Gordon Long: America Has a Structural, Not Cyclical, Problem

I gave President Barrack Obama six months to roll-out his doomed Keynesian policies, twelve months to discover they were flawed and eighteen months to realize that the solution to America’s problems must lie within a different economic framework. I had hoped by the end of twenty-four months to see new policies closer to an Austrian economic philosophy emerge. I was wrong.

 

Though, even the Wall Street Journal recently featured an article on the re-emergence of the Austrian School of Economic philosophy, it would appear that President Obama’s administration still neither gets it, nor I am afraid ever will. Key defections by his leading economic advisors, talk of the need for QE II and a Stimulus II, and a political collapse in public confidence suggests a growing awareness that Keynesian policies are not working, as many predicted they wouldn’t. Obama's exciting rhetoric of Hope and Change has left myself and the majority of recent polled Americans disillusioned and disappointed. What I see the administration failing to grasp is twofold:

 

I-America has a Structural problem, not a cyclical business cycle problem. Though the cyclical business cycle was greatly worsened by the financial crisis, I would argue that the structural problem facing the US is actually a contributor to what caused the financial crisis.

 

II- America has a Credit demand problem, not a Credit supply problem. It isn’t that the banks won’t lend, but rather that few can any longer afford or qualify (on any reasonably and historically sound basis) to borrow.

A STRUCTURAL PROBLEM

 

1) Trade Balance: Insufficient Export/Import Ratio

 

We are all painfully aware that the US has not produced sufficient exportable product to support its standard of living for many years. Manufacturing in the US has been in steady decline since the 1960’s and the excess spending during the Vietnam War. It has been 50 years since the US had a balanced budget (forget Clinton's social security slight of hand). Over the last 10-15 years the US has seriously compounded this problem by accelerating the de-industrializaton of America without a strategy to replace salable export product. Corporate industrial strategies of outsourcing, downsizing, and off-shoring were never countered other than by an excess consumption splurge which fostered massive real estate and retail expansion distortions.

 

Simply said: A US Service Economy that is based on 70% GDP consumer consumption does not pay the bills!

For a brief period of time following the dotcom implosion, the US operated as a mercantile “Financial Economy” that turned out to have been nothing more than a historic illusion.

1999

2009

 

As the graphs below clearly show, since late 1999 with the surge in the adoption of the internet, unemployment in the US has spiked. Clerical, manufacturing and almost any job that could be further automated through networking advancements were replaced. 

 

 

 

 

2) Creative Destruction: Slowing Innovation Rate

 

In my recent paper INNOVATION: What Made America Great is now Killing Her! , I described how the dotcom bubble ushered in a change in America that is still reverberating through the nation and around the globe. The Internet unleashed productivity opportunities of unprecedented proportions in addition to new business models, new  ways of doing business and completely new and never before realized markets.  Ten years ago there was no such position as a Web Master; having a home PC was primarily for word processing and creating spreadsheets; Apple made MACs and ordering on-line was a quaint experiment for risk takers.

 

In 1997 prior to the ‘go-go’ Dotcom era unfolding, America’s unemployment was less than half of what it is today at 4.7%.  At that time the US added 3 Million net jobs which reflected the creation of 33.4 Million new positions while obsolescing or cutting 30.4 Million old positions. Job losses occurred in old vocations such as typists, secretaries, filing clerks, switchboard operators etc.  Hired were new occupations such as C++ programmers, web masters, database managers, network analysts, etc. 

 

 

As our research chart above however illustrates, the additions have fallen off precipitously while the job losses have stayed relatively flat. In 2009 job losses were 31M and only slightly larger than 1997, which would be expected with further internet application development. New job creation however was only 24.7M which is dramatically lower than the 33.4 in 1997.

 

Over 98% of all jobs created in America have traditionally been created by companies with less then 500 employees. Recent research by the Kaufman Foundation shows that in fact new start ups versus existing businesses dominated the creation of new positions.

America’s slowing ability to innovate which is reflected in published research papers, patents issued and numbers of college graduates with advanced math and science degrees has seriously fallen behind. I laid out the seriousness of this problem in my early 2010 paper: America - Innovate or Die!

 

It is more than a little disconcerting that after 13 Trillion in stimulus measures we see business spending on capital investment STILL shrinking in the US.

 

It can’t be any clearer, the US has a structural problem. The administration can not possibly fail to realize this. My sense is they just don't know what to do about it.

A DEMAND PROBLEM

 

1) Credit Available - Demand Flat.

 

According to the Federal Reserve's latest quarterly survey of banks' lending practices recorded during July 2010, “for the first time since 2006, banks are making commercial and industrial loans more available to small firms, with about one-fifth of large domestic banks having eased lending standards. This offset a net tightening of standards by a small fraction of other banks."  Also, for the past six months, banks have continued easing lending to large and mid-sized firms. What's more, banks also reported that they stopped cutting existing lines of credit for commercial and industrial firms for the first time since the Fed added the question in its survey in January 2009. As for consumer loans, banks also reported easing standards for approving loans.

 

Credit is available, but demand remains flat.

 

Asked in the July survey how demand for commercial and industrial loans has changed over the past three months, 61% of banks responded "about the same," while 9% said "moderately weaker." While it was good news that 30% responded "moderately stronger," it's not exactly a surge in demand.  Even in a slowly recovering economy, the growing distaste for credit among our debt-weary public has hampered the way for new purchases and investments.

 

This isn't all that is surprising. The latest economic indicators paint a very exhausted consumer: In the years leading up to the financial crisis, he bought too much house and too many cars. The consumer is in burn-out mode, more focused on either saving or paying down credit card debt than buying more appliances and gadgets.

 

The amount consumers owed on their credit cards during the three months ending in June dropped to its lowest levels in more than eight years, indicating that cardholders continue to pay off balances in the uncertain economy, according to TransUnion's second quarter credit card statistics.

 

The average combined debt for bank-issued credit cards fell by more than 13% to $4,951 over the previous year. This represented the first three-month period where credit card debt fell below $5,000 since the three months ending in March 2002. Meanwhile, personal savings have risen to 6.4% of after-tax incomes, about three times higher than it was in 2007.

 

Perhaps what the Fed's quarterly report is really saying is this:

"There's a growing distaste for credit. The American consumer is the child who ate too much and spoiled his dinner. And even if you hand him his favorite meal on a silver platter, he's just not that hungry.”

 

2) Shifting Demographics

 

Another obvious but seldom highlighted factor affecting demand is shifting demographics. The Baby Boomer generation is no longer the consumption engine it has been to the US economy.

 

 

 

 

We have a generation that, as has been predicted for some time, is reducing its expenses but it may be even more dramatic than forecasted. With home housing prices no longer being the wealth generation vehicle they had expected it to be, stocks not delivering the returns they had been told to expect for the 'long term’ investor and medical expenses climbing above their worst budgeted targets, the baby boomers are being forced to cut back even further than the expected demographics were warning about.

 

The demand for credit to finance new acquisitions is not the same priority it was only a few years ago. Harry Dent's extensive demographic research lays this out in indisputable detail.

 

All Federal Reserve and Government actions are about increasing credit supply.  None effectively address demand.

THE RESULT

 

40.8 Million Americans on Food Stamps	Employment at unprecedented lows

 

Expect it to get worse until the administration finally realizes that we have both a structural and demand problem facing America, not a cyclical business cycle and credit availability problem. I personally don't believe for a minute that the Obama Administration haven't come to realize something is wrong. The White House simply doesn't know what to do about it. They are doing the only thing our Washington political machine knows what to do - throw money and credit at the problem, which is precisely what got us into this problem in the first place.

 

Doctored Unemployment Claims Data

The BLS has announced that as a result of the Labor Day weekend, 9 states (among which the biggest one California) did not report initial claims data to the bean counters, so instead the government had to "estimate" what the data would have been: yep, estimate, what the data was in these nine states. From Bloomberg: "For the latest reporting week, nine states didn’t file claims data to the Labor Department in Washington because of the Labor Day holiday earlier this week, a department official told reporters. California and Virginia estimated their figures and the U.S. government estimated the other seven." Official data is now made up on the fly. This US economic data reporting has just entered the twilight zone. Also, when the data is officially made up, it is not that difficult to get data that is "better than expected." The full list of states is: DC, Illinois, Idaho, Hawaii, Oklahoma, Michigan, and Washington. California and Virginia estimated themselves.

Can't Compete! U.S. Competitiveness Declines

from AP:

BEIJING — The U.S. has slipped down the ranks of competitive economies, falling behind Sweden and Singapore due to huge deficits and pessimism about government, a global economic group said Thursday.
Switzerland retained the top spot for the second year in the annual ranking by the Geneva-based World Economic Forum. It combines economic data and a survey of more than 13,500 business executives.
Sweden moved up to second place while Singapore stayed at No. 3. The United States was in second place last year after falling from No. 1 in 2008.
The WEF praised the United States for its innovative companies, excellent universities and flexible labor market. But it also cited huge deficits, rising government debt and declining public faith in politicians and corporate ethics.
"There has been a weakening of the United States' public and private institutions, as well as lingering concerns about the state of its financial markets," the group said.
Mapping a clear strategy for exiting the huge U.S. stimulus "will be an important step in reinforcing the country's competitiveness," it said.
The report was released in Beijing ahead of a WEF-organized gathering of global business executives next week in neighboring Tianjin. The group is best known for its annual Davos meeting of corporate leaders.

Urgent Letter to Obama

from the Daily Capitalist blog:
The President
White House
Washington, D.C. 20500
Dear President Obama:
I observed with some concern a photo of you and your glum economic team in the White House Rose Garden during your September 3 address on the jobs report.

I am aware that you are gravely concerned about the economy and the employment situation. Understandably so since your policies of fiscal and monetary stimulus have failed to create economic growth or employment. Yet despite such failures you advocate more of the same remedies in the face of their failure.
On Labor Day you announced new spending of $50 billion on infrastructure construction to create “jobs”. This is in addition to the American Recovery and Reinvestment Act commitment of $499 billion for similar projects. According to your web site, Recovery.gov, only $296 billion of that amount has been spent so why do we need more?
Yet the economy is stagnant, if not declining, unemployment is high and going higher, and credit is still largely unavailable to most American businesses even if they were willing to borrow. Home buyer credits have failed to stop the decline in home prices and Cash for Clunkers has had no lasting effect on the auto or appliance industries.
I suggest that since existing policies have failed to revive the economy, your Administration should try something different. I offer you several innovative policies that would actually speed a recovery and lead to higher employment.
The problems that we need to quickly solve are:

• High unemployment.
• Declining output.
• Credit freeze.
• Surplus of housing and commercial real estate.
• High private debt load.
• High federal debt.

Until the economy starts growing again, these problems will persist.
Unless we understand the causes of our problems, solutions are not easy. Because you place great emphasis on “what works” rather than economic theory, I will get to the specific issues straightaway.
Here are some guiding principles for “what works”:

1. Economies can repair themselves without a lot of government help. History has proven this time and again.
2. Government interference in the repair process can hinder recovery or even make things worse.
3. Government spending is very inefficient.
4. Individuals can make better choices about what to do with their money than the government.
5. Economic growth only comes from private enterprise. The corollary of this is that government can only spend money, not make money.
6. Since government produces nothing, then real growth and real jobs can only come from private enterprise.
7. If government spending is inefficient and if economic growth comes only from the private sector, then taking vast amounts of money out of private hands and putting it into government hands will hinder growth.
8. Government spending to revive an economy has failed wherever and whenever it has been tried.
9. More legislation increases uncertainty for businesses, making them reluctant to expand (called “regime uncertainty” in economic terms).

With these time-tested guiding principles in mind, here are some specific policies that you should immediately implement to allow the economy to quickly recover. They will “work.”
Fix the Banks
Cure the credit freeze by eliminating policies that cover up the fact that many of our banks are financially unsound. These policies generally relate to how banks value the assets that secure real estate loans, primarily commercial real estate (CRE) loans. These policies allow banks to overvalue their loan assets. These policies include “mark-to-make-believe” (rather than “mark to market”) and “extend and pretend” each of which allow banks to maintain a fiction. If the actual values of these loans were realized, banks would be required to foreclose on these bad assets. By getting these loans off their books, they would be able to recapitalize and become  financial sound.
Why is this important? It is the only way to restore credit to small- and medium-sized businesses and resolve the oversupply of CRE. Big businesses have plenty of credit from the big money center banks. It’s the regional and local banks which finance the rest of us that are in trouble.
We have just gone through the world’s biggest financial bubble. During this bubble, projects that made no sense but for the cheap Fed money and the false appearance of paper prosperity, were hugely over-produced. Now that the bubble has burst, we are in the mopping up stage of recovery. Banks are reluctant to extend credit because they are unsure of their financial future. The longer banks hold on to these malinvestments, their balance sheets will remain clogged up, and credit will remain restricted. Yes, more banks will go out of business; the process is never pretty but it is necessary. It is important to keep in mind that until this done, millions of unemployed Americans will stay jobless longer.
Bring Back the RTC
If you allow banks to fail as did President Bush I (mostly S&Ls actually), then there will be many foreclosed CRE projects that will need to be liquidated by the FDIC. Alan Greenspan, then Fed chairman, for all his faults did the right thing by urging the creation of the Resolution Trust Corporation, a separate entity whose function was to liquidate S&Ls and sell off the foreclosed assets from failed institutions. It actually worked pretty well and a huge slug of bad real estate, mostly apartments, were sold off to investors. The investors got great deals, but, more importantly, the economy recovered sooner.
The RTC dealt with 747 S&Ls with total assets of $394 billion (according to the Wikipedia article). According to the latest FDIC report there are 829 “problem” banks with $403 billion in assets as of Q2 2010. It is conceivable that this idea would work again.
Stop Passing Laws
Surveys reveal that the number one problem for business is uncertainty created by the government. They have been hit with an onslaught of complex legislation the consequences of which they don’t understand. This is called “regime uncertainty” in economic terms. The truth is, according to the surveys, that even if credit was available, businesses aren’t borrowing because they don’t know what the government will do to them next. Consider that three major pieces of legislation have been passed during your administration: the American Recovery and Reinvestment Act, the health care bill, and the Dodd-Frank financial overhaul bill. Further, they are uncertain if taxes on them will be raised.
No new laws are required to allow the economy to recover. I urge you to speak to business and tell them that we Americans trust their ability to drive our economy, and that your Administration will enact no new laws that will create greater burdens on their ability to expand, borrow, hire, and reap profits.
Stop Useless Spending
While your Administration has gamely tried to convince us that you have created jobs, we know that is fiction. The CBO report and claims by prominent economists have no credible evidence that any real jobs were created. If it were the case that government could create jobs then there would be no need for the private sector. Of course you know well that history has proven that policy to be a disaster.
Only private enterprise can create a real job. Having the government pay people to work is not a “job” in the same sense as a job in the private sector. When a business hires an employee, it is because somewhere down the line consumers want the end product of his or her productivity. The job created by the business is generated by economic activity until consumers decide otherwise.
If the government pays someone to do something, it isn’t generated by economic activity. When the money stops, the job stops. That has been the case of all of fiscal stimulus spending. While someone is earning money from the government, the money to pay him or her comes from taxes, which ultimately can only be generated from private enterprise.
If the government takes money out of the economy to pay people to do things it wants done rather than let the economic forces of private enterprise work, then businesses who create real jobs will have less money with which to expand their businesses. You should consider what the person from whom the money was taxed was going to do with the money. It would aid recovery to let private enterprise keep their money.
Encourage Saving Rather Than Spending
With historically high debt loads, job uncertainty, a lack of retirement funds, and declining home values, is it not reasonable for people to increase savings? Urging people to spend at this time runs counter to people’s innate sense to take care of themselves. While people are trying to repair their financial condition after the housing and credit bubble, urging more spending is reckless advice. People are rightly using their common sense.
There are two substantial benefits to saving. It allows families to reduce their debt burdens. Once they pay down their debts, they will be more willing to spend without the fear that they will end up homeless. Saving also creates the new capital that will be required for businesses when they decide to expand. It is not as if the Fed can just print dollars to create wealth and capital; wealth can only come from savings.
Policies that encourage spending such as Cash for Clunkers or home buyer credits or various tax credits for government-favored projects only encourage spending and thus reduce savings. Furthermore, they appear to have no lasting economic impact.
Don’t Raise Taxes
In light of the detriment to the economy of giving the government more of our earnings right now, an increase in taxes would be harmful to a recovery. While we face a serious deficit in the federal budget, the only way to pay down national debt is to have a vigorous growing economy and a reduction of government spending. With the right policies put in place, lower taxes would help create economic growth.
Raise Interest Rates
Fed policies to expand the money supply to create inflation will eventually succeed. Thus they are planting the seeds for perpetual stagnation and inflation. To prevent this new disaster, the Fed should immediately raise the Fed Funds rate and stop new attempts at quantitative easing. This will have an immediate positive impact. First, it will encourage saving as people seek higher, safer returns on their capital. Second, it will unmask malinvested projects, clear away the burden of their related debt load, and allow capital to be redirected to profitable ventures. Third, it will prevent the rise of inflation which robs savers of their wealth. Fourth, it will prevent the creation of a new destructive stagflationary cycle.  Fifth, as in the Volcker era, greater savings and low inflation will eventually lead to new economic growth and higher employment.
I strongly urge you to adopt these innovative solutions to solve our nation’s desperate economic problems.
Sincerely,
Dr. Jeffrey Harding

Goldman Sees Much Slower U.S. Growth

US Macro Outlook for the Next 12 Months and Dollar Implications

Combining the new information over the summer with our global growth forecasts, it appears the most likely scenario now is one of ‘pro-cyclical decoupling’ of the US economy from the rest of the world.

As the table shows, we expect the US economy to grow substantially below trend over the next 12 months and in 2011 as a whole. This expected weakness remains directly linked to a number of persistent structural imbalances, which in some cases have started to deteriorate again. In particular, the following points have caught our attention:

• Survey data points to sluggish growth. The latest ISM readings for the manufacturing and nonmanufacturing sector point to continued sluggishness in the  respective sectors. Although the latest headline reading in the manufacturing ISM showed marginal improvements, the order-inventory gap and other forward-looking components suggest further sequential slowing lies ahead.
• Persistent high unemployment is a particular feature of the current US problems, hinting at a large output gap. It reflects the need to reallocate considerable economic resources from artificially inflated sectors (in particular, real-estate-related). A shift of a sizeable part of the labour force from one sector to another takes time.
• The US household savings rate remains too low relative to the US’s own long-run history, international comparisons and the demographic situation. As savings rise, the unusually high share of consumption in GDP will likely decline.
• Import demand has picked up strongly during the inventory cycle, highlighting just how little the US economy has rebalanced and how much US demand seems to depend on foreign supply. Relocating production to the US is a slow process.
• Rate differentials have moved sharply against the USD as markets increasingly priced in our own sluggish US growth scenario. Our expectations of renewed Quantitative Easing in the US, following the recent ‘baby step’ of extending the mortgage program, suggest rate differentials are unlikely to boost the USD anytime soon. On the other hand, stronger growth outside the US, in a positive decoupling scenario, would likely weaken the US via a corresponding shift in rated differentials.
• Finally, fiscal consolidation needs in the US are among the most important globally and on many measures, including from the IMF, the adjustment need in the US is comparable to that in the UK, Spain and Greece. Tighter fiscal policy will add to the outlook for slowing final demand in the US, a potentially USDnegative development.

Retail Investors Run for the Exits

This is getting really ridiculous. In the week ended September 1, domestic equity mutual funds saw $7.5 billion in outflows: the biggest one week outflow in 2010 since the $13.4 billion redeemed in the Flash Crash week. The trend developing is simple: retail investors withdraw increasingly greater numbers in weeks in which the market is down even a little, and withdraw just a little in weeks in which the low-volume melt up presents them with an opportunity to get out at a better price level. Of course, the common thread is that as we have said for 18 consecutive weeks, retail just wants out. And now that, courtesy of Mary Schapiro, retail has finally put two and two together, and knows that even the regulators are concerned about redemptions, which are perceived by the SEC as being a function of distrust in market structure, we now fully expect more and more redemptions.

Year to Date the total pulled out is a whopping $62 billion, incidentally with both inflows and the market having peaked at the same time in April. On thr other hand, if the market were tracking mutual fund redemptions (whose net liquidity is now down to just 3.5% of assets and getting worse by the day), the S&P would be in the 900 range. Once the destructive impact of the Fed's daily meddling in the stock market is eliminated, it will get there. The longer stocks are artificially held up at current artificial levels, the greater the crash when reality and anti-gravity finally meet.

PS, for those confused by contrary media reports elsewhere, ETFs, as we disclosed previously, saw a major outflow in August as well (except for notable gold ETF exclusions). This is a secular rotation out of stocks. Period.

It's Curtains for Credit Cards

Sept. 8 (Bloomberg) -- Americans are shunning their credit cards and using debit to avoid incurring more debt, said Javelin Strategy & Research.
Total payment volume for debit cards surpassed credit-card volume for the first time in 2009 and will continue to eclipse it in 2010, according to a report released today by the Pleasanton, California-based market-research firm that specializes in financial services.
At San Francisco-based Visa Inc., the world’s biggest payments network, the total payment volume for debit cards increased by 7.9 percent in 2009 to $883 billion as credit-card volume declined by 7.3 percent to $764 billion. Volume for debit cards at No. 2 MasterCard Inc. in Purchase, New York, rose by 5.8 percent and 2.8 percent at No. 4 Riverwoods, Illinois-based Discover Financial Services.

Beige Bunk

Very little impact on stocks.

"Reports from the twelve Federal Reserve Districts suggested continued growth in national economic activity during the reporting period of mid-July through the end of August, but with widespread signs of a deceleration compared with preceding periods." -- Federal Reserve beige book

Food Inflation: Corn Continues Climb

Corn futures in Chicago generated record trading Sept. 3 as signs that U.S. farmers won’t harvest as large a crop as once expected fueled buying from speculators.
A total of 556,034 corn futures contracts changed hands at the Chicago Board of Trade on Sept. 3, the exchange said today. That was the corn market’s busiest day since the CBOT began trading the grain in 1877, topping the previous one-day record of 516,076 contracts on June 12, 2008.
Grain trading surged this summer after drought slashed Russia’s wheat crop and harvest prospects in the U.S. eroded, sending corn up 35 percent since the end of June to 15-month highs.
Many traders expect the U.S. Department of Agriculture will lower its estimate for this year’s corn harvest after excessive rains in some areas of the Midwest hampered crop development, said Jack Scoville, a vice president and analyst with Price Futures Group, Inc., in Chicago.
“People are finally starting to realize that maybe the production isn’t there,” Scoville said today, referring to corn. “Some areas got too much rain, some areas got a combination of too much and then too little. For whatever reason, the yields don’t seem to be coming in so well.”
Based on early harvest results from Arkansas, Indiana, Ohio and southern Illinois, “yields have not been too impressive,” Scoville said.
The USDA, in an Aug. 12 report, estimated the 2010 corn crop at 13.37 billion bushels, up 1.9 percent from the 2009 crop and an all-time high.
But the recent rise in corn futures suggests the market expects the USDA to reduce its crop estimate to about 13.2 billion bushels, Scoville said.
A harvest at that size “is still a nice crop,” Scoville said. But “if we’re trading 13.2 (billion bushels), we’re not going down” in price.
The USDA is scheduled to release its next Crop Production report Sept. 10.

At today’s close, corn for December delivery was unchanged at $4.64 ½ a bushel, after reaching $4.69, the contract’s highest price since June 2009. December corn is up about $1.21 from a contract low of $3.4325 reached June 29.
The recent surge in grain futures trading has been primarily driven by speculators, Scoville said. An upswing in agricultural futures this year also reflects bull markets in cattle and hogs that have attracted hedge funds and other speculators.
Moreover, many investors have piled into crude oil and other commodities the past few years, seeking better returns as traditional investments such as stocks languished.
“With the Russian weather, people are looking to get involved in commodities,” Scoville said. “There’s still a lot of interest in owning commodities right now. People are starting to realize they better get something on the books” in commodities.
Chicago corn futures trading this year through August averaged 249,146 contracts a day, up 23 percent from the same period in 2009. Wheat futures averaged 96,875 contracts a day, up 38 percent.
In addition to corn, futures contracts based on wheat, soybean meal, soybean oil and live cattle notched record trading days in 2010, according to Chicago-based CME Group Inc., the exchange operator that bought the CBOT in 2007.
On Aug. 19, trading in CME’s live cattle futures and options totaled an all-time high of 109,420 contracts, surpassing the previous record of 109,397 in June 2007.
At today’s close, October lean hog futures fell 1.45 cents to 75.75 cents a pound, while October live cattle fell 2.025 cents to 96.425 cents a pound. The CME hog contract is based on carcass values.

Societe Generale's Albert Edwards Cuts Lose on Equities

"The current situation reminds me of mid 2007. Investors then were content to stick their heads into very deep sand and ignore the fact that The Great Unwind had clearly begun. But in August and September 2007, even though the wheels were clearly falling off the global economy, the S&P still managed to rally 15%! The recent reaction to data suggests the market is in a similar deluded state of mind. Yet again, equity investors refuse to accept they are now locked in a Vulcan death grip and are about to fall unconscious...

The notion that the equity market predicts anything has always struck me as ludicrous. In the 25 years I have been following the markets it seems clear to me that the equity market reacts to events rather than pre-empting them. We know from the Japanese Ice Age and indeed from the US 1930's experience, that in a post-bubble world the equity market merely follows the economic cycle. So to steal a march on the market, one should follow the leading indicators closely. These are variously pointing either to a hard landing or, at best, a decisive slowdown. In my view we are poised to slide back into another global recession: the data is slowing sharply but, just like Japan in its Ice Age, most still touchingly believe we are soft-landing. But before driving off a cliff to a hard (crash?) landing we might feel reassured when we pass a sign that reads Soft Landing and we can kid ourselves all is well.

I read an interesting article recently noting the equity market typically does not begin to slump until just AFTER analysts begin to cut their 12m forward EPS estimates (for the life of me I can't remember where I read this, otherwise I would reference it). We have not quite reached this point. But with margins so high, any cyclical slowdown will crush productivity growth. Already in Q2, US productivity growth fell 1.8% - the steepest fall since Q3 2006. Hence, inevitably, unit labour costs have begun to rise QoQ. This trend will be exacerbated by recent more buoyant average hourly earnings seen in the last employment report. Whole economy profits are set for a 2007-like squeeze. And a sharp slide in analysts' optimism confirms we are right on the cusp of falling forward earnings (see chart below).

Edwards get downright hostile when discussing recent economic data out of US. We understand - the ever more acute manipulation of data by the BEA drones is getting infuriating. (bold below is Albert's)

August's rebound in the US manufacturing ISM was an even bigger surprise. This is a truly nonsensical piece of datum as it was totally at variance with the regional ISMs that come out in the weeks before. The ISM is made up of leading, coincident and lagging  indicators. The leading indicators - new orders, unfilled orders and vendor deliveries - all fell and point to further severe weakness in the headline measure ahead (see chart above). It was the coincident and lagging indicators such as production, inventories and employment that drove up the headline number. Some of the regional subcomponents (eg Philadelphia Fed workweek) are SCREAMING that recession is imminent (see left hand chart below).

Lastly, Edwards discusses the feasibility of his S&P 450 target in light of a Fed that is resolute in never ever allowing stocks to fall again.

Indeed we know that a central plank of the unhinged policies being pursued by the Fed and other central banks is to use QE to deliberately target higher asset prices. Ben Bernanke in a recent Jackson Hole speech dressed this up as a "portfolio balance channel", but in reality we know from current and previous Fed Governors (most notably Alan Greenspan), that they view boosting equity and property prices as essential for boosting economic activity. Same old Fed with the same old ruinous policies. And by keeping equity and property prices higher, the US and UK Central Banks are still trying to cover up their contribution towards the ruination of American and British middle classes - (see GSW 21 January 2010, Theft! Were the US and UK central banks complicit in robbing the middle classes? - link). The Fed may indeed prevent equity prices from slumping with any QE2 announcement. But this sounds a familiar refrain at this point in the cycle. For is monetary easing in the form of QE that different from interest rate cuts in its ability to boost equity prices? Indeed announced rate cuts in previous downturns often did generate decent technical rallies. But in the absence of any imminent cyclical recovery, equity prices continue to slide lower (see chart below).  The key for me is whether QE2 can revive the economic cycle, not equity prices temporarily.

And here is the kicker for all those expecting a massive stock surge on the imminet QE2 announcement: 

Many of our clients think QE2 might give a temporary flip to the risk assets but that the subsequent failure to produce any cyclical impact will cause an extremely violent reaction as investors lose faith in QE as a policy tool and Central Banks in general.

Forget our suggestion about the Greenspan-Edwards deathmatch (aside from the obvious outcome) - we cede it to the SocGen dude preemptively:

If we plunge back into recession, do not place too much confidence in the Central Banks having control of events. As my colleague, Dylan Grice, said last week "let them keep pressing their buttons." Ultimately they cannot fool all of the investors, all of the time.

Amen.

Gold Edges to New High Despite Some Relief in Europe

The sovereign debt issues are not going away. They will only intensify! Morgan Stanley recently predicted that there will be a sovereign that will default on its debt. The only questions are who and when.

HONG KONG (MarketWatch) -- Gold for December delivery touched a high of $1,262.30 an ounce in electronic trading on Globex by late Wednesday afternoon in Asia. That's a more than two-month high for the December 2010 contract, though it tops the record settlement price of $1,259.30 for a widely-traded contract reached at the close of New York trading Tuesday. The contract was last up $2 at $1,261.30. "With European debt concerns set to intensify, we expect further investment diversification to propel the metals [gold and silver] to fresh highs," James Moore, an analyst at TheBullionDesk.com in London, said in a report Wednesday.

Hedge Fund Redemptions May Force Liquidations

First mutual funds, then ETFs, now Hedge Funds. Bloomberg reports that the smartest of the smart money have posted an outflow of $2.9 billion in July, or 0.2% of total assets: the most since January, based on TrimTabs research. "July's number follows an outflow of $2.7 billion in June. The industry has dropped 4 percent since April 2010, according to Trimtabs, which attributed the decline mostly to negative returns in May and June. Flows have now been negative five of the last eight months (see chart, this page), the worst eight-month stretch since the September 2008 to April 2009 period." And for those wondering why hedge funds are counting down each of the remaining 17 trading days with increasing dread, is the following reason from TrimTabs: "Redemptions should resume in September; historically one of the worst months for hedge fund flows. For the year, flows toward hedge funds stand at $1 billion, following redemptions of $172 billion in 2009 and $150 billion in 2008. We believe it is safe to assume this “lost” $320 billion will not come back to the industry any time soon." As is now well known, the July rally was broadly missed by hedge funds which are now underperforming the general market according to the Bloomberg BAIF Hedge Fund Index. The only open question is how many managed to lever into the rally of the first week of September and pull the cord at the very top.

Trimtabs said that hedge funds appear to have missed out on market gains in the S&P 500 Index during July because of conservative positions. The S&P 500 surged 6.9 percent during the month, while hedge funds gained only 1.93 percent. A survey by Trimtabs shows hedge fund managers remain bearish on equities. That may reflect the deteriorating economic landscape and the reluctance of hedge funds to take on risk having only recently recovered many of the losses that occurred in 2008.

It also appears that the hedge fund industry is not at all immune from the same size-scaling issues prevalent everywhere else in finance:

The industry continues to show signs of consolidation. The funds with more than $5 billion in assets have recorded net inflows of $7.7 billion this year, while funds with less than $200 million have seen net losses of $18.3 billion, equivalent to 15.7 percent of assets.

Yet the most damning piece of data is the simplest one: the performance of the hedge fund universe as a whole, which is not only negative YTD, meaning most highwater marks are in major danger of not getting surpassed, but that hedge funds are broadly underperforming the S&P itself, which infuriates LPs more than charges of child porn, embezzlement, and felony theft leveled as the portfolio manager.

(Global Hedge Fund Returns per Bloomberg)
Another observation which validates what we have been saying is that Long-Short strategies are among the worst performers of the year, losing 4.09% YTD, as record implied correlations make traditional hedging impossible. The best strategies of the year: Mortgage-backed arbitrage, Convertible Arbitrage, and Asset backed arbitrage.

There are 17 trading days left in September, and the hedge fund community will be dreading each and every one of them, keeping a close eye on the fax machine and the hated redemption notice by end of trading on September 30.

Meredith Whitney: Wall Street to Cut 80,000 Jobs!

Securities firms around the world will cut as many as 80,000 jobs in the next 18 months as revenue growth begins to slow, said Meredith Whitney, the former Oppenheimer & Co. analyst who now runs her own firm.
The reductions, about 10 percent of current levels, will come after 2010 compensation payments, Whitney, 40, said in a report dated Aug. 31 and obtained by Bloomberg News today. The industry’s payouts will be “down dramatically,” said Whitney, who started New York-based Meredith Whitney Group after correctly predicting Citigroup Inc.’s dividend cut in 2007.
“The key product drivers of Wall Street’s revenues and profits over the past decade have been in a structural decline over the past three years,” Whitney said in the report. “2010 marks the first year in many in which Wall Street-centric firms will go through structural changes.”
Barclays Plc, Credit Suisse Group AG and Royal Bank of Scotland Group Plc may lead a slowdown in hiring in Europe as the fixed-income trading boom fizzles out, recruiters said last month. Barclays Capital’s income from trading bonds and commodities fell 40 percent in the first half amid the sovereign debt crisis. Fixed-income, currencies and commodities trading was the biggest revenue contributor at investment banks from Deutsche Bank AG to Goldman Sachs Group Inc.
While regulatory reform, including higher capital requirements, will force some of these shifts, there will be a “deeper secular change” due to declining revenue in businesses such as securitization, Whitney wrote.
Banks around the world cut 330,000 jobs during the latest financial crisis, according to data compiled by Bloomberg. Some have added employees recently as markets recovered. Barclays Capital hired about 3,600 people in the 12 months through June 30, while Credit Suisse hired 1,800 and RBS’s securities unit increased headcount by about 1,100.
Even though emerging markets will continue to expand, they won’t do so fast enough to offset the declines in the U.S. and Europe, Whitney said.

Gold Grabs New Record

SAN FRANCISCO (MarketWatch) -- The most widely traded gold contract posted a new settlement high Tuesday, as investors ploughed into assets seen as safer during times of economic distress. Fueled by a report that the European bank stress tests masked some problems, gold for December delivery ended $8.20, or 0.7%, higher at $1259.30 an ounce. That topped the settlement high for a most-active gold contract hit in June, of $1258.30 an ounce.

Back to Bearish?

With stocks down nearly 100 points on the Dow, and in the negative throughout the trading day, one has to wonder if the mood has shifted once again. Over the weekend, various prominent voices in the finance community have continued to assess the economic fundamentals, analyzing more closely the internals of last week's day, and are increasingly turning thumbs down on stocks and the macroeconomic picture.

During these consolidations, I take numerous small trades for 3-4 ticks each. They often last only a few minutes each.  There are numerous small bad trades, but more good trades. They add up!

Irish Bund Bailout Imminent?

from Zero Hedge:

The Irish-Bund spread is going nuts on reports that the ECB is bidding up sovereign debt once again, together with a WSJ report that the Stress Test was, as everyone with half a brain knew all too well, a blatant lie, and sovereign debt was misrepresented. Earlier, a report in the FT Deutschland suggested that the bailout of Anglo Irish alone, (not to mention AIB and Irish Nationwide) would be sufficient to threaten the country's solvency. Things domestically are no better, after a poll in the Sunday Independent found that 74% of respondents believed the country would default, and preceded earlier news that Irish consumer confidence plunged from 66.2 to 61.4. The IMF's recent expansion and creation of credit facilities is now roundly seen as having focused on Ireland, but many now believe that it may be too late and a Greek-type rescue is in the works as the second domino is about to topple. Hopefully the Irish will figure out the Ambrose Evans-Pritchard was right all along, and that the time to riot is now if they hope to get the same preferential treatment by the ECB/EU/IMF as was afforded to Greece... Because we all know what the endgame is now.

Signs of Sagging

Additional European Sovereign Debt Concerns

from Bloomberg:
Stocks and U.S. index futures fell, the euro weakened while Treasuries and bunds rallied on concern Europe’s debt crisis may worsen. Oil and copper retreated.
The MSCI World Index dropped 0.6 percent at 7:27 a.m. in New York. Futures on the Standard & Poor’s 500 Index lost 0.7 percent after U.S. markets were closed yesterday for the Labor Day holiday. The euro depreciated the most in a week against the yen. The yield on 10-year Treasuries slipped 4 basis points to 2.66 percent. The gap between German and Irish bond yields climbed to a record high, while German-Greek yield spread increased to the widest since May.
“Banks still face problems in regards to their capital ratios,” said Michael Koehler, head of strategy at Landesbank Baden-Wuerttemberg in Mainz, Germany. “Investors will keep worrying about a possible double dip in the next few weeks,” referring to a renewed recession.
Banks led stocks lower on concern they’ll require more capital to compensate for holdings of bonds in Europe’s weakest economies. Germany’s banking association said yesterday that the nation’s lenders need to raise $135 billion and Pacific Investment Management Co. said Greece still faces “substantial” default risk. Policy makers in Japan and Australia cited concerns over the outlook for the U.S. in keeping interest rates on hold today.
More than seven shares fell for every one that gained in the Stoxx Europe 600 Index, which lost 0.8 percent after reaching a four-week high yesterday. A government report showed German factory orders unexpectedly fell in July as demand in the euro region weakened, indicating the recovery in Europe’s largest economy is losing momentum. The MSCI Asia Pacific Index slid 0.2 percent.
Santander, Barclays
Banco Santander SA slid 2.3 percent and BNP Paribas SA lost 2.7 percent. Barclays Plc sank 3.6 percent as Britain’s third- largest bank named President Robert Diamond as chief executive officer, succeeding John Varley. The cost of insuring financial- company bonds against default climbed by the most in a month, with the Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers rising 8.5 basis points to 138, according to JPMorgan Chase & Co.
Rio Tinto Group led basic-resources stocks lower, losing 2.6 percent, as Australian Prime Minister Julia Gillard clinched a deal to keep power. Gillard’s Labor government has proposed a tax on mining profits.
The decline in U.S. futures indicated the S&P 500 may pare last week’s 3.8 percent rally. President Barack Obama is planning to increase tax relief for businesses and federal spending on the nation’s transportation system to bolster an economy that’s losing jobs heading into the November congressional elections. The unemployment rate may approach 10 percent in coming months, according to economists at BofA Merrill Lynch Global Research and Morgan Stanley.
Greek, German Bonds
The German bund yield dropped 7 basis points to 2.27 percent. Greek bonds plunged, pushing the yield on the 10-year security up 28 basis points relative to bunds to 942 basis points, the most since the European Union and International Monetary Fund crafted a bailout package in May.
The Irish-German 10-year yield spread increased 37 basis points to 380 basis points, the highest since Bloomberg records began in 1991. The Portuguese-German spread was 352 basis points, from 333 basis points yesterday.
The yen rose against all 16 of its major peers, strengthening 1.3 percent to 106.99 versus the euro and 0.4 percent to 83.90 per dollar. The euro weakened 1 percent to $1.2751. Australia’s dollar dropped 0.6 percent against the U.S. currency.
Copper, Oil
Copper for delivery in three months fell 2.1 percent on the London Metal Exchange, the biggest drop since July 16. The S&P GSCI index of 24 commodities lost 0.8 percent, the first decline since Aug. 31. Corn was down 1.3 percent. Crude for October delivery retreated 2.3 percent to $72.90 a barrel on the New York Mercantile Exchange. Yesterday’s transactions will be booked with today’s for settlement purposes as there was no floor trading because of the Labor Day holiday. Brent crude for October settlement on the London-based ICE Futures Europe Exchange dropped 1.5 percent to $75.71 a barrel.
The MSCI Emerging Markets Index slipped 0.5 percent, the first decline in five days. OTP Bank Nyrt., Hungary’s largest lender, led the BUX index 1.5 percent lower. Russia’s Micex index lost 1.3 percent, dragged down by energy and mining companies.

Worried Wall Street Needs Miracle to Salvage Quarter

from Bloomberg:
After two months bankers would like to forget, Wall Street may need a September to remember to avoid closing the books on the worst quarter for investment banking and trading revenue since the peak of the financial crisis.
For the number of shares traded on U.S. exchanges to match last year’s third quarter, average daily volume for the rest of the month would have to top that of any trading day in the last three years. Debt trading also needs to pick up, as corporate bond trading in July and August was down 8 percent from the same period in 2009, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Troubling economic data and uncertainty over European sovereign debt and the global recovery led investors to step back from the markets, analysts said. The result may be the lowest revenue from investment banking and trading for the five largest Wall Street banks since the fourth quarter of 2008, when they had combined negative revenue of $3.35 billion.
“Activity levels in the last three weeks of September should be a lot better than July and August, but it would have to almost be off-the-charts good to save the third quarter,” said Jeff Harte, a Chicago-based analyst at Sandler O’Neill & Partners LP. “I don’t think there’s going to be a lot more clarity about the macro environment, and that’s what people seem to be wrestling with before activity picks up.”
Stalled Recovery
The five largest Wall Street firms by investment-banking and trading revenue -- Goldman Sachs Group Inc., JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Morgan Stanley -- may not get much relief from their advisory work.
While the dollar value of completed mergers and acquisitions is up slightly for the first two months of the quarter from the same period last year, debt and equity underwriting totals have fallen. And trading has come to dwarf investment banking on Wall Street: The five firms booked more than five times as much revenue from trading in the first half as from advisory and underwriting.
Trading volumes dropped in July and August as investors weighed data that hinted at a stalled economic recovery. Growth in gross domestic product in the second quarter was cut to 1.6 percent from the initial 2.4 percent. Sales of new homes in the U.S. dropped in July to the lowest level on record, and consumer confidence that month had the biggest decline since 2008. The Federal Reserve said on Aug. 10 that growth will likely be at a “more modest” rate than anticipated.
Trading Declines
Equity investors have traded a daily average of 14.2 billion shares on U.S. exchanges so far in the third quarter, according to Bloomberg data. That’s the worst start of any quarter since the first three months of 2009, when the Standard & Poor’s 500 Index touched its lowest point in almost 13 years, and 25 percent less than the average for last year’s third quarter, the data show.
To match the volume of the third quarter of 2009, investors would have to trade an average of 30.6 billion shares a day for the rest of September. That’s more than twice the daily average so far this quarter and higher than any single day since 2006.
Trading of U.S. equity options has declined for each of the past three months after jumping to a record 405 million contracts in May. Average daily volume on U.S. exchanges in the third quarter has fallen to 13.3 million contracts a day, down 23 percent from the prior quarter, according to data compiled by Bloomberg and Options Clearing Corp., the Chicago-based firm responsible for settling all U.S. options trades.
The average daily dollar amount of U.S. Treasuries traded in July and August was down 1.7 percent from 2009’s third quarter and 13 percent from last quarter, according to data from ICAP Plc, the world’s largest inter-dealer broker.
‘Sizable Bounce’
“The major investment banks are very dependent on high transaction volume, so there’s no escaping that being a drawback to their bottom-line results,” said William Fitzpatrick, a financial-industry analyst with Milwaukee-based Optique Capital Management, which oversees about $700 million, including JPMorgan and Bank of America shares. “I think we’ll get a sizable bounce in the fall, only because we’re coming off such a depressed level. That’s typical of the summer months, though this summer was worse than previous years.”
Spokesmen for the five banks declined to comment about third-quarter trading and investment-banking revenue.
While trading volumes are an indicator of performance, they may not correlate directly with firms’ revenue because banks make money on changes in the value of the securities they hold and transaction fees that may not be related to volume.
Fixed-Income Bets
Even if volumes stay low, fixed-income trading revenue will probably improve from the second quarter because firms are less likely to have bets that cause large losses than they had in the last quarter, said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York.
Second-quarter fixed-income revenue at JPMorgan and Goldman Sachs missed some estimates as credit concerns spiked and the yield spread between corporate bonds and similar Treasuries widened 47 basis points over the three months. The spread has narrowed 16 basis points this quarter to 180 basis points, according to the Bank of America Merrill Lynch Global Broad Market Corporate Index.
“The big fixed-income players, JPMorgan and Goldman, performed badly in the second quarter, and the reason was they went into the quarter positioned for the credit markets to improve,” Hintz said. “They’ve positioned themselves much better for market conditions now.”
‘Dominant Business’
The five firms generated $67.1 billion in the first half of the year from advisory, debt and equity underwriting, and from trading stocks and bonds. That was down 12 percent from a year earlier. Trading and investment banking account for 34 percent of the five firms’ total revenue, ranging from 81 percent at New York-based Goldman Sachs to 21 percent at Bank of America in Charlotte, North Carolina.
Analysts surveyed by Bloomberg have cut their average third-quarter revenue estimates for the five banks by a total of $994 million since the beginning of August, to $90.9 billion from $91.9 billion, as they have scaled back expectations.
“Sales and trading, certainly for everybody, has been the dominant business over the last few years,” Seth Waugh, chief executive officer of Deutsche Bank AG’s Americas division, said in a Sept. 2 Bloomberg Radio interview. “That’s decreased, volumes have decreased and margins have decreased a little bit. That doesn’t mean that it isn’t going to be a great business again. It just means that it’s probably going to go through a little bit of a trough right now.”
M&A Deals
Companies worldwide completed $247.3 billion of mergers and acquisitions in the first two months of the quarter. That’s up from the same period last year, when they completed $239.3 billion of deals before ending the quarter with $352.7 billion.
A higher level of activity in announced deals may give hope for future quarters. Companies announced deals totaling $404.5 billion in July and August, more than double the $195.2 billion a year earlier. Those included a $40 billion hostile takeover bid by Melbourne-based BHP Billiton Ltd., the world’s largest mining company, for Potash Corp. of Saskatchewan Inc.
An increased number of deals will help banks generate greater fees and encourage a pickup in trading, said Richard Bove, an analyst at Rochdale Securities in Lutz, Florida.
“If the M&A market picks up the way I think it will, then M&A will give a boost to get trading going again,” Bove said in an Aug. 23 Bloomberg Television interview. “This recovery in trading is not going to be very dramatic, and it’s not going to be very quick. It’s going to be over a longer period of time.”
Hong Kong IPOs
Revenue may be diminished in future quarters as firms spin off, sell or shut down their proprietary trading desks to comply with the Volcker rule, which was passed in July as part of the U.S. financial overhaul. Goldman Sachs plans to disband its principal strategies business and New York-based JPMorgan will shut down its proprietary trading operations, people familiar with those plans have said.
Investment banks are having trouble taking advantage of one growth area. Hong Kong initial public offerings this year have raised almost five times as much as they did in the first eight months of last year, led by the $12 billion portion of Agricultural Bank of China Ltd., the world’s biggest IPO. Bankers are charging the lowest fees on record, just 2.2 percent on average, to arrange the IPOs, compared with 6.4 percent fees in the U.S., according to data compiled by Bloomberg.
The low trading volumes may also have an impact on some banks’ retail brokerage businesses, including Bank of America Merrill Lynch and Morgan Stanley Smith Barney. Morgan Stanley, based in New York, pushed back its brokerage profitability goals in July, saying that the May 6 market plunge scared away individual investors.
“Retail is absolutely moribund, there’s nothing going on in retail,” Sanford Bernstein’s Hintz said. “The retail investor has dug his foxhole and put on his helmet, and he’s just sitting there.”

U.S. Unemployment Rising Again

The jobless rate in the U.S. is likely to approach 10 percent in coming months as the economy fails to grow quickly enough to employ people rejoining the labor force, according to economists at BofA Merrill Lynch Global Research and Morgan Stanley.
Private payrolls climbed 67,000 in August, after a gain of 107,000 the previous month, and the unemployment rate rose to 9.6 percent, Labor Department figures showed Sept. 3. The economy expanded at a 1.6 percent annual rate in the second quarter, down from 3.7 percent in January through March.
Employers including government agencies have added 723,000 workers to payrolls so far in 2010, showing it’ll take years to recoup the 8.4 million jobs lost during the recession, the biggest employment slump in the post-World War II era. Still, the August employment report eased concerns the economy will falter and may postpone action by Federal Reserve policy makers aimed at bolstering the recovery.
“Growth is too sluggish to successfully bring down the unemployment rate,” said Michelle Meyer, a senior economist at BofA Merrill Lynch in New York. “At this stage, about one year into the recovery, this was still quite feeble job growth.”
BofA Merrill Lynch says the jobless rate will peak at 10.1 percent next year, up from a previous projection of 9.5 percent, with growth slowing to 1.8 percent for all of 2011, down from an earlier estimate of 2.3 percent.

Is Slowing Germany Manufacturing Sector a Global Leading Indicator?

German factory orders unexpectedly fell in July as demand in the euro region weakened, indicating the recovery in Europe’s largest economy is losing momentum.
Orders, adjusted for seasonal swings and inflation, declined 2.2 percent from June, when they surged a revised 3.6 percent, the Economy Ministry in Berlin said today. That’s the biggest drop since February 2009. Economists forecast a 0.5 percent gain, according to the median of 40 estimates in a Bloomberg News survey. From a year earlier, orders climbed 18 percent, when adjusted for working days.
Evidence of slowing growth comes after the German economy expanded at the fastest pace in two decades in the second quarter, boosted by exports. An index of manufacturing fell in August and investor confidence dropped to a 16-month low. Still, Daimler AG, the world’s second-biggest manufacturer of luxury cars, said yesterday that sales jumped in August.
“It’s a sign that Germany can’t decouple from the global economy,” said Alexander Koch, an economist at UniCredit in Munich. “While this is a backlash against last month’s surge and monthly figures can be volatile, the economy simply can’t continue to grow at the same pace as in the first half of the year.”

More European Debt Worries

from Fox Business:

Stock futures pointed to a lower open Tuesday as traders return to work after last week’s strong performance and the long holiday weekend.

As of 6:20 a.m. in New York, the Dow Jones Industrial Average futures were down 60 points, or 0.58%, to 10394, the S&P 500 index futures lost 7.8 points to 1095.70 and the Nasdaq 100 futures were down 8 points to 1859.00.

It’s a quiet start to the trading week with no major economic data and only a few company earnings reports this morning.

Stocks were weighed primarily down by a buoyed U.S. dollar, which in turn put pressure on dollar-denominated commodities such as oil.

In early trading, the dollar was down 1% against the euro and 1.4% against the Japanese yen. The British pound lost 0.9% against the dollar.  Traders cited a lack of news and lingering debt concerns out of Europe as the reasoning behind the dollar-based rally.

Oil was sharply lower in electronic trading, falling $1.67 a barrel, or 2.24%, to $72.93 while gold was down $3.70 to $1,247.40 a troy ounce. Copper futures were down 2.3%.

The energy and mining companies were the early decliners in U.S. equities, led lower by Exxon Mobil (XOM: 61.34 ,0.00 ,0.00%), BP (BP: 37.40 ,0.00 ,0.00%), Freeport McMoRan (FCX: 78.52 ,0.00 ,0.00%) and BHP Billiton (NYSE:NYSE:BHP).

Shares of the banks, most notably Barclays (BCS: 20.27 ,0.00 ,0.00%) may trade heavily today after the company announced that its CEO John Varney will step down and will be replaced with investment-banking head Robert Diamond.

from Bloomberg:

Even after a 750 billion euro ($960 billion) bailout for the weaker economies in the euro zone, investors are skittish about sovereign debt -- and about the banks that hold the region’s government bonds.
A default by Greece could trigger the collapse of banks with large sovereign-bond holdings, says Konrad Becker, a financial analyst at Merck Finck & Co. in Munich. “A default by one EU country would lead to an evaporation of trust in banks,” he says. “If investors aren’t willing to invest in banks anymore, then many banks will go bust in months, not years.”
The new concern about the fragility of the region’s banks comes as politicians and regulators are eager to claim progress in fixing the global financial system, almost two years after credit markets cracked, Bloomberg Markets magazine reports in its October issue.
The European Union has stress tested 91 lenders, giving 84 of them passing grades. In the U.S., President Barack Obama in July signed the biggest package of new U.S. banking laws since the Depression. The Basel Committee on Banking Supervision, meanwhile, is readying new capital and liquidity rules for world leaders to agree upon when the Group of 20 meets in Seoul in November.
Europe, however, faces a special challenge in righting its banks: the sovereign-debt crisis. Europe’s largest financial companies hold more than 134 billion euros in Greek, Portuguese and Spanish government bonds, according to a tally in May by Bloomberg News based on interviews and company statements.
Greek Debt
Even after the EU and International Monetary Fund worked out the rescue plan in May, investors are still demanding a high premium for buying Greek debt. As of Sept. 3, the yield was 11.28 percent on 10-year Greek bonds compared with 2.34 percent on similar German bonds. At the end of August, the gap between the two, the yield spread, was the widest it has been since the peak in May, just before European leaders agreed on the bailout.
Yields on Irish bonds jumped after Standard & Poor’s on Aug. 24 cut the country’s credit rating one step to AA-, citing concern that the rising cost of supporting Ireland’s struggling banks will increase its budget deficit. The yield spread versus German bonds climbed to the highest in at least 20 years.
The hesitancy among investors also shows up in the spreads on bank bonds, with some European institutions paying higher borrowing costs compared with their U.S. counterparts.
As of Sept. 2, buyers demanded an extra 383 basis points, or 3.83 percentage points, over the yield on government debt to own 5- to 10-year bonds sold by Paris-based BNP Paribas SA, according to Bank of America Merrill Lynch index data. The comparative premiums were 275 basis points for Citigroup Inc. bonds and 192 basis points for JPMorgan Chase & Co. bonds; both of those banks are based in New York.
‘Still Badly Damaged’
“We face a banking system that is still badly damaged and which is still trying to repair its balance sheets,” Bank of England Governor Mervyn King said on Aug. 11 at a press conference in London. “It has to raise funding at very high costs, and that makes it difficult for banks to lend.”
Lenders have been slow to raise the capital they need. With yields on European bank debt so high, the market has shrunk. The region’s banks, including U.K. lenders, sold about 18 billion euros of debt in August, the smallest amount for the month since 2004.
Many European institutions continue to rely on central banks for funding. In July, the European Central Bank loaned 132 billion euros for three months to 171 financial institutions. ECB President Jean-Claude Trichet on Sept. 2 extended emergency lending measures for banks into 2011. The bank will keep offering unlimited one-week and one-month loans until at least Jan. 18, and will offer additional three-month funds in October, November and December.
Parking Money
Wary of lending to each other, banks are also using the ECB to hold record amounts of their cash. On June 9, euro-zone lenders deposited a record 369 billion euros overnight at the ECB, more than in October 2008, during the credit meltdown.
“The amount banks have parked at the ECB is just outrageous,” says Florian Esterer, a fund manager at Zurich- based Swisscanto Asset Management AG who invests in financial stocks, including Commerzbank AG and Royal Bank of Scotland Group Plc.
The bank-stress-test results, published on July 23, should help restore investor faith in the region’s financial industry, Trichet said at a press conference on Aug. 5. Still, those examinations fell short of addressing the possibility of a default by a euro-zone country.
Not Tested
Regulators believe the May bailout will succeed, says David Green, who was head of international policy at Britain’s Financial Services Authority from 1998 to 2004. “It would be quite perverse for governmental agencies to assume that the program isn’t going to work,” he says.
The tests covered government bonds held by banks for possible sale -- not those held as reserves on their balance sheets. Europe’s banks only have to write down sovereign debt in their reserves if there’s significant doubt about a country’s ability to repay in full or make interest payments. The region’s lenders have about 90 percent of their Greek sovereign debt on their balance sheets, according to a survey by Morgan Stanley.
Europe’s governments can’t afford to question the quality of bonds they’ve sold to banks, says Chris Skinner, chief executive officer of Balatro Ltd., a financial industry advisory firm in London. “Bankers have got Europe’s governments in their pockets, primarily because politicians cannot change the way lenders do business without undermining confidence in sovereign debt,” he says.
Toxic Assets
While they’re stuck with their government bond holdings, Europe’s banks are also still carrying much of the troubled assets they had during the 2008 meltdown. Euro-zone lenders will have written down about 3 percent of their assets from the peak of the credit crisis by the end of 2010, compared with 7 percent for U.S. banks, the IMF estimated in April. The steeper writedowns by U.S. banks are partly because they held a higher proportion of securities, the IMF said.
That doesn’t excuse the lack of candor shown by many European lenders about the unsellable assets on their books, says Raghuram Rajan, a finance professor at the University of Chicago. “European banks haven’t owned up to the large amounts of toxic debt that they hold,” says Rajan, who was chief economist at the IMF from 2003 to 2007.
“The stress tests weren’t severe enough,” says Julian Chillingworth, who helps manage $21 billion at Rathbone Brothers Plc, an investment firm in London. “Many bond investors aren’t convinced the Greeks are out of the woods.” And if the Greeks haven’t emerged from their crisis yet, then neither have the European banks that hold their debt.

The Neurosis of the Liberal Mind

“When the modern liberal mind whines about imaginary victims, rages against imaginary villains and seeks above all else to run the lives of persons competent to run their own lives, the neurosis of the liberal mind becomes painfully obvious.”  Lyle H. Rossiter, Jr., MD

Europe: Doubling Down on Debt

Summer vacation is over and things in Europe may soon start rocking and rolling all over again. Not only is France about to experience its first 24 hour general strike this Tuesday in a long time, which will likely remind everyone else in Europe (hint Greece and Ireland) that austerity is the new normal across the Atlantic and the 14th annual monthly salary is not going to come back just because nobody is talking about it, but as the FT reports Europe needs to issue double the amount of debt in September compared to August. From the FT: "Eurozone governments will try to raise €80bn ($103bn) in September compared with new bond issuance of €43bn in August. Spain is expected to attempt to borrow €7bn in September compared with €3.5bn in August, according to ING Financial Markets." The dramatic ramp up in issuance is forcing the FT to speculate that "some of the weaker economies could fail to raise the amount of money they need as eurozone governments attempt to issue double the amount of debt this month compared with August." For all those who have been waiting for the perfect storm in Europe to finally develop the time of waiting may be over.
More from the FT:

Padhraic Garvey, head of rates strategy for developed markets at ING Financial Markets, said: “We are heading into a critical period as the chances rise that a government may fail to raise the money it needs.

“Spain, Portugal and Ireland are the obvious ones to worry about. Are investors willing to stay long, or buy the debt of these countries? I’m still not seeing investors willing to buy into the periphery.”

Some strategists say the return of most investors from holidays this week could increase volatility in these markets because many have put decisions on their portfolios on hold during the summer.

With most investors back at their desks, some could start selling peripheral debt in the coming weeks, particularly as the outlook for the global economy has deteriorated. In spite of some better than expected data out of the US last week, worries about a double-dip recession have increased.

But other strategists insist governments will have little difficulty in funding themselves, even if they have to pay higher premiums or yields to attract investors. They say countries such as Portugal and Ireland have already raised most of the money they need this year.

Government bond yields of the peripheral countries, however, may come under further selling pressure.

Expect the stock market to begin acting even more deranged over the next three weeks, now that the Fed has to perform double duty to make sure that all the upcoming auctions don't clog the system to a halt, and the realization that Europe has been bankrupt all along in 2010 isn't comprehended by too many of the "naifs."

More From David Rosenberg on Jobs. OUCH!

As with the Manufacturing PMI report, however, the details point to a far less rosy picture than the headline figure and market reaction suggest, again well summarized by Gluskin Sheff’s David Rosenberg via The Pragmatic Capitalist here in which he notes (we quote):

1. Aggregate hours worked were flat.
2. All the employment gains were part-time — full-time employment, as per the Household Survey, plunged 254,000.
3. Those working part-time for “economic reasons” surged 331,000 — the biggest increase in six months.
4. While private payrolls were better than expected, 10,000 of that +67,000 tally reflected returning construction workers who had been on strike.
5. Manufacturing employment was down 27,000 and total goods producing jobs were flat — hardly signs of a robust economic backdrop.
6. The diffusion index for private payrolls actually fell to 53.0 from 56.7 in July — a seven-month low. It was 68.0 at the April high, which is consistent with an economy slowing down to stall-speed.
7. The labor market gap widened with the all-inclusive U6 unemployment rate rising to a four-month high of 16.7% from 16.5% in July. This is why the odds are stacked against a sustained acceleration in wages.

Keep in mind that markets did not have much time to digest the US jobs reports Friday before markets closed, and could well take back gains next week upon reflection on the above details. Volumes in the stock market rallies were exceptionally thin, further undermining out belief in the rally
In sum, last week’s market movers suggest a rally that is a mere countermove in the longer term downtrend, particularly considering the hurdles that lie ahead as discussed below.