One month ago, Bridgewater’s Ray Dalio warned the New York Fed that even a modest, 1% rise in rates, and thus inflation, would lead to trillions in losses and “trigger the worst price decline in bonds since the 1981 bond market crash.” Now, it is the turn of Elliott Management’s Paul Singer. In a letter to investors seen by CNBC’s Kate Kelly, Elliott Management execs warned of essentially the same thing: that a rapid inflation is the $30 billion hedge fund’s biggest concern in the current environment, and that such a spike would not only collapse bond prices, but potentially lead to a stock market crash.
“This may seem like a strange thing to worry about under the current circumstances, but the tide toward inflation could turn rather abruptly,” wrote the money managers in their Q3 letter dated Oct. 28. “If inflation starts accelerating to an annual rate of high single digits or greater, it will be quite difficult for the mix of strategies that Elliott favors to ‘keep up.'”
However, sudden price hikes were only one of the Elliott team’s worries, according to the recent letter. Another is Singer’s biggest recurring fear: that the artificial market created by central bankers over the past 7 years will undergo rapid “renormalization.” Lingering over Elliott’s portfolio management is a persistent fear that central bankers — by collectively cutting interest rates 673 times since the financial crisis — have so upended the natural price levels of stocks, bonds and many other assets, “that the economy and markets are operating in denial of reality.”
Paraphrasing from the latest Greenlight letter, sent on the same day, in which David Einhorn said that “we have central bankers who are determined to see flashing lights that aren’t there…. we are more than seven years into an economic recovery, yet central bankers behave as if we’re still in crisis”, Elliott writes that “every sniffle is being treated by central banks as acute respiratory distress syndrome worthy of ‘code-blues’ and teams of frantic pumpers and fixers… what this policy landscape has engendered is a widespread belief, or at least a strong suspicion, that stock and bond prices won’t ever be allowed to go down in any meaningful way.”
Such a mentality, according to Singer, “has encouraged massively risky behavior.”
Aside from his traditional pessimistic warning that the central-bank created “market” will implode sooner or later, Elliott predicts that during the coming months or years, oil prices will trend higher than their current $45 level, but not by much. “The oil market has largely achieved balance,” the managers wrote, “albeit with high stock levels, and we expect medium-term price appreciation to be limited by the return of U.S. production growth in the $50-60 range.”
Singer also touched on one of his long-running favorite investments, gold, and noted that its flat performance during the third quarter, and the move down in response to the increasing belief that the Fed will soon rate interest rates, seemed puzzling: “Given the market gyrations that have accompanied each of the Fed’s previous attempts at hiking policy rates over the last few years, now would seem to be an inopportune time to abandon the only actual safe haven that investors may reach for as an alternative to the really bad deal offered by fixed income instruments given current pricing.“
Translated: Elliott is buying gold here.
Singer then looked at Europe, and specifically Italy which he said is in a state of “tremendous flux” that will only continue should Prime Minister Matteo Renzi fail to win a Dec. 4 referendum intended to simplify the country’s governance.
“The resulting unrest may be more impactful than Brexit,” the letter stated. Meanwhile, in Germany, the straits faced by Deutsche Bank, the troubled financial giant now in talks to settle fraud charges with the U.S. Justice Department, may be overplayed in the market, given that the German government, in Elliott’s view, will do whatever is ultimately needed to stabilize the biggest German lender.
“Regardless of what Chancellor (Angela) Merkel currently says, Germany will stand behind Deutsche Bank in extremis.”
He is right,