"If you're not concerned, you're not paying attention" say Axel Merk, founder and Chief Investment Officer of Merk Funds.
Like many, he sees today's excessive high-price, low-volume, zero-volatility markets as an unnatural and dangerous result of misguided intervention by the Federal Reserve. But Axel has additional perspective than most, as the senior economic adviser to his family of funds is a former President of the Federal Reserve Bank of St Louis and a former FMOC member:
What’s driving the excessive complacency is today's markets is monetary policy. One of the main goals of monetary policy has been to reduce the risk premium; to make it less expensive for risky borrowers to borrow money. We see that everywhere, such as when we hear about how Spain now pays the same as the US on its long-term debt. And so risky borrowers don’t pay much more than the credit worthy borrowers.
The reduction in the risk premium is what reduces volatility, and of course that spills over to other assets. We see that in the equity markets, the currency markets — we see it everywhere. And volatility is compressed as well.
Janet Yellen was asked about this just a few days ago and she pretty much said how she’s not concerned about complacency in the market. She’s complacent about complacency. To me that’s about as significant as Greenspan suggesting houses can never go down, and Bernanke suggesting subprime loans were contained. It’s a major, major problem.
Obviously, there are plenty of challenges in the world. Usually what tips a market over, though, isn’t the most obvious thing because that’s already “priced in”. As a result, nearly anything can tip this market over. Suddenly one day people wake up and the glass is half empty, and everybody runs for the hills.
Many see the Fed having run out of bullets in it efforts to keep markets elevated. Axel's opinion is "Not quite yet":
The Fed has bought all these assets by creating money out of thin air and now they’re stuck with these. If they were to sell them (it’s much easier to buy securities than to sell them), prices would plunge and, more importantly, the Fed would sell these assets at a loss.
Now, the capital base and the equity of the Fed is very small. Odds are that the losses would wipe out the equity at the Fed.
And so the Fed would rather not sell those securities — instead, they can pay interest on reserves. But I don’t think actually they’ll do that either, because of the conflict with Congress (if we’re going to start paying interest on reserves to somehow raise rates, that’s going to be political nightmare because we'd be paying $billions — if not over $100 billion — to banks to entice them not to lend).
There’s another tool that they have: it’s called reverse repos. I’m not going to explain this now in detail, but it’s essentially the same thing as paying interest on reserves with a key difference: Congress is not going to 'get it' for a year or so. And so the backlash from Congress is going to take a little longer to come. But that problem is going to come nonetheless.
As a result of these risks, Axel recommends the average investor be well-diversified outside of stocks and bonds, and maintain a high degree of liquidity. More information on the newly-launched fund (OUNZ) discussed in the podcast can be found here.
Click the play button below to listen to Chris' interview with Axel Merk (27m:11s):
by davefairtex