In the last three pieces, I have written on why I believe financial market commentary to contain more instances of bullish errors in cognition rather than bearish.
Let me once more openly state that I am an S&P 500 bear. I believe the US equity market to be meaningfully overvalued; my fair value estimate for the index probably lives somewhere around 1100. For the record, I am not a permabear that hates these 500 companies, many of them some of the best in the history of mankind. I disagree with the price, feeling that it is a huge mismatch to the actual prospects which these intrepid firms face. I cannot wait to be an SPX bull again! It's more fun, and espouses a more optimistic view of the world.
One byproduct of my bearishness has been to observe the tremendous skew in bias as it relates to commentary on the market. It is always easier to spot the logical fallacies espoused by someone on the other side of an argument from yourself.
Don't get me wrong; there is always a bull case and a bear case for any market. Some bulls (such as James Kostohryz) present a lucid and credible case for why the market has more upside. There are also bears (I will not name any directly) who seem to take glee in the prospect of the global economy being ripped asunder. To me, these souls seem not like chicken-littles, but rather as hopeful Neros who may yet dance and play the fiddle while Rome burns.
This miniseries is on the reality that market media and commentary exhibit more poor analysis by bulls than by bears. Largely, this is simply a function of the fact the bulls "control the mic" more often.
"But I hear bears growling all the time!"
Sure. Bears get their fifteen minutes of fame, and sometimes more than that. And there are outlets such as ZeroHedge that cater to such viewpoints. Furthermore, there are many "Market Outlook" articles on SA that posit a downbeat future for equities. Similarly, there are definitely permabears (Marc Faber or Felix Zulaf come to mind) who grace the pages of Barron's or appear on CNBC with regularity.
But honestly, while I know very little about you, dear reader, I do know that you are a human, positively brimming with biases. No worries, I have and frequently exhibit them also!
Perhaps you have heard the saying "Whoever discovered water, it wasn't a fish." The saying points to the idea that because fish live in water, they take its existence for granted.
See, we live in a world dominated with reasons to "buy buy buy." That is our natural predisposition: you make money by buying investments. The financial media is in no hurry to correct this human error. Managers, be they financial advisors or portfolio managers, make money by gathering assets. As a group, these firms are financially vested in the notion that you should be invested all the time. Not all individuals in the industry are sharks who don't care about the individual investor, of course. But the economic incentive set is to scrutinize and debunk bearish commentary, while promoting bullish commentary.
As a fun example of what I'm speaking of, I'll have you reference a piece I wrote several months back "In Defense of Market Timing (Sort of)." In the piece I address the popular Wall Street argument that "You must stay invested in the market because if you only missed the ten best days in the last 20 years..."; you have likely heard such an argument before. It's actually a very poor argument. And it speaks volumes that by contrast one rarely hears what would have happened simply by missing the ten worst days over the same time frame. Wall Street simply has no great motive for correcting such horrible analysis.
You can read an intro to this series with a discussion of how the media and commentary dealt with Carl Icahn's announced sale of Apple (NASDAQ:AAPL) stock vs. Berkshire's (NYSE:BRK.A) (NYSE:BRK.B) announced purchase. The next piece examined page views for Long Idea vs. Short Idea articles on SA. And the last piece examined financial assets (about $60T worth, ex-cash) held on household balance sheets.
My argument in a nutshell is that the motivation of most investors and most financial advisors and managers is aligned with rather than against the capital markets. While it always takes a buyer and a seller to transact, both investor psychology and the structure of the financial industry (including the financial media) is to consider reasons for higher prices rather than lower in an asymmetric fashion. There is more that can be said on this aspect of market bias, and in the future I may yet do so.
But I'd now like to turn my attention in an altogether different direction.
When Bias IS the news
Having discussed that financial media commentary will likely skew to the bulls, I want to turn my attention from bias in the news towards what happens when bias is the news.
What happens when policymakers themselves exhibit bias in terms of their policy action? Let me clearly define by what I mean by policy bias: when policymakers purport one plan or set of goals, and then act in a way that is inconsistent with that said goal set. Perhaps they do so as a consequence of some set of cognitive errors. Or perhaps the stated goal is not the same as the actual goal. Probably it is some combination of the two.
I will supply an example.
In November 2012, Shinzo Abe came to power in Japan and with him the "three arrows" of Abenomics, as his collective policies have come to be known. The three arrows were monetary stimulus, fiscal stimulus, and structural reform. You can read more about the policy here, as it is not my intent to discuss how the policies have played out. Suffice it to say, there has been precious little headway made on the latter two arrows, but monetary easing has been running full throttle. But I digress.
In the immediate aftermath of Abenomics, the Yen sunk like a stone vs. the dollar (which is significant, because in September and December of 2012, Mr. Bernanke announced QEIII/IV (MBS and Treasuries, $40B a month each; as a consequence the dollar weakened against the Euro).
Using the FXY as a proxy, I calculate that in the 112 trading days between November 13, 2012 and April 25, 2013, the Yen experienced an average daily log loss of .203% per trading day; that is a huge and sustained plunge.
Of course, this was very good for risk assets all over the globe, most especially Japanese stocks, which almost doubled during the coinciding six months. Readers may or may not know that the Yen has been a "funding currency" since the inception of Abenomics, which means that speculators all over the globe short the yen - effectively borrowing yen, to buy global risk assets.
In 2014, the Japanese economy hit the skids, largely due to the April '14 implementation of Abe's second arrow which entailed an increase in the nation's value added tax. So, just 36 hours after the Fed officially concluded its QE program in October 2014, the BOJ announced an expansion of its own QE program - "QQE."
Risk assets the world over surged on the announcement. To make the point clear, S&P futures jumped instantaneously at around midnight EST. Within a day, the S&P had made a new all-time closing high. Clearly, weak yen = "risk on". The Nikkei pushed beyond its resistance at about 16,500 and into "new" territory. I put new in quotes because of course the Nikkei hit 40,000 back in 1990... one day...
The yen dutifully spilled hard on the QQE announcement. In just 29 days, FXY lost 11% of its value; that amounts to a whopping .38% daily average log loss.
Since this late January, however, the Yen has been singing a different tune. At the end of January 2016, the BOJ announced ZIRP. Most consider this another attempt to weaken the currency, as it had experienced undesirable strength. And for a day or so, it worked. The USD/JPY pair leaped about five cents on the announcement. Then it turned around.
In the 64 trading days between Jan. 29 and May 2 of 2016, FXY had a total log return of 12.8% - an average daily return of .175%. Now bear in mind that when the Yen had plunged on central bank announcements, the daily falls had been .203% and .38%. So this strengthening, while definitely impressive, was actually not as extreme as either of the two yen declines.
So how did Kuroda, head of the BOJ, respond?
A May 19, 2016 WSJ article had this to say:
SENDAI, Japan-Bank of Japan Gov. Haruhiko Kuroda said he would act quickly if the yen's rise threatens his inflation goal, highlighting his caution over exchange rates ahead of a major international convention.
"Be it exchange rates or anything, if it has negative effects on our efforts to achieve our price-stability target, and from that perspective if we figure that action is necessary, we will undertake additional easing measures," Mr. Kuroda told reporters Thursday.The remarks by Mr. Kuroda come at a time of tension between the U.S. and Japan over whether the yen's appreciation seen earlier this year is sharp enough to warrant intervention by authorities. Investors are closely watching whether Tokyo and Washington will continue to clash over yen policy during a meeting in northern Japan Friday and Saturday of finance chiefs from the Group of Seven leading industrialized nations. He also reiterated that the BOJ has kept in place massive stimulus to achieve its target of 2% inflation, not to guide the yen lower.
This sounds reasonable from a strictly theoretical perspective. But consider that his goal is to achieve 2% inflation. The yen lost about 40% of its value against the dollar in a two-year period. On steep declines, the bank said nothing. Meanwhile, their target was not even close to met.
One could almost imagine that Kuroda's statement that the BOJ has no express intention of pressing the yen lower is dubious. At the G-7 meeting, US Treasury Secretary Jack Lew had some confrontational words with the Japanese finance secretary over "competitive devaluations."
This from CNBC (emphasis added in bold):
In its own statement released after the G-7 meeting ended on Saturday afternoon, Japan said that the group had reaffirmed its existing exchange rate policies, including not targeting FX rates, and agreed that excess volatility and disorderly currency moves could hurt the global economy.
The G-7 finance leaders "underscored the importance of all countries refraining from competitive devaluation," according to the Japanese summary. The summary included a note saying it "does not officially represent the G-7 consensus."
After the meeting, however, Japanese Finance Minister Taro Aso said he had told Lew that there had been "rapid, one-sided" moves in the yen's value. Aso also noted this his exchange with Lew had not been heated.
"I understand to a certain degree that [the yen] may move up or down. However, looking at the past several weeks, the yen has moved by 5 yen in two days or 8-9 yen in 10 days and we cannot clearly say such a move is orderly," he said.
...Ahh. So we have a failed attempt at 2% inflation (note: the Japanese do not filter out oil price volatility in their version of inflation), plus an international accord not to target FX as a means of gaining a competitive advantage. Plus an express statement that the BOJ does not directly target the Yen as a policy tool...
The BOJ launched QE and watched the Yen fall rapidly. Did nothing. The Yen rises rapidly, and the BOJ comes out two days in a row threatening intervention. Clearly, the BOJ simply doesn't like being defied by the market. Clearly, watching one's currency fall by 40% immediately after a policy announcement is part and parcel of currency manipulation. As I have demonstrated, the rise in the Yen over a multi-day time frame was actually slower than the two falls in the Yen in 2012 and 2014.
But policymakers don't just make policy: they make news. As a matter of fact, global equity indexes bottomed on May 19, exactly with the Yen (up until a couple days ago) and Kuroda's threat of intervention. Global equities followed the yen's swift move higher, peaking out almost exactly at the same time as the currency did.
The BOJ has without doubt targeted its currency as a way of achieving its goals. The G-7 nations have expressly committed not to use currency as a means of competitive devaluation. When the currency was plunging, Japanese officials never once made any kind of pronouncement declaring that the fall was destabilizing or problematic. On the other hand, as soon as the currency pendulum swung the other way, they came out and violated their international accord, claiming that the market was behaving in a disorderly fashion.
BOJ "bias" or policy incongruence became the news; the yen drove lower, and risk assets higher. Since the Yen has regained all its strength, most risk assets have forfeited all of their gains. Perhaps these risk markets are weighing the likelihood that any BOJ FX interventions are likely to be muted and temporary.
There are many instances where policymakers' claimed objectives or commitments are not in keeping with their actual behavior. With frequency, these lapses become the news, and global markets react to it.
As a final point, I am not insinuating that the market's reaction to these policy lapses is itself some form of bias. Frankly, markets may correctly take advantage of a policy inconsistency; alternatively markets may differentiate between the official claims or targets and some common narrative. This is not unlike the difference between consensus earnings expectations and whisper numbers on quarterly earnings releases. In this sense, the market reaction to these policy actions or musing can be highly rational.
So is Japan's yen policy the result of bias? I think so, certainly as it concerns the bank's response to speedy devaluation vs. appreciation. There is room for disagreement on the degree to which this constitutes bias, even as I have defined it. Still, there are many examples of this sort of policy "bias" all over the globe. And I'm sure you the reader can guess whether these biases generally prop asset markets up or whether they pull them down.
Disclosure: I am/we are short SPX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: short ES via options and futures positioning.