Beware Central Banks’ “Illusion Of Control”; Spitznagel Warns “If The Fed Hikes, Markets Will Go Down Very, Very Hard”

Beware Central Banks’ “Illusion Of Control”; Spitznagel Warns “If The Fed Hikes, Markets Will Go Down Very, Very Hard”

by Tyler Durden
Sep 15, 2016

Central banks have created a bubble in the stock market, which will come down "very, very hard" when it finally prices in a series of Fed rate hikes, said Universa's Mark Spitznagel, warning that "the markets are absolutely not positioned for this."

CNBC anchors were stunned into relative silence as Spitznagel unleashed truth-bomb after truth-bomb. Those 'facts' are just hard to argue with…

Key Excerpts…

CNBC: Well what’s the precipitating factor?

Spitznagel: Well, the ultimate cause of that would be the fact that the central banks got us here in the first place. Ultimately, my view is that central banks are the cause of bubbles.

CNBC: So you’re betting essentially that the central banks, whether it be the Fed or the ECB, they can’t unwind the trade that they put on years ago. It’s going to be a messy unwind for their trade.

Spitznagel: There’s no doubt about that.

CNBC: But is that really a black swan? Because you’ve got all these people at Delivering Alpha talking about it, isn’t a black swan supposed to be something that nobody is talking about? Godzilla attack on Tokyo, out of the blue, or something like that?

Spitznagel: So it’s great that everyone’s talking about this now. I had a little less company a few years ago when this was sort of building and now it’s so obvious, you know, the casual user has become an addict, and now we’re concerned about this. And that’s great. But you’re right it’s not a black swan. The reason I’m going to still call it a black swan is because the markets still price it as a black swan.


Spitznagel: The markets are absolutely not positioned for this. There is this sort of collective psychology that says that the Fed can keep this going, that the Fed is in control. But, in fact, central banks are not in control. In many ways central banks are the tail wagging the dog. We think that central banks are so big relative to the market, but, in fact, central banks are tiny relative to the market. Central bank balance sheets are twenty-trillion, the whole global securities and derivatives market is a half-a-quadrillion. So, in fact, central banks are miniscule compared to that. The only thing they have going for them is this collective psychology. It’s an illusion of control.

CNBC: The asymmetric bet that you’re putting on to reflect this, does this focus on the treasury market, or does it focus on equities? Do you think all asset classes go down in this scenario?

Spitznagel: I focus very much on the systemic left tail of equities. But, to answer your question, yes, I think all assets are very much correlated. I think there’s just one big bet out there, so diversification really isn’t going to work. Timing this is not going to work. Remember, the equity has extreme duration now. These low rates and this high valuation means that they’re extraordinarily sensitive to changes in rates, extraordinarily sensitive to changes in risk premiums and growth.

Spitznagel: If the Fed proceeds with rate hikes the markets will go down very very hard, just by duration alone.

CNBC: A series of hikes?

Spitznagel: If the market is going to price in a series of hikes, the stock market has to go down very hard. And this is high dividends, this is all equities have got to go down very very hard. So I don’t think it’s really possible.

CNBC: What’s the percentage? What’s the percentage that it would go down? Some think that the Fed pumped in all this liquidity into the system, that it drove up asset prices, let’s just say stocks, drove up stock prices by x amount, that that has to be unwound when the Fed starts to take that away.

Spitznagel: Ok so the Fed’s gonna, what are they gonna do, raise rates two-hundred basis points? Is that what you mean, if we find ourselves there in a year? The markets will be much much lower. I would argue that central banks cannot allow rates to free float. Which is a little bit of a crazy statement. We cannot allow this most important market that there is, interest rates.

CNBC: The most liquid market that there is.

Spitznagel: Right, but it’s also an important price signal, it’s the most important price signal. And we can’t let it free-float, we can’t let the discovery process work. If we did that, the markets would be cut in half, the stock market would be cut in half.

h/t Jim S

Leave a Reply