Saturday, June 26, 2010

Economic Day of Reckoning Arrives for States

from Bloomberg:
Californians don’t see much evidence that the worst economic contraction since the Great Depression is coming to an end.

Unemployment was 12.4 percent in May, 2.7 percentage points higher than the national rate. Lawmakers gridlocked over how to close a $19 billion budget gap are weighing the termination of the main welfare program for 1.3 million poor families or borrowing more than $9 billion in the bond market. California, tied with Illinois for the lowest credit rating of any state, is diverting a rising portion of tax revenue to service debt, Bloomberg Markets magazine reports in its August issue.

Far from rebounding, the Golden State, with a $1.8 trillion economy that’s larger than Russia’s, is sinking deeper into its financial funk. And it’s not alone.

Even as the U.S. appears to be on the mend -- gross domestic product has climbed three straight quarters -- finances in Arizona, Illinois, New Jersey, New York and other states show few signs of improvement. Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June, according to the Center on Budget and Policy Priorities, a Washington research institution. State spending is 12 percent of U.S. GDP.

“States are going to have to cut back spending and raise taxes the same way Greece and Spain are,” says Dean Baker, co- director of the Center for Economic and Policy Research in Washington. “That runs counter to stimulating the economy and will put a big damper on the recovery in the latter half of this year.”

State budget woes are a worsening drag on growth as the federal government tries to wean the economy from two years of extraordinary support. By Jan. 1, funds from the $787 billion federal stimulus bill will dry up. That money from Washington has helped cushion state budgets as tax revenue has plunged.

State leaders won’t be able to ride out this cycle the way they have in the past. The budget holes are too large. For the first time since 1962, sales and income tax revenue fell for five straight quarters, through December 2009, according to the Nelson A. Rockefeller Institute of Government at the State University of New York at Albany.

Lawmakers need to overhaul tax policy, underfunded public pensions and entitlement spending programs such as Medicaid if they want to establish long-term plans that will foster growth, says former New Jersey Governor Christine Todd Whitman.

“States don’t have a choice anymore,” Whitman says. “These problems are going to require major surgery.”

On May 20, New Jersey Governor Chris Christie vetoed a Democratic bill that would have raised income taxes for residents earning at least $1 million a year to help close an $11 billion deficit. Christie, a Republican, wants to cut spending for school districts and cap property tax increases.

“At some point, the people’s ability to pay runs out,” Christie said in a speech in New York on May 25.

Friday, June 25, 2010

Bob Janjuah's Horrendous Economic Forecast

From RBS' Bob Janjuah:
Plse refer to my most recent cmmts (26th Apr, 25th May & 27th May) for the backfill. Things are playing out pretty neatly so no change in view. However, a few observations/comments:

 1 - WE  have now had Ben B talk up the recovery and the outlook for rate hikes, following on from a few Fed hawks last week (even President Obama was talking up the eco recovery post the payroll release last week!!). I assume they are all rehearsing in public for some tragi-comedy skit they are abt to perform, maybe at some July 4th party. I can ONLY assume this because I cannot believe that they are being serious in any way when talking up the recovery and the prospect of rate hikes. And price action in markets is making it pretty clear that the market is fully prepared to call the Fed's bluff here.

Policy makers need to realise that YES, you can fool some of the people some of the time. But NO, you can't fool all the people all of the time. It seems pretty clear that the market is beginning to figure out how ridiculous the consensus view is for global growth and earnings, and instead is BEGINNING to price in the kind of multi-yr global growth outcome that Kevin and I have been talking abt - closer to 2.5% pa global, rather than 4.5% global.
 Remember, I have used the word 'BEGINNING'.....850 S&P remains my fair value target for this yr - and I would not be at all surprised to see us undershoot even this low level on the way down. And in case you need to ask - the FED ain't raising rates for a very very long time (2012?). The world ALREADY has significant policy tightening on its way - fiscally in the UK and Europe (the most recent developments are moves towards EVEN TIGHTER POLICY), thru the strengthening USD in the US and China/the developing world (which is pegged to the USD), thru specific policy action in China, and globally thru financial sector reform/regulation.

So, Ben, keep up the rah rah if you have to, but I think you need to accept that folks are beginning to see the post-Lehman global recovery for what it was - a 1 yr wonder driven by the most extraordinary policy response ever seen in history at the global economy level. And folks are now beginning to accept that a slow down is on its way, with policy makers pretty much all-in.

All that's now left, as I have said before, is for the Fed to shift to a USD5trn or so new QE programme, likely in co-ordination with a bunch of other central banks, which in total may give us USD10trn or more of new QE. But this isn't happening until much much later this yr or, more likely, next yr.
2 - For the inflationists out there, you must accept that the true private sector trend, which govt's have fought hard against but where defeat for govt now looks clear, is one of debt deflation. BUT, there is an important source of inflation out there. Just look at recent developments in CHINA regarding the push by workers to demand and to get massive wage increases (Honda China, Foxconn). This is all part of the twin problem in China - speculative bubbles and inflation. As per my recent pieces, one way out of the global growth hole now building is for China to reverse policy and go uber easy again. Unfortunately these developments re workers and wages makes it even more unlikely that China rides to our collective rescue. Rather, I expect China to stay tight on policy for the rest of this yr. Not good at all for global growth. And watch import prices in the West - the trend will be ugly. However, CPI inflation in the West is unlikely as Western workers have zero bargaining power, and corporations have huge profit margins that can be cut into to absorb import price increases in order to sustain/grow market share & revenues. Of course the implication for corporate profits/earnings aren't that great, but the equity analyst community will figure that out...eventually.

At the outset I said that there was no chge in view. This applies Strategically where, on a 3/6mths I remain v bearish risk (equities, credit, EM etc) and bullish USTs & the USD. And Tactically, I still think the real fireworks and nastiness will be a July/Aug/Sept phenomena. HOWEVER, shrt term the key zone is, in S&P cash speak, 1040/1020. A clear break below this zone would indicate that a MAJOR sell-off is coming sooner rather than later, down to the mid-800s. It also seems to me that as part of this move, we are building up the pressure for a huge one/two day move where global stocks drop well over 5%, maybe up to 10%. This last 'call' is based on nothing more than my (ample!) gut-feel. But I know I am not alone in this regard. Let's see, but I am preparing for Flash Crash 2...sadly the excuses used to play down Flash Crash 1 have been exposed as bogus, so I wonder what the next set of excuses are - its been a while since we used the old 'rogue trader' excuse so my money is on that horse.

Cheers, Bob

Evans-Pritchard Predicts Fed $10 Trillion QE

In his latest column, the Daily Telegraph's A. Evans-Pritchard does a good job of recapping all the various reasons why Bernanke has now completely cornered himself, and facing a newly collapsing economy, is left with just one recourse: the printing of more, more, more paper. This should not come as a surprise to anyone who has read even a few posts on Zero Hedge - the only response the Fed is left with as deflation accelerates, and as the Fed and the banking cabal refuse to do an orderly reorganization whereby financial firms grow into their balance sheets via a debt restructuring (and equity wipe out), is the spewage of more, inflation-stimulating, fiat. Ironically, as this newly printed and rapidly diluted monetary representation (because it increasingly is not equivalent to money) makes its way only and almost exclusively to those with direct discount window access, i.e., the mega banks (and for some ungodly reason, the clearinghouses soon), the assets that will be bid up are all tangible commodities, while secondary assets, which are contingent on a properly functioning reserve banking (money multiplier) system, collapse in a deflated heap of liquidations. Yet one notable section in AEP's post draw our attention: "Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed's balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion." We are very curious where the DT's reporter has found this information, since if it comes from a credible source this is a massive game changer, and while many have speculated this will happen sooner or later, to know for a fact that QE is definitely coming is major news, and, if true, we are stunned the WSJ's Jon Hilsenrath, who recently has had his ear "very close" to the Fed's internal process, has not reported on this yet.
Incidentally, the $5 trillion number was referenced previously on Zero Hedge in a post by RBS economist, and uber-realist, Bob Janjuah, as follows:

All that's now left, as I have said before, is for the Fed to shift to a USD5trn or so new QE programme, likely in co-ordination with a bunch of other central banks, which in total may give us USD10trn or more of new QE. But this isn't happening until much much later this yr or, more likely, next yr.
We agree with Bob: the next QE phase will most certainly not occur before the midterms, which as the recent abdication of a national budget demonstrated, are a critical priority for the administration, over and above the telegraphing of the country's catastrophic state to the general population, which is precisely what a nuclear monetary blast would be (let alone a new fiscal one - it is no incident that today, for the first time, a new $35 billion unemployment stimulus bill crashed in the Congress after it could not muster enough votes). Therefore, we are confident that the Fed has its hands tied well until December, although we anticipate a January lift off date for QE version 2 and final, which, as Bob Janjuah notes, will likely come in collaboration with every single central bank in the world, in one last (failed) reflation attempt: the final spasm for the Keynesian religion.

ECRI Continues Lower, Pointing Toward Double Dip

from Tyler Durden at Zero Hedge blog:
It's getting close: the fabled -10% annualized change (see David Rosenberg) which guarantees a recession is now just 3.1% away, which at this rate of collapse will be breached in two weeks. The ECRI is now at December 2007 levels, the time when the last recession officially started. The index dropped from an annualized revised -5.8% (previously -5.7%) to -6.9%. As a reminder, from Rosie, "It is one thing to slip to or fractionally below the zero line, but a -3.5% reading has only sent off two head-fakes in the past, while accurately foreshadowing seven recessions — with a three month lag. Keep your eye on the -10 threshold, for at that level, the economy has gone into recession … only 100% of the time (42 years of data)." We are practically there.

Sunday, June 20, 2010

Road Map to the Global Financial Crisis

ECRI Isn't Looking Pretty

from Zero Hedge blog:
The ECRI weekly leading index is continuing its accelerating dive, and is now well into negative territory, hitting -5.7 for the past week: a 2.2 decline from the prior week. Here is why, as David Rosenberg, this is a critical indicator, and why we may have just 4.3 more points to go before the critical -10 threshold: "It is one thing to slip to or fractionally below the zero line, but a -3.5% reading has only sent off two head-fakes in the past, while accurately foreshadowing seven recessions — with a three month lag. Keep your eye on the -10 threshold, for at that level, the economy has gone into recession … only 100% of the time (42 years of data)." At this rate of decline -10 will be taken out in the first week of July.
And some more recent observations on ECRI from Rosie:

Suffice it to say, when the ECRI was drifting lower in 2007, it got to -3.5%, where are we are now, in November and unbeknownst to the consensus at the time that a recession was only one month away. Remember that the economics community did not call for recession until after Lehman collapsed — nine months after it started; and go back to 2001, and the consensus did not call for recession until after 9/11 and again the economy had been in recession for a good six months).
Updated ECRI:

China Says It Will End Currency Peg

from the Bank of China:
In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.
Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Since then, the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role.

ECRI Confirms Almost Certain Likelihood of Double Dip Recession

from John Hussman of Hussman Funds:

Barry Switzer, the former head coach at the University of Oklahoma, once said "Some people are born on third base, and go through life thinking they've hit a triple." Among the fascinating aspects of the recent economic "recovery," probably the greatest is the failure of analysts to understand that this growth is none of the private sector's doing.
Wall Street seems to have no concept at all that every bit of growth we've observed over the past year can be traced to government deficit spending, with zero private sector expansion when those deficits are factored out. As I noted last week, if one removes the impact of deficit spending, "the economy has recovered to the point where the year-over-year growth rate since early 2009 now matches the worst performance of any of the 50 years preceding the recent downturn." In effect, Wall Street's is seeing "legs" where the economy is in fact walking on nothing but crutches.
Similarly, it is apalling that Ben Bernanke can say with a straight face that many of the "investments" made by the Fed have been repaid "and some have even made a profit," without immediately noting that the two primary sources of these repayments have been, directly or indirectly, the U.S. Treasury, and savers who are receiving near-zero interest on bank deposit instruments.
If we fail to recognize that the "good news" reported over the past year is due not to a recovery in intrinsic economic activity, but instead to massive government intervention, we risk being blindsided as those synthetic effects gradually erode.
On that point, it is notable that the Economic Cycle Research Institute (ECRI) reported Friday that its Weekly Leading Index has slumped to the lowest level in 44 weeks, and has now gone to a negative reading.
Chart thanks to Mike "Mish" Shedlock
ECRI head Lakshman Achuthan is quick to point out that the downtrend in the WLI is not (yet) sustained enough to indicate an oncoming double dip. Then again, it's important to recognize how quickly the ECRI is likely to shift its position if we observe further deterioration. The WLI also moved to negative readings in 2007, but the ECRI cautiously avoided interpreting it as a recession warning until a few weeks later when the deterioration was sufficiently persistent.
John Markman, writing for MarketWatch, reports " Looking out over the horizon using his longer-term leading indexes, Achuthan sees a 'strong chance' of more frequent recessions in the coming decade than at any time since the 1970s. If that occurs, then he points out there will be major constraints on politicians' counter-cyclical response that did not exist in 2008. That's because the next recession will begin with unemployment not at 4.5%, as the last one did, but in the high 8% range. Also policy makers won't be able to cut rates as they are likely to still be near zero, and fiscal spending will be a problem due to all of the borrowed stimulus already fired off.
"A lot of people are going to wonder, Achuthan says, how this could happen again so soon after the last crisis. And he points out that the 'great moderation' in economic growth from 1985 to 2007 -- when recessions seem to have been ironed out of the system -- is over. That was an anomaly. The new reality will be a return to sharp cyclicality with a vengeance"
From my perspective, the evidence isn't yet sufficient, from a probability standpoint, to firmly anticipate a double dip. But it is notable how close the evidence is to locking in on that conclusion.
The following is our refined set of "Aunt Minnie" criteria for identifying oncoming recessions. See the November 12, 2007 comment Expecting a Recession for details. In every instance we've observed these conditions, the U.S. economy has either already been in a recession, or has been within a few weeks of what turned out in hindsight to be the official beginning of a recession. There have been no false signals.
1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields. This criterion is currently in place.
2: Moderate or flat yield curve: A yield spread between the 10-year Treasury yield and the 3-month Treasury yield of anything less than 3.1%. As of last week, the 10-year Treasury yield was 3.22%. The 3-month Treasury bill yield was 0.08%. So virtually any decline in the 10-year yield from here will put this criterion in place.
3: Falling stock prices: S&P 500 below its level of 6 months earlier. This is not terribly unusual by itself, which is why people say that market declines have called 11 of the past 6 recessions, but falling stock prices are very important as part of the broader syndrome. This criterion is currently in place.
4: Moderating ISM and employment growth: Manufacturing PMI (at or) below 54, coupled with either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron's piece years ago), or an unemployment rate up 0.4% or more from its 12-month low. At present, both of the employment measures are in place. Last month, the ISM PMI dropped from 60.4 to 59.7.
For all intents and purposes, unless the credit spreads, the S&P 500, or the yield curve reverse, a further decline in the Purchasing Managers Index to 54 or below would be sufficient to confirm a "double-dip recession." Note that by itself, such a level might not be particularly troublesome. But in concert with the other evidence we observe, it would be sufficient to complete the syndrome of risk factors.
The historical recession signals based on the foregoing criteria are depicted in blue in the chart below. Actual recessions are depicted in red. The chart reflects the widely held assumption that the recent recession ended in June 2009, though it is not clear that this assumption is appropriate. Given that the economy has not recovered to anywhere near its previous peak, a second downturn would most probably be viewed by the NBER as a continuation of the recent recession rather than a separate event.
In short, it is small relief that neither the ECRI Weekly Leading Index nor our recession risk Aunt Minnie have provided confirming evidence of a double dip, because both would require rather minimal extensions of their recent deterioration to go to a hard warning.
Market Climate
As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action, holding the Strategic Growth Fund to a fully hedged investment stance. In this position, the primary source of day-to-day fluctuations in the Fund is the difference in performance between the stocks held by the Fund and the indices we use to hedge (the S&P 500, Russell 2000 and Nasdaq 100).
The somewhat oversold condition of the market on a short-term basis may soften the impression that there is any urgency to risk management here. I think that could be a mistake. It's worth repeating that if you are following a disciplined investment program and your asset allocation is constructed to weather a wide range of potential risks, I would prefer that you ignore my views and do nothing. But if your investment security or future plans would be unacceptably affected by a further, possibly substantial market loss, and particularly if you'll need the funds in a short number of years, I would suggest getting your risk exposure to the point where you can tolerate negative market outcomes.
Randall Forsyth offered the following nugget in Barron's last week, with which I can't disagree: According to Bespoke Investment Group, there have been 58 "corrections" of 10% or more in the Standard & Poor's 500 since 1927. In 33 cases, the corrections stopped short of the 20% bear market threshold and the market went on to higher highs, while 25 times they grew into a full-grown grizzly. But in the 32 instances when the market has dropped as much as this one has -- 14.4% from the April 23 peak through Monday -- the outcome has been heavily weighted to the losing side. Only seven times drops of that size stopped short of the 20% bear mark. In the 25 other times the decline extended to 20%, the average bear market decline was 35.5%.
As with our own work, we've observed fairly benign market outcomes from similar conditions about 20% of the time. The remaining 80% of the time has been characterized by more pointed losses. The probability mix is not good, particularly because that 80% group has several "fat tail" events featuring deep market plunges. Keep in mind that after a clear break of major support levels, markets often recover back to that previous support, which can create a feeling of "all clear" complacency. Be careful - as I've noted many times over the years, the steepest losses in a market downturn typically follow the "fast, furious, prone-to-failure" rallies that clear an oversold condition.
In bonds, the Market Climate remained characterized last week by moderately unfavorable yield levels and favorable yield pressures. Credit spreads continue to reflect concern about default risk that tends to benefit default-free securities, particularly U.S. Treasuries. Yield levels are not compelling on the basis of holding to maturity, so Treasuries are not long-term values. We have to recognize that the merit of U.S. Treasuries is essentially based on "speculative" factors relating to further credit strains. For that reason, I expect that we will clip our duration in Treasuries (now less than 4 years, mostly in intermediate term notes), in response to a significant further retreat in yields.
My views relating to inflation hedges such as TIPS and precious metals shares still hold - while I strongly expect inflation pressures in the second half of this decade, it is very difficult for investors to maintain that sort of thesis in the face of contradictory short-term evidence. As further credit strains are likely to prompt fears of deflation, I expect that our heaviest positioning in investments like TIPS and precious metals shares will be in response to price weakness on those fears. We've got enough exposure in Strategic Total Return that we would be comfortable with a sustained advance in these investment classes, but again, my expectation is that we'll see opportunities in the quarters ahead to establish larger positions on weakness rather than strength.