Saturday, August 21, 2010

Bubble Math

Preserve and Protect: Mapping the Tipping Points

by Robert Long at Market Research and Analytics. This is consistently one of the finest analyses I've read anywhere. He not only indicates where we've been, but where we're headed, and what to look for!

The economic news has turned decidedly negative globally and a sense of ‘quiet before the storm’ permeates the financial headlines. Arcane subjects such as a Hindenburg Omen now make mainline news. The retail investor continues to flee the equity markets and in concert with the institutional players relentlessly pile into the perceived safety of yield instruments, though they are outrageously expensive by any proven measure. Like trying to buy a pump during a storm flood, people are apparently willing to pay any price.  As a sailor, it feels like the ominous period where the crew is fastening down the hatches and preparing for the squall that is clearly on the horizon. Few crew mates are talking as everyone is checking preparations for any eventuality. Are you prepared?
What if this is not a squall but a tropical storm, or even a hurricane? Unlike sailors, the financial markets do not have the forecasting technology for protection against such a possibility. Good sailors before today’s technology advancements avoided this possibility through the use of almanacs, shrewd observation of the climate and common sense. It appears to this old salt that all three are missing in today’s financial community.
Looking through the misty haze though, I can see the following clearly looming on the horizon.
Since President Nixon took the US off the Gold standard in 1971, the increase in global fiat currency has been nothing short of breathtaking. It has grown unchecked and inevitably has become unhinged from world industrial production and the historical creators of real tangible wealth.
Do you believe trees grow to the sky?
Or, is it you believe you are smart enough to get out before this graph crashes?
Apparent synthetic wealth has artificially and temporarily been created through the production of paper. Whether Federal Reserve IOU notes (the dollar) or guaranteed certificates of confiscation (treasury notes & bonds), it needs to never be forgotten that these are paper. It is not wealth. It is someone else’s obligation to deliver that wealth to the holder of the paper based on what that paper is felt to be worth when the obligation is required to be surrendered. It must never be forgotten that fiat paper is only a counter party obligation to deliver. Will they? Unfortunately, since fiat paper is no longer a store of value, it is recklessly being created to solve political problems. What you will inevitably receive will be only be a fraction of the value of what you originally surrendered.
In the chart above, we see that just when the exponential expansion seemed to have run its course during  the dotcom bubble implosion, we subsequently accelerated even faster. Cheap central bank money; the unregulated, off-shore, off-balance sheet increase in securitization products; a $617T derivatives market; and the domination of the credit producing Shadow Banking system then took us to even greater levels. Bubble after bubble continues to propel us, as more recently the Bond Bubble replaced the Real Estate bubble.  Similar to trees not growing to the sky, something always happens which creates a tipping point, a moment of instability or a critical phase transition. Suddenly what worked no longer works.
I have written extensively in a series entitled “Sultans of Swap” and another series entitled “Extend & Pretend” the growing and clearly evident tipping points that are unquestionably now on the horizon. You can ignore them at your peril, but when the storm swells hit, don’t say you were never warned and no one saw this coming.  
Consolidating the trends and distortions outlined in these two series, we arrive at the following ‘large brush’ death spiral leading to a failure of fiat based currency regimes. Click all charts below to enlarge them.
The above cycle is well supported by recent and still unfolding developments. These have been mapped onto the cycle.

Let’s now list the Tipping Points which have become abundantly evident over the last few years and which are continuously expanded on our web site Tipping Points.  We track each of these on a daily basis on the site.  The rankings shown below, though they do shift, we have found to stay relatively stable on a quarterly basis.  Each Tipping Point has the capability of individually being a catalyst to advance the sector marked in red above.
TIPPING POINT                                                                        CHARACTERIZATION               RANKING

Historic Unemployment rates in G7
Unprecedented budget shortfalls & funding problems
Historically high Bond Prices
Historic level of financial market participation and dependency (i.e. pension entitlements)
Market Values are down 45 - 55% with little write downs as of yet being taken by banks, insurance or financial holders. 
Shadow Inventory, Strategic Defaults, Looming OptionARMS ‘python’, LTV levels.
The Sub Price of Europe – Level of borrowing in non sovereign currency (EU loans)
Unfunded Pension Liabilities - > $100T in US
Insolvency and Inability to stimulate economies
Bank Ratios of 50:1 and toxic debt on and off the balance sheet
Deferred accounted write-downs for Real Estate, Commercial Real Estate & HELOCS
Israeli attack on Iran  - Middle East escalation
Withdrawal of Financial Crisis Triage Programs and interest rate normalization
Accounting for Commercial Real Estate market values, loan loss reserves
Reversal in Interest rate and impact on government financing budgets
Presently: Gulf Oil Spill Economic fallout and possible hurricane impact
Impact of Obamacare, Dodd-Frank Bill and others in reaction to present environment.
Ability for Japan to continue to fund national debt with shifting demographic patterns.
Bankruptcy & Mal-Investment Catalyst
Inability of the US to finance imbalances
Geo-Political tensions - Escalating
Real Estate & speculative growth bubbles
Fannie, Freddie, Ginnie, FHA, FDIC, Pension Guarantee backstop funding.
Reverse Gearing & margin pressures
Impact of slowing consumer sales and increasing savings rate on 70% consumption US Economy
Growing social unrest and public rage
Emergence of alternative solutions such as SDRs. Inflationary repatriation impact
Slowing Corporate Top-Line revenue growth rates
Domestic Inflationary Pressures
Global Overcapacity & Underutilization
Shortages, Peak Oil & Asian Growth demand.
Production shortages, distribution break-downs with growing Asian demand
Over-Valuation and unrealistic earnings estimates.
Unknown black swan
Unknown black swan

We can never be sure of the sequence and time frame of any particular Tipping Point. Like a house of cards you never know which one, or what movement will precisely bring the house of cards down. What you know however, is that it will happen – you just need to be patient and prepared. Unfortunately few have the patience or think they can time it for even more profit. The greatest trader of all time, Jesse Livermore, wrote after a life time of trading, that his best gains were made when “he bought right and sat tight!”
Our current analysis on Tipping Points reflects the following:
DETERMINING MORE GRANULARITY – We are in the 2010-2011 Transition Phase

In my articles EXTEND & PRETEND: A Guide to the Road Ahead  and EXTEND & PRETEND: A Matter of National Security I outlined even more granularity to the virtuous cycle turning vicious spiral.

We can now overlay the Tipping Points onto this map. We arrive at the following.


·          Commercial Real Estate – Finally forced to account properly for mark-to market valuations.
·          Housing Real Estate – Option ARMS come due and FHA / FNM / FDE / FDIC are seen as insolvent.
·          Corporate Bankruptcies – Unfunded Pension impacts and debt loads (gearing) on reduced revenues.
·          State, City & Local Government Financial Implosion – Non Accrued Pension Obligations, falling tax revenue and years of accounting gimmicks come home to roost.
·          Central & Eastern Europe – The ‘sub-prime’ of Europe will soon erupt on the EU banking network as evidenced recently by Hungary and the Baltic States.
Significantly Increasing Interest Rates – A Major Global News Focus
A $5T Quantitative Easing (QE II) Emergency Action
It will likely be triggered by a geo-political event or false flag operation.
·          Entitlement Crisis -  The unfunded and underfunded Pension charade ends
·          Credit Contraction II – Credit Shrinks Violently
·          Banking Crisis II – Banking Insolvency no longer able to be hidden through Extend & Pretend.
·          Reduced Rating Levels  - Falling Asset Values and Collateral Calls on $430T Interest Rate Swaps
·          Government Back-Stopped Programs -  FHA, Fannie Mae, Freddie MA, FDIC go bust
·          Lending ‘Roll-Over’ – Game Ends

A recent Zero Hedge contributing author summarized the current environment nicely:
"There is an entrenched insolvency problem in the United States, and a picture is worth a thousand words. Insolvency is not illiquidity; insolvency is about income that can’t service debt burden. Notice where things fall off the cliff: I believe we are getting close to this point. Just need a catalyst. Sequential bond auction failures here, a sovereign default there, massive liquidity drain all around, worse… whatever. The fumes running the engine (QE, or credit easing) are dwindling."
There is an old sailor’s saying:
Red sky at night, sailors delight.
Red sky in the morning, sailors take warning!
Every morning the next batch of economic numbers is released and the indications are consistently red. Of course the market initially drops, and then miraculously rises on no volume. Since 2007 we have potentially constructed the largest head and shoulders topping formation we have ever seen.
This doesn’t mean the markets are imminently headed down. What it does mean is you should be meticulously battening down your financial hatches and checking your options for every eventuality.
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain

Original article here.

Friday, August 20, 2010

30 Consecutive Months of Small Business Job Losses

"We Live In Interesting Times"

from Todd Harrison at Minyanville:

“We used to play for silver, now we play for life; ones for sport and one’s for blood at the point of a knife.”
We live in interesting times. During the last two years, a financial virus spawned and infected the economic and social spheres as a matter of course.

This isn’t just about money anymore. Our civil liberties, the foundation of free market capitalism and the quality of life for future generations are dynamically shifting as we traverse our current course. (See: The Short Sale of American Icons)

I once offered that Shock & Awe was a tipping point through a historical lens; as Baghdad blew-up on CNN, I somberly sensed America would never be the same. That’s not a political statement -- we don’t know what would have been if we didn’t invade -- it’s simply an observation. Almost overnight, world empathy turned to global condemnation.

If we’ve learned anything through these years, it’s that unintended consequences tend to come full circle. Whether it’s the moral hazard of bailing out some banks, the gargantuan profits of a chosen few -- Goldman Sachs (GS), JP Morgan (JPM), Bank America (BAC), Morgan Stanley (MS), Wells Fargo (WFC) -- the caveats of percolating protectionism, or the growing chasm of social and geopolitical discord, times they are a-changin’ and it’s freaking people out.

As speculators are vilified and hedge funds are perceived as acceptable casualties of war, financial fatigue will evolve in kind. We’ve already seen the burnout manifest in trading volume -- upwards of 70% of the flow are the robots -- and we’ve witnessed it in financial media, with reported ratings of some of CNBC’s marquee shows down as much as 25% year-over-year. (See: The War on Capitalism)

Sun-tzu once said, “If your enemy is superior, evade him. If angry, irritate him. If equally matched, fight and if not, split and reevaluate.” As we navigate this socioeconomic maelstrom, an increasing number of people are weighing their options -- and some of the smarter folks I know are “going dark.”

What does that mean? They’re selling businesses, unwinding trading operations or otherwise distancing themselves from the capital markets. The thematic reasoning is straight out of an Ayn Rand novel: “I can’t compete and when I do, the rules of engagement change in the middle of the game. I’ll let the powers that be vanquish themselves and return in three to five years to sift through the remains.” (See: The Last Gasp Bubble)

The first time I heard this, I took notice. The second time, it piqued my interest. Now, with four or five savvy seers pulling the plug, I felt compelled to communicate these observations. I’m often early and sometimes wrong but I’ll always put it out there; while few are talking about this, it’s on many people’s mind.

I’ll also share that the most lucid thought I’ve had since offering in 2003 that we should "sell tech and financials, buy energy and metals and open a taco stand in Costa Rica" is to edge away from NYC. While I’m not the panicky type -- heck, some would say I thrive under pressure -- I would be remiss if I didn’t offer the respect of that honesty. I’m unsure of the genesis of this particular vibe -- quality of life or proactive self-preservation -- but the intuition is palpable and ever-present.

As it stands, I'm not in a position to do that -- this is where we are and this is what we do -- but my personal choice doesn’t alleviate the overarching societal shift or the collective tension that seems to be percolating. I speak with a ton of people in an array of industries throughout the world and "business is great" feedback is a rarity.

More often than not with increased frequency, the sentiment skews in the other direction, as do anecdotal data points such as thinning crowds at concerts and excess capacity at high-end restaurants and sporting events. There are of course exceptions -- $10 million plus homes in Manhattan are well-bid, due in large part to Wall Street bonuses -- but they’re an outlier in the broader array of our societal fray.

Last week on Minyanville, we shared the following feedback from someone within our community. And I quote:

I read your exchange on “going dark” and wanted to share some anecdotal evidence. I owned a chemical and manufacturing corporation that employed twelve people. We sold the company in October, 2009 for three reasons: expectations of higher future tax rates (income and cap gains), lack of clarity in regulations and the perceived coming wave of governmental policies.

Looking at that last sentence reminds me of why we decided to take our cards off the table after a successful run; the words EXPECTATION, CLARITY, and PERCEIVED.

All of these lead to one thing -- uncertainty. It was hard enough to make a dime with the relative stability of the previous period. Change the operating environment and in my mind, you change the probability of success. Smart people (being presumptuous there!) don’t wager in that environment!

Now, I’m not suggesting we cower in a corner, buy guns and butter and get all Mel Gibson on each other. Further, I understand most folks aren’t in a position to seize the day and walk away. I’ve written in the past that if we’re not part of the solution, we’re part of the problem and that remains true, now more than ever; society, at the end of the day, is simply a sum of the parts.

As we wrestle with reality and attempt to operate in the best interests of ourselves and those we love, some have chosen to extricate themselves from an increasingly tenuous struggle to focus on the little things in life. I suppose they’re lucky to have that option and their actions are consistent with a widespread reprioritization following the Great Recession. I’ve written about them before; net worth vs. self-worth, having fun vs. being happy and the caveats of looking for validation at the bottom of a bank account. (See: Memoirs of a Minyan)

For those motivated to power through to better days and easier trades, the actions of a few effects the lives of many; we, the people, need motivated, innovative proactive problem-solvers to remain engaged as the second side of the storm approaches. While our financial equation is multi-linear and ever-changing, my sense is that we’ve got four to five years of perseverance and preservation as a precursor to the profound, generational opportunities that will emerge thereafter. (See The Eye of the Financial Storm)

Looking at this emerging trend of “distancing” another way, we know the opposite of love isn’t hate, its apathy. Through that lens, folks walking away from the capital market construct may indeed be another step in the steady migration from what was to what will be. We often say the leaders who emerge from the crisis are rarely the same as those who entered it. At the very least, it should be noted that several former leaders have removed themselves from the running.

May peace be with you.