good afternoon and welcome to capital account i'm lauren lyster here in washington d.c. these are your headlines for tuesday september eleventh two thousand and twelve today stocks advance ahead of the fed decision or the rally loses steam ahead of the meeting or it resumes out there are people are resolved to whatever they think is going to happen this all depends on which headlines you read out what time to day now whether you believe them or not they underscore the impact of macro trends on the stock market today and speaking of our guest says markets are addicted to q e but at what cost and what are the consequences plus speaking of the macro

environment. u.s. stocks rallied to their highest levels in four years after europe's central bank announced a sweeping plan to solve the region's debt crisis. and that was just last week and now the german constitutional court is expected to hand down a decision on the permanent bailout fund in europe the e.s.m. tomorrow but our guest will explain why all of this action in europe can be summed up in a single dance the dance of the fireflies david kotok chairman of cumberland advisors is here to shine a light on the situation plus what does the growth and e.t.f. exchange traded funds indicate about the macro focus we're talking so much about will discuss let's get to today's capital account.

so bugs in general the crawly bugs are not very cute most are pretty disgusting in my personal opinion though i do have to say and i'll venture to say many will agree there is something magical about these. fireflies there is something alluring about bugs that can light up and dance turn on the headlights though shine them and those bugs stop where they just look like bugs and you can see what's really in front of you so what does all of this have to do with the european debt crisis saga which have seen new episodes last week expected tomorrow how does this all become

a dance well joining me from our new york studio to talk about this and much more is david kotok chairman of cumberland advisors and author of this book from bear to bulls with e.t.s. and first thank you so much for being on the show i really appreciate you being here today nice to be with you it's great to have you so let's talk about europe because last week we had the decision from the e.c.b. of the o.m. team program the unlimited bond buying program tomorrow there is an expectation that a decision will be handed down from the german constitutional court on the e.s.m. but let's back up because you just got this whole european saga as a dance of the fireflies what is the dance of the fireflies well i was looking for a metaphor and if you think about fireflies in the dark evening in the summer night you see them flash you see different mosaics appear and you're not but you're not really sure what's there you are it's not clear you turn on the headlights of your

car and illuminated things the fire flies immediately stop but you can see very clearly turn your lights off and they resume we've had an ongoing greek tragedy with lots of actors in new york and it's continuing right through today and i thought of this is a metaphor i was looking for a metaphor of the different actors the different. the constant changing and every once in a while a light goes on and you can see things clearly that's how come i call their name did the do. and so the fireflies and in this scenario what ultimately is the head light shining light on it is that the markets end and who are the firefly is is it all the policy makers trying to create solutions are the losers in there of policy makers politicians the personalities make up the fireflies. we could use any place in the world and make that statement. the markets drive

pricing they attempt to price risk they do so based upon the best information they have and they change when the information changes and so that's how we get a little light on the subject that's how we illuminate it and that is what has driven policymakers to have to have to change greece would not have changed were not for credit spreads credit downgrading and an assessment of its budget like opened up the facts the same is true in perth for your the same is true when you investigate the e.c.b. program deeply and you begin to understand the nuances the pieces which come together in this remarkable remarkable piece of history in monetary policy in economics and you're talking about this latest bomb buying program which markets got really excited about it first but as you said you've gone through the nuances

and it doesn't seem like there is much to be excited about in terms of what this really has as a solution so how does this fit in to this dance well it one has to understand why the e.c.b. did what it did first of all you have to turn the chapter back to greece. when greece restructured and defaulted it exercised something called a collective action clause and it forced the bondholders to take a new security after the fact it breached the contract d.c. be held some of those bonds so the e.c.b. made a deal in a bond swap before the default so it could maintain a senior claim that created an impression on the markets which they hadn't thought about before there was some research on it but they hadn't thought about it and

what did the market say they said d.c. b. that has the power to have a senior claim above our bons can they then realize they have rather than fair oh well that's right we got stiffed yeah and so what happened they said we're going to widen out the credit spread because if they did it to us once they'll do it to us again portugal spreads when out spain went down italy went out we saw an adjustment in credit spreads because the market had to price in a new possibility that there could be a senior claim by the central bank now druggy has a problem he's got these countries with mile wide spreads he needs a program and furthermore he's got a new vehicle coming assuming the german court tomorrow doesn't rule it as an unconstitutional vehicle and i don't believe they will the market doesn't believe they will so that vehicle says starting in two thousand and thirteen

all the bonds will have the same collective action clause. druggy has to get that spread narrow before the sim kicks in so what does he do he comes up with a program he buys shorter term three years season bonds that are already trading in the marketplace and he says we'll buy them if there's a request for hill there are three countries that have done that and we won't take a senior position on the credit spreads come back to the drug he has said he didn't say it but what what he's done is we've made a mistake we had unintended consequences they've made things a lot worse we've got to fix it and that's what's driving part of the structure of this fascinating new bond buying plan season bunz it could be a ten year bond with three years left to go that could be subject to manipulation

for the seniority claim the bank has pledged not to do it and in the end to suppression of an action coming in two thousand and thirteen where new debt excess of a year maturity will be issued with a collective action clause throughout europe and now you say that this is this bond buying operation is essentially at the end of the day it is can kicking it's more monetary solutions for fiscal problems you talked about two kind of these new developments in central banking changes to the rules as well and some of these nuances we've seen a lot of unprecedented action since the two thousand and eight financial crisis you talked about some recently in an interview when it comes to excess reserves at the fed in interest paid on them now there's some discussion about cutting that interest paid these progressions is this going in a dangerous direction are you concerned that things are becoming more and more experimental where you have two questions there am i concerned absolutely yes. is

it dangerous the answer is we don't know if you look at this u.s. central bank the total size of the balance sheet of the federal reserve before lehman a.i.g. was about nine hundred billion today it's two point nine trillion it's two hundred two trillion more if you look at the g four central banks the big four in the world they used to be about three and a half trillion that's japan the u.k. the european central bank and the federal reserve they're over nine trillion and they're about to get larger so what have we done we've created four trillion in excess reserves being held by these banking systems what do we have to show for. the bankers claim and verdict is one of them had we not done this it would have

been a lot worse well there's no way to know that it's a counterfactual claim right there are some studies which would try to price it or argue it when you read them they have a very wide dispersion of outcomes and so there's a little selectively going on here what else have we done we've taken interest rates down to zero and we're holding them there and we're promising to keep holding them there and that's where we are in the short run we've suppressed longer rates of good quality credits now when you drop the short term interest rate what do you do you immediately give relief to the borrower. the saver the provider of capital still holds the original position you bought a five year cd it paid five percent interest during the five years the rate didn't change but as time goes by you drive down those rates you create financial repression on the savers right in comes go down and you get scared and yet save

more spend less and that's exactly what the central banks don't want them to do and that's exactly what's happening today so is it dangerous vince reinhard talks about financial repression i think is on the something the work that we've done in our shop says it's evolving it could become dangerous ok yeah well i would agree with you there on financial repression certainly an unintended consequence of all of this that said despite these record balance sheets despite financial repression markets still want more kiwi when the fab comes out with a decision on thursday so what would be the purpose of more q.e. except to feed what you call an addiction by the market well the i think markets are now addicted to q.e. q e their pricing in some action they're celebrating in advance of the party. there's a point in which q.e. becomes counterproductive the more you do not only do you get less and less and

less each step but you begin to send it impression that the repression is going to be here for a while then it flips to the other side we haven't had a symmetrical test yet lauren we've had the from in dropping the interest rates we're now in the middle or more of who knows where we are and so we haven't seen it yet the first central bank that does q.e. and gets a negative response will change this system dramatically it might be our federal reserve it may happen this week while and there is a prediction and maybe in that sense it will be a good thing to finally have a reality check if there is a negative response about what these programs are doing we're going to have more after the break i got to go to a quick one but we'll talk to david kotok chairman of congress land advisors in just a moment because still ahead we'll ask our guest about exchange traded funds you did write the book on the math for all and what their growth says about the desire

for macro investing you won't want to miss it the first or closing market numbers. i'm sorry that i had to do this i've been in so much pain in the past year that i can't take it anymore the stomach and chest pains have been getting worse and no doctor has been able to help me please know that i'll finally be at peace with no more pain i wish i could have had a life with it was a bit well these pictures are being moved why. mother to my kids i love you all so you all in heaven when your time comes i'm going to meet jesus christ.

thousands of u.s. troops in iraq received one of these drugs a drug called lariam and it may have prevented many soldiers from getting sick the question tonight is whether or not soldiers were adequately warned about its rare side effects serious life changing side effects.

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welcome back let's switch gears a little bit e.t.f. so what are the exchange traded funds as everyone in our audience probably knows as laid out in our guest book they're structured operated and regulated like mutual funds gain exposure to the market in the same way but unlike mutual funds that can be bought and sold just once per day these trade like traditional stocks and their exchange traded before one thousand nine hundred three though they didn't exist now they comprise one point two trillion dollars in u.s. assets about fourteen hundred of them are registered and trading in the u.s. with nine hundred more on the way so what does this growth indicate about the direction of markets i want to ask our guest david kotok chairman of cumberland advisors and author of the book from bear to bull with e.t.f. so given mr kotok we're talking all about these macro trends the markets the stock market addicted to q we addicted to central bank policy essentially i'm curious you

know you write about e.t.s. in your book and the growth of the men and this is essentially a way to trade sectors i'm curious if you think something there's something to the growth in e.t.s. alongside the growth of kind of the macro role in markets what do you think will. introduce democracy to the investor. with a package of instruments you can deploy around the world different allocation to different asset classes stocks growth stocks small cap stocks large cap stocks bonds commodities you name it you can a re a portfolio and you don't need a billion dollar foundation and sixty analysts to do it and so e.t.f. has revolutionized the options for an investor i can take a million dollars and i can replicate a yale university foundation account in the billions because of these instruments

now there's something about the insurance that requires people to do their homework at least investigate past the amount of time you would if you were going to go buy a new car and look into them dig into them understand them because they're different the sponsors are different the structures are different b.t.s. are a marvelous instrument they are efficient tax efficient cheap to trance transact in you can do it all day and all any time of the day do you think the growth speaks to the desire to trade on macrame is it supposed to and best an individual stocks based on their fundamentals well i think that that's a piece of it ok people people who want to trade the macro can do it with e.t.s. they want to do specific sectors or industry groups you want to buy the homebuilders for example because you think housing is going to recover you can go to one e.t.f. and buy the homebuilders in a in a basket and in that basket. you have

a survivor bias today the companies that got in trouble and or down in stock price or out because they're not around anymore have been removed from that basket it's a cleanse basket it has a survivor bias now you can't do that as easily with other instruments so i say for the e.t.f. investor you want to own gold or own g.l.d. you've got the gold e.t.f. or are you which is a little cheaper look at the fees you might like that one better disclosure we hold them if you want to own homebuilders buy x h b great e.t.f. gets the homebuilders disclosure we hold it for our clients so there's a lot of ways to do it with the ts and you look at e.t.s. and how they performed according to different sectors during a bear market in a bull market subsequently and recent years and i thought it was interesting the takeaway from broad based e.t.f.

what you looked at which what they showed about which companies performed best among small mid and large caps during the bear and bull market along with the difference between growth and value stocks what was the kind of key takeaway although i'd love to dive in deep and this is kind of we just have one at a time so what's the key takeaway there where the key takeaway is if you dissect the t.f. you know what's in it you know the weights and then you can begin to make decisions about the nature of the market take a position on the market is it a bull market is it a bear market what do i expect and you can see ways in which to position along with your view if you don't have a view then you might as well throw darts at stock pages but if you do have a view the e.t.f. gives you a way to do it what i did in the book and you said summed it up well i thank you for featuring the book is i took a downward move and then upward move back to the same level took apart all the sectors in industry groups in the s. and p.

five on. it index and comparative against the index so investors could see which have seen which sectors did better did worse in bear markets and bull markets and we tried to explain why that's the subject of the book right and what i thought was interesting was you found for example at the broad based e.t.f. that small caps were where you wanted to be when it turned into the bull market and that large caps were more resilient during the bear market period and kind of the same thing with volatility when it comes to growth versus value stocks so really key interesting takeaways there david kotok i have to ask you about one thing as switching gears from your book and that's you host a famous fishing trip in maine i want to make sure i get to this before we run out of time and you and you invite big wigs and you have a get together a great group of people that are all operating on chatham house rules meaning nobody can quote anybody on the record without their permission so that people can

speak freely how would you characterize the group this year because i know is this summer and what the sentiment was well it's a gathering of diverse views so you can have a beer and sitting across the table from each other the debates are fierce what we do is we invite it's very invitation only and we bring together people of goodwill and we just discuss it in a remote place in maine we do a little fishing we have a little wine we have some meals we actually have an entertainment we we enjoy each other's company. and it gives us a way in a relaxed environment to talk about important issues in global markets economics finance politics geopolitics and that's what we do we spend a weekend doing it and people have a lot of fun they also come away with some serious thoughts and if we provoke a thought or two than it's

a success most people want to come back laura i'm sure they do more out of time but just quickly would you sum up this sentiment this year as more bearish or bullish very concerned because policies are not clear there's no long view as to how the navigate through the water and so i would say the sentiment was cautious concerned there were some bulls of course in the audience but a lot of folks were very cautious in terms their outlook especially in two thousand and thirteen with budgets fiscal cliff political outcomes all the stuff we know what you i think refer to as the uncertainty premium which is really aptly named thank you so much for being on the show today i really appreciate all of your insight david kotok chairman of cumberland advisors.

let's wrap up with loose change to me trick a fan as is here to join me as we play you a clip of this very cool video. it was made by a fan which we appreciate very much a capital count had a shout out. with that alley so this is our hat tip to our education or. you know people would be drowning in liquidity maybe if they're watching it kind of goes it's a fun little video it's circling online with the future because it kind of goes there because of us little bags i really liked when when it was paul krugman jumped

off and said bernanke i love it because in the q. we filled pool there and hanging around sort of only all these are the drowned investors that if only i had watched capital count more often they would have understood very very sweet we appreciate it we appreciate being included course of our job is showing that love burning he's been critical of our name here is something i don't well but i mean it's not what but you know. what's interesting is that in the real world situation there should be a giant sucking function underneath this pool drippers of the flies from force because they're pumping all this liquidity but it's it's not circulating because getting sucked in the black hole of neverending liability. seven hundred plus trillion dollars group of black hole so lation ery forces speaking of them let's talk about this story a florida pizza shop owner scott van duzer seemed genuinely surprised last sunday

when a new customer came into his store big apple pizza. ok you're going to see. i was so excited gave him a big bear hug and he's a registered republican but said he voted for obama no way because of his stance on small businesses well reportedly republicans attack van duzer view yelp giving him a one star rating and leaving negative reviews like these saying that was disrespectful and he is insertion of suck up politics made me lose my appetite for big apple pizza and never eating at a big apple pizza again any of them no way i would never eat at a pizza shop that supports this president's social agenda isn't complete disrespect for our constitution when i'm in it i just think it's interesting for a stablish man politics when you're saying your reporting to be for a small business is for free enterprise supporting them but you're going into

filing their website for political reasons or they were. charming i'm sure if you meet him in person it's like you want to give a big bear hug that's exciting he doesn't have the united nations. the secret service we go berserk we want a guy go to prison the barrow you go by. what became of this secret service for this oh well maybe if. they knew about i don't know really you look to look at the prison was like. can you guys. i don't know i guess this is democracy at work though going and taking it to the what are you always goes to trolls men to forget and their trolls whatever. whatever they. know what they are going to. write about anybody and dimitri are out of time with your tirade leave our viewers to go troll on our website that thank you so much for

watching that's all we have time for though and don't forget the fact to come back to. in the meantime you can follow me on twitter at lauren lyster give us feedback on the show catch anyone messed youtube dot com slash capital account watch us an h.d. on hulu and have a great night. at michoud free critique ations free.