Saturday, March 26, 2011

What Happens If Japan Must Sell U.S. Debt to Rebuild?

from Washington Times:

Some lawmakers and market analysts are expressing rising concerns that a demand for capital by earthquake-ravaged Japan could lead it to sell off some of its huge holdings of U.S.-issued debt, leaving the federal government in an even tighter financial pinch.
Others say a major debt sell-off by Tokyo is unlikely, but noted that the mere fact that questions are being raised speaks volumes about the risks involved in relying so heavily on foreign investors to fund U.S. debt.
“This natural disaster in Japan concerns me that it could speed up what’s coming, because they are the second leading buyer of our debt,” Sen. Rand Paul, Kentucky Republican, told The Washington Times. “Small degrees of differences in how much they buy of our debt, I think, can make a big difference in interest rates that we have to pay people to buy our debt.”
With the federal government having piled up $14.2 trillion in debt, budget experts are warning that the country is on an unsustainable fiscal path. Congress, they say, must find cuts in all areas of the budget, while reforming the entitlement programs — Social Security, Medicare and Medicaid — that are the biggest drivers of national spending.
Congress has passed short-term spending bills this year that nibble on the edges of government spending, and President Obama has offered a 2012 spending plan that also saw spending rise.
Concerns about the financial plight facing Japan, which trails only China among foreign holders of U.S. Treasury debt, aren’t helping the picture.
“They have a lot of bonds,” former Sen. Pete V. Domenici told The Times this month after testifying before Congress about the country’s mounting debt woes. “Are they in such bad trouble that they are not going to buy anymore? If they don’t, who do we look to?”
Asked point-blank last week if he thought Japan’s troubles could affect the U.S. borrowing costs and interest rates, Treasury Secretary Timothy F. Geithner told a congressional hearing, “I do not.”
Japan, which held some $886 billion in U.S. debt in January, is “a very rich country, with a very high savings rate,” Mr. Geithner said.
But some two weeks after the earthquake, uncertainty still reigns over whether Japan will reduce its purchases of Treasury debt and other foreign assets — a decision that could force the U.S. to pay higher rates on its securities to attract buyers and possibly drive up U.S. interest rates.

Friday, March 25, 2011

Consumer Confidence: Not Just the Drop, But the Size of the Drop

from Zero Hedge:

While today's consumer confidence index missing expectations (at 67.5 or the lowest since April 2009) was not a big surprise following our prediction of just that happening when we reported that the Bloomberg Consumer Comfort index hit a 7 month low, what was very disappointing was that the Expectations component had its fifth largest drop in history, plunging from 72 to 58. This is a lower reading than that recorded when the "recession", according to the NBER at least, was still raging. As a reminder the recession ended with "expectations" at 70.

Dollar Recovers Following Fed Governor Plosser's Comments (Buenos Aires) – EUR/USD lost over 70 pips in a few minutes, following FED’s Plosser hawkish comments, signaling an economic policy reversal. The common currency has been under pressure most of the week, as after reaching a fresh yearly high at 1.4250, profit taking along with Portugal debt woes had been pushing the cross to the downside.

Quoting right now around 1.4080, pair faces immediate support at the weekly low set at 1.4053, followed later by 1.4000 psychological level. However and despite recent losses, bullish trend remains intact, according to Valeria Bednarik, chief analyst, as long as above 1.3950 price zone.

Consumer Sentiment Declines, Stocks Rise on Positive GDP, Earnings

Consumer sentiment in the U.S. dropped more than forecast in March, damped by higher gasoline costs and the effects of Japan’s natural disaster.
The Thomson Reuters/University of Michigan final index of consumer sentiment decreased to 67.5, the lowest level since November 2009, from 77.5 in February, the group said today. The median forecast of 67 economists surveyed by Bloomberg News projected a reading of 68.
Gasoline prices hovering near the highest levels since October 2008 are straining the finances of American households, whose spending makes up about 70 percent of the world’s largest economy. While unemployment has fallen for three months, Japan’s earthquake crisis led to a plunge in stock values, at one point wiping out all of 2011’s gains.
“Consumers are concerned about the rise in gasoline and food prices,” said Ward McCarthy, chief financial economist at Jefferies & Co. in New York who correctly forecast the drop. “People who are now shelling more money out of their pockets every time they fill the gas tank have a whole lot less left over for anything else they want to spend money on.”
Forecasts in the Bloomberg survey ranged from 65 to 71. A preliminary reading issued earlier this month was 68.2. The sentiment index averaged 89 in the five years leading up to the recession that began in December 2007.

Thursday, March 24, 2011

America's Finances Rank Among World's Worst

The US ranks near the bottom of developed global economies in terms of financial stability and will stay there unless it addresses its burgeoning debt problems, a new study has found.

US Capitol Building with cash
In the Sovereign Fiscal Responsibility Index, the Comeback America Initiative ranked 34 countries according to their ability to meet their financial challenges, and the US finished 28th, said David Walker, head of the organization and former US comptroller general.
"We think it is important for the American people to understand where the United States is as compared to other countries with regard to fiscal responsibility and sustainability," Walker said in a CNBC interview. "Americans are used to rankings and they're used to ranking very high, but frankly in this area we rank very low."
While the news is bad, there is a bright side.
"Here's the good news: Some of the top countries had their own fiscal challenges, made reforms and now rank highly," Walker said. "If we adopt the recommendations of the National Fiscal Responsibility and Reform Commission or ones that have similar bottom-line impact, we move from 28 to 8."
As the US languishes near the bottom, these countries make up the top five: Australia, New Zealand, Estonia, Sweden, China and Luxembourg.

Gold Erupts to New Record High

$1450/ounce and still rising.

Consumer Discomfort

"Consumer confidence in the U.S. fell last week to the lowest level since August as more Americans became despondent over the economy. The Bloomberg Consumer Comfort Index dropped to minus 48.9 in the period to March 20 from minus 48.5 the prior week. The measure of the current state of the economy slumped to a 15-month low."

But at least Wall Street is "confident"!

Durable Drubbing!

But at least earnings were good this morning.

WASHINGTON (MarketWatch) — Orders for U.S. durable goods in February posted the biggest drop in four months, largely because of lower sales of heavy machinery and defense-related products, government data showed Thursday.
The Commerce Department said new orders for U.S.-made products designed to last three years or more fell 0.9%. Monthly orders minus the volatile transportation sector dropped 0.6%.
Economists surveyed by MarketWatch had expected orders to rise by 1.5% overall and by an even stronger 2.5% minus transportation.
Orders have now declined in four of the past five months, suggesting some hesitancy on the part of businesses to continue to expand until they see further strengthening of the U.S. economy.
“February’s U.S. durable goods orders report is unequivocally bad,” said Paul Ashworth, chief U.S. economist of Capital Economics.
The biggest decline for February occurred in orders for machinery, which fell 4.2% to $26.6 billion. Also, orders for major defense items sank 24.8% to $8.3 billion.
Another category of orders closely watched by economists, known as core capital goods, dropped 1.3% on the heels of a 6.0% decline in January. That category excludes defense and transportation and gives a better indication of longer-term trends in the private sector.
After the report was issued, Morgan Stanley and Bank of America Merrill Lynch were among several firms that cut their economic forecasts for first-quarter U.S. growth. They now expect the economy will grow between 2.2% and 2.5%, below the current MarketWatch consensus of 3.1%.
The disappointing data will focus even more attention on next month’s durables report. What’s been a prolonged surge in the manufacturing sector would seem to indicate that the recent decline in orders is a temporary lull — but another poor report could renew worries over whether the fragile U.S. recovery is weakening.
“For now, we will put a heavy discount factor on the durables data, but we will be watching the March report with keen interest,” economist John Ryding of Conrad DeQuadros wrote in a report.
The durable-good reports also appeared to be discounted by investors. U.S. stock markets opened higher in Thursday trading, with the Dow Jones Industrial Average (DOW:DJIA)  extending Wednesday’s gains.

More durables data

The biggest bright spot in February: orders minus defense rose 0.4%, marking the second increase in a row after three straight declines. Government purchases of defense products are uneven and can sometimes distort the data.
Shipments of durable goods, meanwhile, rose 0.3% last month, following a 0.2% increase in January.
Shipments of core capital equipment goods, which the government uses to help calculate gross domestic product, rose 0.8% in February.
Inventories of durable goods climbed 0.9% last month, the 14th consecutive increase.
Orders for January, meanwhile, were revised up to a 3.6% increase. The government originally reported that total orders rose 3.2% on the month.

Stocks Give Up Most Gains

We'll see a reversal soon, I suspect. Wall Street continues its delusional oblivion.

And Stocks Continue Obliviously Higher

Crude Tops $106

Wednesday, March 23, 2011

Gold Just a Few Dollars From New Record

Just a few dollars more now...

Then Blast Off!

With crude oil at $106 and rising also, this is going to end in tears! Wall Street is blind to it sown hubris!

Stocks Reverse, Begin to Rise

Even with crude oil at nearly $106! I can't stomach stocks at this price and crude elevated too!

Crude Oil Ticks Close to $106

We're within 6 cents of $106.

from  Bloomberg:
Crude oil futures extended gains after a U.S. government report showed a bigger-than-forecast drop in supplies of gasoline.
Gasoline inventories fell 5.32 million barrels to 219.7 million in the week ended March 18, the Energy Department said today in a weekly report. Stockpiles were forecast to decline by 2 million barrels, according to the median of 16 analyst estimates in a Bloomberg News survey.
Inventories of crude oil rose 2.13 million barrels to 352.8 million, the department said. Supplies were forecast to climb by 1.5 million barrels.
Crude oil for May delivery rose 58 cents, or 0.6 percent, to $105.55 a barrel at 10:37 a.m. on the New York Mercantile Exchange.
Oil traded at $105.45 a barrel before the release of the report at 10:30 a.m. in Washington.
Oil also rose as the U.S. and its allies prepared to attack Libyan leader Muammar Qaddafi’s troops and protesters clashed with government forces in Syria, bolstering concern that supply will be disrupted.

From Bad to Worse: New Home Sales Collapse in February, Stocks Sink

WASHINGTON (MarketWatch) — Sales of new single-family homes collapsed in February, the Commerce Department reported Wednesday, as a combination of high unemployment, tumbling prices and a glut of cheaper alternatives brought activity to a near-standstill.
New-home sales fell 16.9% to a seasonally adjusted annual rate of 250,000 in February, though January’s figures were revised higher to 301,000 from 284,000. Compared to February 2010, sales collapsed by 28%.
Every region but the West saw record lows, and in the Northeast, sales dropped by 50% compared to year-earlier levels.
Economists polled by MarketWatch had expected a slight rise to a 290,000 rate in February. January’s sales were hurt in part by abnormally bad weather and the expiration of a California tax credit.
The new-home sales release is notoriously volatile, and the margin of error is plus or minus 19.1%. The less-volatile three-month average to February was 295,000, compared to 307,000 in January.
Demand for new homes is weak, constrained by still-high unemployment, a slow-growing economy, but most of all the remnants of the house-price bubble, with many owners unable to move due to being underwater on their mortgage.
Furthermore, it’s now far cheaper to buy an existing home due to the glut of foreclosed properties on the market.
The median price of a new home in February was $202,100, a dive of 13.9%, which is the largest one-month percentage drop on record. Even so, the median existing-home price was $156,100 in February. In Dec. 2007, the first month of the Great Recession, the gap between the price of new and existing homes was far narrower, when a new home fetched $227,700 and a lived-in home cost $207,100.
At the current sales rate, there are supply of 8.9 months, the highest backlog since the 9.1 months in August 2010.

WASHINGTON (TheStreet) -- Sales of newly built homes plunged 16.9% in February to a seasonally adjusted annual rate of 250,000, the Commerce Department said Wednesday, a far bigger jump than expected and the worst rate on record since 1962. 
February's rate of home resales remained 24.8% below the cyclical peak of 6.49 million units in November 2009, which was the initial deadline for the first-time homebuyer tax credit, and 2.8% below the home resale rate in February 2010.

Tuesday, March 22, 2011

Stock Futures Sink After Hours

We're now lower than the lows of the day session. Something is afoot!

U.S. Apprpoaching Fiscal Insolvency

from CNBC:

The United States is on a fiscal path towards insolvency and policymakers are at a "tipping point," a Federal Reserve official said on Tuesday.

The President of the Federal Bank of Dallas, Richard W. Fisher
Jean Ayissi | AFP | Getty Images

"If we continue down on the path on which the fiscal authorities put us, we will become insolvent, the question is when," Dallas Federal Reserve Bank President Richard Fisher said in a question and answer session after delivering a speech at the University of Frankfurt. "The short-term negotiations are very important, I look at this as a tipping point."
\But he added he was confident in the Americans' ability to take the right decisions and said the country would avoid insolvency.
"I think we are at the beginning of the process and it's going to be very painful," he added.
Fisher earlier said the US economic recovery is gathering momentum, adding that he personally was extremely vigilant on inflation pressures.
"We are all mindful of this phenomenon. Speaking personally, I am concerned and I am going to be extremely vigilant on that front," Fisher said in an interview with CNBC.
Fisher added that the U.S. Federal Reserve had ways to tighten its monetary policy other than interest rates, including by selling Treasurys, changing reserves levels and using time deposits.
He added that he does not support the Fed embarking on an additional round of quantitative easing.
"Barring some extraordinary circumstance I cannot forsee...I would vote against a QE3," Fisher told CNBC. "I don't think it's necessary. Again, we have a self-sustaining recovery."

U.S. Inflation Continues to Surge

from Zero Hedge:

hasing all the fluttering glow in the dark swans over the past month has put some of the key issues facing the US economy on the backburner. But just like today's surging inflation update in the UK confirmed, there is only so long that any given crisis can be used a distraction from the real problems at hand. And here is where we stand: per a quick check with the recently released and constantly updated MIT billion price project, which just happens to correlate 93% with the CPI, 2011 inflation in the US is trending at an 8.3% annual rate of increase. This is only comparable to China, which just happens to have a growth rate (presumably that is double that of the US), and is almost three times higher than the latest inflation data released by... Zimbabwe. Below is the most recent inverse disinflationary data confirmation from MIT (and plotted by John Lohman). By now we hope readers are honing their iPad eating skills.

Obama's Treasonously Catastrophic Oil Policy

from Investors Business Daily:

Energy Policy: While leaving U.S. oil and jobs in the ground, our itinerant president tells a South American neighbor that we'll help it develop its offshore resources so we can one day import its oil. WHAT?!?
With Japan staggered by a natural disaster and a nuclear crisis, cruise missiles launched against Libya in our third Middle East conflict and a majority of U.S. senators complaining about a lack of leadership on the budget, President Obama decided it would be a good time to schmooze with Brazilians.
His "What, me worry?" presidency has given both Americans and our allies plenty to worry about. But in the process of making nice with Brazil, Obama made a mind-boggling announcement that should make even his most loyal supporter cringe:
We will help Brazil develop its offshore oil so we can one day import it.
We have noted this double standard before, particularly when — at a time when the president was railing against tax incentives for U.S. oil companies — we supported the U.S. Export-Import Bank's plan to lend $2 billion to Brazil's state-run Petrobras with the promise of more to follow.
Now, with a seven-year offshore drilling ban in effect off of both coasts, on Alaska's continental shelf and in much of the Gulf of Mexico — and a de facto moratorium covering the rest — Obama tells the Brazilians:
"We want to help you with the technology and support to develop these oil reserves safely. And when you're ready to start selling, we want to be one of your best customers."
Obama wants to develop Brazilian offshore oil to help the Brazilian economy create jobs for Brazilian workers while Americans are left unemployed in the face of skyrocketing energy prices by an administration that despises fossil fuels as a threat to the environment and wants to increase our dependency on foreign oil.
Obama said he chose Brazil to kick off his first-ever visit to South America in recognition of that country's ascendancy. He has also highlighted one of the reasons for America's decline — an energy policy that through the creation of an artificial shortage of fossil fuels makes prices "necessarily skyrocket" to foster his green energy agenda.
In an op-ed in USA Today explaining his trip, Obama opined: "Brazil holds recently discovered oil reserves that could be far larger than ours. And as we seek to increase secure-energy supplies, we look forward to developing a strategic energy partnership."
Yet in his alleged quest for "secure-energy supplies," he refuses to develop oil and natural gas resources in U.S. waters. His administration has locked up areas in the West where oil shale reserves are estimated to be triple Saudi Arabia's reserves of crude. His administration is even stalling on plans to build a pipeline to deliver oil from Canada's tar sands to the U.S. market.
That project would build a 1,661-mile pipeline from the tar sands of Alberta to U.S. refineries near Houston. It would create 13,000 "shovel-ready" jobs and provide 500,000 more barrels of oil per day from an ally.
Yet it's now being held up by the State Department because it crosses an international border, on the grounds that it needs further environmental review. Shipping oil by tanker from Brazil is safer and more secure?
If Brazil had copied our current energy policy, it wouldn't have discovered in December 2007 the Tupi field, estimated to contain 5 billion to 8 billon barrels of crude, or its Carioca offshore oilfield that may hold up to 33 billion barrels.
Haroldo Lima, head of Brazil's National Oil Agency, estimates that Carioca might hold as much as five times the reserves of Tupi. Somehow the Brazilians aren't too worried about oil spoiling the pristine beaches of nearby Sao Paulo or Rio de Janeiro in the tourist season.
We suggest that President Obama return home and start worrying about an unapologetic American renaissance in which we focus more on American energy and American jobs and less on mythical environmental hazards and foreign accolades.

Monday, March 21, 2011

Existing Home Sales Plunge to 9-Year Low

from CNBC:

Sales of previously owned U.S. homes fell unexpectedly sharply in February and prices touched their lowest level in nearly nine years, implying a housing market recovery was still a long off.


The National Association of Realtors said Monday sales fell 9.6 percent month over month to an annual rate of 4.88 million units, snapping three straight months of gains.
The percentage decline was the largest since July.
Economists polled by Reuters had expected February sales to fall 4.0 percent to a 5.15 million-unit pace from the previously reported 5.36 million unit rate in January, which was revised slightly up to 5.40 million.
The median home price dropped 5.2 percent in February from a year earlier to $156,100, the lowest since April 2002.
"If the price declines persist, even with the job market recovery, that could hamper recovery in the housing market," said NAR chief economist Lawrence Yun.
Compared with February last year, sales were down 2.8 percent.
Oversupply of homes and a relentless wave of foreclosures are pressuring prices, holding back recovery in the sector, whose collapse helped to tip the U.S. economy into its worst recession since the 1930s.
Foreclosures and short sales, which typically occur below market value, accounted for 39 percent of transactions in February, up from 37 percent the prior month.
All-cash purchases made up a record 33 percent of transactions in February.
Sales last month fell across the board, with multifamily dwellings declining 10 percent and single-family home units dropping 10.0 percent.
At February's sales pace, the supply of existing homes on the market rose to 8.6 months' worth from 7.5 in January.

Gold Nears Record Highs

Reports out this morning that Iran's gold purchases have allowed them to amass reserves equivalent to or surpassing those of Great Britain. We're just $7 from a new record high.

Hussman: Perspective on Recent Market Weakness

from John Hussman of Hussman Funds. I nominate John Hussman to be the next Fed chairman. That monthly chart speaks volumes about where we're at. Even devastating earthquake, tsunamis, Arab world unrest, and catapulting crude oil prices, can't dampen the bubblishness of Wall Street. 

Good analysis and perspective:

The market action of the past two weeks contrasts with the generally uncorrected advance of recent months. The chart below places this pullback in perspective, relative to the "big picture" for the S&P 500, showing monthly bars since 1996. I suppose it's possible for investors to characterize the recent decline as a "panic" if they press their noses directly against their monitors, but in that case, they really do have a short memory. The pullback has been negligible even relative to the action of the past several months, and is indiscernible in the big picture. As of Friday, the market remained in an overvalued, overbought, overbullish, rising-yields syndrome that has typically been cleared much more sharply than anything we saw last week.

We still expect to establish a moderate positive exposure to market fluctuations if we can clear some component of this syndrome, provided that market internals (breadth, leadership, sector uniformity, etc) don't also deteriorate substantially enough to signal a shift to risk aversion among investors. We've already seen meaningful breakdowns in international markets, both within and outside of Asia. Thus far, market internals in the U.S. have maintained intact, though still burdened with a negative syndrome of conditions over the short-to-intermediate term. Even with a more constructive position, we would still expect to maintain a strong line of put option protection in the event of abrupt weakness, but suffice it to say that we don't require a major change in valuation in order to be willing to accept greater market exposure - just enough to clear this syndome without strongly damaging market internals.
In order to clear this syndrome, last week's decline would have required either a meaningful retreat of investor bullishness, or a deeper price decline on the week. That said, the pullback did clear very short term overbought conditions, and we covered some short calls and lowered some put strikes as the market briefly challenged the 1250 level. This maintains a defensive line of index put options for the entire portfolio of Strategic Growth, but leaves us with short calls against only 60% of the portfolio. The change wasn't very observable on Thursday and Friday, because the sharp drop in implied volatilities (to a VIX of 23) created some short-term drag. But even here, any sustained upmove in the market should be far more comfortable than what we've experienced since QE2 triggered the recent speculative run.
It's important to recognize that various indicators used by investors often have implications contrary to what is commonly assumed. For example, the strong ISM Purchasing Managers Index reading above 60 is widely seen as a favorable indication for stocks, yet historically, readings above about 59 have been followed by negative average returns for the S&P 500 over the short- and intermediate-term, and flat returns over a 12-month horizon. Weaker PMI readings are actually preferable, so long as they don't occur within a syndrome of pre-recession signals (rising credit spreads, flattening yield curve, weak employment growth and tepid stock returns).
Meanwhile, a "This time is different" perspective may very well apply to the increasingly extreme policy moves that have been required to produce a surface layer of economic growth, but while this has affected short-term market dynamics to a surprising degree, it doesn't materially change the long-term stream of cash flows that stocks are likely to deliver. So positive short-term returns come at the cost of progressively thinner long-term return prospects.
Our investment orientation is emphatically long-term and full-cycle. Even so, short- and intermediate-term returns do matter, particularly those that have some hope of being retained. Even in richly valued markets, there are often conditions that have been associated with positive average return/risk profiles when you look across numerous subsets of historical data. Those favorable conditions reasonably warrant a moderate exposure to market fluctuations, and we would certainly prefer to observe and respond to those opportunities. Until we do observe them, however, we have aligned ourselves with the expected return/risk profile associated with the current set of market conditions. For now, that profile remains negative.
The events in Japan have had a tragic effect on individual lives, and they are undoubtedly in all of our prayers. With respect to the global economy, there will likely be supply disruptions, and reallocations of trade, but we would expect these to be mainly of a short-term nature. Given that the most strongly affected areas were not heavily urbanized or industrialized, the increased demand for raw materials is also unlikely to be enormous. Instead, it is likely to be modest and spread over a large number of years. Witness the slow pace of reconstruction in the wake of Katrina, and in other places that have been hit by natural disasters in the past. Invariably, such disasters result in rapid destruction but very slow and long-term reconstruction.
The larger economic problem is that this disruption is occurring when there are other economic pressures elsewhere, particularly in Europe. The U.S. has quite a bit of slack capacity, so the prospects for economic growth over a multi-year period seem reasonably good, but the frequency of weak patches is also likely to be higher in the next several years, and it is worth keeping in mind that much of the recovery we've observed - particularly in the credit markets - is a veneer over continuing credit issues.
Nobel economist Joseph Stiglitz tied the issues together nicely in an interview that appeared in Barron's over the weekend. Speaking about Japan, he observed "The sad thing is that they've never fully recovered from the bubble of 1989 bursting. In that sense it should remind the U.S. of what happens if you allow a bubble to get outsized. It's water under the bridge, but Bernanke and Greenspan have to bear some responsibility for that ideology that bubbles don't really exist, and they clearly do. When we went into this financial crisis, the administration said, 'We won't make the mistake of Japan and delay restructuring.' That's exactly what we did. It's mind-boggling that we haven't learned any of the lessons of Japan."
My only disagreement might be that any of this is actually "water under the bridge," because the same basic policies that produced the bubble are still very active. These policies have driven financial assets to rich valuations and low prospective returns, which compete sufficiently well with zero interest rates, but offer little for long-term investors. Meanwhile, the financial sector has a continuing overhang of delinquent and unforeclosed homes, which the FASB still allows banks to carry on their books at amortized cost. When the main source of "prosperity" is the policy-induced elevation of asset prices - rather than the allocation of savings into productive investment - it helps to remember that present gratification often equates to future unpleasantness.
When we look around the world, we see difficult social tensions, particularly in North Africa and the Middle East where the poor are dealing with enormous increases in the prices of basic commodities (and where the much of their budgets go for food and fuel), at the same time that others in the same societies are enjoying disproportionate wealth, particularly based on strong oil revenues. Certainly, inequality and oppressive leadership has existed in many of these countries for a long time. But we have to ask what has heightened these tensions to the tipping point at this particular time.
The Buddha taught that you can only understand something by looking deeply at its interconnectedness to other things, and to our own selves - nothing has a separate existence. "This is, because that is; this is not, because that is not." The problems and imbalances that have inflamed the world did not emerge from a vacuum. Rather, this is, because that is. It cannot possibly help that the Fed continues to pursue an aggressive policy that drives short-term interest rates to negative levels, which predictably encourages commodity hoarding around the globe, and the unintended consequences that result.
In any event, our present investment stance is not driven by a thesis regarding QE2, underlying credit issues, or even the sustainability of economic growth. It is driven by present, observable conditions on a wide variety of measures. On the basis of a large ensemble of historical time periods, valuation thresholds, and indicator sets, present conditions map into the expectation of negative total returns per unit of risk. Strategic Growth and Strategic International Equity remain well-hedged, though the composition of those hedges reflects the conditions we observe in the U.S. versus other countries (risk aversion is weaker in the U.S., which creates the potential for more speculation, particularly if we clear overbought or overbullish conditions).

End the Fed: Not Just a Slogan Any More

from Forbes:

To put it mildly, the Federal Reserve has a dismal track record. It bears significant responsibility for almost every major economic upheaval of the past 100 years, including the Great Depression, the 1970s stagflation, and the recent financial crisis. Perhaps the most damning statistic is that the dollar has lost 95 percent of its value since the central bank was created.
Notwithstanding its poor performance, the Federal Reserve seems to get more power over time. But rather than rewarding the central bank for debasing the currency and causing instability, perhaps it’s time to contemplate alternatives. This new video from the Center for Freedom and Prosperity dives into that issue, exposing the Fed’s poor track record, explaining how central banking evolved, and mentioning possible alternatives.

This video is the first installment of a multi-part series on monetary policy. Subsequent videos will examine possible alternatives to monopoly central banks, including a gold standard, free banking, and monetary rules to limit the Fed’s discretion.
One of the challenges in this field is that opponents of the Fed often are portrayed as cranks. Defenders of the status quo may not have a good defense of the Fed, but they are rather effect in marginalizing critics. Congressman Ron Paul and others are either summarily dismissed or completely ignored.
The implicit assumption in monetary circles is that there is no alternative to central banking and fiat money. Anybody who criticizes the current system therefore is a know-nothing who wants to create some sort of libertarian dystopia featuring banking panics and economic chaos.
To be fair, it certainly might be possible to create a monetary regime that is worse than the Fed. That is why the next videos in this series will offer a careful look at the costs and benefits of possible alternatives.
As they say, stay tuned.

...But Don't Tell the Housing Market

WASHINGTON (MarketWatch) — Sales of previously owned homes dropped 9.6% in February and prices fell to their lowest level since 2002, reflecting a continued slump in the U.S. real estate market.
The National Association of Realtors on Monday said sales of existing homes dropped to a seasonally-adjusted annual rate of 4.88 million from an upwardly revised 5.4 million in January. Economists surveyed by MarketWatch expected sales to drop to a rate of 5.1 million.

Wall Street Sees No Risk

Sunday, March 20, 2011

Gold Up $10

Crude Oil Up $2.50

I'm surprised stocks are too -- modestly!!

End of QE2 Coming, Inflation, and You're Not Going to Like What Comes Next

by John Mauldin:

What happens when the Fed is finished with QE2? I have been letting that filter into my thinking lately as I look at the economic landscape and the data we have seen the past few weeks. Correlation is not causation, as I often say, but all we can do is look back at what happened last time and speculate about the future. A very dangerous occupation, but your fearless analyst will plunge on ahead into the jungle of a very hazy future. You come with me at your own risk!

New York Times Bestseller

Quickly, a big Mauldin thanks to those who already bought my book, Endgame, as it made the New York Times bestseller list yesterday, earlier than I thought it would. That would be my 4th, and that and my kids are about my only small claims to fame. I have ruthlessly promoted the book to you, and so this week I resist my inner promotional demon and simply provide a link to where you can read the reviews and buy the book if you have not, or get it in your local stores. At the end of the letter, I note that I will be at a book launch party in London Monday evening, and would love to have you stop by. Details below. And now to this week’s letter.

The End of QE2?

The Fed committed to buying $600 billion of Treasuries between the beginning of QE2 in November and the end of June. June is 3 months away. What will happen when that buying goes away? The hope when QE2 kicked off was that it would be enough to get the economy rolling, so that further stimulus would not be deemed necessary. We’ll survey how that is working out, with a quick look at some recent data, and then we go back and see what happened the last time the Fed stopped quantitative easing.
First, the guy on the street is getting squeezed. Real US consumer spending slowed in January and looks like it did only marginally better in February. The Fed argues that inflation is mild, as they prefer to look at “core” inflation (inflation without considering food and energy). If you look at it that way, they are right. And in normal times, I can kind of see why we strip out energy and food, as they are very volatile price points and can move a lot from month to month.
But that argument gets a lot weaker when your main policy, that of significant quantitative easing, is perhaps CAUSING the rise in food and energy (as well as weakening the dollar)! If the Fed policy is at least contributing to the cause of total inflation, arguing that food and energy don’t count doesn’t hold water. Let’s look at the following chart from

In particular, notice the rise in the last three months since the beginning of QE2. Inflation is running at over 5% on an annualized basis. Companies like Kimberly (diapers, etc.), Colgate, P&G, and others all announced 5-7% price increases this week. These are companies that provide staples we all buy. Those prices matter. Even Wal-Mart will have to pass those increases on. To say that food and energy don’t matter misses the point. These items have real economic impact.
As my friend David Rosenberg wrote this morning:
“In February, there was no inflation at all in average weekly wage-based earnings but there was 0.5% inflation in consumer prices, meaning that real work-related income was crushed 0.5% and has now deflated in each of the past four months and in five of the past six months, during which it has contracted at a 2.3% annual rate. Once the effects of fiscal stimuli wear off, this negative income trend will show through in a much more visible slowing in real consumer spending that we doubt the markets have fully discounted. So far, what has happened in equities has been treated as a financial event – just wait until the economic event follows suit. And it’s not only fiscal stimulus that is soon to subside. We still have that 86% correlation over the past two years between movements in the Fed balance sheet and the direction of the S&P 500 – this too will come home to roost before long, whether or not we end up seeing a resolution to the crises in Japan, Libya or Bahrain.”
He goes on to give us this chart:

How’s that QE2 thingy working for you, Mr./Ms. Average Worker? Prices up, income down? And remember, most workers got the equivalent of a 2% pay hike with the temporary boost in Social Security, which goes away at the end of the year (and without which the economy and consumer spending would be even worse!).
Maybe that’s why New York Fed Chief William Dudley got heckled this week. (Courtesy of the Agora 5 Minute Forecast:)
“Dudley – a 21-year vet of Goldman Sachs – stepped out of his bubble to explain Fed policy to real people in Queens.
“It might not have been the first time Dudley attempted to gain the trust of the hoi polloi, but we’re pretty sure it’ll be the last. The details here were reported widely. We divined the scene from a Reuters report.
“First Dudley swore up and down that inflation was no problem. ‘When was the last time, sir,’ came a reply from the audience, ‘that you went grocery shopping?’”
“Dudley boldly proceeded to explain the concept of ‘core CPI’ – the cost-of-living measure designed for people who don’t eat or consume energy. Heh, we know firsthand how well that goes over…
“Then in a brilliant stroke, he pointed to Apple’s shiny new iPad 2 to illustrate his point. ‘Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful,’ he gamely explained. ‘You have to look at the prices of all things.’
“‘I can’t eat an iPad,’ someone yelled from the crowd.”
Ouch. (For the record, I do go to the grocery store and Wal-Mart and Home Depot, as well as other less frugal venues.)
And core inflation may soon be under pressure. There were two articles yesterday, one from Yahoo and the other on Bloomberg. Both related to rising pressure on rental costs. (My recent lease renewal increase was significantly above core CPI!) (From
“Already, rental vacancy rates have dipped below the 10% mark, where they had been lodged for most of the past three years. ‘The demand for rental housing has already started to increase,’ said Peggy Alford, president of… By 2012, she predicts the vacancy rate will hover at a mere 5%. And with fewer units on the market, prices will explode.”
Look at this graph showing their projections:

Here’s what to pay attention to. Notice that since 2002 (or thereabouts) rental costs have been flat, and down of late (inflation-adjusted). If projections are anywhere close, we could see a rise in rents of 15% by the end of 2012.
Let’s remember that 23% of the CPI and 40% of core CPI is Owner Equivalent Rent. If they are right, that adds about 3% to total CPI and 6% to core CPI! Will the Fed be telling us to focus on core inflation in 12-18 months? And those prices will start to show up steadily.
“This is a sharp change from the recession, when many Americans couldn't afford to live on their own. More than 1.2 million young adults moved back in with their parents from 2005 to 2010, said Lesley Deutch of John Burns Real Estate Consulting. Many others doubled up together.
“As a result, landlords had to reduce prices and offer big incentives to snag renters. Now that the recession is easing, many of these young people are ready to find new digs, mostly as renters, not owners. Plus, the foreclosure crisis continues unabated, and the millions losing their homes are looking for new places to live.”

Producer Prices Up 35-40% in the Last Six Months

Then let’s look at business. The Producer Price Index was out this week, and it was way up – 1.6% for the month, or an annualized 20%+. Even if you look at the last year, it was up a real 5.8%. That is inflation in the pipeline. Look at this chart from Notice the trend since QE2 was announced in August and implemented in November.

I won’t bore you with the details, but for those interested, go to and search for “Japan supply issues” and further on “semiconductors.” It is clear that, at least for a while, prices of electronics and tools are going to rise as one company after another is shutting its production lines down in Japan. Auto manufacturing plants in the US will have to close soon, as critical parts from Japan are not going to be forthcoming. Flat screen TVs? The iPad 2 I keep trying to find? All sorts of companies are going to get their costs squeezed even further. Remember, the above PPI numbers are from before the Japanese earthquake and tsunami and nuclear disaster.
(I was in Tokyo less than two weeks ago. I can’t imagine the stress and anguish going on there. The scope of the disaster is just shattering. I encourage my readers to go to and donate directly to their Japanese fund or the charity of your choice.
A few details from Japan, though, gleaned from here and there. Sony alone makes 10% of the world’s laptop batteries. Japan is responsible for 30% of global flash memory, 20% of semi-conductors, and 40% of electronic components.
The point is that the Fed has created real pressure in the price pipeline, primarily on basic commodities and energy. “Crude” goods, which is basically materials before there is any value added, are up 28% from a year ago and pushing an annualized 35-40% for the last six months. Those costs are filtering in to final finished products. And when you add in the supply-related problems from the recent disaster? It is not a pretty picture for profits.
Let’s go back and look at a graph from friend Vitaliy Katsenelson, from a few weeks ago. It points out that corporate profits are back close to all-time highs as a percentage of GDP.

As the brilliant Jeremy Grantham says, and I am paraphrasing, corporate profits are among the most mean-reverting of all statistics. And this makes sense unless capitalism is broke. High profits entice competitors to come in and take market share by selling for less.
If corporate profits went back (mean-reverted) to their longer-term average, P/E ratios would be close to 24 at today’s prices. Corporations have some room to absorb some price increases, but at the expense of the bottom line.

What Happens When We Come to the End of QE2?

We have only one instance where the Fed cut back on quantitative easing, and that was last year. It is a data set of one, but it is all we have. So, let’s look at what happened. As noted by several sources (but I am looking at Rosie’s list right now), the Fed let its balance sheet contract by some 12% from late April to late August. Quoting:
“Now over that interval ...
“The S&P 500 sagged from 1,217 to 1,064….
The S&P 600 small caps fell from 394 to 330….
The best performing equity sectors were telecom services, utilities, consumer staples, and health care. In other words — the defensives. The worst performers were financials, tech, energy, and consumer discretionary….
Baa spreads widened +56bps from 237bps to 296bps…
CRB futures dropped from 279 to 267….
Oil went from $84.30 a barrel to $75.20….
The VIX index jumped from 16.6 to 24.5….
The trade-weighted dollar index (major currencies) firmed to 76.5 from 75.5….
Gold was the commodity that bucked the trend as it acted as a refuge at a time of intensifying economic and financial uncertainty — to $1,235 an ounce from $1,140 and even with a more stable-to-strong U.S. dollar too….
The yield on the 10-year U.S. Treasury note plunged to 2.66% from 3.84%…”
What will happen this time around? Is the economy strong enough to grow on its own without stimulus, or strong enough that the Fed will be reluctant to continue with QE3?
My friends at Macroeconomic Advisors have reduced their first-quarter GDP projection to 2.5%. Morgan Stanley has dropped theirs from 4.5% less than six weeks ago to 2.9% today. That is a huge drop in a short time for a forecasting model. Forecasts at other economic shops are being slashed as well. States and local governments, as I have continuously noted, are cutting more than 1% of GDP from their budgets as I write. That translates into real-world pressure on the GDP (even if it’stemporary, which I believe it to be, we live in the present).
I am not ready to use the “R” word, but Muddle Through could show up with a true vengeance this summer, with higher inflation and slower growth. I lived through the ’70s, and frankly, I would just as soon not go see that movie again.
The danger here is that the Fed (Bernanke) watches the economy slow and decides we need another round of quantitative easing. I have resisted that idea but, as I have noted, sometimes we need to think about the unthinkable.
And thus, I come to the end of the letter with a brief note on a very worrisome conversation I had yesterday with Martin Barnes, editor of the esteemed Bank Credit Analyst. Martin is one of the people I call when I want to know what the Fed might do. I guess I was looking for assurance that the Fed would not do QE3. I did not get it.
“Look, John” (insert Scottish brogue as I paraphrase), “if the Fed sees the economy rolling over into recession they will put their mandate for employment ahead of their mandate for stable prices.”
“But that would mean higher inflation in the face of a slow economy.”
“And?” he shot back. “That would just be the price of trying to increase employment, in their minds.”
“But at some point you have to bring out your inner Volker!” I intoned. “What about the future?”
The conversation continued, but I never got my warm and fuzzy assurances. For the record, another round of QE, unless there is a true liquidity crisis (and the last QE did not qualify!), would be a disaster, at least from the cheap seats where I sit. There are all sorts of inflationary and stagflationary consequences, none of which I like.

Unemployment Worsens in Nealry All Metro Areas

from USAToday:

WASHINGTON (AP) — Unemployment rose in nearly all of the 372 largest U.S. cities in January compared to the previous month, mostly because of seasonal changes such as the layoff of temporary retail employees hired for the holidays.

The Labor Department said Friday that the unemployment rate rose in 351 metro areas, fell in only 16, and was unchanged in 5. That’s worse than December, when the rate fell in 207 areas and increased in 122.
Other seasonal trends, such as the layoff of construction workers due to winter weather, also contributed to the widespread increase.
Nationwide, the unemployment rate dropped to 9% in January from 9.4% the previous month. It ticked down to 8.9% in February. But the national data is seasonally adjusted, while the metro data isn’t, which makes it more volatile. The metro data also lags the national report by one month.