Thursday, September 5, 2013

Things That Make You Go Hmmm…A Barrel of Monkeys

By Grant Williams



"What's more fun than a Barrel of Monkeys?

Nothing!"

Not my words, but those of the Milton Bradley Co., which still produces under license a game first created by a gentleman named Leonard Marks, who sold the rights to his simple but addictive game to Lakeside Toys in 1965.

It would be difficult to imagine a simpler premise for a game than that of Barrel of Monkeys. The rules of the game, printed on the bottom of the plastic barrel in which the monkeys are contained, are simplicity itself:

Dump monkeys onto table. Pick up one monkey by an arm. Hook other arm through a second monkey's arm. Continue making a chain. Your turn is over when a monkey is dropped.

Easy!

Each barrel contains 12 monkeys but can accommodate, at a push, 24, which makes the game so much more enjoyable. What could be better than assembling a long chain of tangled monkeys, each reliant on those either side of it for purchase, with just the one person holding onto a single monkey's arm at the top end of the chain, responsible for all those monkeys dangling from his fingers.

Of course, with great power comes great responsibility; and that lone hand at the top of the chain of monkeys has to be careful — any slight mistake and the monkeys will tumble, and that, I am afraid, is the end of your turn. You don't get to go again because you screwed it up and the monkeys came crashing down.

On May 22nd of this year, Ben Bernanke's game of Barrel of Monkeys was in full swing. It had been his turn for several years, and he looked as though he'd be picking up monkeys for a long time to come. The chain of monkeys hanging from his hand was so long that he had no real idea where it ended.

That day, in prepared testimony before the Joint Economic Committee of Congress in Washington, DC, Bernanke stated that the Fed could increase or decrease its asset purchases depending on the weakness or strength of data:

The program relates the flow of asset purchases to the economic outlook. As the economic outlook — and particularly the outlook for the labor market — improves in a real and sustainable way, the committee will gradually reduce the flow of purchases.

To assuage any lingering doubt, he continued:

I want to be very clear that a step to reduce the flow of purchases would not be an automatic, mechanistic process of ending the program. Rather, any change in the flow of purchases would depend on the incoming data and our assessment of how the labor market and inflation are evolving.

Markets fluttered a little as they tend to do around these carefully stage-managed performances, but remained largely sanguine. However, in the Q&A session that followed his prepared remarks, Bernanke, in response to a fairly innocuous question, went a little off-piste, straying into some improv, making a suggestion that, within minutes, had given rise to a phenomenon which by the end of the day had earned its very own soubriquet: the "Taper Tantrum":

If we see continued improvement and we have confidence that that's going to be sustained then we could in the next few meetings ... take a step down in our pace of purchases. If we do that it would not mean that we are automatically aiming towards a complete wind down. Rather we would be looking beyond that to see how the economy evolves and we could either raise or lower our pace of purchases going forward.

The statement contained the usual bit about the Fed being open to both decreasing OR increasing bond purchases; but it added one, as it turned out vital, piece of information:
"... we could in the next few meetings ... take a step down in
 our pace of purchases."
Boom! That's all it took. The monkeys began to shiver, shake, and screech.

Now, I have been saying for the longest time that these days nothing matters to anybody until it matters to everybody, and that is largely down to the Fed themselves (and their peers across the various oceans and borders who are complicit in this era of free money). The proof of my statement is seen in the fact that as soon as Bernanke mentioned that the "taper" — which, let's face it, EVERYBODY knows has to happen sooner or later — would possibly begin before the end of 2013, markets began to crumble.

The S&P 500 dropped a quick 6% on the outlandish idea that free money by the trillion wasn't going to continue forever, and this came as something of a shock to investors who had watched the index levitate relentlessly as the stimulus being applied by the Fed to the tune of $85bn a month did its job — and by "did its job" I wish I were talking about lowering unemployment and stimulating growth; but, alas, I'm talking about bolstering bank balance sheets and driving equity prices to unsustainable and unfairly valued levels.
As you can see from the chart below, the market turned around and recovered its losses pretty quickly as a seemingly endless procession of Fed governors and "friendly" journalists were rolled out to explain — in increasingly panicked tones — that everything was OK and that the esteemed Chairman didn't actually say they would definitely be cutting off the easy money.

Source: Bloomberg

In his own prepared remarks the following morning, Fed mouthpiece and Wall Street Journal reporter Jon Hilsenrath was quick to soothe:

(WSJ): The next step by the Fed could be especially tricky. One worry at the central bank is that a single small step to shrink the size of the program could be interpreted by investors as the first in a larger move to end it altogether. [Yesterday] Mr. Bernanke sought to dispel that view, part of a broader effort by Fed officials to manage market expectations.

If the Fed takes one step to reduce the bond buying, it won't mean the Fed is "automatically aiming towards a complete wind-down," Mr. Bernanke said. "Rather we would be looking beyond that to seeing how the economy evolves and we could either raise or lower our pace of purchases going forward. Again that is dependent on the data," he said.

It's OK, folks. Ben's got this. Calm down.

After the scrambling was over and the 6% air pocket was safely navigated, the S&P 500 first regained and then surpassed its previous high. At this point, the Punditocracy (as my buddy Scott calls it) declared that any "taper" had now been priced in.

And there the story should have ended. Nothing to see here folks, get back to your couches.
But of course it didn't end.

To continue reading this article from Things That Make You Go Hmmm… – a free weekly newsletter by Grant Williams, a highly respected financial expert and current portfolio and strategy advisor at Vulpes Investment Management in Singapore – please click here.






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