Monday, May 7, 2012

Investors were not ready to make a 180-degree turn

Treasury prices fell Tuesday when news that the U.S. manufacturing sector unexpectedly grew at its strongest pace in 10 months cast doubt on views the U.S. economy was faltering and would need more stimulus from the Federal Reserve.
The Institute for Supply Management said its index on nationwide factory activity rose to 54.8 in April, up from 53.4 in March.
"The ISM index was a notable contrast to the mostly weaker data we have seen over the past month or so, so stocks rallied and you saw a mild sell-off in U.S. Treasuries following this number," said Eric Stein, vice president and portfolio manager at Eaton Vance Investment Managers in Boston.
"The market was taken offside by the strong ISM number," said Jeffrey Given, managing director and portfolio manager at John Hancock Asset Management. "Most of the early manufacturing indicators pointed to a weaker number, not a stronger one, so the stronger-than-expected ISM index diminished some of the concerns about the growth outlook.

The Reserve Bank of Australia

A bigger-than-expected rate cut in Australia, spurred by domestic weakness, reminds investors that the U.S. and Europe are not alone in the global-economic jitters.
The Reserve Bank of Australia on Tuesday cut its benchmark overnight lending rate by 50 basis points to 3.75%. The size of the rate cut was a surprise to most analysts, who had expected just 25 basis points.
"This decision is based on information received over the past few months that suggests that economic conditions have been somewhat weaker than expected, while inflation has moderated," said Reserve Bank Gov. Glenn Stevens in a statement.
Indeed, the RBA does have more to worry about than inflation.

Market volatility increases

Even though market volatility increased recently, Nike (NKE) continues to do the sideways shuffle.
The stock is in a flat base with a 113.07 buy point. Nike has been in a seven-point range since hitting an all-time high March 20. It has dipped below its 50-day line intraday, but has yet to finish below the line.
Despite its recent sideways action, Nike has an up-down volume ratio of 1.6. This indicates that buyers are in control. The demand gauge was at 1.4 three weeks ago.
Nike is the world's largest marketer of athletic shoes and apparel. Thanks to innovative products and brand strength, the company has delivered year after year of growth. Even in tough economic times in 2008 and 2009, Nike reported top- and bottom-line growth.
The company is on track for a second straight year of double-digit earnings growth. Nike has a three-year Earnings Stability Factor of 3, signaling a steady stream of profits.

look at this stock

A handful of Big Cap 20 stocks are near buy points.
Being near the price of an entry, though, is no guarantee the stock will reach that price and clear it in strong volume. That's why a disciplined investor will always wait for the breakout.
Comcast (CMCSA), the No. 1 U.S. cable TV provider, is starting its fifth week of a potential flat base. On the weekly chart, though, the stock is only a day away from the five-week minimum.
If the flat base is completed, the buy point would be 30.51. A breakout in volume at least 40% above average would be required to validate the buy point.
Comcast is in the Telecom Services-Cable Satellite industry group, which was No. 41 of 197 groups, as of Monday's IBD. However, there's another way to look at this stock — as an indirect housing play.
An increase in housing naturally boosts cable sales. At Comcast's earnings call in February, CEO Brian Roberts said, "We don't see housing growth at the moment, but someday, that's going to happen."

Low interest rates

As the world begins recovering from the worst financial crisis in 70 years, an odd couple of winners have emerged: stocks and gold. So far this year, the Dow Jones Industrial Average, a bet on economic recovery, is up 14%. Gold futures, a bet on calamity, are up 19%. The reason: Low interest rates and heavy government stimulus have poured cheap money into financial markets, helping both the economy and stocks. But the creation of all that money, together with the Federal Reserve’s maintenance of near-zero benchmark interest rates and the prospect of heavy government borrowing to fund deficits, threatens to weaken the dollar and fuel inflation and economic volatility later.
Dangerous Side Effects of Ultra-Easy Money (pinecarr)
In order to engineer a 180-degree turnaround in trader psychology, from the chronic fear of meltdowns last year, to the opposite side of the spectrum – the euphoric illusions of V-shaped recoveries, the “Group-of-20” have committed $12-trillion of taxpayer money, equivalent to a fifth of the entire globe’s annual economic output. The G-20’s largesse

Place in investing

The term "value" can be highly subjective when it comes to investing. In the world of options trading some of that determination can be increased in its authority, if we see a situation, which sports relative value when comparing one contract to other surrounding contracts. Typically, traders using calculated values from a trading platform of their choice will simply notice the implied volatility of the contract, either a call or put, in question, is priced differently than other nearby options.
An alternative means to recognizing this kind of value can be accomplished by lining up synthetic markets. This is a useful exercise for traders looking to remain sharp and reliant on their own mental facilities and a skill, which still has a place in investing, despite all the whiz-bang technology out there.
Hypothetically, let's consider a call market in conjunction with stock to form a synthetic put and compare it to the pricing of a real listed put contract. When the call is examined as part of this

The strategy is inconclusive

The Royal Bank of Scotland has added the first exchange traded note to its "Trendpilot" ETN family that ventures abroad.
RBS China Trendpilot ETN (TCHI) — like RBS' six other ETNs — tracks its underlying index when it's trading above the 100-day simple moving average. If the index falls below that key line for three days straight, it switches to tracking three-month U.S. Treasury bills. TCHI will switch back to tracking the BNY Mellon China Select ADR Total Return Index when it trades at or above the 100-day for three consecutive days.
The note aims to capture most of the upside when the index is rising and avoid most of the downside when it's falling. RBS touts that its ETNs let you apply an actively managed strategy without

The stock has now fallen

Wall Street ended mixed Friday after the major indexes faded heading into the close. Bellwether tech stock Apple (AAPL) sank 2%, ending just above its 50-day line.
The Nasdaq turned a 0.9% gain earlier in the day into a 0.2% loss, wrapping up the third straight down week for the tech-heavy index.
The S&P 500 and Dow Jones industrial average both snapped two-week losing streaks despite slipping from earlier highs. The S&P 500 rose 0.1%, slicing an earlier 0.8% gain, while the Dow climbed 0.5%, easing off a 0.7% intraday rise. Turnover was higher on the NYSE, but lower on the Nasdaq.
Despite the market's pullback, some leaders continued to hold strong.
Firearms maker Sturm Ruger (RGR) rose more than 3% to close near its session high. It's now 14% past a 46.78 buy point from a flat base cleared March 22. That lift was in reaction to news that the

Returning to business

If anyone mentions the just-released 3.5% U.S. third quarter GDP growth, just throw this chart in their face. Cash for Clunkers clearly distorted the U.S. economic figures in an unsustainable fashion.
According to the Bureau of Economic Analysis (BEA), motor vehicle output spiked a seasonally-adjusted 157.6% quarter on quarter. This is completely unprecedented. Vehicle output is clearly going off a cliff next quarter. The question will be how low can the blue line below go.

Positive territory for the year

Below is an updated snapshot of 2012 equity market returns for 78 countries around the world. Of the 78 countries shown, 64 are in positive territory for the year, while 14 are in the red. The average YTD percentage change for all countries shown is 7.11%. Of the G7 countries, Japan, Germany and the US are outperforming the overall average.
Four of the G7 countries are significantly underperforming the average. The UK and Canada are currently up just over 1% year to date, France is up just 0.93%, and Italy is down 4.84%. Spain has been the worst of any country in 2012 with a year to date decline of 15.36%.

Monday, April 16, 2012

Many issues surrounding strip-malls

In what can be seen as a good sign, strip-mall vacancy has fallen for the first time in seven years. Despite the positive news, Reis states that it is too early to claim that this is a rebound. As you may know, this area of real estate was battered by the housing crisis and the subsequent recession.
Senior economist for Reis, Ryan Severino spoke on the topic:

Vacancies finally began to fall during the first quarter, declining by 10 bps. This is the first

Balance was revised

Analysts predicted that the trade deficit would narrow to $51.8 billion in February from $52.6 billion in January.
Statistics released last month indicated that the trade deficit had significantly expanded in January to its widest since 2008.
Last month's trade balance was revised narrower only slightly, to $52.5 billion.
While many see a widening trade deficit as a negative sign, historically an expanding trade deficit has been found to correlate directly with a rising GDP.
From the Census Bureau:

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced today that total February exports of $181.2 billion and imports of $227.2

Returning to business

CHART OF THE DAY: Cash-For-Clunkers MASSIVELY Distorted GDP

The spread of fear in the market

Whether you approve of his style or not, Karl Denninger cuts through the BS and says it like it is. The corruption and self-dealing in these bailouts is disgraceful. One must wonder whether there is any integrity left in government or our financial system. You and I and all other taxpayers are bailing these crooks out instead of sending them to jail.

More Arrogation Of Power?

Bloomberg has an interesting story up on the AIG derivative “payoff” mess I’ve repeatedly written about:

Beginning late in the week of Nov. 3, the New York Fed, led by President Timothy Geithner, took over negotiations with the banks from AIG, together with the Treasury Department and Chairman Ben S. Bernanke’s Federal Reserve. Geithner’s team circulated a draft term sheet outlining how the New York Fed wanted to deal with the swaps — insurance-like contracts that backed soured collateralized-debt obligations.

Actual price of the metal can go

I have been a big fan of using gold and silver positions to protect against the deterioration in the specifically the dollar and all fiat currencies in general.
There are several ways one can invest in precious metals. The first is to actually take physical possession of the metal. You buy bullion bars or coins. A second way is to invest in mining stocks. A third way is to invest in ETF’s like GLD or SLV that track the underlying metals. Each offers its own particular advanatages and disadvantages.
Buying the metal is the safest method because you have physical possession. It is also somewhat clumsy, involves storage problems and reduces your ability to get in or out of the market quickly. Mining stocks afford ease of in/out of the market, but expose one to major market moves and risks/events particular to the mining company itself. In up or down moves in the underlying metal, mining stocks often move multiples of the metal itself. ETFs offer the advantages of quick in/out

Expansive influence of speculative finance

Doug Noland’s latest post regarding “The Newest Abnormal” tracks many of the past buzzwords applied to the economy. Past terminology applied to economics and markets shows up in hindsight to be little more than post-crises rationalization at best. At worst, it was a form of Madison Avenue spin to entice unwary investors back into markets.
He details some of the history of this “marketing” and concludes that, despite clever phrases, we are still trying to blow bubbles. Here are a couple of excerpts from his piece:

The “miracles” were – without exception – belatedly recognized as Bubbles.
I’m thinking more “The Newest Abnormal”. To be sure, there have been some popped Bubbles. But we remain trapped in the same old Bubble-inciting paradigm of activist central banking and government intervention. I have expounded the view that a “government finance Bubble” emerged with the bursting of the Wall Street/mortgage finance Bubble. I would argue that Bubble dynamics have taken firm hold in China, throughout Asia, and in the “developing” economies more generally.
The New Normal implies more monetary order, while the Newest Abnormal suggests unrelenting Monetary Disorder. The proponents of the New Normal would tend to view extreme government intervention as a stabilizing force

Greater part of our economical institutions

Frederic Bastiat was probably the most influential economic essayist ever. He died in 1850. His “broken window fallacy” is probably the single most important principle in economics. It anticipated Keynesian economics and vitiated most of it before Keynes was born. Still today, one need only pick up the newspaper to find multiple violations of the principle. Ditto with economic speeches, especially by government-owned economists. Read Bastiat’s original essay and learn the single most important principle behind sound economics. This is an Econ 101 post. It probably should be sent to 500 plus people in Washington, DC who don’t or won’t understand this principle.

The Broken Window

“Neither industry in general, nor the sum total of national labor, is affected, whether windows are broken or not.”

Have you ever witnessed the anger of the good shopkeeper, James B., when his careless son happened to break a square of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact, that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation: “It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”
Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.
Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade — that it encourages that trade to the amount of six francs — I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.
But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”
It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented.
Let us take a view of industry in general, as affected by this circumstance. The window being broken, the glazier’s trade is encouraged to the amount of six francs: this is that which is seen.
If the window had not been broken, the shoemaker’s trade (or some other) would have been encouraged to the amount of six francs: this is that which is not seen.
And if that which is not seen is taken into consideration, because it is a negative fact, as well as that which is seen, because it is a positive fact, it will be understood that neither industry in general, nor the sum total of national labor, is affected, whether windows are broken or not.
Now let us consider James B. himself. In the former supposition, that of the window being broken, he spends six francs, and has neither more nor less than he had before, the enjoyment of a window.
In the second, where we suppose the window not to have been broken, he would have spent six francs in shoes, and would have had at the same time the enjoyment of a pair of shoes and of a window. Now, as James B. forms a part of society, must come to the conclusion, that, taking it altogether, and making an estimate of its enjoyments and its labors, it has lost the value of the broken window.
Whence we arrive at this unexpected conclusion: “Society loses the value of things which are uselessly destroyed,” and we must assent to a maxim which will make the hair of protectionists stand on end — to break, to spoil, to waste, is not to encourage national labor; or, more briefly, “destruction is not profit.”
What will you say, Moniteur Industriel? What will you say, disciples of good M. F. Chamans, who has calculated with so much precision how much trade would gain by the burning of Paris, from the number of houses it would be necessary to rebuild?
I am sorry to disturb these ingenious calculations, as far as their spirit has been introduced into our legislation; but I beg him to begin them again, by taking into the account that which is not seen, and placing it alongside of that which is seen.

$50 $44

“Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”

The reader must take care to remember that there are not two persons only, but three concerned in the little scene which I have submitted to his attention.
One of them, James B., represents the consumer, reduced, by an act of destruction, to one enjoyment instead of two.
Another, under the title of the glazier, shows us the producer, whose trade is encouraged by the accident.
The third is the shoemaker (or some other tradesman), whose labor suffers proportionately by the same cause.
It is this third person who is always kept in the shade, and who, personating that which is not seen, is a necessary element of the problem. It is he who shows us how absurd it is to think we see a profit in an act of destruction. It is he who will soon teach us that it is not less absurd to see a profit in a restriction, which is, after all, nothing else than a partial destruction. Therefore, if you will only go to the root of all the arguments which are adduced in its favor, all you will find will be the paraphrase of this vulgar saying — what would become of the glaziers, if nobody ever broke windows?

Sunday, March 25, 2012

Credit burdens are too large to be supported

The bailout fiasco is just now starting to show up for the act of desperation that many suspected it was. Instead of allowing markets to resolve a severely over-leveraged and distorted economy, the government decided to try to “bluff” its way through one more time. This strategy has been one used for almost 5 decades. Each time the credit stimulus required is bigger than the last. Each time the distortions to relative prices is made worse. Each time the misallocation of resources becomes greater. Each time the credit levels of individuals and government expand. Each time inflation becomes a bigger problem. Finally, a time comes when malinvestment and credit burdens are too large to be supported. It is probable that we have reached that point. To appreciate how far we have come regarding the abuses of credit creation, one need only note that since the Federal Reserve was created in 1913, the dollar has lost about 96% of its purchasing power. Most of that loss (probably in excess of 90%) has occurred since 1980.
There are still many that believe that government actions will get us out of our predicament. They won’t. When we come out of this mess, it will be in spite of these actions. They will serve to make the problem worse and cause it to last much longer. Japan has been employing similar stimuli for two decades, and its economy has still has not recovered.
As time passes, it will become apparent to all but the dullards that these interventions were non-helpful and actually harmful. Most understand economics only experientially. Events as discussed in the following post by Rolfe Winkler today are what will continue to surface with the passage of time and provide enough instances for the experiential learners.
Besides being a terrible decision that will cost taxpayers dearly, the article also talks about the unintended consequences of drawing deposits away from smaller, solid banks to the weaker GMAC. The unintended consequence is to weaken the stronger banks.

Monday, March 19, 2012

liberal intellectuals had to make a choice

Who were these people?

They were like scientists trying to address a convention of witch doctors.

They gave up career and fame to stick with the truth and say what had to be said.

… it is very dangerous for an economist to seek fame and fortune and to work closely with political establishments, simply because, in [Hayek's] experience, the most important trait of a good economist is the courage to say the unpopular thing. If you value your position and privileges more than truth, you will say what people want to hear rather than what needs to be said.

They chose freedom even when it was at the expense of their own bank accounts and even though their choice brought professional decline and risked failure in the eyes of their colleagues.

… the man who is willing to do what is right regardless of the circumstances.

It takes more than technical knowledge to be a good economist. It takes moral courage, and that is in even shorter supply than economic logic.

These were a remarkable group of economists that valued truth over fortune. In our materialistic, relativistic world, there are few like them today in any field. Too many economists have become “rent-an-economist,” willing to say or do anything for advancement and income. Other professions, including the physical sciences, have their whores as well, but the nature of the social sciences provides greater opportunities for such behavior.
To find out more about these people and their counterparts, read the following article.

Economics and Moral Courage

Hans Mayer (1879–1955)

It must be really painful to be an economist of the mainstream today — at least, it should smart to some extent. In a financial and economic calamity of the current scale, people naturally want to know who issued the warnings about the real-estate bubble and its likely aftermath.
When private-sector jobs have not grown at all in ten years, and when ten years of domestic investment is systematically undone in the course of 18 months, when housing prices in some sections of the country collapse 80 percent, and when formerly prestigious banks go belly up or receive many billions in rescue aid, people want to know which economists saw this coming.
Perhaps it is these economists — the ones who had long issued the warnings, and not the ones

This is the fourth Crisis period in American history

The always interesting and provocative James Quinn:

This is the fourth Crisis period in American history. The prior three were the American Revolution, the Civil War, and the Great Depression/World War II. We’ve experienced two revolutions and one world war that killed 65 million people. There is no way to avoid what awaits us. Like the seasons, we must go through Winter before we can experience Spring again. The only question is what events will transpire to generate the public fury that always occurs during the Crisis era. Will it be a foreign conflict over oil that transforms into a World War? Will it be a nuclear missile exchange in the Middle East? Will it be a nuclear device detonated within the U.S. borders? Or, will it be a domestic civil war due to a total collapse of our economic system? The conflict is likely to be triggered by natural resources or lack thereof.

Friday, March 16, 2012

Europe is in real trouble

Why Everyone Is Wrong About the Inflation/Deflation Debate

Jim Bradley
Let’s face the facts about the inflation/deflation debate:

1 – No one really knows or can possibly know what the “endgame” will be …
2 – The goal for investors is to be “future independent” as much as possible: a strategy that wins in nearly any market.
Consider the real issues facing the authorities right now:
1 – If they allow significant price deflation banks could fail in great numbers, and then they may be forced to really monetize which could ignite hyperinflation
2 – If they push in significant price inflation, the currency will collapse, and they may be forced to really deflate to bring back confidence (the “austerity” plans)
In sum, the Fed is facing a cliff on both sides of the path. They will try and stay in the middle.
That means the Fed will end up oscillating policy between price inflation and deflation with a bias toward whichever risk (U.S. government creditors or the banking system) they perceive as the greater.
Now consider the dollar. It is bad, except:
1 – Everyone else is in real trouble and in more trouble than the U.S. !
2 – The Euro is the only substitute in tradeable size against the dollar, and Europe is in real trouble!
The financial elite hold far more wealth in financial dollar assets than they possibly can hold in real goods. How are they going to hedge the risk that things might get out of hand if the dollar “must” devalue?
Let’s get a quick answer.
You might note that savvy market players, with the help of the central banks, can push markets to extremes and this helps the nimble set up to benefit from the other side (sell high, buy low).
Consider the fact that, in 1998, the real estate tax exclusion was quietly passed and the Fed subsequently allowed huge increases in mortgage credit.
Now, what is the one market, that recently was busted, that can take the kind of money flows that the big boys have stored in financial assets? After all we are talking trillions …
Hmmmmm.
In other words, the big boys can prepare for the risk of devaluation by buying cheap real estate and stocks of banks “that will survive” at near dirt cheap prices. This offsets the risk that things get out of hand (necessitating rapid price inflation) before (if) a global currency is introduced. If a solid global currency is introduced, then, in my view, the dollar is really toast.
So how to invest?
1 – Buy gold. It will benefit from a collapse in assets and from devaluation. Note that the dollar price of gold has almost nothing to do with “price inflation” and “price deflation” (convince yourself of this by noting the huge fall in the price as inflation continued for decades). It is more sensitive to whether there is a solid foundation under dollar assets – and the foundation can be broken by either a higher risk of price inflation or price deflation.
2 – Hold cash.
3 – Determine when your income is (1) price inflation advantaged or (2) price inflation disadvantaged or (3) price deflation advantaged or (4) price deflation disadvantaged.
For earners in industries that are doing well in price inflation and price deflation, hold medium amounts of real estate debt. Since income tends to hold steady, price deflation means other expenses drop and the debt is affordable; if there’s price inflation there’s an increase in income allowing a real return. This can take the place of some gold investment.
For any other combination, lean toward more cash, severely limit use of debt, build up a cushion, gain alternative income sources, and put some money in gold or alternatives like gold that are not someone’s liability. While you may decide to bet on one side of the market, the premise here is that it is difficult to know the outcome.
4 – Keep in mind that the authorities face real trouble with both price inflation and price deflation, so they may administer “survival” (they already have) and let some financial institutions fail which will curtail the price inflation effects when giving out lifelines financed with printed money.
5 – Remember, the purpose of the Fed is to benefit the banks and elite finance. They do that by providing a market for treasuries so that Congress can overspend. But now that the Fed can issue it’s own perpetual debt (paying interest on reserves!) the next step is to insulate themselves from U.S. government control and U.S. government insolvency.
6 – Remember, the most logical outcome is oscillation of price inflation and price deflation. When one seems to be reigning, operate with the other side in mind. In other words, during high and slowing inflation (indicating a peak), accumulate cash invested in shorter term assets in preparation for price disinflation. During price deflation, pick up bargains. Worst case, you will likely do better than those that believe the trend will be in one direction.
Good luck investing.
Disclosure: Author holds a position in Gold ETFs.

Which led to asset price stabilization

A depression was borne out of high levels of private sector debt made apparent by a financial crisis.
The effects of this depression have been lessened by economic stimulus and government support.
Government intervention led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more asset price increases. This has led to a false sense that green shoots are leading to a sustainable recovery.
In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized
Because large scale government deficit spending is politically impossible, expect a second economic dip within three to four years at the latest.

While I might quibble with his time frame and the necessity of government spending (a bit too Keynesian), it is a valuable piece that provides background for those attempting to understand better what has happened and what the future may hold.

Thursday, March 15, 2012

Savings via currency depreciation

“We concluded a decade ago that governments can always make money worth less by printing it faster than we, its citizens, can increased its value by our industry. For us it’s the same day over and over again: crash after crash, yet no deflation spiral. Instead we see a slow, steady destruction of the purchasing power of our income and savings via currency depreciation–a gradual, perpetual, stealthy dollar debt default. We call this stealth default, hidden in plain sight, The Game.”

Adding liquidity to the system

“By using our balance sheet, the Federal Reserve has been able to overcome, at least partially, the constraints on policy posed by dysfunctional credit markets and by the zero lower bound on the federal funds rate target. By improving credit market functioning and adding liquidity to the system, our programs have provided critical support to the financial system and the economy. Moreover, we have carried out these programs responsibly, with minimal credit risk and with close attention to the exit strategy. Our activities have resulted in substantial changes to the size and composition of our balance sheet. When the economic outlook has improved sufficiently, we will be prepared to tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration.”

Investors know where we stand on the topic

In this particular case, “V” stands for Valuation because every basis point of this 60% rally in the U.S. equity market from the lows has been due to an unprecedented expansion in P/E ratios. In fact, by some measures, the S&P 500 is already trading at valuation levels that would ordinarily be consistent with an economic expansion that is five-years old as opposed to a recovery that, at best, is in its infancy stages.
ONE OVERVALUED MARKET
There has been plenty of debate over whether equities are overvalued or not, and certainly we would assume that many investors know where we stand on the topic. Let’s look at the facts now that the September data are in.
On an operating (“scrubbed”) basis, the trailing P/E multiple on the S&P 500 has expanded a massive 10 points from the March lows, to stand at 27.6x. Historically, when the economy is taking the turn away from contraction towards expansion, which indeed was the case in Q3, the trailing P/E multiple is 15x or half what it is today (and that 15x is also calculated off depressed earnings level of prior recessions – we have more on the historical comparisons below). While we will not belabour the point, when all the write-downs are included, the trailing P/E on “reported” earnings just widened to its highest levels in recorded history of nearly 140x, which is three times the levels prevailing during the height of the tech bubble.
It is interesting to hear market bulls talk about how distorted it is to be using trailing multiples that include ‘recession earnings’ (even though using ‘forward’ earnings means relying on consensus forecasts on the future and these are rarely, if ever, correct). It is also interesting that the last time the multiple was this high was back in March 2002, again after a huge countertrend rally that deployed ‘recession earnings’ from the 2001 downturn. If memory serves us correctly, this was right around the time that the bear market rally started to roll over and in fact, six months later, the S&P 500 was hitting new lows and 34% lower than it was when the multiple had expanded to … today’s level!

Wednesday, March 14, 2012

Help the environment by increasing fuel efficiency

According to the Administration: “This is the one stimulus program that seems to be working better than just about any other program.” But this program, other than as judged by certain car buyers who thought they got “great deals,” has failed in terms of its stated goals. The disturbing part of the quote is that it is probably true. If so, how much damage have the other programs imposed on the economy?

That the program failed should not surprise anyone with a modicum of common sense. Economists centuries ago did not know about automobiles, but they knew the general principles that would thwart similar programs. The Wall Street Journal provides its take below.

Remember “cash for clunkers,” the program that subsidized Americans to the tune of nearly $3 billion to buy a new car and destroy an old one? Transportation Secretary Ray LaHood declared in August that, “This is the one stimulus program that seems to be working better than just about any other program.”
If that’s true, heaven help the other programs. Last week U.S. automakers reported that new car sales for September, the first month since the clunker program expired, sank by 25% from a year earlier. Sales at GM and Chrysler fell by 45% and 42%, respectively. Ford was down about 5%. Some 700,000 cars were sold in the summer under the program as buyers received up to $4,500 to buy a new car they would probably have purchased anyway, so all the program seems to have done is steal those sales from the future. Exactly as critics predicted.
Cash for clunkers had two objectives: help the environment by increasing fuel efficiency, and boost car sales to help Detroit and the economy. It achieved neither. According to Hudson Institute economist Irwin Stelzer, at best “the reduction in gasoline consumption will cut our oil consumption by 0.2 percent per year, or less than a single day’s gasoline use.” Burton Abrams and George Parsons of the University of Delaware added up the total benefits from reduced gas consumption, environmental improvements and the benefit to car buyers and companies, minus the overall cost of cash for clunkers, and found a net cost of roughly $2,000 per vehicle. Rather than stimulating the economy, the program made the nation as a whole $1.4 billion poorer.
The basic fallacy of cash for clunkers is that you can somehow create wealth by destroying existing assets that are still productive, in this case cars that still work. Under the program, auto dealers were required to destroy the car engines of trade-ins with a sodium silicate solution, then smash them and send them to the junk yard. As the journalist Henry Hazlitt wrote in his classic, “Economics in One Lesson,” you can’t raise living standards by breaking windows so some people can get jobs repairing them.
In the category of all-time dumb ideas, cash for clunkers rivals the New Deal brainstorm to slaughter pigs to raise pork prices. The people who really belong in the junk yard are the wizards in Washington who peddled this economic malarkey.

Investors should be wary

To believe that we are leaving the financial woods to a return to sunshine implies that we know what is going on. That certainly does not appear to be the case with the banking system as evidenced in Banks Have Us Flying Blind on Depth of Losses: Jonathan Weil . Is this incompetence or coverup on the part of regulators? Investors should be wary of either answer and recognize that they probably don’t have accurate enough information to be heavily invested in financial markets.

The retail investor has not come back

There is ample evidence that the retail investor has not come back to the market. These stats are consistent with this evidence. They may also be indicative of the fact that people are tiring of “tout” TV. My impression, based on sporadic viewing, is that this message has been absorbed. The on-air tone seems to have gone from ultra-optimistic to merely optimistic. References to GE below indicate they have made another enemy.

CNBC September Total Viewership Down 37% YoY
According to Nielsen, CNBC’s annual decline in total September viewership was a massive 37%: the worst YoY performance in 2009. The decline in the demo audience also hit a high of 27%. The dilemma for Jeff Immelt is the following: do CNBC pundits keep pumping GE (which everyone ignores, as CNBC’s credibility is practically nonexistent), or, at the expense of marking a few hundred billion assets at GECC to fair market value, incite another major market crisis. Perhaps, just perhaps, if the later were to occur, CNBC would have some chance of salvaging its prior year numbers. Although with CNBC now spending hours a day advertising GE engines, it seems like external advertisers couldn’t care less: after all, GE is subsidizing its own station by selling them ad space. Business schools have a word for that: vertical integration. Sane people have another word: biased reporting.

Corporate earnings are missing

This is One Funny Looking Bull
by Bill Bonner
London, England

The longer the rally persists, the more dangerous it becomes.

The S&P 500 is up almost 60% since March. The Dow just had its best
quarter since '98. 

Yesterday, the Dow slipped 29 points. Is the rally finally rolling
over? Or is this a genuine bull market, just taking a pause?

If it is a real bull market, then it's a funny looking bull - one
that's missing parts! 

For example, corporate earnings are missing. P/E ratios are rising far
above the corporate earnings that support them. This puts the market
35% overvalued, on a cyclically adjusted P/E basis, says Smithers & Co.
And if you look at it in terms of its "q" ratio - a comparison of
capitalization to replacement costs - the S&P is even more overvalued.
As for emerging markets - "they're off the charts," says The Financial
Times.

Another missing part is the consumer. This from David Rosenberg:

"Consumer confidence not only surprised to the downside in September
but the Conference Board index actually fell to 53.1 from 54.5 with
both the 'present situation' and the 'expectations' component failing
to build on the August rebound. Before we go any further on the
details, let's recall the following:To Read More.....

* Historically, by the time the S&P 500 rebounds 60% from the trough,
the confidence index is sitting at 92.0; 

* The month recession ends, the index is, on both an average and median
basis, sitting at 72.0;

* During an economic expansion, the consumer confidence averages 102.0;
in a recession, it averages 72.4.

"Just to put a 53.0 reading into proper perspective. It's still
recessionary... The only categories [that] actually saw their
confidence level rise in September were the ones in the lowest income
strata - less than $25,000 (their confidence rose two points). After
all, they're the only ones really benefiting from all the government
intervention into the economy and the markets."

It's not hard to figure out why consumers lack confidence; this bull is
lacking in jobs, too. A worse-than-forecast report came in from ADP
Employer Services yesterday. It said US companies cut 254,000 more jobs
in September. And Reuters reports that jobless rate rose in August in
all US cities.

The bull is also missing production. Another report told us that
manufacturing activity in the Chicago area is still in recession. In
the United States as a whole, the latest numbers tell us that GDP fell
in the 2nd quarter - but by less than forecast. "Less than forecast"
might be good news if stocks were at an epic low. Instead, at current
levels, it is much like a doctor who tells the family: "Thank God he
got medical attention. He's dead, but not as dead as he would have been
without it."

Another important part this bull market is missing is the retail stock
market investor. Hey, this rally has no legs at all!

We have insisted - with no proof, up until now - that the mom and pop
investor is no longer counting on the stock market for his retirement.
He's seen what can happen. At the low in March, adjusted for inflation,
he was back to where he was 40 years ago. That is, in real terms, he
had not made a dime from the stock market (aside from dividends) during
his entire adult lifetime.

We guessed that he was not buying stocks.

Now, here's the evidence: according to TrimTabs, only $2.5 billion has
gone into equity mutual funds in the last six months. Bond funds have
attracted 13 times as much money as equity funds, says a Morningstar
report. 

"US retail investors...have watched this rally from the sidelines," the
FT concludes.

Wait a minute. Someone is pushing up stock prices. If not the retail
trade, who? We don't know. Maybe hedge funds. Maybe institutional
speculators. The pros have a different outlook. If this rally turns out
to be real, and they miss it, their jobs and reputations are in danger.
If it turns out to be phony, on the other hand, they risk clients'
money. On balance...they are better off getting in than staying out.

But just as the pros jump like lemmings into equities...they could all
scramble out fast. Give them a fright...and this rally is over.

Where might the fright come from? We can think of several
possibilities. One is the housing sector. If foreclosures begin to
increase...and prices fall...even the pros may put two and two
together. 

Likewise, a shocking unemployment number could cause them to connect
the dots.

Then, look out below...
Another thing that might trigger a sell-off in the stock market: a
sudden setback in China...

Today is a big day in China...it marks the 60th anniversary of the
communist victory. "The Chinese people have stood up," said Mao,
announcing the victory in 1949. 

Then, over the next two decades, whenever the Chinese stood up...Mao
shot them down himself. Mao's long march to power was a huge setback
for human political progress - if there is any. The man was a thorough
scoundrel and a complete incompetent at everything, except getting
power and holding onto it. Every program was a disaster. When he set
out to 'liberate' the masses, they ended up as slaves. When he set out
to feed them, they starved. When he proposed to empower them with his
"democratic dictatorship," they ended up with bullets in the back of
the head.

But 60 years later, the commies are still in power. China is still red. 

And yet, thanks to the curious way the world turns, China's economy is
now freer and more competitive in many ways than the United States. Go
figure. 

As economies age, more and more people become 'rentiers.' That is, they
get some special privilege...some inside angle...some conniving
advantage. The latest numbers, for example, tell us that almost half of
all households pay no federal taxes. They collect benefits - jobless
benefits, food stamps, education, day care, Medicare, Social Security -
without contributing to the system that provides them. Add to this
number the millions of households that pay taxes but receive a large
part of their money from the government itself - employees,
contractors, lobbyists, etc. - and you have enough to win any election
in the country. 

But the welfare chiselers and food stamp cheats are small time crooks.
The big crooks go for billions. John Crudele in The New York Post:

"...Sept. 18, 2008 [US Secretary of the Treasury...Henry] Paulson
placed his first call of the day at 6:55 a.m., to Lloyd Blankfein, who
succeeded Paulson as CEO of Goldman. It's unclear whether the two
connected because Blankfein called Paulson minutes later. 

"And then Blankfein placed another call to Paulson at 7:05 a.m. for
what looks like a 10-minute conversation. 

"After that Paulson called Christopher Cox, Securities & Exchange
Commission Chairman twice; British Chancellor Alistair Darling and New
York Federal Reserve head (and now Treasury Secretary) Tim Geithner two
times. 

"Then Paulson took another call from Goldman's Blankfein. 

"It wasn't even 9 a.m. yet - 30 minutes before the stock market was to
open - and Paulson and Blankfein had already exchanged three phone
calls."

It pays to have friends in high places. That was the day the market
learned of Paulson's bailout proposals. Could Goldman have gotten word
before others? Hey, we're not accusing anyone...

under the control of the banking cartel

James Quinn with another well-researched and provocative post:

Congress has done a phenomenal job in taxing, spending and borrowing. Nobody does it better. They should get a Congressional gold medal for taxing, spending and borrowing. Up until 1913, the government was limited in their ability to spend because there was no personal income tax and the currency of the United States was backed by hard assets. Woodrow Wilson and Congressmen, under the control of the banking cartel, created the Federal Reserve and the personal income tax in 1913. The unleashing of politicians from any constraints on their spending has led to a predictable result. The US dollar has lost 97% of its value versus gold since 1913. The U.S. National Debt was $2.9 billion in 1913. Today, it is $11.9 TRILLION, a mere 400,000% increase in 96 years. That is the good news. President Obama plans to add at least another $9 TRILLION to our debt in the next 10 years. That is the actual plan. Can you picture George Washington spinning in his grave?

Here is another excerpt:

Rather than conclude that the gig is up and that running up huge deficits in order to police the world and provide welfare benefits to the 50% of the population that does not pay income taxes, Obama and Bernanke have decided to double down. Their solution is to double the National Debt, greatly expand the welfare state, and continue to police the world. Does anyone really think it is going to work? Bankruptcy is a certainty.

Tuesday, March 13, 2012

Regulation is responsible for current dissatisfaction

Many people believe that the problems in our current healthcare system are created by a failure of the free-market. Accepting such a premise, it is easy to look to some type of government intervention to improve matters. But it is exactly this viewpoint and “solution” that created the present system. The problems of health care cannot be a free-market problem because we do not have a free-market in health care. It is highly regulated, becoming more so with each passing year. Many believe this regulation is responsible for current dissatisfaction and problems and argue that a free market would solve such problems

Economy has been made worse

That we are in an economic mess is well known. That the so-called economic policies applied by Washington will do little to correct the problems (indeed, they will exacerbate the problems and greatly extend the economic misery) is less well-known and less widely accepted.

Here is an excerpt from this morning’s free email from David Rosenberg, in my opinion the best analyst of current economic conditions. (Sign up for his newsletter if you want timely and insightful analysis.) In it he details the results for the Cash-for-Clunkers “success” and additional programs to be provided by Washington:

THE ECONOMY LOOKS SICK OUTSIDE OF GOVERNMENT STIMULUS
Now that Cash-for-Clunkers is over, auto sales are collapsing again. Edmunds.com says the run-rate so far in September is down to 8.8 million units at an annual rate, but we see now that JD Power’s tracking is down to 590,000, which would be little better than a 7.0 million rate or half the pace of August and 24% below the already-depressed levels of a year ago. The November 30th expiry date for the first-time homebuyer subsidy, and this group has been responsible for one-third of housing activity, may also have something to do with the below-consensus sales figures for August that came out last week.
But don’t worry — Uncle Sam is coming back to the rescue. Congress is moving to extend emergency jobless benefits to over one million workers who are about to see their benefits expire by year-end. The House already approved on Tuesday a 15-week extension in states with unemployment rates of 8.5% or higher (oh — that only includes 27 states right now, by the way) and now Congress is looking at extending and expanding the homeownership tax credit. The short-term-ism in fiscal policymaking in terms of still trying to promote consumption and credit remains is fully intact and is actually quite sad because the U.S. boomer population is seriously short of savings needed to fund a boom in the retirement community over the next two decades. A Harvard University report shows that 60% of Americans do not have enough savings to fund their retirement. Why the government wants to resist the natural trend towards higher savings rates is … well, it’s unnatural. When your homeownership rate is over 67% and your consumption-to-GDP ratio is over 70%, you’re no exactly suffering from under-spending.

All Cash for Clunkers did was advance demand for autos. In doing so, it guaranteed that future auto sales will be lower than they otherwise would have been. The micro-economic distortions created by such programs (higher automobile sales at the expense of other consumption, encouraging consumers to go deeper into debt, etc.) are probably more important than the macro effects but are impossible to measure. This program was typical government — good politics but terrible economics. It is just another version of the game of “kick the can down the road and worry about the problems when they show up tomorrow.”
Government spending may succeed in pumping up GDP for the next quarter or two. If so, Wall Street touts will celebrate the news, and politicians will endanger their backs bowing to the masses. But nothing positive has been accomplished except politically. Economically, the condition of the economy has been made worse. GDP goes up because it is defined to include government spending as a component. But GDP is supposed to measure the well-being of a region as defined by economic activity. Economic activity can only improve by the increased production of real goods and/or capital formation, neither of which any government can do. If the private sector shrinks but is offset by an increase in the public sector, we are not better off. We become poorer, not richer via that outcome. It is only the private sector that produces; government only consumes.

In the absence of the gold standard

America has produced its share of radicals, both left and right. Although the definitions of “radical” have shifted over time (our Founding Fathers would be considered extremists today), those that are on the wrong side of prevailing definitions are usually precluded from public roles. Exceptions can be found, usually accompanied by a perceived “road to Damascus” conversion. Senator Robert Byrd of WV, an alleged former member of the Klan, is one example. Another astonishing example is provided below. This man stated the following:

The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
Deficit spending is simply a scheme for the confiscation of wealth.
… the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.

Based on the above, one would assume this man would have no desire to serve a government whose primary role, as perceived by him, was plunder of the wealth of its citizens. Furthermore, one might also assume that such a man would be judged unfit to serve, because his philosophical framework would be a threat to the myth of government and the bulk of its programs. Yet such a man did go on to serve and serve admirably in the eyes of many. Indeed, in terms of the thinking reflected in the statements above, he became the Chief Officer of Plunder. In more polite terms, the office is known as Chairman of the Federal Reserve. His name, of course, is Alan Greenspan otherwise dubbed “The Maestro” by admirers in the media. Lately, his admirers have lessened as his policies are seen to have been at the root of our current economic problems. Perhaps he should have stuck to his original principles rather than become an instrument of the State and a part of the problem.

Timing of the dollar’s decline

An interesting interview on CNBC about the dollar, gold and the fix that the Fed finds itself in. There are a couple of points to be made. 1) The debt is, I believe, substantially greater than the $60 Trillion used in the clip. The social obligations (medicare, social security, etc.) alone greatly exceed this amount. 2) A depreciation of the dollar of 50% is probably not unreasonable in terms of an unstated Fed/government goal. Whether 14 years is a reasonable period to achieve that is moot. Markets rather than the Fed may be the ultimate determinant of the amount and timing of the dollar’s decline. Why would massive holders (China, Japan, etc.) of dollar-denominated assets passively accept this outcome? Regardless, if this scenario plays out, then Americans look forward to having the price of imports dramatically escalating (near 50%) at the same time as the purchasing power of their Social Security is being halved. Whether the future plays out according to this clip or in some other fashion, the standard of living in this country is destined to dramatically decrease.

Treasuries in the future

The Fed is filling up with toxic assets. This graph from Davos (via Zerohedge) shows the composition of the Fed’s balance sheet. Before the crisis (circa December 2008) the Fed held only Treasuries and a small handful of other assets totalling about $800 billion. Today, the Fed has assets of almost $2 TRILLION!

There are many who argue the Fed has violated their charter by adding non-Treasury assets. The interpretation of statutes may have legal significance but it is irrelevant to markets that are being increasingly dominated by China, Japan, etc. The Fed has become substantially more risky, perhaps as much as some of the banks they have bailed out. Of course, they, in conjunction with the Treasury, have something called a printing press that individual banks do not.
Per this chart, the Fed had about $800 billion of safe assets in December 2007. Virtually all of this was Treasuries. Now, the Fed’s holdings of Treasuries has been reduced to about $400 million. Much of the rest, arguably, might be considered toxic waste. Thus they have gone from 100% safe assets to about 20%.
Another interesting observation from this chart is that the Fed actually reduced their holdings to close to zero until March of this year. At that point 100% of what they were carrying could have been considered junk or high risk. Since March the Fed has been building up its holdings of Treasuries using reductions in bank loans and the return of rescue funding as sources.
It is likely that the “safest” assets are the ones that have already been paid back to the Fed. If the Fed had any intentions of an exit strategy, the paydown of these assets would have been a natural way to implement it. On the other hand, it is entirely possible that it was necessary for the Fed to buy Treasuries in order to not have failed Treasury auctions. If so, that means that they likely will be buying many more Treasuries in the future, presumably not being able to fund them with paybacks as occurred within the last few months.
The assets on the Fed’s balance sheet are the best indication of liquidity or potential money in the financial system. In about 3 months these assets rose by well over 100%. Much of this is dry tinder being held as excess reserves by banks, probably in anticipation of greater losses to come. Any misplaced match however could ignite this tinder. Whether this happens soon or further down the road cannot be reasonably forecast. It is doubtful that the Fed’s balance sheet will decrease materially from here. It is more likely to double before this mess is over.
It is very difficult to envision a scenario that doesn’t end in very high inflation. The timing of that is less certain.

Policy actions will affect the economy

The referenced article is a talk given at the Chicago Fed. It discusses the Monetarist vs. “Output-gappers” views on inflation and deflation. Monetarists are probably represented best by the late Milton Friedman. Output-gappers are best represented by Keynesians such as Paul Krugman.

I favor Friedman as opposed to the output-gap position. Implied in the output-gap position is the “incorrect” definition of of inflation/deflation as rising or declining prices. The Friedman position tends to fail empirically in recent years because of technological improvements and financial innovations. That is, the very definitions of money are blurred and changing. Does one include the “shadow-banking” system or not? Does one adjust for sweep accounts that effectively reduce reserve requirements in the banking system? These are merely two of the examples that muddy the empirics and destroy what had been long- standing correlations.

Neither position has an adequate theory of the business cycle. Output-gappers tend to be entirely ad hoc, usually pointing to some external event such as a supply shock. Monetarists always blame recessions on a slowdown in the rate of money creation.
The Fed’s dual mandates of sound money and high levels of employment have placed them in a role as a Central Planning Authority. These mandates, although not necessarily conflicting, become so in a politicized democracy. Every “blip” in the data becomes important and pressures the Fed to do something. It is impossible for them to admit that they have limited control, don’t know when policy actions will affect the economy or how much of an effect they will have. Monetarists such as Friedman argued that these unknowns resulted in Fed remedial actions greatly exacerbating the conditions they intended to solve.
The same commentary can be offered regarding fiscal policy. It too is burdened with unknown lags and effectiveness. Because it is directly a part of the political process, it has enormous front-end lags while the program is endlessly debated, pork inserted, etc. The emergency stimulus bill is a good example. While it passed quickly, only a small amount of the money has been spent. It is estimated that it will not all be spent until the end of 2010 or beyond.

Real resources as loose monetary policy

Doug Noland of has it right on his “No Exit” Possible scenario. Our economy has become totally dependent upon government spending, interventions and subsidies. There is no recovery in the private sector, nor is there likely to be one in the next several years. Federal meddling will continue to create distortions that will require additional and continued meddling. From a political standpoint, there will be no good time for an exit. However, at some point, the system will not be sustainable. Markets will eventually end the meddling regardless of whether it is politically or economically feasible or timely. When that happens, our lives and economy will never be the same again.

No Exit:

ECB President Jean-Claude Trichet penned an op-ed in today’s Financial Times, “Europe has Mapped its Monetary Exit.” Following the path of Chairman Bernanke, Mr. Trichet explains in some detail the ECB’s plan for exiting its program of “enhanced Credit support.” And further tracing the Fed’s footprints, Mr. Trichet is keen not to spook the markets: “Stressing the importance of the exit strategy should not be confused with its activation: it is premature to declare the financial crisis over. Today is not the time to exit.”
President of the New York Fed, William Dudley, stated clearly in Monday’s interview with CNBC’s Steve Liesman that he believes it is too early for the Fed to begin its monetary stimulus exit. “…The economy isn’t growing very fast and we do have a very high unemployment rate.” Deep structural impairment ensures that there will be no agreeable time for policymakers to reverse course.
Ahead of the Group of 20 meeting, UK Chancellor of the Exchequer Alistair Darling commented today that nations should “abandon measures” when recovery takes hold. If it were only that easy. The Fed has already promised markets an extended period of ultra-loose monetary conditions. And I would expect dollar vulnerability (strong euro) coupled with more general systemic fragilities will keep ECB “exit” policy stalled or, at best, restricted to tiny Greenspan-style baby steps.
I’m rather skeptical with respect to central banker “exit” chatter. As markets have recovered and economies stabilized, they have been compelled to articulate somewhat coherent plans for returning to a more stable monetary backdrop. On the one hand, central bankers are keen to reassure the markets that inflation fighting remains a top priority. At the same time, central banks go to great pains to ensure the markets that no meaningful monetary tightening is in the offing anytime soon. On the surface this appears an act of walking a fine line. In reality, markets these days fret only monetary tightening.
In response to Mr. Liesman’s question on the Fed’s commitment to purchase $1.25 TN of agency MBS, Mr. Dudley made telling comments. “Market expectations are very, very important. And the market expects us to complete these programs, to do the full amount. So to contradict that market expectation, I think, is a pretty high hurdle.”
When I contemplate “exit” strategies, I think specifically in terms of policymakers eliminating government market intrusions that distort the price and flow of finance throughout the financial system and real economy. Today – and over the years – one can certainly look to the (activist) Federal Reserve’s (and other central banks’) manipulations of the targeted “Fed funds” rate as a fundamental government intrusion. For years now, artificially low “pegged” borrowing costs have distorted pricing and price relationships for financial instruments and risk more generally. Over time the Fed became only more comfortable – and encroaching – with its capacity to influence market behavior (i.e. lending, speculating, leveraging, investing in risk assets, etc).
Yet, as I’ve argued over the years, the government’s intrusion into our nation’s mortgage market has likely been as consequential in distorting both market pricing and the allocation of financial and real resources as loose monetary policy. The GSE’s used the market’s perception of implicit government backing to balloon their books of business to $5 Trillion. Today, more explicit Washington guarantees will empower Fannie, Freddie, the FHLB, the FHA, VA, Ginnie Mae and others to accumulate Trillions more risk exposure. I can’t take any talk of an exit strategy seriously until I see some coherent plan for disengaging the federal government from our nation’s mortgage industry.
>From this morning’s Wall Street Journal (Nick Timiraos and Deborah Solomon):
“In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006… FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year… Before the boom, the FHA wasn’t a big player in the housing business because it didn’t follow private lenders in loosening its standards. Borrowers had to fully document incomes and insured loans were capped at $362,000. Congress increased those limits last year to as high as $729,750 in the most expensive markets. In August, the FHA and the U.S. Department of Veterans Affairs backed 40% of loans for all home sales.”
It is as well worth noting that Fannie Mae increased its book of business (retained mortgages and MBS guaranteed) by $70bn in the past two months (to $3.22 TN). And, according to Bloomberg data, y-t-d issuance of agency (Fannie, Freddie, and Ginnie) MBS is already approaching $1.3 TN, compared to full year 2008’s $1.153 TN, 2007’s $1.148 TN, 2006’s $903bn, and 2005’s $958bn.
So, it has reached the point where Washington is underwriting the majority of existing mortgage debt throughout the system and is now backing essentially the entire amount of net new mortgage Credit. Meanwhile, the Federal Reserve is purchasing/monetizing about $25bn of agency MBS – on a weekly basis. As Mr. Dudley stated, “Part of the whole point of the agency mortgage-backed securities purchase program was to drive mortgage rates down to therefore make housing more affordable – to cushion the decline in the housing market. So I think it has been very effective.”
Effective perhaps, but what about an exit strategy? Well, I see a “No Exit” sign. These distortions have been going on for too many years and become too systemic. Indeed, government interventions are at the core of systemic fragilities that ensure Washington will continue to meddle. Exiting government intervention would entail the Fed normalizing rates and ending its massive program of monetization, while an exit by the federal government would entail an end to its expansive program of guaranteeing Trillions of mortgages and mortgage-backed securities. Understandably, the markets spend little time fretting the possibility of Washington getting cold feet on mortgages (or rates).
The Mortgage Bankers Association was out this week with a proposal for revamping the GSEs. From The Wall Street Journal (Nick Timiraos): “A mortgage-industry trade group is calling for Congress to transform Fannie Mae and Freddie Mac into several smaller privately held companies that would issue mortgage securities carrying an explicit government guarantee.” With the help of a government-directed “bad bank,” Fannie and Freddie could be restructured and, apparently, have another go at it. The federal government’s explicit backing of MBS was the key facet to the proposal, a feature seen as necessary for the market’s acceptance of the mortgage securities.
The Administration is to issue its own recommendations for mortgage overhaul next year. We can only hope that this scheme of breaking the GSEs into a group of new “private” companies – benefitting from explicit government debt guarantees – is not adopted. The last thing the system needs going forward is a bunch of little Fannies running around – with hot stocks – trumpeting a seductive story of a new and improved risk models that can promote mortgage lending, housing recovery, and economic growth – with the taxpayer on the hook for only more losses.
As I have written previously, the number one policy priorty these days should be to ensure the course of policymaking does not bankrupt the country. The Federal Reserve must do its part first and foremost by protecting our currency. The Fed must in a timely manner exit its crisis management regime of zero interest-rates and massive monetization – especially of MBS. To avoid “bankruptcy,” the federal government must move aggressively to exit massive deficit spending and the accumulation of systemic mortgage risk.
Regrettably, signs read No Exit on all fronts. And it is this mortgage issue that worries me the most, as few seem to appreciate the mounting risks. Conventional thinking has it that the governent can step in temporarily and stabilze the housing markets. And when home prices reflate and the economy recovers, the private Credit system will take over as the federal government gracefully exits.
The more likely scenario is that federal government market intervention further distorts the marketplace – creating a dyamic whereby only government-guaranteed mortgages attract market demand. Any move by the government to retreat from its backing of the mortgage market would risk acute instability. And, at some point, the government’s accumulation of debt and mortgage obligations would begin to impact the market’s view of creditworthiness.
There is the appearance that government intervention throughout the mortgage marketplace provides a free lunch: Households, once again, enjoy access to plentiful cheap mortgage Credit, while there’s no impact to the cost of federal borrowings. Why would anyone in their right mind even contemplate an Exit – especially when things remain so fragile? Why not wait a year or two or a few…
Yet I would argue that there is a huge and festering (latent) cost to Washington’s mortgage operations. At some point along the way – and you can count on it being a rather inconvenient juncture for the markets and economy – creditworthiness will become a hot issue. The market will finally demand higher yields for Treasuries, agencies, and GSE MBS – and will surely be less than enamored with our currency. MBS backed by today’s artifically low mortgages will come back to bite. And when the market turns against “federal” debt obligations, you can count on the market really, really turning sour on mortgage risk. That will mark the point when years of government market interventions and distortions come home to roost.

Monday, March 12, 2012

Act quickly to stop inflation

. It deals with Albert Edwards judgment as to where the stock market is headed. His assessment, at least in its end point regarding the stock market, is virtually identical to mine.
Sometime we wonder if we are the only ones who are stunned by the ridiculousness coming out of the stock market on what seems a daily basis. Luckily, there is at least one other person out there who, like us, take a bemused approach to the endless insanity. As Albert Edwards says in his latest note: “I’ve been doing this job long enough to recognise when the markets are entering a new phase of madness that leaves me scratching my head with bemusement. The notion that we are in a sustainable economic recovery is as ludicrous as it was in 2005-2007. But investors are back on the dance floor, waltzing their way towards the next, inevitable implosion – yet another they will no doubt claim in retrospect was totally unpredictable!”
In that vein, it is not surprising that Edwards shares our disdain toward the Chairman:
“Very little surprises me anymore in this business. But even I was surprised by Ben Bernanke?s comment on CBS?s ?60 minutes? that he has ?100% confidence? that he can act quickly to stop inflation getting out of control. Surely if there is one thing Ben Bernanke should be 100% confident about, it is his own fallibility. Remember this is the man who was not only adamant that US house prices would not decline, but refuted the very notion that there was even a house price bubble in the first place! I realise these guys have to pretend that they know what they are doing, but you would have thought that, having been at the epicentre of the biggest economic and financial crash since the 1930s, he would show a little humility and uncertainty. Apparently not.”
But when the entire system, the whole global ponzi pyramid, knows it has no choice but to continue ploughing ahead, as otherwise the consequences would lead to the end of the financial system as we know it, what can one do but join the banks…
“In July 2007, the then CEO of Citigroup, Chuck Prince, told the Financial Times that global liquidity was enormous and only a significant disruptive event could create difficulty in the leveraged buyout market. “As long as the music is playing, you’ve got to get up and dance,” he said. “We’re still dancing?. This of course was a variant on the Japanese saying “When the fools are dancing, the greater fools are watching.” Well, I suppose if Bernanke is specifically targeting the equity market with QE, who but the most curmudgeonly bear would not be gyrating their hips in time to the music?
Unlike Ben Bernake, I like to retain some sense of humility. And it’s at times like these that I really start to think I haven’t got a clue what is going on anymore. It really is a mad, mad, mad world. Although on the sell-side I think I remain a lone voice of bearishness, there are other commentators who share my extreme scepticism of the current situation.”

Financial Armageddon on the Weimar experience

I have never felt comfortable with stocks as an inflation hedge in rapid inflationary periods. While they tend to be driven up, they generally do not keep pace with inflation as well as hard assets. If that is the case, then you will lose purchasing power even as your nominal wealth increases. That is better than fixed income investments where you will lose both purchasing power and nominal wealth.

Here is some data from Financial Armageddon on the Weimar experience:

Timing Is Everything

Choices for individual investors

This started out to be an article in the investing series, but began to wander into other areas. While I am overdue for the investment article and hope to have it out soon, I thought I would publish these ramblings.

There will be a major article out mid-week on QE2. It will be the basis of my current thinking on where the economy is going. Investors should not miss this.
I have been an investor for decades. When I started, investing was simpler in the sense that there were fewer choices for individual investors. Stocks, bonds and real estate were the primary ones. Brokers had to be involved and outrageous fees were charged compared to today. Now trading costs are almost zero, information is instantly accessible and it is possible to trade almost any market at any time of day from anywhere.
Government played a smaller role in the economy and in markets. The Keynesian notion that government was necessary to offset slumps and equilibrate the economy had not yet taken hold. Once it did, politicians exaggerated its claims and abused the tool. Spending, under the guise of economic necessity, became a preferred vote-buying vehicle. Earmarks quickly became a staple of political behavior.
Honesty and integrity used to characterize relationships between people. Business deals were often done with handshakes, without hundreds of pages of legal documents. “His word is his bond” was assumed until proven otherwise.
People believed in what was “right” rather than what was “legal.” Today the ethical “right” has been replaced with “is it legal?” To paraphrase what passes for today’s morality: “I don’t care what’s right; can I get away with it legally?”

Justice Brandeis

Ethical behavior is rarer now, perhaps for the reason cited by Judge Brandeis:

In a government of laws, the existence of the government will be imperiled if it fails to observe the law scrupulously. … If government becomes a lawbreaker it breeds contempt for law: it invites every man to become a law unto himself. It invites anarchy.

On the other hand, perhaps none of this is new. Edmund Burke, reflecting on the French Revolution, expressed similar concerns over societal deterioration:

The age of chivalry is gone. That of sophisters, economists and calculators has succeeded.

Perhaps it is just a natural cycle of civilization where moral decay precedes and then accelerates the decline of a nation.
Our economy used to be driven by manufacturing and productivity. Growth could be expected to be about 3% per year, except in years when recessions hit. Recoveries were generally quick, characterized by rapid growth that offset prior bad quarters and returned the economy to its 3% trendline.
Our economy is now diminished. We no longer manufacture much, at least on a percentage basis as compared to the past. Instead, we have driven GDP via massive consumption. Consumption is not a bad thing, but to sustain it requires the creation of value or wealth. That comes from production and productivity growth. We have recently engaged in massive consumption without either.
When you are not producing, the only way that to increase consumption is via the draw-down of savings/investment or debt-based purchasing. Both have occurred and both have been the main drivers of our economy for the past three decades. Both are unsustainable over the long-run.
The capital base (real savings and investment) of an economy is the most important determinant of wages. Economies that have tools for their citizens are more productive than those that don’t. Hence they have higher wages. Our people earn more than most of the world not because we are “chosen.” We earn more because we have more capital in the form of machinery and equipment. A bulldozer operator moves more dirt in an hour than a primitive-based economy using hundreds of workers with crude implements can do in a day. The bulldozer operator as a result earns much more than he would without the equipment.
If physical capital is not growing faster than the population, real wages must come down. In our consumption economy, capital has been used up and not replaced. As a result, the average real weekly wage today is lower than it was in 1964. Nominal wages are higher, but the dollar buys less as a result of inflation.
The other driver for consumption has been debt. For at least the past twenty years, people lived beyond their incomes. Consumption soared, but production did not. Many of us borrowed our way to a better life. The financial industry was abetted and encouraged by the government to create easy credit.
For a while, this behavior appeared rational. After all, credit was cheap and our monetary wealth exploded primarily due to a run-up in the stock market and housing prices. When the dot-com bubble burst in 2000, Alan Greenspan dropped interest rates too low and held them there for too long. This created the housing bubble which was also assisted by a loosening of credit standards for those buying homes.
Existing homeowners felt rich as the value of their homes soared. Many used these increased values as a source of better living by refinancing to higher loan levels and taking cash out of their homes. Reality set in when housing values began to collapse and return to traditional norms, leaving many homeowners “under water.”
There are plenty of villains in the saga of the last few decades. There is no need to affix blame other than to say that when government intervenes it distorts prices. Prices are information. They are “language” in the sense that they tell us how to behave – conserve here, expend more there, invest more or less over here, etc. Distorted prices cause a distorted allocation of resources. By distorted allocation, I refer to one that cannot be sustained once the interventions end.
It is useful to offer a few comments on “greed.” Many individuals were “flipping homes” and were wiped out. They have been accused of being “greedy.” Greed is always something that someone else engages in. When we engage in similar behavior, we think of it as self-interest, trying to improve the quality of life for our families. I don’t know how to define greed and neither does anyone else. As Gordon Gecko stated: “Greed is good.” I interpret greed that way so long as it stays with the law and ethical norms. Then, it is no different than ambition or motivation.
The story of the last couple of decades was distorted prices that misled consumers and investors. Government intervention distorted housing prices. For several years, home prices rose rapidly in some markets. Stock prices were languishing. Many believed that the best investment they could make was in second homes, expanding their existing homes or flipping homes. Rising home values signaled to people that they were “rich.” Based on signals from the marketplace, there was no need to continue to save for retirement because their homes would provide that. People unfortunately borrowed against what they believed to be real wealth.
None of this behavior was irrational unless you were a knowledgeable economist who understood what was happening. And even economists missed what was happening. Most of the world was behaving rationally by taking actions that we now know were wrong. They trusted our information system known as prices. They did not know that government intervention had produced false and misleading prices, driving housing values beyond what could be sustained.
The tragedy of housing and other asset bubbles is that people trusted their government and trusted the price system that government was distorting. They had no way of knowing the the government had ruined this information transmission mechanism. It was not “greed” that created the economic mess but government intervention.
In hindsight it is easy to see that housing was a massive bubble. Yet the average Joe is not a sophisticated investor. He has innumerable interests, probably none as important as improving the quality of life for his family. Economists like Ben Bernanke missed the bubble. Why would we expect a plumber, accountant or even a business executive to spot it?
Unfortunately government intervention is still distorting prices. Investing success will come to those able to spot these distortions and properly estimate how long they might continue.

Friday, March 9, 2012

Our problems were created over multiple decades

I am frequently asked by readers to provide a market forecast. As I have said before, it is possible to do so but it is impossible to do so with any reasonable degree of certainty.

The probability of an accurate forecast is slight in normal times. The current situation is hardly normal, reflecting economic and political conditions never before seen in our investing lifetimes. What we are about to experience is apt to make the Great Depression look rather mild in comparison.
The recent market sell-off in virtually everything except the US dollar and Treasuries might be attributable to the situation in Japan, the worsening conditions in Europe, the fact that our economy is not recovering, the expectation that the Fed will end QE, the expectation that the QE will not end or a myriad of other things. One never really knows contemporaneously, often not even with the passage of time.
Talking heads have answers to all market movements in spite of the fact that no one can truly know. They provide explanation for what drives markets for a day or a week. For them any change is meaningful, never merely “noise.” Talking heads are paid to provide answers that sound good. Never mind whether the answers are true or not. All they must do is convince listeners that they are “experts.” That is, they must sound good while spewing BS.
I have no idea why this market is selling off. Nor do I know why it got as high as it did. The latter suprised me. While I wonder why it took so long for an apparent sell-off to begin, that is often the pattern. Perhaps Mr. Market, like Wiley Coyote, finally looked down and saw only air below. Regardless, the market levitated longer than many expected.
The euphoria that drives markets up is always fed by our unquestioned belief that tomorrow will be like yesterday or better than yesterday. That wishful thinking was augmented by government rah rah, a compliant media spinning bad news and the issuance of likely manipulated statistics. Of course, the most massive stimulus the planet will ever see, played a huge part also.
So where are we now? Is this the beginning of a major downturn or merely a minor correction for a rally that needed some rest? There is no way to know for certain, but the factors discussed in the third paragraph are ominous and have not gone away. No positives that I am aware of can mitigate these. Indeed, there are more negatives lurking or threatening to break out. In short, it is impossible to be optimistic.
But markets don’t care about our individual judgments. They are going to do what they do best and that is perplex and confuse us most of the time.
I am not anxious to commit funds to this market in the short-term, a year or so. Events can change yet I just cannot think of any that could make me change my mind. Nor do I believe there is reason to be positive on a longer term basis. Our problems were created over multiple decades. They are likely to take that long to solve. Over the longer term, markets are apt to produce returns well below historical averages.
Having said all that, I keep my eyes open and look for signs that might indicate change. Sadly, I do not believe this is like any prior economic or financial condition. Governments around the world are mostly broke and desperate to pretend that things are just fine. They are not, and governments pretending otherwise are only making things worse.
Be very careful. Your objective should not be to increase your wealth but to protect your purchasing power. Some of course will because vast sums of money will be made and lost in the economic armageddon that lays ahead. Money will not be made via conventional investment techniques.

Thursday, March 8, 2012

Identifying and assessing opportunities

In an interview of Simon Black by Chris Martenson the following topics were discussed:

The nature and scope of the opportunity he sees foreign markets offer – on investing, business and personal levels

Why much of the developing world is in a secular ascendancy vs developed countries

The investing edge his boots-on-the-ground info scouting gives him in identifying and assessing opportunities

The universal trend he observes in all governments to preserve the status quo – and why that means the US is likely to continue down its current inflationary money-printing path

How developing exposure to countries outside your own offers reduced risk and higher potential returns to your investment portfolio

How individuals of any means can pursue “true freedom”: sufficient personal wealth, time and liberty – by looking abroad

The economy plunges into another recession

Claus Vogt sees two possible events occurring from where we are today:

Bond collapse scenario. Mass psychology in global bond and currency markets drive the action.
One night, you go to bed thinking that the majority of market participants retain confidence in government debt, more than enough to prop up bond markets forever.
Then, the next morning you wake up to discover that the global confidence in the U.S. has been shattered by a singular event, and all hell is breaking loose.
Borrowing becomes next to impossible or prohibitively expensive. Banks fail. The financial system as we know it unravels. The economy plunges into another recession.
A video replay of 2008? No. Because this time governments do not have the will or the means to fight it.
Recession scenario. We wind up essentially falling off the same cliff as in the bond collapse scenario, but we get there via a different pathway.
This scenario begins where the first scenario ends — with a double-dip recession.
The recession guts government tax revenues, bloating the federal deficit even further.
And this is what leads to a government funding crisis, much as it has for many cities and states around the U.S.

He discusses the signs that point both ways in his article.
As most readers of the site should know, I consider either of these possible and probably lean more to the former. The important point, at least for me, is that neither of these are endings. Either represents just another intermediate step on the way to a Great Depression.

Monday, May 7, 2012

Saturday, May 5, 2012

Thursday, May 3, 2012

Wednesday, May 2, 2012

Tuesday, May 1, 2012

Monday, April 30, 2012

Friday, April 27, 2012

Monday, April 23, 2012

Sunday, April 22, 2012

Wednesday, April 18, 2012

Monday, April 16, 2012

Friday, April 13, 2012

Tuesday, April 10, 2012

CHART OF THE DAY: Cash-For-Clunkers MASSIVELY Distorted GDP

Friday, April 6, 2012

More Arrogation Of Power?

Thursday, April 5, 2012

Tuesday, April 3, 2012

Saturday, March 31, 2012