More People Depend on Government Than Support It

Home Sales Disappoint!

The latest stock rally on Monday 10-15 was ignited by news that home starts had increased. But Wall St forgot that housing STARTS don't equate to home SALES. Home starts -- building -- only add to an already-bloated inventory! That is DEFLATIONARY, and is not a sign off recovery!

Now, reality returns to Wall St! Today, we learn that existing home SALES have declined. There is NO housing recovery!

Wha...? Dow Surpasses 200 Point Decline

Stocks Plunge 150 Points

Stocks Stumble On Bad Earnings Reports

Reality returns to Wall St for a day!

Figures That As Headlines Worsen, Stocks Rise!

Interesting that despite higher unemployment claims, stocks are up! Figures!

The Fed's Unintended (As In "Self-Defeating") Consequences

Interesting quote from Goldman Sachs today:
"Once the price of Brent crude /oil/ reaches $125 /per barrel/, global economic growth becomes challenged and ultimately makes QE self-defeating. "

(Today, Brent crude is trading at $113.)

And from Zero Hedge regarding oil:
"The unending efforts of our glorious central-banking planners to raise asset prices and encourage 'animal spirits' through the trickle-down of unicorn-tears via the wealth effect have side-effects. Unintended consequences of 'leaking liquidity' finding its way into hard assets and 'things that have relatively limited supply' have stalled hopes of a stimulus in China (/due to high/ food inflation) and caused refis to mysteriously lag on misplaced future rate expectations in the US (ZIRP /the Fed's Zero Interest Rate Policy/). The biggest 'problem' the central-bankers face, however, is energy prices. The liquidity surges directly impact the price of oil (which is already under pressure from the ever-igniting fears of Middle-East flare-ups)."

Philly Fed Surpasses Explanation

ANOTHER EXAMPLE OF DATA MANIPULATION?

The Philly Fed manufacturing index was just released for September. It was surprisingly BETTER than expected.

But as they say, the devil is in the details! ALL of the internal data worsened from the previous month. It seems very strange that the headline figure can improve, while all the internal supporting data that created that headline WORSENED at the same time!

Here's one explanation of the bizarre data:
"And yet anyone who takes the 2 minutes to look at the internals, such as the collapse in the Number of Employees Sub-Index, which tumbled from -7.3 to -10.7 (the lowest since September 2009), the decline in the Average Employee Workweek, or the surge in Prices Paid from 8 to 19, double the change in Prices Received which means plunging corporate profits, or the ever critical New Orders which declined from 1.0 to -0.6, and one can see why this is a report only an Econ Ph.D-cum-Central Planner can love. Finally adding insult to injury, is the 6 month forecast, which unlike all other regional Fed diffusion indices, collapsed by half, from 41.2 to 21.6, as the Hopium at least in the city of brotherly mugging appears to be running out. Stocks kneejerk in every possible direction hoping the Fed will provide a direction."

Last Week's Halcyon Unemployment Claims Turn Sour Again

As of this morning, we now know that last week's huge drop in unemployment claims to the lowest levels in 4 years was very clearly an aberration, not a new trend. We know this because this week's unemployment claims leaped back to the trend. And not just to trend, but to the upper end of the trend! Of course, Wall St. is ignoring this news. They are having another Pollyanna Party.

Today's unemployment claims, which this week includes California (last week, the BLS said California didn't report), showed 388,000 new claims. That is closer to the 369,000 from two weeks ago and near the upper trend line that we have been accustomed to over the past several months. Last week's, just for the record, was just 339,000, the lowest level in four years. Of course, it didn't include more than 10% of the population of the U.S.

But as expected, the propaganda media is ignoring this news today. It's just soooo mundane to report the real trend, instead of the dreamily overoptimistic outlier from last week that was no doubt intended to prop up Obama's re-election prospects.

The BLS' explanation THIS week of LAST week's aberration?

"it appeared that state-level administrative issues were distorting the data"

Well duh! 

Euphoria! The Pollyanna Party Continues

Modestly mixed economic news yesterday has sparked a sharp stock market rally yesterday and today, bouncing off the lower Bollinger Band. Yesterday's modestly better-than-expected retail sales figures, while ignoring the Empire State manufacturing index that showed continued contraction, ignited the rally, which is picking up steam today. The Pollyanna Party is renewed!

Current Economic Perspective With a Chess Twist

I just love this guy. May I nominate Hussman for Fed Chair?


John P. Hussman, Ph.D.

“Patience is the most valuable trait of the endgame player. In the endgame, the most common errors, besides those resulting from ignorance of theory, are caused by either impatience, complacency, exhaustion, or all of the above.”

– Pal Benko

I’ve long been fascinated by the parallels between Chess and finance. Years ago, I asked Tsagaan Battsetseg, a highly ranked world chess champion, what runs through her mind most frequently during matches. She answered with two questions – “What is the opportunity?” and “What is threatened?” At present, I remain convinced that the key opportunity lies in closing down exposure to risk, because prices in both bonds and stocks have been driven to the point where the prospective additional compensation for risk is extraordinarily thin on a historical basis, and much of these gains are the result of monetary interventions in perpetual search of a greater fool.

The final minutes of a Chess game often go something like this – each side has exhausted most of its pieces, and many pieces that have great latitude for movement have been captured, leaving grand moves off the table. At that point, the game is often decided as a result of some seemingly small threat that was overlooked. Maybe a pawn, incorrectly dismissed as insignificant, has passed to the other side of the board, where it stands to become a Queen. Maybe one player has brought the King forward a bit earlier than seemed necessary, chipping away at the opponent’s strength and quietly shifting the balance of power. Within a few moves, one of the players discovers that one of those overlooked, easily dismissed threats creates a situation from which it is impossible to escape or recover.

My impression is that investors have been so entranced by the moves of their two Knights – Ben Bernanke and Mario Draghi – that they have allowed an entire army of pawns to pass across the board without opposition. In Chess, those overlooked, seemingly insignificant passed pawns can draw away the opponent's resources, or even be poetically transformed into the most powerful pieces in the game.

What are those passed pawns? On the basis of normalized earnings (which correct for the cyclicality of profit margins over the business cycle, as stocks are very, very long-lived assets) our projection for 10-year S&P 500 total returns is lower than it has been at any point prior to the late-1990’s bubble, with the exception of 1929. While it is very true that valuations have been even richer at various points in recent years, it should also be noted the S&P 500 (including dividends) has now underperformed Treasury bills for well over 13 years as a direct result. Similarly, the Shiller P/E remains higher than about 95% of instances prior to the late-1990’s bubble. Numerous recent weekly comments have detailed the variety of hostile indicator syndromes we presently observe, particularly the variants of “overvalued, overbought, overbullish” conditions that have regularly been followed by profound market losses over the intermediate-term (though not necessarily the short-term).

Meanwhile, my view continues to be that a recession in the U.S. is already an overlooked passed-pawn, as is the sharper-than-expected economic weakness in China, as is the overleveraged, undercapitalized state of the European banking system – particularly in Spain – where policy makers are misguided enough to believe that Draghi’s words alone are sufficient to substitute for bank capital and fiscal stability. The growing U.S. debt/GDP ratio is another passed-pawn, because while I expect the “fiscal cliff” will be resolved by a half-hearted combination of tax cuts and modest spending reductions, the final result is likely to leave a large structural deficit which we are only capable of financing due to the good fortune of unrealistically depressed interest costs and a combination of monetization and Chinese capital inflows (all which make endless deficits seem misleadingly sustainable).

Hugh Hendry of Eclectica recently got the tone right in his concerns about the endgame we are facing:

"Today, the world is grotesquely distorted by the presence of fixed exchange rate regimes. There are two. There is the Euro, and there is the dollar-remnimbi. All of Europe has defaulted. There are many stakeholders in the European project. There are financial creditors and then there are the citizens of Europe. Remarkably, the political economy of Europe is that the politicians chose to default on their spending obligations to their citizens in order to honor the pact with their financial creditors. And so of course what we're seeing is that as time moves on, the politicians are being rejected. So when I look at Europe, the greatest source of inspiration I have is fiction... We have the longest-serving Prime Minister, the Prime Minister of Luxembourg Mr. Juncker, who is on record as having said that 'when times get tough, you have to lie.' … the truth is unpalatable to the political class, and that truth is that the scale and the magnitude of the problem is larger than their ability to respond, and it terrifies them. The reality is that you just can't make up how bad it is. But it has precedent, and precedent perhaps offers us some navigation tools.

"The number one rule in terms of looking after wealth is preserving that wealth... I think we are single digit years away from the most profound market clearing moment - a 1932 or a 1982, where you don't need smart guys or girls, you just need to be bold. The crisis started here, it went to Europe… we could see a hard landing in Asia, coinciding and indeed being encouraged by the problems in Europe, and if you get those two events colliding, and given the lack of protection on such a scenario in Asia, then you would have another profound dislocation. And that's the point where you reach the bottom, and you don't need wise guys, you just need courage."

As an economist, I think it is important to recognize the underlying factors that support the present situation, as well as those that threaten it. The U.S. has benefited from low monetary velocity - the willingness of U.S. savers, financial institutions, China’s central bank, and others, to hold idle currency balances without meaningful compensation. Indeed, the reason that tripling the monetary base has not resulted in inflation is that monetary velocity has declined in direct proportion to that increase. In effect, people have passively held zero-interest money in whatever amount it is created. Contrast this with the German hyperinflation, when velocity rose as money became a “hot potato” – causing prices to rise even faster than the rate at which money was printed. Contrast the present situation also with the period from 1973 to 1982, when monetary velocity was rising, which also resulted in prices rising faster than the money supply. What creates inflation is the unwillingness of people to passively hold money balances, which then turns money into a hot potato. Higher interest rates on safe assets would have this effect, as that would create an alternative to zero-interest currency (which is why continued low inflation now relies on either holding interest rates at zero indefinitely, or massively contracting the Fed’s balance sheet should non-zero interest rates ever be contemplated).

Somehow, I suspect that all of us recognize that the present state of the world economy is being held up by extraordinary distortions both in the monetary realm and in fiscal policy, but for whatever reason, it is more pleasant to simply assume that everything is just fine, instead of thinking about the adjustments that would be required in order to move back to a sustainable global economic and financial situation. To some extent, we’ve become desensitized to extraordinarily large numbers – if hundreds of billions don’t solve the problem, then a few trillion will – ignoring the magnitude of those figures relative to our actual capacity to produce economic output.

Our problems are not insurmountable, but they are very difficult problems that do not have an easy solution or quick fix in some bold policy action (even in unrestrained ECB monetization). Deleveraging is hard. You simply cannot bring down the debt/GDP ratio unless a) economic growth exceeds interest rates by enough to offset the primary deficit*, or b) the government chooses to default on and restructure its debt obligations.

[*Geek's note : technically, the requirement is that (g - i) * Debt/GDP + PD/GDP > 0, where g and i are GDP growth and the interest rate on the debt, respectively (either both real or both nominal), and PD is the primary non-interest deficit (or surplus if positive)].

Importantly, printing money can bring down debt/GDP only if the government first locks in a low interest rate on its publicly-held debt by issuing very long term bonds, and then pursues enough inflation to raise nominal economic growth above that interest rate. Inflation will not devalue debt if the interest rate on the debt can be continuously reset in response. Presently, nearly all of the publicly-held U.S. debt is of short maturity. At an overall deficit of nearly 10% of GDP and a primary deficit of about 6%, there is very little chance that the ratio of publicly-held debt/GDP, which has nearly doubled since 2008, will easily stabilize in the coming years – particularly if we experience another recession. Moreover, we are unlikely to get consumer demand sustainably growing without dealing head-on with the problem of mortgage restructuring and underwater home equity – something that has been utterly ignored by policymakers. Done correctly, all of that is uncomfortable enough. Done poorly, it is profoundly destructive. Europe has already done it poorly, and it is not finished.

That said, I should emphasize that our present defensiveness does not rely on the assumption that we’ll see some profound economic dislocation. Rather, our defensiveness is driven by syndromes of evidence that have repeatedly been associated with negative return/risk outcomes in dozens of subsets of historical data. I’ll say this again: we are not defensive because of recession concerns or views about global financial strains. We are defensive because the market conditions that most closely resemble those at present have regularly, and throughout history, been associated with negative return/risk outcomes, on average.

The endgame of the market cycle

Just as the endgame is the part of the Chess match that counts the most, the final part of a market cycle is often where the most critical choices are made. The fact is that a bear market wipes out more than half of the gains achieved during the average bull market. For cyclical bear markets that occur during extended “secular” bear periods as we’ve observed since 2000 (featuring multiple bull-bear cycles, each which achieves successively lower valuations at the bear troughs), the bear markets typically wipe out closer to 80% of the gains achieved during the preceding bull period.

“Once you are in the endgame, the moment of truth has arrived... The amount of points that can be gained (and saved) by correct endgame play is enormous, yet often underestimated.”

– Edmar Mednis

In early March, our estimates of prospective stock market return/risk dropped into the most negative 2.5% of historical data (see Warning, A New Who’s Who of Awful Times to Invest), yet the S&P 500 is presently about 4% higher than it was then, and our estimates have dropped further, to the most negative 0.5% of historical observations. As I observed at the time, “While a few of the highlighted instances were followed by immediate weakness, it is more typical for these conditions to persist for several weeks and even longer in some cases ... When we look at longer-term charts like the one above, it's easy to see how fleeting the intervening gains turned out to be in hindsight. However, it's easy to underestimate how utterly excruciating it is to remain hedged during these periods when you actually have to live through day-after-day of advances and small incremental new highs that are repeatedly greeted with enthusiastic headlines and arguments that ‘this time it's different.’”

And so, we find ourselves facing the likelihood of another cyclical endgame, where in Benko’s words “impatience, complacency, exhaustion, or all of the above” can encourage investors to ignore rich valuations, weak economic fundamentals, heavy insider selling, overbullish sentiment, overbought market action, increasingly negative earnings preannouncements, and other syndromes that have historically been hostile for stocks.

These risks are easy to dismiss. Yields and prospective returns have been driven lower as investors seek an alternative to an ocean of zero-interest money, and prices have been driven higher – a fact that makes rising prices seem somehow automatic. The question is this - what else is left for investors to anticipate, with prices not depressed at all (as they were at the start of prior rounds of QE), and with QEternity now having removed any further “announcement effects.” Though market risk has been advantageous, it is doubtful that the market returns we’ve observed are durable.

“It often happens that a player is so fond of his advantageous position that he is reluctant to transpose to a winning endgame.”

– Samuel Reshevsky

So while it is true that stocks have advanced a few percent since March, my strong view is that this is good fortune born entirely of investor anticipation of ECB and Fed announcements that are now behind us. Indeed, the S&P 500 is lower now than when QEternity was announced, and on a volume-weighted basis, is also lower than when Draghi threw his hail-Mary pass over the Bundesbank. By our estimate, the present ensemble of market conditions is associated with a historical rate of loss in the S&P 500 approaching -50% annualized. Now, I don’t expect conditions to be similarly negative for a full year - the typical course is for the market to transition to less negative conditions after an initial hard decline. But I continue to believe that the gain in the S&P 500 since March, when our return/risk estimates became overwhelmingly negative, should not be the basis for complacency here.

“In the endgame, an error can be decisive, and we are rarely presented with a second chance.”

– Paul Keres

From a strategic standpoint, I believe that the best approach to the complete market cycle is to accept risk roughly in proportion to the return that can be expected as compensation. Indeed, this is one of the key results of finance theory. Our estimates of return/risk vary over the market cycle based on prevailing market conditions – being very hostile in periods when the market is in a mature, overvalued, overbought, overbullish market environment, and generally being aggressive when the market is in an undervalued, oversold, overbearish environment. To believe that we simply will never see the latter environment again, or that the next point we observe it will be at even higher prices than today, is an assumption that strains credibility from a historical standpoint. In any event, my perspective is that investment positions should not be based on a one-off forecast of what will occur in this specific instance, but on the average return/risk profile that has historically accompanied each prevailing set of market conditions.

“It is not a move, even the best move, that you seek, but a realizable plan.”

– Eugene Znosko-Borovsky

As Tsagaan suggested, the two ways to progress, and the two ways to err, are embodied in the questions “What is the opportunity?” and “What is threatened?” For our part, this particular cycle – this particular chess game – has been unusual in that we were forced to ask in 2009 whether far more was threatened than what had typically been at risk during other post-war market cycles. The “two-data sets problem” to address that question took enough time to solve that we missed an opportunity that we could have taken if our methods were already robust to out-of-sample Depression-era data at the time. That said, I believe that investors are committing a mistake in casually dismissing the question of “What is threatened?” in a mature, overvalued, overbought, overbullish market here. From my perspective, it appears to be the same error they made in 2000 and 2007.

 “The winner of the game is the player who makes the next-to-last mistake”

– Savielly Tartakover

From an investment perspective, the menu of opportunities appears very limited in an elevated stock market, with 10-year Treasury yields now down to 1.6%, and even corporate bond yields down to 2.7%. The opportunity here seems much more likely to be in limiting risk and taking gains than in extending risk and seeking further advances. Meanwhile, the historical chronicle of bull market gains that have been lost during the endgame, and the extent to which bear markets cause the surrender of those gains, should be a compelling answer to the question of what is threatened.

... and a final quote with absolutely no context

“A computer once beat me at chess. But it was no match for me at kick-boxing.”

- Emo Philips

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.

Doom Deepens

But stocks rise. Figures!

Volume Reverses, Shows Strong Selling

The Klinger volume indicator has developed a sharp reversal, suggesting strong selling of stocks.

EZ Slides Toward the Abyss

from the WSJ:
NEW YORK—Stocks opened lower as investors digested a bleak assessment for global growth and waited to see whether the start to earnings season would underscore economic worries.
The Dow Jones Industrial Average ticked down 22 points, or 0.2%, to 13563 in the minutes after Tuesday's opening bell. The Dow fell 26.50 points, or 0.2%, on Monday, snapping a three-session win streak.

IMF Says Risk of Global Recession Rising

OECD Tells U.S. To Put It's Fiscal House In Order

And just when the slowing economy was reaching stall speed, economists at the OECD give us this:

The world's finance ministers gathering in Tokyo this week will ramp up pressure on U.S. and European officials to resolve two mounting threats to the global economy: a standoff over budget policy in Washington and another dangerous turn in the euro-zone debt crisis.
At the annual meetings of the International Monetary Fund and World Bank, officials from the 188 nations that own the two institutions will plead for action as the world economy decelerates to its slowest growth since the global recession that started four years ago.

Today's Unemployment Farce

It wouldn't be election season, would it?

Today's unemployment report is so clearly a farce that it doesn't deserve any mention, but it is still today's market mover. So far, as the news and data is sliced and diced, stocks have given back about 75% of the initial gains. 

from Zero Hedge
We already noted the absolutely stunning surge in reported Household Survey jobs which "added" 873,000 jobs, or the most since 2003 and the second most in the past decade, which was just a little bit off the Household Survey used in the monthly NFP jobs changes, which came at 114,000, or about 8 times less. But what was the reason for this epic jump in Household survey jobs? Simple, and those who have read our series on America's transition to a part-time worker society know the answer. The reason is that the number of part-time people employed for economic reasons soared by 582,000 to 8,613,000, the most since October 2011, and the largest one month jump since February 2009, when "restoring" confidence in the economy was all the rage... and just before the Fed announced the full blown QE1 in March of 2009. Odd symmetry.

more:
Here's a peculiar statistical aberration:

• Household Survey people employed: +873,000 (source)
• Part-time jobs for economic reasons: +582,000 (source)

-> 582,000 divided by 873,000 = 0.666666666666*
Aka: precisely two thirds. Whatever are the odds...

Stock Market Volume Explodes

The Klinger Volume indicator is exploding the last couple of days. See the circled are in the lower panel of this chart. If the Fed is funneling money to the big banks, who are funneling those funds into their own stocks (financials) and commodities, then this is highly inflationary!

Is the Fed trying to manipulate stocks higher to get Obama reelected, or are private investors feeling more confident after Romney's performance in the debates last night. The fact that they are buying "materials, energies, and financials" is evidence of the first scenario!

Of course, with the jobs report tomorrow, anything could happen, but clearly, Wall St is anticipating good news tomorrow morning.

Commodity Prices Push Stocks Higher

Note what KIND of stocks are higher -- materials (ie., commodities), energies, and the financials -- those that push the Fed monetary largesse around! This spells higher inflation, not greater prosperity!

Did Stock Futures Rise Because Romney Won the Debate?

I couldn't help noting that stock futures rose suddenly and sharply last night immediately during and following the Presidential debate between Mitt Romney and Barack Obama. What struck me was the odd hour -- between 8 and 10 pm Mountain Time -- that it occurred.

Why is this such an odd hour? Because at 10 here in Utah, the East coast of the US is already asleep (midnight), and it is still just 5 am in London, when most Europeans are still in bed. Both of North America and Europe are still asleep. Asia is awake, but the market movers in Asia usually occur earlier in the evening, around 6 pm here.

Thus, market movers at 10 pm are very rare. Perhaps the market was reacting to the perception that Romney handily won the debate, even in the eyes of left-wing pundits! Perhaps the market is reacting to the shift in momentum that this is likely to create in the presidential race, and a likely surge for Romney in polls!