Saturday, October 2, 2010

Chris Martenson: Emerging Trend May Shift Markets Rapidly

By my analysis, we are not yet on the final path to recovery, and there are one or more financial 'breaks' coming in the future.  Underlying structural weaknesses have not been resolved, and the kick-the-can-down-the-road plan is going to encounter a hard wall in the not-too-distant future.  When the next moment of discontinuity finally arrives, events will unfold much more rapidly than most people expect. 
My work centers on figuring out which macro trends are in play and then helping people to adjust accordingly.  Based on trends in fiscal and monetary policy, I began advising accumulation of gold and silver in 2003 and 2004.  I shorted homebuilder stocks beginning in 2006 and ending in 2008.  These were not ‘great' calls; they were simply spotting trends in play, one beginning and one certain to end, and then taking appropriate actions based on those trends.
We happen to live in a non-linear world; a core concept of the Crash Course.  But far too many people expect events to unfold in a more or less orderly manner, with plenty of time to adjust along the way.  In other words, linearly.  The world does not always cooperate, and my concern rests on the observation that we still face the convergence of multiple trends, each of which alone has the power to permanently transform our economic landscape and standards of living.
Three such trends (out of the many I track) that will shape our immediate future are:

  • Peak Oil
  • Sovereign insolvency
  • Currency debasement
Individually, these worry me quite a bit; collectively, they have my full attention.
History suggests that instead of a nice smooth line heading either up or down, markets have a pronounced habit of jolting rather suddenly into a new orbit, either higher or lower.  Social moods are steady for long periods, and then they shift.  This is what we should train ourselves to expect.
No smooth lines between points A and B; instead, long periods of quiet, followed by short bursts of reformation and volatility.  Periods of market equilibrium, followed by Minsky moments.  In the language of the evolutionary biologist Stephen Jay Gould, we live in a system governed by the rules of "punctuated equilibrium."
Complex Systems
Our economy is a complex system.  The key feature of such systems is that they are inherently unpredictable with respect to the timing and severity of specific events.  For the uninitiated, they can look enormously fragile and prone to flying apart at any minute; for the seasoned observer, there is an appreciation that the immense inertia of the economic system will almost always delay and dampen the eventual adjustments.
Like everybody else, I have no idea exactly what’s going to happen, or precisely when.  Anybody who says they do know should be greeted with a furrowed brow and a frown of suspicion.  As my long-time readers know, I prefer to assess the risks and then take steps to mitigate those risks based on likelihood and impact.
Which means that although we cannot predict the size (exactly how much) or the timing (precisely when) of economic shifts or world-changing events, we can certainly understand the risks and the dimensions of what might happen.  Just as we cannot predict when an avalanche will release from steep slope, or even where or how big it will be, we can readily predict that constant snowfall coupled with the right temperature conditions will lead to an avalanche sooner or later, and more likely in this gully than that one.  Given certain conditions, we might expect one that is larger or smaller than normal.  Although we don't know exactly when or how much, we do know that when snow accumulates, so do the risks of more frequent and/or larger avalanches.
Such is the nature of complex systems.  While inherently unpredictable, they can still be described.  The most important description of any complex system is that it owes its order and complexity to the constant flow of energy through it.  Complex systems require inputs.  This is one way in which we can understand them.
Given this view, one easy "prediction" is that an economy without increasing energy flows running through it will stagnate.  To take this further, an economy that is being starved of energy becomes simpler in the process -- meaning fewer jobs, less items produced, and a reduced capacity to support extraneous functions.
Accepting "What Is"
The most important part of this story is getting our minds to accept reality without our passionate beliefs interfering.  By ‘beliefs’ I mean statements like these:
  • “Things always get better and are never as bad as they seem.”
  • “If Peak Oil were ‘real,’ I would be hearing about it from my trusted sources.”
  • “Dwelling on the negative is self-fulfilling.”
While each of these things might be true, they also might be false and therefore misleading, especially during periods of transition.  Our job is to remain as dispassionate and logical as possible. 
Let's now examine more closely the three main events that are converging -- Peak Oil, sovereign insolvency, and currency debasement -- using as much logic as we can muster.
Peak Oil
Peak Oil is now a matter of open inquiry and debate at the highest levels of industry and government.  Recent reports by Lloyd's of London, the US Department of Defense, the UK industry taskforce on Peak Oil, Honda, and the German military are evidence of this.  But when I say “debate,” I am not referring to disagreement over whether or not Peak Oil is real, only when it will finally arrive.  The emerging consensus is that oil demand will outstrip supplies “soon,” within the next five years and maybe as soon as two.  So the correct questions are no longer, "Is Peak Oil real?" and "Are governments aware?” but instead, "When will demand outstrip supply?" and “What implications does this have for me?”
It doesn't really matter when the actual peak arrives; we can leave that to the ivory-tower types and those with a bent for analytical precision.  What matters is when we hit “peak exports.”  My expectation is that once it becomes fashionable among nation-states to finally admit that Peak Oil is real and here to stay, one or more exporters will withhold some or all of their product "for future generations" or some other rationale (such as, "get a higher price"), which will rather suddenly create a price spiral the likes of which we have not yet seen.
What matters is an equal mixture of actual oil availability and market perception.  As soon as the scarcity meme gets going, things will change very rapidly.
In short, it is time to accept that Peak Oil is real - and plan accordingly.
Sovereign Insolvency
Once we accept the imminent arrival of Peak Oil, then the issue of sovereign insolvency jumps into the limelight.  Why?  Because the hopes and dreams of the architects of the financial rescue entirely rest upon the assumption that economic growth will resume.  Without additional supplies of oil, such growth will not be possible; in fact, we’ll be doing really, really well if we can prevent the economy from backsliding.
Virtually every single OECD country, due to outlandish pension and entitlement programs, has total debt and liability loads that Arnaud Mares (of Morgan Stanley) pointed out have resulted in a negative net worth for the governments of Germany, France, Portugal, the US, the UK, Spain, Ireland, and Greece.  And not by just a little bit, but exceptionally so, ranging from more than 450% of GDP in the case of Germany on the 'low' end to well over 1,500% of GDP for Greece.
Such shortfalls cannot possibly be funded out of anything other than a very, very bright economic future.  Something on the order of Industrial Age 2.0, fueled by some amazing new source of wealth.  Logically, how likely is that?  Even if we could magically remove the overhang of debt, what new technologies are on the horizon that could offer the prospect of a brand new economic revival of this magnitude?  None that I am aware of.
In the US, the largest capital market and borrower, even the most optimistic budget estimates foresee another decade of crushing deficits that will grow the official deficit by some $9 trillion and the real (i.e., “accrual” or “unofficial”) deficit by perhaps another $20 to $30 trillion, once we account for growth in liabilities.  This is, without question, an unsustainable trend.
It’s time to admit the obvious:  Debts of these sorts cannot be serviced, now or in the future.  Expanding them further with fingers firmly crossed in hopes of an enormous economic boom that will bail out the system is a fool’s game.  It is little different than doubling down after receiving a bad hand in poker.
The unpleasant implication of various governments going deeper into debt is that a string of sovereign defaults lies in the future.  Due to their interconnected borrowings and lendings, one may topple the next like dominoes.
However, it is when we consider the impact of the widespread realization of Peak Oil on the story of growth that the whole idea of sovereign insolvency really assumes a much higher level of probability.  More on that later.
For now we should accept that there's almost no chance of growing out from under these mountains of debts and other obligations.  We must move our attention to the shape, timing, and the severity of the aftermath of the economic wreckage that will result from a series of sovereign defaults.
Currency Wars
We could trot out a lot of charts here, examine much of history, and make a very solid case that once a country breaches the 300% debt/liability to GDP ratio, there's no recovery, only a future containing some form of default (printing or outright).
In a recent post to my enrolled members, I wrote:
The currency wars have begun, and the implications to world stability and wealth could not be more profound. Fortunately, all of my long-time enrolled members are prepared for this outcome, which we've been predicting here for some time.
When pressed, the most predictable decision in all of history is to print, print, print.  So I can't take credit for a 'prediction' that was just slightly bolder than 'predicting' which way a dropped anvil will travel; down or up?
The only problem is, widespread currency debasements will further destabilize an already rickety global financial system where tens of trillions of fiat dollars flow daily on the currency exchanges.
You can be nearly certain that every single country is seeking a path to a weaker relative currency. The problem is obvious: Everybody cannot simultaneously have a weaker currency. Nor can everybody have a positive trade balance.
If a country or government cannot grow its way out from under its obligations, then printing (a.k.a. currency debasement) takes on additional allure.  It is the "easy way out" and has lots of political support in the home country.  Besides the fact that it has already started, we should consider a global program of currency debasement to be a guaranteed feature of our economic future.
Conclusion (to Part I)
Three unsustainable trends or events have been identified here.  They are not independent, but they are interlocked to a very high degree.  At present I can find no support for the idea that the economy can expand like it has in the past without increasing energy flows, especially oil.  All of the indications point to Peak Oil, or at least "peak exports," happening within five years.
At that point, it will become widely recognized that most sovereign debts and liabilities will not be able to be serviced by the miracle of economic growth.  Pressures to ease the pain of the resulting financial turmoil and economic stagnation will grow, and currency debasement will prove to be the preferred policy tool of choice.
Instead of unfolding in a nice, linear, straightforward manner, these colliding events will happen quite rapidly and chaotically.
By mentally accepting that this proposition is not only possible, but probable, we are free to make different choices and take actions that can preserve and protect our wealth and mitigate our risks.
What changes in our actions and investment stances are prudent if we assume that Peak Oil, sovereign insolvency, and currency debasement are 'locks' for the future?
I explore these questions in greater depth in Part II of this report (enrollment required)

Something Smells Fishy With the ISM

from Zero Hedge:

Digging beneath the surface of today's ISM report revealed a complete economic disaster: bad components (Inventories and Price) were up, while good ones (Orders and Employment) were down, as we pointed out at our first view of the ISM. What this implies, as John Lohman highlights, is that the "best" indicator - Orders less Inventories, plunged lower. As John explains: "Statistically, orders minus inventories leads ISM composite by 3 months (i.e., the highest correlation is at lag 3).  Even when smoothed 3 months (slowing it down), orders minus inventories leads EPS estimates, and below 5 typically means a peak or plateau (and by definition therefore a slowing growth rate) in earnings estimates."

We are now well below 5, and looking at historical precedents, the market is now certainly due for a correction, which would definitely occur if the Fed would finally leave the economy alone for at least one second. But no, as Jim Grant earlier stated so eloquently, the Fed is now "lethally" ingrained in all sorts of intervention and manipulation of the US economy, and the only way the two can separate from each other is through the implosion of either, or both. And since the parasitic Fed is far more powerful than even the host country it has invaded for the past 97 years, we have a bad feeling it will be left standing long after America has been brought to ruin.

Friday, October 1, 2010

Cliff-Diving Dollar

Gold Countdown Continues -- $322/oz.

Diving Dollar

Thursday, September 30, 2010

BLS Commits Fraud With Jobs Data

from Zero Hedge:

For all those who continue to doubt the statistically quetionable methods of our Labor Department, as well as for all others who mock those who doubt the veracity out of anything coming out of the BLS, the following chart should provide much needed closure. The top section of the chart below demonstrates weekly prior revisions in initial claims for all of 2010. Readers may be surprised to discover that beginning in April, of 2010, continuing through today, there have been 22 out of 23 consecutive upward prior weekly revisions! In other words, the BLS has a definitive mandate to underrepresent the "current" weekly data and to allow it to catch up with reality once it has become "prior", and thus no longer market moving, when in reality should the BLS present true data it would have likely missed estimates on more than half the occasions it has "beaten" and caused ridiculous market spikes like the one experienced earlier. Furthermore, combining all individual weekly data, demonstrates that the BLS has underrepresented initial claims by roughly 80,000 year to date. The chart pretty much leaves no room for doubt as to the BLS "trans-statistical" approach to quantifying data. As for the lower chart, it shows the same thing but with continuing claims, which have been revised upward pretty much consecutively for the entire year.

And there you have it - magical BLS statistics in action.
h/t John Lohman

Reuters Exposes Fed "Insider Trading"

By Kristina Cooke, Pedro da Costa and Emily Flitter
NEW YORK/WASHINGTON (Reuters) - To the outside world, the Federal Reserve is an impenetrable fortress. But former employees and big investors are privy to some of its secrets -- and that access can be lucrative.
On August 19, just nine days after the U.S. central bank surprised financial markets by deciding to buy more bonds to support a flagging economy, former Fed governor Larry Meyer sent a note to clients of his consulting firm with a breakdown of the policy-setting meeting.
The minutes from that same gathering of the powerful Federal Open Market Committee, or FOMC, are made available to the public -- but only after a three-week lag. So Meyer's clients were provided with a glimpse into what the Fed was thinking well ahead of other investors.
His note cited the views of "most members" and "many members" as he detailed increasingly sharp divisions among the officials who determine the nation's monetary policy.
The inside scoop, which explained how rising mortgage prepayments had prompted renewed central bank action, was simply too detailed to have come from anywhere but the Fed.
A respected economist, Meyer charges clients around $75,000 for his product, which includes a popular forecasting service. He frequently shares his research with reporters, though he kept this note out of the public eye. Reuters obtained a copy from a market source. Meyer declined to comment for this story, as did the Federal Reserve.
By necessity, the Fed spends a considerable amount of time talking to investment managers, bank economists and market strategists. Doing so helps it gather intelligence about the market and the economy that is invaluable in informing the bank's decisions on borrowing costs and lending programs.
But a Reuters investigation has found that the information flow sometimes goes both ways as Fed officials let their guard down with former colleagues and other close private sector contacts.
This selective dissemination of information gives big investors a competitive edge in the market. In the past, Fed officials themselves have privately expressed discomfort about the cozy ties between the central bank and consultants to big investors, though their concerns have largely fallen on deaf ears.
No one is accusing Meyer and his firm, Macroeconomic Advisers -- or any other purveyors of Fed insights for that matter -- of wrongdoing. They are not prohibited from sharing such information with their hedge fund and money manager clients.
But critics question whether it is proper for Fed officials to parcel out details that have the potential to move markets around the world, especially with the government's involvement in the economy being so pronounced.
"It's certainly not what Fed officials should be doing," said Alice Rivlin, a former Fed governor and now a fellow at the Brookings Institute think tank. "The rules when I was there were you don't talk to anybody about anything that could be used for commercial purposes."
In an effort to counter concerns about close ties between business and government, U.S. President Barack Obama issued an "ethics pledge" that forbids appointees of his administration from contacting the agencies they worked under for at least two years after leaving.
But such measures are tough to enforce. And in the case of the Fed's Washington-based board, governors are allowed to transition directly into a banking sector job immediately after they leave the central bank, though they must first serve out a rather lengthy 14-year term, which many do not.
Against the backdrop of today's shaky recovery and the Fed's efforts to provide ongoing support to growth, information about what central bank officials agree or disagree on can be even more valuable than usual.
Haag Sherman, chief investment officer of Salient Partners, a Houston-based money management firm that oversees around $8 billion in assets, says even the slightest hint of the possible direction of policy can give investors a huge leg up.
"The fact is that government today is driving the markets more than any time in recent history and having insight into near-term and long-term plans provides a money manager with a significant competitive advantage," Sherman said.
Markets have been particularly sensitive to Fed policy in recent months as renewed weakness in the economy sparked widespread speculation that the central bank would try to ease borrowing conditions further, probably by ramping up its purchases of U.S. government bonds.
By adding to the over $1.7 trillion in such purchases undertaken in response to the financial crisis so far, the Federal Reserve would be providing further incentives for banks to lend and consumers to borrow -- despite the fact that official interest rates are already effectively at zero.
In his note, Meyer said many Fed officials hadn't found out about the pace of mortgage prepayments -- which meant the central bank's support for the economy was ebbing -- until just before the August 10 meeting.
"For a few members, it was too late to affect their decisions; for others it was a very important factor, even the most influential factor," wrote Meyer. "Shouldn't the FOMC at least have a neutral balance sheet policy given the weaker outlook? This was obvious to the doves, persuasive to the center, but not the hawks."
Fed-watching, of course, has long been a cottage industry, albeit a fairly wealthy one. Investors are constantly looking for clues about what officials may or may not be thinking, parsing their language much like Kremlinologists of yore. And markets can jump at the first whiff of a change in tone.
For example, five days after Meyer's note, the Wall Street Journal published a more detailed account of the divisions on the Fed's policy-setting committee. The newspaper report was credited with moving bond yields 0.20 percentage point, a relatively steep decrease.
Small wonder that large funds are willing to shell out tens of thousands of dollars a year to receive "color" -- as investors refer to the useful tidbits that plugged-in consultants supply.
The precise number of former Federal Reserve employees tapping their network of old colleagues can't be determined, but by most accounts they are a sizable group.
"The revolving door between the Fed and the private financial sector is quite significant," said Timothy Canova, professor of international economic law at Chapman University School of Law in Orange, California.
There is no required registration process for economic and monetary policy consultants, former Fed lawyers say.
Some especially high-profile former Fed officials now have their own shops, too: Former Fed Chairman Alan Greenspan's Greenspan Associates offers policy consulting to Pimco, the world's biggest bond fund.
For graphic on Fed insight and yields see:
Though rarer, access is sometimes also bestowed upon outsiders. Paul Markowski, a China expert who counts hedge funds and foreign central banks among his consulting clients, has never worked at the Fed but says his relationships with officials there date back to the 1960s. For him, he says, it's a question of knowing the individuals on the committee well enough to understand their sometimes cryptic signals.
"You have to establish a relationship over time. If you go and see someone once or twice you are not going to be able to read what they are saying to you properly," he said. "They look at me, for one, as someone who has deep relations with the financial markets. It's a two-way street."
On the same day as the Fed's eventful August meeting, Markowski wrote to his clients: "While I thought they could hold off doing what they did, a senior Fed official told me that after measuring the risk of doing nothing they had little to lose and more to gain."
On Friday, September 24, three days after the September 21 meeting, he described a string of conversations with "three big Feddies."
Earlier in the year, just a day after the April 27-28 gathering, Markowski offered clients the type of material that, if true, went beyond anything even the minutes from the meeting would offer three weeks later:
"I had two interesting phone conversations with senior Fed officials -- one last night and another this morning. What I heard was that going into the meeting the staff were split 50:50 as to the recommendation on rates; there were 6 members who favored some change in the asset sales issue and 3-4 who favored changing (the Fed's commitment to keep rates low for an extended period), with another 1-3 suggesting putting the change off to the next meeting."
Of course, speaking to one or two officials at the central bank does not necessarily provide the full story, especially at a time when policymakers diverge on key issues such as the outlook for the economy and appropriate policy actions.
Niche analysts may also have a vested interest in exaggerating the extent of their access -- it makes their offering all the more enticing.
Some investors point out that markets are inherently volatile, and inklings into the broad contours of policy do not necessarily translate into an obvious short-term trading strategy.
"Having this information from the Fed would be beneficial only if you understood what the effects of what the Fed is doing might be," said Joseph Calhoun, strategist at Alhambra Investments in Miami.
Even those who seem to be in the know are not always right: both Meyer and Markowski called the August 10 meeting wrong, thinking the Fed would hold pat when it in fact chose to provide additional stimulus.
But Canova, the Chapman law professor, says the immediate investment value of the information is not the main issue. For him, the backroom exchanges are part of a bigger problem of financial industry influence over economic decision-making.
"This is one of many quid pro quos in a system of opaque subsidies," Canova said. "It seems to me naive to think private investors would routinely share proprietary information without any legal obligation or subpoena unless they were getting some tangible benefits in return."
Over the past two decades, the Fed has become much more transparent than it once was. In the 1990s, it began releasing the results of its interest rate decisions and minutes of its policy meetings, as well as transcripts of those gatherings with a five-year lag.
Yet as institutions go, the Fed is hardly a paragon of openness. Chairman Ben Bernanke seldom speaks to the press on the record. When he does, it is often during well-orchestrated, pre-vetted events. During the financial crisis, Fed lending to troubled financial institutions, including the infamous rescues of AIG and Bear Stearns, was done hurriedly and behind closed doors, fostering public suspicion and political ire.
The Fed's opaque communications structure makes it easy for markets to misinterpret the rather terse policy statements released after each meeting, adding to the demand for kernels of wisdom about their decisions.
The pitfalls of the Fed's communication strategy were highlighted by the August 10 meeting. Just a few weeks earlier, Bernanke had spent the bulk of his testimony to Congress discussing the central bank's eventual exit from its ultra-accomodative policies. And the Fed had done little to explain to markets the link between the economic outlook and the size of its balance sheet.
For many investors, therefore, the policy pivot on August 10 -- the decision to buy more bonds -- came out of the blue. Markets broadly took the Fed's move as a significant shift toward more support for the economy. Some market participants also interpreted it as a sign the Fed was more worried about the economy than it was letting on.
When its policymakers are on the same page, the Fed often has no trouble making its position known following its FOMC meetings. But when policymakers disagree, as has been the case recently, the cacophony of voices can merely confuse markets.
That may be one reason Fed officials feel the need to help investors better understand the public statements they make.
Other central banks around the world try to avoid such risks by taking a different approach. Some strip away some of the mystery around policy by stipulating a specific inflation target. The European Central Bank holds a press conference after its key meetings that gives its president, Jean-Claude Trichet, a chance to explain the reasoning behind its actions in a public forum.
"If Bernanke can't stop the leaks he ought to have a full press conference after the meeting. It's inappropriate for certain people to gain an advantage on information from the Fed," said Ernest Patrikis, a former No. 2 official at the Federal Reserve Bank of New York and now a partner at law firm White & Case.
For the U.S. Federal Reserve, the willingness to share market-sensitive information may reflect the institution's history and culture. Critics have long argued that the central bank has been too close to the financial industry.
The Fed was established in 1913, in part as a response to the panic of 1907, by bankers who wanted a lender of last resort to help prevent frequent runs on the nation's financial institutions.
Bankers still serve on boards of directors of regional Fed banks and former Fed staffers are hotly sought after on Wall Street and in the investment community.
Meyer founded his consulting firm, then called Laurence H. Meyer and Associates Ltd, before joining the Fed in 1996. When he left the Fed in 2002, he returned to his firm, now called Macroeconomic Advisers.
Another example is Susan Bies, who retired from the Fed's board in 2007, and took a job on the board of Bank of America in 2009. A number of chief economists at top U.S. banks at some point have also held staff positions at the Fed.
Going the other way, William Dudley, head of the powerful New York Federal Reserve Bank, was the chief economist at Goldman Sachs and a partner at the firm.
Critics say this revolving door structure makes it difficult for Fed staffers to be disciplined in not inadvertently revealing too much in conversations with old colleagues and friends.
Fed board staffers who retire even get to keep their pass for the central bank's building, which boasts fitness facilities, a barber and a dining room.
Though their identification badges designate their "retired" status, they are not restricted to where they can go once inside the building -- even if they now work in the private sector.
Nowhere is the sense of cliquish old-world camaraderie more evident than at the Fed's annual gathering for world central bankers in Jackson Hole, Wyoming. Receiving an invitation to the exclusive event is no small feat, and economists take pains to get themselves on the short list. Being there means face time with Fed officials in an informal setting -- and more importantly, a stamp of legitimacy that is difficult to put a price tag on.
This year's conference, held in late August, featured not only panels on monetary policy and a string of speeches from leading central bankers and academics, but also an unusual evening excursion to watch a horse-whisperer tame a wild stallion.
"Too often, the Federal Reserve believes that rules do not apply to them," said Sherman at Salient Partners. "If we allow some to have access, then how are we different than those that follow 'crony capitalism' in the Third World?"

Moody's Downgrades Spanish Debt

from Zero Hedge:
Moody's downgrades Spain from AAA to Aa1, a rating which pretty much everyone knew would not last, with the kneejerk reaction nonetheless being to spike bunds. However, as Goldman immediately reminded everyone who cares, this was (supposed to be) "completely priced in."

No Coincidence. Dollar Plunges, Crude Skyrockets

from Fox Business:

SINGAPORE, Sept 30 (Reuters) - U.S. crude on Thursday isset to close September with the strongest gain in seven monthsafter stockpiles at the world's largest consumer declined whilea weak dollar lifted most commodities.
U.S. West Texas Intermediate crude oil futures for Novemberfell 17 cents at $77.69 a barrel at 0443 GMT, after nettinggains of more than 2 percent to settle at a 7-week high onWednesday. WTI is set to rise around 8 percent in September,the strongest monthly increase since February.

Fed Causes Worst Quarter for Dollar SInce 2002

Can you say, "inflation"?
from Fox News:

HONG KONG, Sept 30 (Reuters) - The dollar was stuck near aneight-month low on Thursday, hobbled by speculation of morequantitative easing from the Federal Reserve, while Europeanstocks took a breather after September's rebound.
The euro, initially steady against the dollar, was down 0.4percent on the day at $1.3578 after Ireland's central bank puta 34 billion euros ($46 billion) price on bailing out AngloIrish Bank under a worst case scenario.
Europe's major equity markets fell on Thursday, with thepan-European FTSEurofirst 300 index of top shares down 0.4percent after the Anglo Irish announcement and a Moody'sdowngrade of Spain's credit rating by one notch to Aa1.
The dollar is down 8.3 percent this quarter against abasket of world currencies, its worst quarter in more thaneight years, as a sluggish economy and stubbornly highunemployment levels in the United States have fuelledexpectations of another round of asset buying by the Fed.
"Speculation of QE2 lingers and is not going away any timesoon. That should keep the U.S. dollar under pressure," saidSue Trinh, senior currency strategist at RBC in Hong Kong.
Asian stocks ex-Japan fell 0.4 percent but hovered near atwo-year high and were set for their best quarter in a year asinvestors poured money into regional markets on the back ofrobust economic growth driven by China.
The MSCI index of Asia Pacific stocks outside Japan hasgained more than 17 percent this quarter, easily outperformingdeveloped markets, with the S&P 500 up 11 percent and Europeanshares up 7.2 percent.
For the year to date, the ex-Japan index is up around 7percent.
Japan's Nikkei ended 2 percent lower but still posted itsbest monthly performance in six, helped by expectations thatfurther easing would curb the yen's strength. On a quarterlybasis the Nikkei is flat, sharply lagging other major markets.
Mounting speculation that the Bank of Japan was preparingto ease monetary policy again and that it could take action atits meeting next Tuesday was keeping the yen's gains in check.
By the end of the Asian session, the dollar was at 83.38yen, just above a 15-year low set just before Japan intervenedto sell the yen on Sept. 15.
"The big turning point in September was intervention. Themove has helped to soothe fears about a further advance in theyen and put the stock market back on a recovery path," saidMasayuki Otani, chief market analyst at Securities Japan, Inc.
"Neither the United States nor Japan has changed theirstance towards easing policy, and that will likely support themarket. The domestic economy is seen slowing from now on, but asharp slowdown is unlikely and stock prices will likely move tofactor that in in advance and build on gains."
Gold ticked lower but held within sight of a record highhit in the previous session, underpinned by continued U.S.dollar weakness. Spot gold eased 60 cents to $1,308.15 by 0630GMT. (Additional reporting by Charlotte Cooper and Masayuki Kitanoin TOKYO; Editing by Alex Richardson)

Anotther Record for Gold

Gold inched higher again. I'm not even going to bother with a chart!

The Fed's Endless Wall Street Bailout

Since the Fed can inject "liquidity" into the financial markets, but can't determine with precision where those funds end up, I suspect that at least some of the Fed's money-printing is finding its way into commodity markets as well. In other words, the Fed's clumsy hand is fueling another commodity bubble! The below document was dated August 2009, and this is only an excerpt of the Executive Summary. 

from Precision Capital Management:

The theory for which we have the greatest supporting evidence of manipulation surrounds the fact that the Federal Reserve Bank of New York (FRNY) began conducting permanent open market operations (POMO) on March 25, 2009 and has conducted 42 to date. Thanks to Thanassis Stathopoulos and Billy O’Nair for alerting us to the POMO Effect discovery and the development of associated trading edges. These auctions are conducted from about 10:30 am to 11:00 am on pre-announced days. In such auctions, the FRNY permanently purchases Treasury securities from selected dealers, with the total purchase amount for a day ranging from about $1.5 B to $7.5 B. These days are highly correlated with strong paint-the-tape closes, with the theory being that the large institutions that receive the capital injections are able to leverage this money by 100 to 500 times and then use it to ramp equities.

Wednesday, September 29, 2010

"I do not support further asset purchases of any size at this time." -- Philly Fed President Charles Plosser

from Reuters:

Plosser acknowledged that growth has moderated, and that inflation has been subdued. However, he said he expects inflation expectations to remain stable and does not see a significant risk of sustained deflation.

Plosser said he opposes asset buying under current conditions because he worries policymakers would squander public confidence in the Fed's ability to combat deflationary expectations by acting prematurely.

Also, he said, it is difficult to see how additional asset purchase could have much impact on the near-term outlook for unemployment.

Plosser has been outspoken in expressing concern about the massive expansion of the Fed's balance sheet, which has doubled from pre-crisis levels as a result of recession-fighting efforts.

Minneapolis Fed: "Taxpayers Get the Risk"

I thought we weren't going to practice socialism!

"The Fed cannot literally eliminate the exposure of the economy to the risk of fluctuations in the real interest rate. It can only shift that risk among people in the economy. So, where did that risk go when the Fed bought the long-term bond? The answer is to taxpayers.
-- Minneapolis Fed President, Narayana Kocherlakota

Gold Edges Higher, Just Short of $1315

Tuesday, September 28, 2010

Market Outlook: QE Doesn't Work, Never Has!

by Ed Yardeni on John Mauldin's "Outside the Box":

BULLET POINTS: (1) Fed study buries textbook money multiplier. (2) The Treasury’s lap dog. (3) Kohn’s exit speech admits Fed is clueless. (4) In 1988, Bernanke questioned money multiplier model. (5) The fiscal multiplier is also baloney. (6) The administration’s stimulators are jumping ship. (7) Profitable companies, not bloated governments, create jobs. (8) No double dips in Earnings Month. (9) Double dip in consumer sentiment. (10) No recovery in housing industry.
I) MULTIPLIERS: Wow, there are Existentialists at the Fed! Two economists, Seth B. Carpenter and Selva Demiralp, recently posted a discussion paper on the Federal Reserve Board’s website, titled “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?” (See link below.) The authors note that bank reserves increased dramatically since the start of the financial crisis. Reserves are up a staggering 2,173% from $47.3bn on September 10, 2008, just before the financial crisis began, to $1.1tn now. Yet M2 is up only 11.4% since September 10, 2008, and bank loans are down $140.2bn. The textbook money multiplier model predicts that money growth and bank lending should have soared along with reserves, stimulating economic activity and boosting inflation. The Fed study concluded that “if the level of reserves is expected to have an impact on the economy, it seems unlikely that a standard multiplier story will explain the effect.”
That not only repudiates the textbook money multiplier model but also raises lots of questions about the goal of the Fed’s quantitative easing policies. As I discussed yesterday, under QE-1.0, Bernanke & Co. offset the shrinking of the Fed’s emergency liquidity facilities with purchases of mortgage securities. QE-1.5 was adopted at the August 10, 2010 FOMC meeting when it was decided that maturing mortgage securities would be offset by purchasing Treasuries. If the Fed decides to implement QE-2.0, as was suggested by Tuesday’s FOMC statement, then it is widely presumed that the Fed would expand its balance sheet again by purchasing $1.0tn of US Treasuries.
The Carpenter/Demiralp study implies that QE-2.0 won’t be any more successful in boosting M2 growth and bank lending than QE-1.0. If so, then the Fed should be renamed “Feddie.” Like Fannie and Freddie, Feddie now owns lots of mortgages. If Feddie buys another $1.0tn of Treasuries, it is simply enabling the US government to continue down the road of reckless deficit-financed spending. The Fed then becomes the lap dog of the Treasury. No wonder that the price of gold is at a new record high this morning.
The Carpenter/Demiralp study quotes former Fed Vice Chairman Donald Kohn saying the following about the money multiplier in a March 24, 2010 speech: “The huge quantity of bank reserves that were created has been seen largely as a byproduct of the purchases that would be unlikely to have a significant independent effect on financial markets and the economy. This view is not consistent with the simple models in many textbooks or the monetarist tradition in monetary policy, which emphasizes a line of causation from reserves to the money supply to economic activity and inflation. . . . We will need to watch and study this channel carefully.”
Isn’t that wonderful? Fed officials are clueless about how quantitative easing is supposed to impact the economy. They aren’t even sure if it has any effect on the economy. The Fed study cited here confirms this known unknown. The Bank of Japan tried quantitative easing to revive their economy and avert deflation, but it didn’t work. By the way, Kohn’s March 24 speech was titled, “Homework Assignments for Monetary Policymakers.” (See link below.) He just retired after spending 40 years at the Fed.
Sinobiopharma - SNBP
Here are more shocking revelations from the study under review: “In the absence of a multiplier, open market operations, which simply change reserve balances, do not directly affect lending behavior at the aggregate level. Put differently, if the quantity of reserves is relevant for the transmission of monetary policy, a different mechanism must be found. The argument against the textbook money multiplier is not new. For example, Bernanke and Blinder (1988) and Kashyap and Stein (1995) note that the bank lending channel is not operative if banks have access to external sources of funding. The appendix illustrates these relationships with a simple model. This paper provides institutional and empirical evidence that the money multiplier and the associated narrow bank lending channel are not relevant for analyzing the United States.”
Did you catch that? Bernanke knew back in 1988 that quantitative easing doesn’t work. Yet, in recent years, he has been one of the biggest proponents of the notion that if all else fails to revive economic growth and avert deflation, QE will work.
So why hasn’t it worked just when we need it most? My theory is that the Keynesian apparatchik in both Japan and the US welcome economic and financial crises as great opportunities to grab power. So they come to our rescue with massive spending programs financed with lots of borrowed money. The Japanese government built roads and bridges to nowhere that nobody needed. The US government can’t seem to even do that. Instead, the stimulus spending has been focused on keeping unionized public workers employed. The government’s intrusion into the economy, with its huge deficits and mounting debt, depresses the private sector. Watching the central bank enable it all by purchasing some of the government’s debt is even more depressing. This is why quantitative easing doesn’t work.
So the textbook model of the money multiplier is irrelevant. Early last year, I argued that the textbook model of the fiscal multiplier is also baloney. In the February 9, 2009 Morning Briefing, I wrote: “I can’t think of a more tired old theory than the Keynesian notion that $1 of additional government spending will generate $1.5 of real GDP. This ‘multiplier effect’ is taught in every introductory macroeconomic textbook. Yet, it is both theoretically and empirically questionable.” I then went on to quote the supporting evidence for my view in an OECD working paper by Roberto Perotti titled “Estimating the Effects of Fiscal Policy in OECD Countries,” which is linked below.
College students should be required to read a paper written by Christina Romer and Jared Bernstein, titled “The Job Impact of the American Recovery and Reinvestment Plan,” dated January 9, 2009 (linked below). When the Obama administration came into office, Romer chaired the Council of Economic Advisors and Bernstein became the chief economist for VP Joe Biden (seriously). The Romer/Bernstein analysis was based on a super simplistic Econ 101 fiscal multiplier model. The government boosts spending by $800bn. GDP rises by 1.5 times as much, i.e., $1.2tn. That creates 4mn jobs. It’s that simple. Sadly for the millions of Americans who are out of work, economists who were skeptical were right to be so. The American Recovery and Reinvestment Act did not work as advertised. Now, some of the major proponents of the fiscal multiplier are leaving the administration, including Romer, Orszag, and Summers.
* Mortgage Market (weekly): What’s happening in the mortgage market? (1) The MBA applications new purchase index fell for the second straight week, down 3.3% in the week ending September 17 following a 0.4% decline the prior week. The index had increased 8.9% over the previous three-week period. The 4-wa rose for the third straight week, but remains around 14½-year lows. (2) The refinancing index fell for the third straight week, down 0.9% w/w and 14.3% over the three-week span. That followed a five-week climb of 29.8%. The level is still more than double the reading at the start of the year. (3) The rate on 30-year fixed mortgage (FRM), based on Freddie Mac data, edged up 5bps the past two weeks to 4.37% from 4.32%, a low for the series going back to 1972. The spread between the FRM and the 10-year Treasury yield is around its historical average, while FRM remains high relative to the federal funds rate.
II) STRATEGY: If the monetary and fiscal multipliers are figments of the imagination of macroeconomic textbook writers, what works? Profits! The Fed does not create jobs. The Treasury can’t do it either. Profitable companies create jobs and expand their capacity to hire more workers when they are optimistic about the outlook for profits. Profitable companies can drive up the stock market even if investors aren’t doing so. They can do that by using their record cash flow to buy other companies and to buy back some of their shares.
The Q3 earnings season is set to begin soon. The bottom-up consensus estimate for the S&P 500 is currently $20.68 per share, up 26.4% y/y. The estimates during the previous six earnings seasons just before companies started to report were all too low by 10.0% on average, in a range of 4.6% to 15.4%. Another underestimate is likely this quarter.
* S&P 500 Sectors Forward Earnings & Valuation (weekly): What’s the latest direction in weekly forward earnings per share and valuation for the 10 S&P 500 sectors? In the week ended September 16, forward earnings edged lower for 9/10 sectors, but valuation rose for all 10 sectors. Forward earnings at a record high for Health Care, and near a record high for Consumer Discretionary, Consumer Staples, and Tech. Forward earnings near a cyclical high for the rest: Energy (21-month high), Financials (21-month high), Industrials (21-month high), Materials (23-month high), Telecom (11-month high), and Utilities (19-month high). S&P 500 P/E up to 12.2 from 11.9 and from a 16-month low of 11.5 in early July, but down from a 27-month high of 15.1 in October 2009. P/Es are up from cyclical lows 11 weeks ago for all of the sectors, but the relative P/E is near a 14-year low for Tech, and near a six-year high for Telecom. For detailed charts including squiggles, see Earnings Week (with Squiggles) on our website.
* S&P 500 Sectors Quarterly Earnings Growth Trends: Any big changes to quarterly earnings and revenue growth forecasts lately? Analysts expect the S&P 500 to record mostly double-digit percentage earnings growth and high single-digit revenue growth from Q3-2010 to Q2-2011, but have trimmed their forecasts in the past month. The S&P 500’s y/y earnings growth forecast for Q3-2010 is down to 27.8% from 28.7%, and the revenue forecast is down to 7.7% from 7.9%. All sectors have had their Q3 growth rate edge lower in the past month, and Telecom was the only sector to have its revenue growth rate rise. Y/Y earnings and revenue growth is expected to be positive for 9/10 sectors in Q3. The earnings growth rate is expected to improve q/q in Q3 for the S&P 500 and three sectors: Financials, Industrials, and Utilities. Revenue growth is expected to slow for the S&P 500, but improve for Industrials and Utilities.
III) EARNINGS MONTH: Joe and I have updated our Earnings Month with September data. So far, there are no double dips in the forward earnings of the 10 S&P 500 sectors and 100+ industries. In fact, new record highs were reached by four of the sectors: Consumer Discretionary, Consumer Staples, Health Care, and Information Technology. Seventeen industries had forward earnings at record highs: Apparel Retail, Biotechnology, Computer Hardware, General Merchandise Stores, Footwear, Gold, Health Care Distributors, Industrial Gases, Leisure Products, Packaged Foods, Pharmaceuticals, Railroads, Restaurants, Soft Drinks, Specialty Chemicals, Systems Software, and Tobacco. This is a good mix of noncyclical and cyclical businesses.
* S&P 500 Sectors Relative Forward Earnings (September): How did forward earnings per share and P/Es perform for the S&P 500 and its 10 sectors in September? S&P 500 forward earnings rose 0.6% m/m, and was up for a sixteenth straight month. The forward P/E edged up to 12.2 from an 18-month low of 12.0 and is up from a 23-year low of 9.5 in November 2008, but is down from a 27-month high of 15.1 in October 2009. Forward earnings rose for nine of the 10 sectors in September, but P/E ratios rose for all 10 sectors. Four sectors had record high forward earnings: Consumer Discretionary, Consumer Staples, Health Care, and Tech. Tech forward earnings up for 19 straight months, Consumer Staples up for 18 months in a row, and Health Care up in 18 of the past 19 months. Financials’ forward earnings up 82% from its cyclical bottom in May 2009, and rose 1.9% m/m in September for the best gain in the S&P 500. Industrials’ P/E ratio down to 13.7 from a five-year high of 16.9 in April and is second highest in the S&P 500. Telecom (14.9) was the highest P/E sector and at a 35-month high in September. Materials P/E of 13.6 down to fifth highest from first in February, and down from a seven-year high of 21.4 in September 2009. Financials’ P/E ratio down to 11.4 from an 11-year high of 17.6 in September 2009. Energy P/E of 10.6 is the lowest of the 10 sectors again, followed closely by Health Care at 10.8.
* S&P 500 Industries Relative Forward Earnings (September): What did forward earnings momentum do among the S&P 500 industries in September? The positive Mo was stronger than in August. Sixty-six of these 77 industries rose in September, up from 58 in August and back in the range of 64 to 69 rising industries seen from April to July. It had been down to a record low of five in November 2008. Seventeen industries had forward earnings at record highs: Apparel Retail, Biotechnology, Computer Hardware, General Merchandise Stores, Footwear, Gold, Health Care Distributors, Industrial Gases, Leisure Products, Packaged Foods, Pharmaceuticals, Railroads, Restaurants, Soft Drinks, Specialty Chemicals, Systems Software, and Tobacco. Valuation rose for 58/77 industries in September, up from 30/77 industries in August and 13/77 industries in July. During May, valuation fell for 76/77 industries. Semiconductors P/E up from a record low in August, but Semiconductor Equipment fell to a record low. (See Earnings Month posted on
IV) US CONSUMER: The US economy is depressing. That’s not my opinion, but rather the opinion of respondents to the monthly Consumer Sentiment and weekly Consumer Comfort surveys during the first half of September. Debbie notes that that the three-month drop in the Consumer Sentiment Index (CSI) from 76.0 during June to 66.6 in mid-September was led by a drop in sentiment among high-income families. Interestingly, sentiment among low-income families increased for the second straight month. Perhaps the former are expecting that their Bush tax cuts will expire, while the latter are expecting that their tax cuts will be extended.
In any event, the double dip crowd can add the CSI to their supporting evidence. It is the lowest since August 2009. The expectations component of this index is down sharply over the past three months from 69.8 during June to 59.1 in mid-September. That’s the lowest since March 2009. There’s no double dip in the weekly Consumer Comfort Index because it never really recovered. Debbie notes that it has been range bound at record lows since early 2008.
* Consumer Sentiment: How are consumers feeling? Still depressed. The Consumer Sentiment Index (CSI) dropped to 66.6 in mid-September, the lowest since last August. Sentiment among high-income families fell to a 13-month low, while sentiment among low-income families increased for the second straight month. The expectations component sank to an 18-month low, while the present situation was little changed around recent lows. House-buying attitudes remained around 4½-year highs, though near the bottom of its recent flat trend. This month, 73% of consumers said it’s a good time to buy a house, while 26% said it was a bad time to buy. Car-buying attitudes skidded to a 21-month low, with those saying it’s a good time to buy a car falling from 65% to 59%, and those saying it’s a bad time to buy rising from 22% to 26%. Consumers’ opinion of government remains around highs for the year. However, the percentage saying the government is doing a bad job (41%) is more than double the percentage of those saying it’s doing a good job (16%). The one-year expected inflation rate dropped to a year-low of 2.2%.
* Consumer Comfort (weekly): ABC News/Washington Post Consumer Comfort Index (WCCI) fell 3 points during the week ending September 18, the largest weekly loss since mid-April. The decline sends the index back to the middle of its range for the year, only 8 points above its all-time low. The buying climate component dropped 6 points for the week, while the personal finances component was 2 points lower. The economic component was unchanged for the fourth straight week.
V) FOCUS ON S&P 500 HOUSING-RELATED INDUSTRIES: One of the main reasons why the US recovery has been subpar, and will probably remain that way for a while, is that the housing industry is still in recession. It isn’t likely to come out of it for several years. While there has been a modest (tiny) upturn in single-family housing starts since the cyclical record low of 360,000 units (saar) during January 2009, houses under construction dropped to a new record low of 276,000 units during August. (The data start in 1970.) This means that construction-related employment will remain depressed.
Housing starts surged 10.5% in August to the highest level since spring, but the activity was driven by a sharp 32.2% spike in apartment construction, which tends to be volatile. New construction of single-family homes, which accounts for 75% of the housing market, rose a much smaller 4.3% to an annualized rate of 438,000, the first increase in four months, but still down 9.1% y/y.
More importantly, permits for new construction increased only 1.8% in August to an annualized rate of 569,000. Permits for condominiums and apartments rose 9.8%, but permits for single-family homes dipped 1.2%, the fifth consecutive monthly drop.
* Housing Starts: A subpar recovery in housing? That’s the most likely scenario. Single-family starts climbed 4.3% in August to 438,000 units (saar) after a 3-month drop of 20.1%. A government tax credit boosted starts ahead of its April expiration. Single-family permits fell for the fifth straight month in August to 401,000 units (saar), down 1.2% m/m and 26.0% over the five-month period. Both starts and permits remain above early 2009 lows, but lack momentum. The housing recovery will likely remain a slow go until the labor market picks up.
* Homebuilding (underweight): The stock price index for underweight rated Homebuilding has tumbled 30.2% from its bull market high for the tenth worst performance in the S&P 500, and is now down 0.6% ytd and trading 9% below its falling 200-dma. Forward earnings positive since February for the first time since July 2007, but has not risen since June. Low mortgage rates and improving credit conditions led to a modest rebound in sales during 2009, and analysts are no longer slashing their consensus annual forecasts. Analysts expect a profit in 2010 for the first time in four years. However, the industry needed a tremendous amount of stimulus to close deals recently, and weak employment remains a concern. NERI had been negative from February 2006 through October 2009 before rising to a five-year high of 24.1% in June, but was negative again in August and September. Housing starts up from their worst readings since the data started in the early 1960s, but likely to remain depressed along with new home sales.
* Home Improvement Retail (overweight): Overweight rated Home Improvement Retail’s stock price index is down 18.1% from its bull market high and trades 2% below its falling 200-dma, but has risen 1.7% ytd. Forward earnings has risen in 16 of the past 18 months to a 33-month high even as the housing market remains troubled. After 11 straight years of double-digit earnings growth from 1995-2005, Home Improvement Retail earnings were pummeled by the housing recession, but analysts expect a return to double-digit earnings growth in 2010 and 2011 even though NERI has been negative again since August. P/E up to 14.0 from a 20-month low of 13.4 in July and at a 14% premium to the market as the profit margin surged to a four-year high of 6.3% in Q2. However, the industry’s retail sales are down 10.0% from its recent peak in May, and has fallen in three of the past four months.
* Computer & Electronics Retail (overweight): The stock price index for the overweight rated Computer & Electronics Retail industry is down 20.4% from its bull market high, and is trading 2% below its falling 200-dma. Forward earnings rose 2.1% m/m in September and is up in 18 of the past 21 months, but remains 5.3% below the record high in September 2007. Analysts expect earnings to rise 12.9% in 2010 and 10.0% in 2011, and their forecasts have edged higher in recent months. The industry’s P/E was up to 9.2 from a two-year low of 8.9 in August, but remains at a near record low 25% discount to the market. Profit margin up to 3.2% in Q2 from an 11-year low of 2.2% in Q4-2007, but we expect the profit margin to remain low for this intensely competitive industry. The forward earnings improvement and the positive NERI since March 2009 is a good start, but consumers need to keep shopping for the price index to keep rising to new bull market highs and for valuation to move higher.

Goldman's Bearish 2011 Forecast

Goldman's Investment Strategy Group has just circulated the most bearish 2011 outlook presentation, detailing why the US economy in 2011 will likely stall and post negative growth. As the chart below demonstrates, the current case, where ongoing QE will likely persist through 2011 and even into 2012, and thus make any discussion of raising rates irrelevant (likely forever, as the Fed will not be able to absorb all the excess slack before it is forcefully removed after 2-3 sequential dollar devaluations) lead Goldman to a GDP expectation of well under half of the Fed's greenshooty outlook of 3%.

Here is how Goldman describes the its across the board outlook revision:

  • Lower growth: We expect GDP to grow 1.5-2.5% in 2011 (down from 2.5-3.0%). Our view is that the growth baton will be passed successfully from inventories and government spending to consumption and investment so growth should remain positive over the next 12-18 months.
  • Higher uncertainty: Our forecast range for GDP is wider (1% instead of 0.5%) at 1.5-2.5%
  • Lower rates: We are lowering our long-term rates forecast to 3.0-3.75% by end 2011 (from 3.75-4.25%).
And according to the "Bad Case" which the Fed is about to enact, Goldman sees a fundamental S&P valuation range of 725-800 based on 10-11x multiples:

It is all about to get very interesting.
Full presentation.

GS Sep 10 Econ Update

Bill Gross Says Fed's QE2 Will Lower US Standard of Living

Some very troubling observations from Bill Gross. In summary: "What the U.S. economy needs to do in order to return to the “old” normal is to recreate nominal GDP growth of 5%, the majority of which likely comes from inflation. Inflation is the classic “coin shaving” technique of government since the Roman Empire. In modern parlance, you print money faster than required, pray that the private sector will spend it to generate investment and consumption, and then worry about the consequences in a later decade. Ditto for deficits and fiscal policy. It’s that prayer, however, which the financial markets are now doubting, resembling circumstances which in part are reminiscent of the lost decades in Japan since the early 1990s. If the private sector – through undue caution and braking demographic influences –refuses to take the bait, the reflationary trap will never snap shut. Investors will likely not know whether the mouse has grabbed for the cheese for several years forward...The most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living. Stan Druckenmiller is leaving, and with good reason. A future of low investment returns, and a heap of trouble for those expecting more, is what lies ahead."
From PIMCO's Bill Gross

Stan Druckenmiller is Leaving
  • The New Normal has a new set of rules. What once pumped asset prices and favored the production of paper, as opposed to things, is now in retrograde.
  • The hard cold reality from Stan Druckenmiller’s “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated.
  • Investors are faced with 2.5% yielding bonds and stocks staring straight into new normal real growth rates of 2% or less. There is no 8% there for pension funds. There are no stocks for the long run at 12% returns.
So the hedgies are in retreat and, in some cases, on the run. Ken Griffin at Citadel is considering cutting fees, and Stan Druckenmiller at Duquesne/ex-Soros is packing his bags for the golf course. Frustrated at his inability to replicate the accustomed 30% annualized returns that his business model and expertise produced over the past several decades, Stan is throwing in the towel. Who’s to blame him? I don’t. I respect him, not only for his financial wizardry, but his philanthropy which includes not only writing big checks, but spending lots of time with personal causes such as the Harlem Children’s Zone. And at 57, he’s certainly learned how to smell more roses, pick more daisies, and replace more divots than yours truly has at the advancing age of 66. So way to go Stan. Enjoy.
But his departure and Mr. Griffin’s price-cutting are more than personal anecdotes. They are reflective of a broader trend in the capital markets, one which saw the availability of cheap financing drive asset prices to unsustainable heights during the dotcom and housing bubble of the past decade, and then suffered the slings and arrows of a liquidity crisis in 2008 to date. Similarly, liquidity at a discount drove lots of other successful business models over the past 25 years: housing, commercial real estate, investment banking, goodness – dare I say, investment management – but for them, its destination is more likely to be a semi-permanent rest stop than a freeway. The New Normal has a new set of rules. What once pumped asset prices and favored the production of paper, as opposed to things, is now in retrograde. Leverage and deregulation are fading from the horizon and their polar opposites are in the ascendant. Some characterize it in biblical terms – seven fat years to be followed by seven years of lean. Others like Michael Moore and Oliver Stone describe it in terms of social justice – greed no longer is good. And the hedgies – well, they just take their ball and go home. What, after all, is the use of competing if you can’t play by the old rules?
Whoever’s slant or side you choose to take in this transition from the old to the “new” normal, the unmistakable fact is that future investment returns will be far lower than historical averages. If a levered Druckenmiller, Soros, or Griffin could deliver double-digit returns in the past, then a less levered hedge fund community with a lower yielding menu will likely resign themselves to a high single-digit future. If a “stocks for the long run” Jeremy Siegel grew used to historically “validated” 9 to 10% returns from stocks prior to writing his bestseller in the late 1990s, then the experience of the last decade should at least temper his confidence that the “market” will deliver any sort of magical high single-digit return over the long-term future. And, if bond investors believe that the resplendent and abundant capital gains of the past 25 years will be duplicated from yield levels of 2 to 3% – well, they just haven’t been to Japan, have they?
There are all sizes and shapes of “investors” out there who have not correctly visualized the lower return world of the New Normal. The New York Times just last week described the previous balancing act that pension funds – both corporate and state-oriented – are now attempting to perform. Their article describes their predicament as the “illusion of savings,” a condition which features the assumption that asset returns on their investment portfolios will average 8% over the long-term future. No matter that returns for the past 10 years have averaged 3%. They remain stuck on the notion that the 25-year history shown in Chart 1 is the appropriate measure. Sort of a stocks for the long run parody in pension space one would assume. Yet commonsense would only conclude that a 60/40 allocation of stocks and bonds would require nearly a 12% return from stocks in order to get there. The last time I checked, the investment grade bond market yielded only 2.5% and a combination of the two classic asset classes would require 12% from stocks to hit the magical 8% pool ball. That requires a really long cue stick dear reader, or what they call a “bridge” in pool hall parlance. Best of luck.
The predicament, of course, is mimicked by all institutions with underfunded liability structures – insurance companies, Social Security, and perhaps least acknowledged or respected, households. If a family is expecting to earn a high single-digit return on their 401(k) to fund retirement, or a similar result from their personal account to pay for college, there will likely not be enough in the piggy bank at time’s end to pay the bills. If stocks are required to do the heavy lifting because of rather anemic bond yields, it should be acknowledged that bond yields are rather anemic because of extremely low new normal expectations for growth and inflation in developed economies. Even the wildest bulls on Wall Street and worldwide bourses would be hard-pressed to manufacture 12% equity returns from nominal GDP growth of 2 to 3%. The hard cold reality from Stan Druckenmiller’s “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated. With deleveraging the fashion du jour, and yields about as low as they are going to go, prosperity requires another foundation.
What might that be? Well, let me be the first to acknowledge that the best route to prosperity is the good old-fashioned route (no, not the dated Paine Webber road map utilizing hoped for paper gains of 12%+) but good old-fashioned investment in production. If we are to EARN IT – the best way is to utilize technology and elbow grease to make products that the rest of the world wants to buy. Perhaps we can, but it would take a long time and an increase in political courage not seen since Ronald Reagan or FDR.
What is more likely is a policy resort to reflation on a multitude of policy fronts: low interest rates and quantitative easing from the Federal Reserve, near double-digit deficits as a percentage of GDP from Washington. What the U.S. economy needs to do in order to return to the “old” normal is to recreate nominal GDP growth of 5%, the majority of which likely comes from inflation. Inflation is the classic “coin shaving” technique of government since the Roman Empire. In modern parlance, you print money faster than required, pray that the private sector will spend it to generate investment and consumption, and then worry about the consequences in a later decade. Ditto for deficits and fiscal policy. It’s that prayer, however, which the financial markets are now doubting, resembling circumstances which in part are reminiscent of the lost decades in Japan since the early 1990s. If the private sector – through undue caution and braking demographic influences –refuses to take the bait, the reflationary trap will never snap shut.
Investors will likely not know whether the mouse has grabbed for the cheese for several years forward. In the meantime, they are faced with 2.5% yielding bonds and stocks staring straight into new normal real growth rates of 2% or less. There is no 8% there for pension funds. There are no stocks for the long run at 12% returns. And the most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living. Stan Druckenmiller is leaving, and with good reason. A future of low investment returns, and a heap of trouble for those expecting more, is what lies ahead.
William H. Gross
Managing Director

David Rosenberg Bearish Except for Gold

Recently, there has been much euphoria to define all those who believe that gold will outperform as goldbugs. We in turn are fairly confident that pretty soon all those who have faith that the central banks will somehow get it right this time, instead of causing all out war again, will be labeled as "paper bugs." What however, surprises us is that all the so called "gold bugs" continue to be invested in the best performing asset class over the past day, 5 days, 1 month, 6 months, 5 years, and 10 years: on a relative basis gold has outperformed stocks in all these time categories, yet it continues to be more hated than even Ben Bernanke, whose stealthy destruction of middle class purchasing power is in fact cheered by the "paper bugs" - we will not bore you with the chart that shows how the dollar has lost almost 100% of its purchasing power since the creation of the Fed. Anyway, here is David Rosenberg, who several months ago joined the gold bandwagon, and presents one of the better defenses to all those who blame gold bugs for not catching the "bungee jump" in the most manipulated stock market in history. "We continue to field criticism that we “missed the call” on the equity market. Well, no doubt we did not see the 1930-style bungee jump last year, but: (i) it’s over, and (ii) there were many other asset classes we liked that did very well: what has done better than gold, which is up more than 30% in the last 12 months." We obviously agree both now, and about 50% back, at the time of the creation of this blog, when we said that the only natural response to Fed insanity is the otherwise useless shiny metal.
More from David:
We think it has to be understood that over 80% of the economic growth we saw from the lows of 2009 in real GDP was due to the massive amounts of federal government stimulus and the huge inventory swing. In other words, the underlying trend in organic real final sales is barely above 0.5%. One has to therefore wonder, with an estimated 1.7 percentage point drag from fiscal withdrawal in the coming year and the evident signs of a peaking-out in the inventory contribution to growth, how the economy does not contract heading into 2011 (perhaps starting in Q4 — the biggest mistake being made right now is confusing the delay of the double-dip with derailment).
Of course, we are likely on our way for a positive monetary shock out of the Fed, but let’s be honest, if QE1 had truly been successful (outside of the narrow goal of bringing in mortgage spreads from the orbit), then we wouldn’t be hearing about QE2 right now. That said, the drag from fiscal restraint alone is worth seven 25bp hikes out of the Fed, so it would seem as though Bernanke et al are going to have their work cut out for them to prevent this fiscal shock from turning the economy over, as was the case in 1937-38. And to think that just six months ago economists on Wall Street were debating when the Fed was going to take “extended period” out of the press statement and embark on the process of tightening monetary policy.
Finally, we are sure to get calls today saying “why are you so bearish? Didn’t you see that article on page A4 of the WSJ discussing how state and local government revenues are rising?” Indeed, there is a column on this today — as of Q2, state and local government revenues have edged up 1.7% YoY — the third increase in a row. Ordinarily, that might be construed as a good sign — after all, at the peak of the GDP growth rates in 2005, revenues were coming in at a near 14% annualized pace.
But it’s one thing for governments to be generating a revenue stream via a booming economy and quite another that is caused by rising taxation, for the latter merely saps spending power out of the private sector, which is exactly what is happening. In the past year, state governments raised taxes the most since data were complied staring in 1979 — 29 of them raised taxes in one form or another (see Local Taxes Sway Races on the front page of the WSJ), and 10 of these involved income tax hikes (yikes!).
Amazingly, despite the lingering deflation in residential real estate, property tax revenues managed to climb 3.3%. We wonder how.
We continue to field criticism that we “missed the call” on the equity market. Well, no doubt we did not see the 1930-style bungee jump last year, but: (i) it’s over, and (ii) there were many other asset classes we liked that did very well.
Look at the S&P 500. It had one of the worst months on record in August followed by a smashing rebound in September that still leaves it in the 1,022-1,217 range for the year. At today’s level of 1,142, the S&P 500 is barely changed since mid-November; nothing to show but flattish returns and a ton of volatility.
The TSX has done a little bit better and in fact we have favoured Canada over the U.S. given the resource and gold exposure. Even here, at 12,190, the TSX is little better than it was in mid-March, so in this case it is six months of a do-nothing market. It is still within the 11,092-12,280 range of 2010.
But we can understand the need for people to label market commentators as being “bullish” or “bearish”; however, in the final analysis, it is all about growing capital in a prudent manner. If somebody was “bullish” on equities at the start of the year and told you to load up on tech stocks (which are actually down), was he/she more correct than someone who wasn’t as “bullish” on the overall market but told you to load up on telecom (+7.0%) and staples (+5.0%) in an overall equity underweight? Or even in the past 12 months, with the overall market up barely double-digits, would a “bullish” strategist have been right if he/she advised you to be long the financials, which are down 4.5%. Or could it be the “bearish” strategist was actually more prescient by being underweight but advising clients to have a core position in basic materials (which happen to be up 9.0%)? There is more to investment advice than merely being “bullish” or “bearish” on a particular asset class, as is usually the case, the real gems are what lies beneath the surface of the forecast as opposed to what makes the headlines.
Our call on bonds has been solid with Treasury market returns of 10% over the past year (outperforming the S&P 500 by more than 50bps). We have been through most of the past year positive on commodities, and the CRB index is up 13%.
The theme of strong corporate balance sheets has been constructive — returns in the corporate bond market have been a solid 11% — equity-like returns for less risk and volatility.
And of course, what has done better than gold, which is up more than 30% in the last 12 months.

Steadily Declining Dollar

QE IS Monetizing the Debt!

Why QE2 WIll Cause Inflation

Keynesian Failure blog:

Now that the Fed has said it’s “prepared to provide additional accommodation if needed”, all that remains to be seen is how much worse things have to get to reach the Fed’s “if needed” threshold, and just how many units of “accommodation” the Fed is “prepared to provide”.
Everybody knows that “accommodation” means quantitative easing. But my readings of professional analysis, media articles and online forums have made clear to me that QE is still a very poorly understood topic. Most people are assuming that this coming round of quantitative easing, or QE2, will have more or less the same result as the last episode in 2008-2010. That is, not much result at all.
But QE2 will be very different from QE1, because it will be conducted differently in very different conditions. Here are three crucial differences between QE1 and QE2 that explain why I think QE2 will be significantly more inflationary than QE1.
QE2 will take place amid less financial stress. The bulk of QE1 coincided with a severe financial implosion. By contrast, QE2 will be launched during a period of protracted stagnation. Houses and the financial assets backed by them will again be falling in price, but their second leg down will not be as sharp or as widely unforeseen as the first. The economy will most likely be contracting before QE2 is launched, but probably only mildly, at least initially.
QE2 will displace traditional buyers of Treasuries into other dollar assets. In QE1, the Fed bought mortgage bonds at a time when foreigners desperately wanted out of the American mortgage debt market. Many of these foreigners switched to cash dollars, which can be seen in part in the sharp increase in cash assets of US branches of foreign banks. In QE2, the Fed will be buying Treasuries at a time of high domestic and foreign demand for them. QE2 will likely amount to about $80 billion per month of Fed Treasuries purchases, up from the roughly $20 billion per month that the Fed is currently buying to replace its retired mortgage debts. That’s out of about $120 billion per month of net Treasuries issuance.
That means about $60 billion per month of private and foreign buying of Treasuries would be displaced into other assets. If those displaced, would-have-been-buyers of Treasuries switch to some other kind of financial assets besides cash, they will displace yet others from other financial asset markets, and so on and so on. If there is not enough demand among the private sector and foreigners to increase the overall pace at which they are accumulating cash dollars, the market will instead satisfy those displaced would-have-been-buyers of Treasuries by creating new financial assets through a credit expansion.
QE2 will not meet any pressing demand for cash. QE1 satisfied a panicked scramble for scarce cash in over-leveraged private markets as credit markets broke down. In QE2, the Fed will be pushing dollars into an economy that is stagnating because the private sector doesn’t want to invest the large amounts of cash it already has. This implies that the private and foreign net buyers of Treasuries who will be displaced from the Treasuries market by QE2 will probably not be nearly as eager to switch to cash as were the sellers of mortgage debt during QE1.
About 90% of QE1 met heightened demand for cash, and only about 10% fueled credit expansion. It’s difficult to predict exactly how markets will accommodate QE2, but I think it’s safe to guess that the portion that fuels credit expansion will be at least 25%.
That might seem like no big deal, a mere $15 billion per month. But thanks to fractional reserve banking, the increase in M2 would be somewhere in the range of $90 billion to $120 billion per month. By comparison, M2 has increased by an average of less than $40 billion per month since QE1’s launch two years ago.
That is why I am expecting a significant acceleration of inflation from QE2, in contrast to the very low pace of inflation that has followed QE1. It is possible the Fed could mitigate this inflation, either by reducing or discontinuing QE, or by raising the rate of interest paid on reserves to encourage more accumulation of cash. But as we all know, the Fed is consistently late to change courses. Almost inevitably, inflation and interest rates on almost everything except Treasuries will be going significantly up.
And that will be devastating for the housing and financial sectors. They are being kept on the artificial life support of near-zero interest rates, instead of letting the market find a true bottom, writing off losses, recapitalizing and moving on. Unfortunately, delaying the day of reckoning is only moving that bottom lower.

Gold Blasts to New Record

Case-Shiller Shows Price Declines

from Fox Business:

The best that can be said for U.S. home prices now is that they are not falling off a cliff anymore.
But they’re not going up, either. The S&P Case-Shiller home price indexes revealed Tuesday a still-stagnant real estate market, as the impact from an earlier government tax credit continues to fade.
The Case-Shiller 20-city index eased by 0.1% in July from June, adjusted for seasonal factors. (It was up 0.6% on an unadjusted basis). The 10-city index was flat seasonally adjusted, and up 0.8% unadjusted.

Consumer Confidence Plunge Sends Stocks Lower

from Fox Business:

U.S. September consumer confidence ebbed to its lowest levels since February, driven by deteriorating labor market and business conditions, according to a private report released on Tuesday.
The Conference Board, an industry group, said its index of consumer attitudes fell to 48.5 in September from a revised 53.2 in August.
Inflation expectations eased slightly, even after the Federal Reserve has said it is ready to take action to keep yields down in an effort to stimulate growth. Consumers' one year inflation expectations edged down to 4.9 percent from 5.0 percent the previous month.
The median of forecasts from analysts polled by Reuters was for a main September reading of 52.5. Forecasts ranged from 48.0 to 55.0.
The August reading was revised down slightly from an original 53.5.
The expectations index slipped to 65.4 from 72.0 last month.

Monday, September 27, 2010

Trading Volume Continues to Plunge

The continuing decrease in volume reported by the US’s largest electronic trading groups has triggered a fear among analysts that the fall in market activity might be more than a seasonal phenomenon.

Trading-focused groups such as ITG, Knight Capital and Charles Schwab enjoyed upbeat second quarters when the European debt crisis sparked extreme volatility. As fear has given way to unease with the global economy, however, trading volumes have fallen sharply.

You’re starting to see some real pain,” said Christopher Allen, an analyst at Ticonderoga Securities. “September is not a material improvement over August. Aside from possibly the US election, I’m not sure what the catalyst is for trading.” A record-long streak of outflows from equity mutual funds – now 20 successive weeks beginning in May, according to the Investment Company Institute – and reluctance by even normally bold hedge fund managers to take big bets has suggested that there are more than seasonal factors at work.

Mr Allen’s figures, compiled last week, show that trades for the trading industry are down 8 per cent so far in September from August, when trading fell to a three-year low.

Fed Admits to Manipulating Broad Financial Markets

Clearly, this includes commodities!

It is no secret that the Federal Reserve, and its now semi-daily interventions in market liquidity via ever increasing Permanent Open Market Operations (aka POMOs, next on deck - Wednesday and Friday for a total of about $7-8 billion), is rather hell bent on creating the impression that the economy is alive and well courtesy of a ramping stock market (when the causal relationship is always the other way around, but who cares). A reader got so disgusted by the POMO ramp game, he sent in an angry letter to Brian Sack's henchmen. Here is the Fed's response.

Dear Mr. (removed to maintain privacy):

Thank you for your recent correspondence in which you expressed your concerns about the Federal Reserve's influence on the stock market. 

The Federal Reserve monitors all sectors of the economy, so that we can be prepared when crises arise. It is within this context that the Chairman is often called by Congress to offer his views on many issues that may or may not be directly related to monetary policy. I want to assure you that the Federal Reserve's monetary policy actions are not aimed at correcting or influencing any particular market. As you know, the goal of monetary policy is to foster conditions conducive to sustaining sound, noninflationary economic growth over time and policymakers must make decisions that provide the greatest benefit overall.

Again, thank you for writing.

Board Staff
So if "the Federal Reserve's monetary policy actions are not aimed at correcting or influencing any particular market" is it safe to assume that actions are aimed at "correcting and influencing" all markets in general? Well, the Fed is already rampaging in USTs, Agency securities and FX, would it be too naive to assume equities are for some reason excluded...