income — a tril-lion dollar plus money manager — was on Bloomberg TV in the middle of last week, saying, “The Fed needs to take over everything. The Fed needs to go to yield curve control.” That is fancy language for no longer having freely traded Treasury markets; just setting the price. Set the price of interest rates at zero out to ten years, at 50 basis points out to 30 years — and set the price of every single corporate bond at 2%. Just forget price discovery, forget the efficient allocation of capital through the capitalist system, set the price of everything.

Let me stress, that’s the CIO of JPMorgan Asset Management who is saying that. But hey, he’s not alone. Rick Rieder, who’s the CIO of Fixed Income at BlackRock has said similar types of things over the last year, as well. Your point is? JIM: If Biden becomes president I’m not so sure that we’re going to end up being any more prudent with a lot of this stuff. Because? JIM: Well, look at Glenn Hutchins or Roger Altman or any of the other Wall Street moneybags that are behind Biden. Do they like this idea that the Fed is basically printing money and buying paper from them at a profit? Do they want to keep this going and going and going? Or do they think, altruistically, “No, we need the Fed to shut this down after the cri-sis is resolved, even though that might mean my financial services firm, or my finances, will take a step backwards.”

I believe that when you start getting into these games like the Bank of Uncle Sam, as McCulley calls it, you need to be very careful because people will start liking it. People will start gaming the Bank of Uncle Sam and they may not want it to end, at least initially. They’ll want it to end, eventually — when we get inflation. But that will only happen when it has become obvious. And that will be way to late. We’ll need to end it earlier, but that’s not when a consensus will form. So my fear is that we won’t be able to end it until it’s way too late. At the risk of misspeaking, Paul’s point is that our immediate problem is deflation, not in inflation, and in fact, a little infla-tion would be welcome. At any rate, if we solve the immediate crisis, we’ll have time to make the necessary readjustments later. If we don’t, it won’t matter. JIM: I’m not predicting that anything will happen. I’m just saying, “Boy, we’re on that road, and I really hope we get off it at some point.” I’d like to see reasons to think that we’re going to show, as I said, discipline and that we’re going to show restraint when it comes to the Bank of Uncle Sam. But those are two words I usually don’t associate with Donald Trump — discipline and restraint. Nor do I. And we have a lot of company. But let’s shift our focus to where we were in the cycles when the virus hit. There’s a mythology out there that everything was great until we hit pause.






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JIM: Yes, there is. Yet the corporate debt market, among others, was an accident waiting to happen. JIM: Absolutely. The repo market had already broken, and it’s a form of corporate debt — the paper is securitized, but it is a form of corporate debt. We were in the 11th year of an expansion that was showing signs of fraying. The economy’s growth was very slow, the stock market was at very high valuations. I don’t want to say that things were bad, but the economy and markets were definitely show-ing signs of wheezing. Don’t forget the bulge in the corporate debt market — the assets outstanding in the class of bonds rated just above junk had grown far faster than assets in better-rated corporate debt. Downgrades were looming for a whole lot of companies on the cusp of slipping below “investment grade.” JIM: I think that was a giant mistake by the rating — it was an unforced error by the rating agencies. Blaming the rating agencies, again? JIM: I understand that as a rating agency you can pretty routinely downgrade a corporate bond to tri-ple-B-minus, which is the lowest investment grade. But to downgrade it again — well, the jump from triple-B-minus to double-B-plus is a big jump. So you could tend to stall there at triple-B-minus. You hesitate to go to the next — non-investment grade — step down. But the problem is — and this what the unforced error is — the rating agencies should have known that if all these issues were piling up in the triple-B-minus category, because they hesi-tated to push them down junk, they’d be forced to do it anyway, in a crisis. In other words, the inevitable next downturn makes the deterioration in those credits unmistakable and then the credit agencies have to give us waves and waves of downgrades at the worst possible time — in the middle of a crisis. We would have been better off — while the economy was still expanding — if the credit agencies had just pushing all those tenuous credits into the high-yield category, while we were better able to handle it. You’re saying the rating agencies should have anticipated the pandemic? JIM: No, they couldn’t have foreseen a pandemic being the pin. But they could have seen that there was a bubble. This is Peter Schiff’s favorite line — COVID-19 is the pin — quit focusing on the pin. There was a bubble out there in triple-B-minus

debt and they should have seen that they were add-ing to that bubble — and should also have known that a pin would come along at some point. And now that pin has come along. In fact, I suspect that was part of the Fed’s thinking yesterday [4/9]. In what sense? JIM: Well, one of the things the Fed said was, “We’ll buy anything that has gotten downgraded to junk after March 22.” Why March 22? I was just about to ask — JIM: That was when they said, “We’ll buy invest-ment grades.” So now the Fed has opened their support program to any bond that has gotten down-graded to junk — become a fallen angel — after they said they’d buy IGs. I think the Fed knows that the rating agencies basically outsmarted themselves in letting that giant bulge bracket of triple-B-minus stuff just build and build. And the Fed also knows that the agencies now have to downgrade those issues in a major league away. For instance, Ford got downgraded on March 24, so its paper qualifies for the Fed buying program. And Ford’s long bond price soared 20 points yesterday, from 60 to 80. But Occidental Petroleum’s debt issues got down-graded on the March 18 and March 20 — before the 22nd, so that debt doesn’t qualify for the Fed buying, and its bonds didn’t move much yesterday, even though the whole market was up. So this Fed buying is also creating bifurcation in the market in the junk space. Bonds that qualify for Fed buying and those that don’t. Delta got downgraded to junk just this morning but not to worry: the Fed can buy Delta’s bonds as well. But they can’t buy Occidental because it was down-graded two days too early. This is the mess that is being created. What boggles my mind is the prospect of the Fed buying ETFs. It’s very Japanese. JIM: They’re limited to buying bond ETFs. Originally, it was any ETF that owns a significant quantity of investment grade bonds. So that would be LQD (the iShares iBoxx $ Investment Grade Corporate Bond ETF), which is the big investment-grade ETF, and that would also include AGG (iShares Core U.S. Aggregate Bond ETF) and BND (Vanguard Total Bond Market ETF), because those are the aggregate and the broad bond market ETFs, which hold some investment-grade corporate bonds. Then, yesterday, they expanded that list to include buying the high-yield ETFs, so HYG (iShares iBoxx $ High Yield Corporate Bond ETF).


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Of course, one of the problems the Fed is now hav-ing is that they hired BlackRock to run their ETF-buying program — and LQD and HYG and AGG are BlackRock ETFs. Gee, a conflict of interest? JIM: Well, you tell me. BlackRock has been hired to basically sell its own inventory and its own ETFs to the Fed. I get it. The Fed doesn’t have expertise in trading ETFs, or in trading corporate bonds — nor do we want them to — so I get it that they’re better off hiring a professional firm, like BlackRock, to do it. Yes, BlackRock has a conflict of interest, but so would anybody they hired. If they hired Vanguard, or Goldman Sachs, or anybody, they’d all have the same conflicts of interest. My point is that the Fed has to tread very carefully to come up with a way to do this without it looking like BlackRock is setting itself up to game the system for its own benefit. Easier said than done — JIM: I’ll bet that they can do it. But I think that’s one of the reasons why the Fed hasn’t started buying this stuff yet. They’ve got to put all of these Chinese walls in place first, before they can start buying ETFs in the fixed-income space. But once they’ve got that program going and once they’ve started buying ETFs — remember, it’s the Treasury that is actually buying the ETFs, with the Fed providing the leverage — Steve Mnuchin could easily say to Jay Powell, “Expand the pro-gram into buying the SPY” (the SPDR S&P 500 ETF Trust). “The President is all in on buying equity ETFs, too.” That would be all it would take — not much. You’re saying we’re on a slippery slope? JIM: And what would get them to take that next step? My guess is a retest of the lows. They’re not going to announce that next week, with the market rallying. But if the market starts to stumble again and is retesting the lows — Well, buying the SPY would not be buying equities outright. I know that Mnuchin and Powell are loath to do that — and they should be. But they could definitely rationalize that they could start playing in the equity ETF space, as well. That’s trillions of dollars right there of equity support that they could be providing. And as you implied, the Bank of Japan already buys equity ETFs. Which seems to buffer the Topix on the

downside, but hasn’t lit any fire under it. Still, isn’t government support of equities, the risk piece in capitalism, a bridge too far? JIM: Exactly. One of the reasons I think Powell and Mnuchin are loath to buy stocks outright and why they’ve been loath, until now, to get into high-yield bonds is because at those levels of the capital structure, you’re getting into the management of these companies. When you own high yields — even if you buy a Ford or anything else that’s been downgraded — if you buy a Delta — there’s a really good chance that as we move forward from here, there will be a restructuring. And a restructuring will require the bondholders to approve it. Maybe even take a seat at the restructuring table. Even if that doesn’t result in the bondholders exchanging some debt for equity, that means the Fed — as the bondholders’ agent — will have to form an opinion about the management of that auto company or airline and approve or disapprove its restructuring plan. And similar stewardship issues arise when you get into equities. If they bought stocks outright, they’d have a vote the proxy every year. Now, the Fed would probably say. “Oh, we’ll just do what ISS — Institutional Shareholder Services — says.” Most likely. JIM: But let me put it another way. Suppose Biden is the president and all of the sudden a powerful member of Congress steps up — say, Alexandria Ocasio-Cortez — and says, “I want to have a say in voting those proxies.” Remember, the stocks wouldn’t be owned by the Fed, they’d be owned by the Treasury. Maybe it wouldn’t be AOC. Maybe it would be Nancy Pelosi or Chuck Schumer, or all of them together, who’d decide that their constituents’ shareholdings entitled them to tell Corporate America how to do stuff. Well, it would entitle them to vote as shareholders, anyway. Isn’t that share-holder capitalism? JIM: Of course, their vote would be about who to put on the board of directors — and the board would then dictate what the company would do — But I get it, that’s why the Fed really doesn’t want to get into buying equities: that’s really the big thing that they are trying to stay away from. That was also why it was a big deal for them to even go into junk bonds, fallen angels. At some point, they’re going to buy a high-yield fallen angel






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that’ll need to be restructured. And inevitably, in a restructuring, there’s going to be one set of bond holders that thinks we should go this direction and there’s going to be another set of bond holders that thinks we should go that other direction — and the Fed will own enough of the bonds that it will be — basically forced to make a decision. That’s not terribly different from what hap-pened to General Motors in 2008 - ‘09. JIM: Right. And the Fed doesn’t want to be put in that position. But that’s what they’re risking right now. At this juncture, their attitude about a lot of this stuff is that they are problems for tomorrow. That’s what Powell recently said about inflation. Right now, he added, the problem is that we’ve seen 17 million people lose their jobs in three weeks [now 22 million in four weeks] — and we’ve got to do something about that. I agree. JIM: I get it. I don’t think that’s wrong. I just don’t know that they have the discipline to back out of all this helicopter money at the appropriate time on the other side of the crisis — especially consider-ing that they’re going to have to get Trump to agree to it. And I’m only criticizing Trump to the extent that we know what he thinks about the Fed. We know what he thinks the Fed should have been doing all along. He thinks negative interest rates are brilliant. Of course. If you are a New York real estate promoter and somebody says, “I’ll give you a loan to build a building — and charge negative rates, which means I’ll pay you every month to take my money” — why wouldn’t you think negative interest rates were the greatest idea ever? On his track record, he’d still find some way to drive the project into the ground. JIM: Perhaps. But he’s repeatedly asked, “Why don’t we have the lowest interest rates in the world?” When someone points out that would require negative interest rates,” Trump typically responds, “Well, we’re the best credit. We should have the lowest interest rates.” I get the argument he’s making, but the reality is a lot more complicated than that. He’s leaving a lot of nuance out. Face it, he’s big on grand pronouncements about things he doesn’t begin to compre-hend. But enough. So you’re telling clients to batten down the hatches? JIM: As far as the outlook goes, what I’ve been say-ing to people is this is a bear market rally. It’s only bounced up 50%, it could still rally higher, to 60%

or recoup even two-thirds of the ground it has lost. But I still think we will revisit the lows. Why? JIM: A lot of the buying that we’ve seen in this market rally has been short-covering or short-term trading. I don’t see what looks like a lot of people making long-term commitments — I’m not hearing, “Oh, I’ve got to get in at 2800” at this point. I also think that once we come to the other side of this V, we’re going to really have to start seriously questioning what long-term changes this pandemic will have created in the economy and society. Will there be a more conservative attitude towards risk? A general de-risking? De-globalization? Only when we answer those questions can we really start to make judgments about what fair value is. Less than it was in January is a fair guess. JIM: I don’t know. I don’t think anyone knows where fair value is now. If you look at some of the strategists on the Street — David Kostin, for instance, at Goldman Sachs, he’s got earnings down 123% in the second quarter. That means he has the S&P 500 companies gener-ating an outright loss. But if you look at the earn-ings estimates coming out from analysts around Wall Street, they’re down 16% for that same period. Talk about wishful thinking. JIM: That is total bullshit. And that is a technical term you can use! That is total BS. And what’s important about that is — if you’re not going to give me an honest assessment of what earnings are going to be — I can’t tell you if this market is rich or cheap. I hear people say, “You’ve got to buy; the stock market’s cheap.” But based on what earnings esti-mates? I think the fair value of the market is prob-ably lower than where we are now, so this is a bear market rally and we’re heading lower. On the fixed-income side of the ledger, I see higher inflation — but not initially. So the bond market will kind of meander in this range we’ve been in — with a lot of volatility, as we go forward. Even though the Fed and Treasury and Congress are now committed to pumping as much money as the economy and mar-kets need? JIM: Yes, the Bank of Uncle Sam is essentially buying everything in unlimited numbers. And that definitely helped put in a low in the market on





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March 23. And yes, I’ve heard the adage, “Don’t fight the Fed.” That’s why we’ve had a 50% rally and maybe this rally will linger a little bit more, or at least the retest will take time. But here’s the existential question you’ve got to ask yourself: If we are at the wrong prices, if the fair value of the market is down around 2200 to 2400 — just to throw out a number — and we’re at 2800 now, can unlimited Federal Reserve leveraging of Treasury dollars forever keep the markets at the wrong price? You don’t think so. JIM: No, it can’t keep the market too high forever. It can keep it up there for a while — and a while can be months — but you can’t keep it there forever. As we slowly work our way out of this, people will eventually come to understand how things have changed; see a new pace established, and realize that the market’s fair value should be at a lower level — so the whole world is going to want to sell to the Treasury and the Fed. Working together, the Fed and Treasury have got a big cattle prod, so they can shock the markets — they hit it in the ass on March 22, and it jumped. They can jump it a few more times, but they can’t keep it aloft forever, not if, in the longer term, things have changed. Now, I recognize there are still a lot of people in the camp that expects the virus to pass, a vaccine to come, and for all of this to be forgotten. If that’s what you believe, then you think this market is a screaming buy. I don’t. Hence my caution. Lastly, about the virus passing ultimately — remember, 4% was the high-to-low decline in GDP in the Great Recession — and we’re going to see a 6% plunge for the first quarter. There was a story going around recently, that people were looking at metrics coming out of China and were thrilled to see, “China’s 80% of the way back.” As if that’s a bullish story. I don’t see it — and I’ll bet the Chinese don’t feel it. JIM: Exactly. If that economy contracted 20% and has only bounced 80% of the way back? That’s a Great Depression. Hope is triumphing over analysis. JIM: I’ve even heard people say, “So what if air travel is impaired, if mass gatherings are restricted, if mass transit is impaired and all the rest — we’ll still make it 90% of the way back. The final 10% will come back when we get a vaccine and can re-open ball parks and concert venues and pack bars

and restaurants again.” They’re describing one of the worst economies in American history if we make it only 90% of the way back. We made it 96% of the way back in the spring of ’09, and look at the pain that entailed. Running 10% below capacity doesn’t sound bad, unless you know what it means. JIM: I don’t think people really understand that a 90% economy implies a 15% to 20% unemploy-ment rate — that is a sustained for a year or two. That is a world of pain. I understand that there’s a cognitive dissidence out there. Who does want to really plumb those depths? And sure, there are still so many unknowns. So maybe I could be overstat-ing the risks by orders of magnitude — or maybe I’m not. But I think we should at least consider the range of possibilities we’re facing. Full economic recovery might take several years. And baby boomers don’t have that kind of time to wait; their retirements are basically now. Gosh, our chat has been just the tonic for my mood! JIM: Sorry, what’s that line about the facts are stub-born things? I’ll leave you with one last thought. As I’ve mentioned here, people right now are more focused on the pin — Covid-19 — than the finan-cial market bubble it pricked. I’ve heard people grumble that the market retreat was unjustified. Look how unperturbed the markets were by the SARS and MERS epidemics, for instance. Those were very different beasts; not nearly as unpredictably infectious — JIM: Not only that, but remember when they hap-pened. MERS hit in the first quarter of 2009. The market was already in the process of establishing its low for that cycle. And how about SARS? Most people forget that it was on March 20, 2003 that the WHO designated SARS a pandemic. Do you know why the headline isn’t seared in our mem-ories? Just two days before that, we’d attacked Iraq in the Gulf War. The markets were already fully braced for bad news when the virus headlines hit. In other words, those other pandemics came near the bottom of a contraction or a bear market. This one hit at the height of a bubble. So it’s not just the health peril that’s disrupted the markets and the economy, it’s that it hit at a vulnerable point in the cycle. Black swan events aren’t really rare, it’s only the confluence of a black swan and a vulnerable market that sparks implosions. JIM: Yes, and now we’re still trying to pretend that this isn’t bad. “Oh, the Fed is printing money and


we’ll find a vaccine and it will all go away.”

Hope is not a strategy. JIM: Well, as I said at the beginning of my recent conference call with clients, “Sure, we’re going to find a vaccine, and as soon as we’re done burying all those people in mass graves, the S&P is going to go right back to 3400. Sorry, 60,000-plus people have died, but it doesn’t mean anything. We’ll soon forget.” But when people say, “We’ll forget,” the mistakethey’re making is forgetting that while people typically forget what you think is important, people don’t forget what they think is important. I’ll give you a personal example. My business partner of 29 years is a guy named Jim Stevens, the founder of Arbor Research & Trading. Jim passed away of a heart attack 8 days ago, while staying at his home in Florida. I didn’t know. I’m so sorry. JIM: Thank you. His family had to have a service for him in Florida — 5 people wearing masks and gloves standing 6 feet apart from each other — and he was cremated because there are no burial ser-vices there now. Now, if they’d had their choice, the family probably wouldn’t have cremated him. They probably would have held a service for Jim back here in in Chicago, where he lived most of his life. They probably would have buried him. Having to make those kind of hard choices — that kind of thing doesn’t get forgotten, is what I’m try-ing to say. Everyone tends to glibly say, “Americans have short memories.” But not about things that are important to them. I don’t think they’ll quickly forget that they had to socially dis-tance — stand six feet apart, wear a mask and be out of work for months — Or cancel funerals and weddings. JIM: Yes — let me stress one other thing. I’m not a permabear. I’ve been more bullish than bearish on stocks over the last 10 years. In fact, I missed the 2018 correction — stayed bullish all through it. And I’ve been very bullish on bonds even longer, given the lack of inflation and the money flows. It wasn’t until about a year ago, when the stock market got back up to more than a 75% retrace-ment of its 2018 retreat, that I said, “Okay, this is too much,” and really started turning bearish, when the S&P was pushing 2900 or so. Granted, it even-tually got to 3400, but — Still, not a bad call, in retrospect.

JIM: Well, what I’m saying is that because I haven’t been a permabear, this dour outlook is uncomfort-able for me — but that’s what I think we have. A dour outlook. I was very early in worrying about this virus being a bigger deal than people thought — just because I understand what exponential growth means. It’s pretty much only good when com-pound interest is working for you. JIM: Precisely. Fifty cases will wind up being 450,000 cases. The other thing that worries me is that people also don’t understand first differences. People expect we’ll hit peak cases on say, Sunday, and that means it’s all over with. But no, actually, the vast majority of people will get sick — and the majority of deaths will occur — after that peak day. Somehow the peak rate of change has been conflated with “the day it ends.” Would that it were so. It only becomes controllable at that day. But we still have to control it — distancing, masks and all the rest. And pray for testing, treatments and a vaccine. Thanks, Jim.

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Welling on Wall St. Interviewee disclosure: Jim Bianco is President and Macro Strategist at Bianco Research, L.L.C. Since 1990 Jim’s commentaries have offered a unique perspective on the global economy and financial markets. Unencumbered by the biases of traditional Wall Street research, Jim has built a decades long reputation for objective, incisive commentary that challenges consensus thinking. In nearly 20 years at Bianco Research, Jim’s wide ranging commentaries have addressed monetary policy, the intersection of markets and politics, the role of government in the economy, fund flows and positioning in financial markets. Jim appears regularly on CNBC, Bloomberg and Fox Business, and is often featured in the Wall Street Journal, Bloomberg News, Grants Interest Rate Observer, and MarketWatch. Prior to joining Arbor and Bianco Research, Jim was a Market Strategist in equity and fixed income research at UBS Securities and Equity Technical Analyst at First Boston and Shearson Lehman Brothers. He is a Chartered Market Technician (CMT) and a member of the Market Technicians Association (MTA). Jim has a Bachelor of Science degree in Finance from Marquette University (1984) and an MBA from Fordham University (1989). This interview was initiated by Welling on Wall St. and contains the current opinions of the interviewee but not necessarily those of Bianco Research, or his partners at Arbor Research & Trading, LLC. Such opinions are subject to change without notice. This interview and all information and opinions discussed herein is being distrib-uted for informational purposes only and should not be considered as investment advice of any sort. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Certain information contained herein may be based upon proprietary research and should not, in any way shape or form, be considered an offer or solicitation for the purchase or sale of any financial instrument. The price and value of investments may rise or fall. There are no guarantees in investment, in economics, iin research, or in life. For further information on Bianco Research, please see www.biancoresearch.com No part of this copyrighted interview may be reproduced in any form, without express written permission of Welling on Wall St. and Kathryn M. Welling. © 2020 Welling on Wall St. LLC

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