All the gold in California

Is in a bank in the middle of Beverly Hills

In somebody else’s name.

So if you’re dreaming about California,

It don’t matter at all where you’ve played before,

California’s a brand new game”

                                                                                                                       -The Gatlin Brothers, 1979


Alpine Apple and Swissflix

As the stock market hits continuous new highs despite rampant talk of a bubble, and bonds sit with perplexing low yields, a few peculiar things have gone by with little comment. We would like to use this occasion to comment. As Larry Gatlin eloquently sang about all the gold sitting in a bank in someone else’s name, we would like to shine a light on some specific banks, namely central banks. Quietly, the world’s central banks have been working in tandem to stabilize global financial markets after 2008, and some ten years later they are still hard at work. The radical techniques employed through Quantitative Easing are well documented, but other techniques have been somewhat ignored.

After a decade of Quantitative Easing,  big central banks are left owning a fifth of their governments’ public debt. These central bankers, led by the Federal Reserve, have bought government bonds and mortgaged backed securities in an effort to keep interest rates low and stoke the coals of feeble economies. The Financial Times tallied up the six biggest central bank holdings and found they held more than $15 trillion of assets. Of this, more than $9 trillion are government bonds. After their buying binges, both the European Central Bank and the Bank of Japan now have balance sheets exceeding the Federal Reserve.

Bonds are one thing, but the staggering amount of stocks owned by the Swiss National Bank and the Bank of Japan cause one to pause. In one single week in August, the Bank of Japan bought over $2 billion of Japanese Exchange Traded Funds. The June total of Japanese stock holdings by the Japanese central bank stood at $127 billion, or over 3% of the Tokyo Stock Exchange’s market capitalization. In contrast,  Switzerland’s central bank has an appetite for stocks outside its border.  The Swiss hold over $80 billion of American equities, including the likes of Facebook, Altria, Netflix, Amazon, Apple and others. These are true American gold star companies sitting in a bank in the Swiss hills in somebody else’s name. In theory, the Swiss could simply print enough Swiss francs, convert to US dollars and purchase American companies. We would not suggest this is their intention, but it still troubles us as we sit quietly in Georgia observing.

GI Josef

So among hurricanes, Korean missiles, and British terrorist attacks, our attention became riveted on Zapad. Yes, Zapad. This is unfortunately not a new generation of Apple iPad, but the name given to Russian war games in the fields of Belarus and waters of the Baltic Sea.  The supposed enemy is Veishnoria, an imaginary land full of NATO funded terrorists sworn to conquer Mother Russia. The Russian military is aiming to crush Veishnoria, and in the process make the likes of neighboring Lithuania and Estonia quite uneasy. The good General Valery Gerasimov, Chief of the General Staff of Russia’s military, is leading the assault on Veishnoria and appears quite adept at doing so. Ordinarily we would pay little attention to such shenanigans, but General Gerasimov has written of “hybrid war” and it has caught our attention. It seems in 2013, Gerasimov wrote a piece describing his hybrid war concept. He wrote “Among such actions are the use of special-operations forces and internal opposition to create a permanently operating front through the entire territory of the enemy state, as well as informational actions, devices, and means that are constantly being perfected”. He goes on, “Long distance, contactless actions against the enemy are becoming the main means of achieving combat and operational goals”.

After watching the General send his men in unmarked uniforms into Crimea, and occupying portions of Ukraine, and then increasing evidence of Russian tampering with elections in sovereign countries, we started to consider the avenue of Wall Street in Veishnoria. What would stop the General from phoning Elvira Nabiullina, Governor of the Russian Central Bank, and requesting a few rubles be directed at purchasing large amounts of Veishnoria’s stocks and holding them? Then at an opportune time, Elvira, mistress of the Russian banks, would sell huge amounts of the small country’s stock and send the economy into a free-fall. All the while General Gerasimov advances, while perhaps even shorting the Veishnoria stock index fund in his own Moscow brokerage account.  Our main concern stems from the unconventional actions of stable central banks and the “hybrid war” of unstable governments. Can the two intersect? Can manipulation of stock and commodity markets coordinated with election manipulation, combined with “contactless actions” create a significant threat to our markets, or maybe our borders? Makes one wonder…

Bonds, Bonds and more Bonds

Along the same lines, another large new buyer of corporate debt turns out to be the very issuers of corporate debt themselves. The Financial Times reports that 30 US companies have managed to accumulate more than $1.2 trillion of cash and securities according to Securities and Exchange Commission filings. Apple holds some $156 billion in corporate debt securities, Microsoft, Alphabet and Oracle, among others, hold significant amounts as well. Ebay holds eighty percent of their portfolio in corporate bonds. These corporations begin to look like mutual funds or asset managers instead of the technology companies they really are. Much of this largesse has accumulated overseas and has stayed there due to the large tax burden levied on US companies upon repatriation of revenue from international operations.

The significance of this development is similar to the central bank holdings of securities. How much do these massive purchasers distort markets and normal market functions? If tax laws were to change, how much corporate paper would be dumped as corporations sold securities to repatriate cash? How much have corporate bond prices been buoyed by these large purchasers’ demand? It appears that tax laws and central bank policies in 2018 will impact the markets. We are prepared to see some change in market momentum due to these altered states. Where once the gargantuan buyers roamed the landscape we expect demand to lessen and a more normal pattern emerge.

Coupled with the big buyers we have described, there have been monumental changes in fund buying where individual investors have quickly moved to passive investments, simply buying index funds to mimic this bull market. This has provided added demand for the stocks included in these indices; again, a big source of demand for stocks that could abate when this bull market slows.  We would be cautious about new commitments to this market. The sources of much of this buying could be drying up as the Federal Reserve reverts to pulling liquidity out of the economy with the bond sales they plan to execute.


E.B. “Chip” Beard

September 2017