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Eric Peters: "We Are About To Reach The Top Of The Wall Of Worry... And Then Look Down"

Following up on Eric Peters' contrarian comments about "technological disruption", in which he said that "we should be careful not to overlook the possibility that today’s disruptive technology companies may be not much more than mechanisms to drive wages down to subsistence levels”, in the One River CIO's latest letter, Peters reverts back to his familiar, macro self with the following brief allegory on recent events, which as always cuts through the noise to highlight what is important, in this case that "the chasm between policy and reality has never been wider" which he says "matters little, until you arrive at the top of the wall of worry. And then look down."

Here are the choice excerpts from his latest letter:

“Absolutely,” answered Trump, as sure as sure can be. You see, the reporter had asked if Mexico would pay. She couldn’t help herself, we’re fixated by walls. We need them; to build, to topple, to scale.

 

They define us, give us purpose. Walls surround us, they’re everywhere, literally, metaphorically.

 

“We are showing that the world doesn’t have to go 100 years back in time,” announced Tusk, symbolically isolating America, while breaking down the wall that separates Europe and Japan.

 

“The deal is the birth of the world’s largest, free industrialized economic zone,” said Abe, shaking hands, the barrier surrounding his little island crumbling.

 

But of course, the most formidable walls exist in our delicate minds. Steel and stone structures all succumb to determined efforts to overcome them; the Iron Curtain, Berlin Wall, Great Wall.

 

But self-doubt is another matter entirely, a barrier towering above all others, the greatest obstacle ever created. In its shadow stands worry. But this wall can be climbed. And eight years into a historic bull market, we’re approaching the top.

 

“Very adverse scenarios for the inflation outlook had become less likely, in particular as deflation risks had largely vanished,” said the ECB, its multinational nerds climbing, their worries dissolving at altitude. Europe’s purchasing manager index rose to 57.4, a six-year high. Unemployment held steady at 9.3%, the 2009 low. After years of senseless agony, the EU held its nose and approved Italy’s bank bailout. And in Germany, manufacturing PMI hit 59.6, industrial production surged 5%, with overnight interest rates still 0.40% below zero and the ECB printing money fast enough to make even Robert Mugabe blush.

 

The chasm between policy and reality has never been wider. Which matters little, until you arrive at the top of the wall of worry. And then look down.

And a bonus anecdote on the Bank of Japan

“Oh dear,” said the CIO, from Tokyo. “No sooner have we declared that Japan is no longer experiencing deflation than we are looking to pre-empt inflation.”

 

We were discussing Kuroda, who in a recent speech quoted Ralph Hawtrey, pioneer in the field of central bank expectations management.

 

“In his book ‘Monetary Reconstruction’ published in 1923, Hawtrey stated that “it is not the past rise in prices but the future rise that has to be counteracted,” said Kuroda in the speech. Hawtrey was later made famous, in the depths of depression, for his argument that public-works spending would not increase employment.

 

“Hawtrey was on the wrong side of history. Yet it is he who the Bank of Japan turns to for support. It has learned nothing.

 

The BOJ has reduced its pace of bond purchases from Y80trln in 2016 to Y50trln in 2017 this year. “They gently announced a recalibration of how they’ll communicate the exit from QE. But bureaucratic organizations don’t tell you what they’re going to do; they tell you what they’ve done. They’ve tightened.”

 

An independent member of the policy board proposed reducing ETF purchases from a targeted Y6trln to Y1trln and J-REIT purchases from Y90bln to Y30bln. “The impact of a reduction in J-REIT purchases cannot be overestimated,” he explained. “Japanese property rests on the assumption that in the end, everything can go into a REIT.

 

So valuation becomes a game of applying the REIT’s cost of capital to property not yet in REITs.”

 

By buying REITs, Kuroda has signaled that everything can eventually be bought by the BOJ, lifting all asset prices, lowering their financing rates.

 

“So speculators who earn their profits by packaging assets to be put into REITS, to then be sold to the BOJ, may be a trifle upset when they change the rules of the game.”