Friday, November 18, 2011

Stagnation in Stocks

Thursday, November 17, 2011

Off a Cliff

Breakout lower!

Next Financial Crisis Coming Soon Thanks to the Fed's Overleveraged Balance Sheet

"There is definitely going to be another financial crisis around the corner," says hedge fund legend Mark Mobius, "because we haven't solved any of the things that caused the previous crisis."
We're raising our alert status for the next financial crisis. We already raised it last week after spreads on U.S. credit default swaps started blowing out.  We raised it again after seeing the remarks of Mr. Mobius, chief of the $50 billion emerging markets desk at Templeton Asset Management.
Speaking in Tokyo, he pointed to derivatives, the financial hairball of futures, options, and swaps in which nearly all the world's major banks are tangled up.
Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius' guess of 10 times the world's annual GDP. "Are the derivatives regulated?" asks Mobius. "No. Are you still getting growth in derivatives? Yes."
In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.
What could it be? We'll offer up a good guess, one the market is discounting.
Seldom does a stock index rise so much, for so little reason, as the Dow did on the open Tuesday morning: 115 Dow points on a rumor that Greece is going to get a second bailout.
Let's step back for a moment: The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place. What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn't pay back 100 centimes on the euro?
That's a rhetorical question, since the balance sheets of European banks are even more opaque than American ones. Whatever the actual answer, it's scary enough that the European Central Bank has refused to entertain any talk about the holders of Greek sovereign debt taking a haircut, even in the form of Greece stretching out its payments.
That was the preferred solution among German leaders. But it seems the ECB is about to get its way. Greece will likely get another bailout — 30 billion euros on top of the 110 billion euro bailout it got a year ago.
It will accomplish nothing. Going deeper into hock is never a good way to get out of debt. And at some point, this exercise in kicking the can has to stop. When it does, you get your next financial crisis.
And what of the derivatives sitting on the balance sheet of the Federal Reserve? Here's another factor behind our heightened state of alert.
"Through quantitative easing efforts alone," says Euro Pacific Capital's Michael Pento, "Ben Bernanke has added $1.8 trillion of longer-term GSE debt and mortgage-backed securities (MBS)."
Think about that for a moment. The Fed's entire balance sheet totaled around $800 billion before the 2008 crash, nearly all of it Treasuries. Now the Fed holds more than double that amount in mortgage derivatives alone, junk that the banks needed to clear off their own balance sheets.
"As the size of the Fed's balance sheet ballooned," continues Mr. Pento, "the dollar amount of capital held at the Fed has remained fairly constant. Today, the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet.
"Prior to the bursting of the credit bubble, the public was shocked to learn that our biggest investment banks were levered 30-to-1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51-to-1! If the value of their portfolio were to fall by just 2%, the Fed itself would be wiped out."
Mr. Pento's and Mr. Mobius' views line up with our own, which we laid out during interviews on our trip to China this month.

Yields Leap, Stocks Leak

Tuesday, November 15, 2011

Fed's Dovish Dissenter Rallies Market

Fed speaker Evans, the lone dissenter in the most recent FOMC meeting, wanting more "accommodation" and Fed money creating, gave a speech today indicating that the Fed will continue its accommodative policy well beyond mid-2013.

Stocks Decline Sharply on Eurozone Woes

Rising bond yields are particularly troubling because 1) they are an accurate harbinger of investor sentiment that something is seriously wrong, and they are demanding higher compensation for the risk, and 2) it increases the costs of borrowing at precisely the worst possible time, just as the Eurozone appears poised to dip into recession. It's not just Italy and Greece, now, either.

Interest costs are rising steadily for Spain, Portugal, and now, even France, which has been assiduous in trying to protect its credit rating, even resorting to intimidation of the credit rating agencies. If France loses its AAA credit rating, it will no longer be eligible to backstop the EU's bailout fund, and Germany would be the sole surviving AAA-rated government big enough to try to bail out the weaker members of Europe, and Germany simply isn't strong enough or big enough to go it alone.

Worse yet, the bailout fund itself is have grave difficulties trying to sell its bonds, and investors simply aren't taking the bait and buying the bonds. The bond vigilantes are fleeing Europe in droves. Trouble this way comes.

Monday, November 14, 2011