Notes From Underground: On Yellen’s Testimony

First, as I have been critical of Chair Yellen’s communication efforts prior to this weeks Congressional testimony, I will give the Chairwoman an A+ for her effort this week. She was very forthcoming in her Senate appearance on Tuesday, and, more importantly, she fended off the idiots in the House of Representatives with clarity and the patience of a saint. The problem with the House is too many ex-prosecuting attorney’s who all try to get Yellen in a gotcha moment, but the Fed Chief was not falling for the trap of providing sound bites for the elections back in the home district. The Senate questions were of a substantial nature while the House was fluff of either adulation or criticism.

In a very telling fashion, CNBC cut away from the House testimony to air the wisdom of Stanley Druckenmiller from their ALPHA Conference. (For the record, it’s better to listen to Congressional hearings on C-Span for there is no time delay.) Chair Yellen’s prepared report to both chambers was very vanilla but on the issue of financial stability she made an interesting comment: “While prices of real estate, equities and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance.” In my opinion, this is a very important issue from a couple of reasons:

  1. What do historic norms mean when you are in an interest environment of global zero rates? More importantly, the historic norms that Bernanke and Yellen have both adhered to have been P/E ratios of the entire market indices. So the historic norms have been corrupted by the issue that Yellen raises about the leveraged loan market and lower-rated corporate debt. If corporations are increasing borrowing to buy stock and pay dividends the P/E ratios are being supported by borrowing, which will come back to haunt when rates rise and or profits slow down. In terms of HISTORIC NORMS, CORPORATE PROFITS AS A PERCENTAGE OF GDP ARE AT ALL-TIME HIGHS. How long can that be sustained so the increased borrowings for financial engineering and not CAPEX will be a burden;
  2. Let me say again. Chair Yellen is no Greenspan or Bernanke and will not march to the beat of a rising equity market forever. Wages are a much greater concern for Janet Yellen than financial sector profits. Until wages rise and afford the American worker a greater piece of the economic pie the FED will be active. However, the RISE OF WAGES have to come off the corporate bottom line even as interest rates remain at historic lows. If the Fed’s policies result in higher inflation so be it. The American worker needs to see some gain in their paycheck and it will be out of the corporate bottom line one way or another. If wages don’t rise but inflation increases the end result is that the worker suffers and demand weakens crimping corporate profits. As Duckenmiller widely proclaims, the FED has overstayed its zero interest policy but for Yellen it may be for good reason: increased wages through improved economic activity.

***The Stanley Druckenmiller interview with Joe Kernen was worth a watch. In quick summary, Druckenmiller maintains that the Fed has made a mistake by continuing its bond buying program and leaving interest rates at zero. He notes that the initial FED efforts of QE1 and its others like the Temporary Liquidity Guarantee Program (TLGP) staved off a financial meltdown and were brilliant. Yet the FED has maintained the program long past its expiration date and risks creating massive imbalances in the financial system. For Druckenmiller, the FED‘s problem is that it doesn’t know when it’s wrong and how to exit from its plan. Druckenmiller ultimately raises the issue of Fed CREDIBILITY. What Kernen failed to ask Druckenmiller was these two questions, which Notes From Underground continuously asks:

  1. If the FED is so wrong why does the long end of the yield curve keep rallying, which results in lower yields?
  2. Stan, if the FED is so wrong, how much GOLD are you buying, or the lack of central bank credibility should prompt large movements into the ultimate store of value. The GOLD should have fallen much more yesterday as the SPOOS and other equity markets rallied. The 30-year bond continued its rally and the curves continued to flatten, but the GOLD held. Yes, today the GOLD has rallied on geopolitical events but it needs watching to see how the metal performs after the geopolitical events become clearer. The 2/10 curve has certainly flattened recently but at today’s low of 199.5  basis points the curve is far from flat, though the short-term trend is certainly flattening. Maybe we will hear more from Mr. Druckenmiller about these trading issues.

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8 Responses to “Notes From Underground: On Yellen’s Testimony”

  1. chems Says:

    re the long end, what are your thoughts surrounding the thesis that it keeps going down for ‘technical’ reasons – Fed is still buying but issuance has been reduced significantly due to sequestration?

  2. GreenAB Says:

    “…If the Fed’s policies result in higher inflation so be it. The American worker needs to see some gain in their paycheck and it will be out of the corporate bottom line one way or another. If wages don’t rise but inflation increases the end result is that the worker suffers and demand weakens crimping corporate profits…”

    a rise in REAL wages is an admirable goal. but i really really doubt it can be achieved. Yra you are absolutely correct in your last quoted sentence. but it only describes the macro of the economy as a whole. but in reality every company will do what is best for itself in the first place. and that means PROTECT your MARGINS. i just don´t see how rising wages won´t affect inflation. if wages rise, then companies will raise prices even faster than now as their costs rise, labor still is the biggest cost factor. the risk is that we will end in a spiral that gets out of hand at some point. if inflation takes off (no matter if wages keep up or not) then interest rates will fly. this economy has been used to near zero interest rates for much of the 2000s. in my view it is better to save the status quo of slowly eroding real wages than to risk a sudden shock. which means – start raising rates now at a slow pace rather than having to rush later.

    the system of capitalism is based on the maximizing of profits. outside real boom years labor will be sqeezed. monetary policy can´t do nothing about it. Druckenmiller is correct with his IBM example – if you can increase your EPS by buying back stock (financed by debt that costs you almost nothing) – then why would you invest in capex/labor…?

    in other news, the Bradley Model just had it´s second major turn date yesterday. it means nothing in some years, but in 2014 it delivered pretty good results. it could well be that we´ve seen the highs of the year and are due for a long slide into November. be careful!

  3. yra Says:

    Chems–great point and/or question.The two major elements you mention are spot on issues but if the fed was /is behind the curve and remain so until wages rise the bond vigilantes should be there to be sellers.I agree with Druckenmiller that they will be but not until the fed ends it accretive bond buying —that is a headwind for the vigilantes which is why the GOLD probably holds up as it is a cheaper way to play in questioning the fed’s credibility

  4. ShockedToFindGambling Says:


    My recollection is that Druckenmiiller’s performance was so poor at Soros’ Quantum Fund, that he had to leave.

    On your 2 questions for SD:

    1) IMO, and as I have said before, the long end keeps rallying mainly because the FED has created a permanent “fight to quality”. Some investors do not trust a Gerry-rigged recovery and therefore keep buying bonds, whose “perceived safety” makes them look like a good buy to these investors. Unless the FED buys every single bond, most investors buying a bond will not buy unless they believe that they are getting a reasonably good deal.

    2) You partially addressed your 2nd question for SD in your last response. You said……..

    GOLD probably holds up as it is a cheaper way to play in questioning the Fed’s credibility.

    I don’t know if you are thinking inflation, recession, or financial collapse (but I’m thinking you mean one of the latter 2).

  5. yra Says:

    Shocked yes as it is the issue of central bank credibility–but no Stan Druckenmiller did not leave for poor performance as far as I know—he is a global macro hall of famer par excellence

  6. ShockedToFindGambling Says:

    Yra- I would like to correct what I wrote previously, which was…..

    “My recollection is that Druckenmiiller’s performance was so poor at Soros’ Quantum Fund, that he had to leave”.

    According to this article in the NY Times, he did not have to leave, but did quit after Quantum’s portfolio was crushed.

    2000: At the peak of the technology boom in 1999 and 2000, Mr. Druckenmiller makes a big bet on Internet stocks. He was a huge buyer of VeriSign, which fell by about 50 percent in a month. The bursting of the dot-com bubble in March 2000 crushes Quantum’s portfolio, prompting Mr. Druckenmiller to quit his post managing the Quantum Fund after a dozen years. At the time, he said: “We thought it was the eighth inning, and it was the ninth. I overplayed my hand.”

  7. yra Says:

    Shocked—as he rightfully said –he has been wrong many times but as any good trader the losses are controlled ,which plays into his criticism of the fed –they don’t know where they are wrong and no exit out —

  8. arthur Says:

    Here is what hedge fund manager Scott Bessent says about Druckenmiller in the book “Inside the House of Money’

    Stan may be the greatest moneymaking machine in history. He has Jim Roger’s analytical ability, George Soros’s trading ability, and the stomach of a riverboat gambler when it comes to placing his bets. His lack of volatility is unbelievable. I think he’s had something like five down quarters in 25 years and never a down year. The Quantum record from 1989 to 2000 is really his. The assets grew from $1 billion to $20 billion over that time and the performance never suffered. Soros’s record was made on a smaller amount of money at a time when there were fewer hedge funds to compete against.

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