Tuesday, January 3, 2012
Stocks Leap Into 2012
And so do commodities! Grains, energies all leaping higher. Crude is up nearly $4 today!
Eurozone Economy Contracts Five Straight Months
...but stocks are higher in the new year. Yup! Makes perfect sense... to the delusional!
from Marketwatch:
The final December reading of the Markit purchasing-managers index for the manufacturing sector rose to 46.9 from a 28-month low of 46.4 in November, matching an earlier estimate.
“Euro-zone manufacturing is clearly undergoing another recession,” said Chris Williamson, chief economist at Markit. “Despite the rate of decline easing slightly in December, production appears to have been collapsing across the single-currency area at a quarterly rate of approximately 1.5% in the final quarter of 2011.”
For the second month in a row, all nations covered by the survey reported a decline in output.
Williamson said it was particularly worrying to see new orders falling at a far faster rate than output. That indicates firms have relied on orders placed earlier in the year to sustain current production levels, he said.
Hussman: Hope for Change in 2012
Happy New Year. We enter 2012 with a great deal of hope, but our hopes are not for more bailouts, or money printing, or any of the myriad policies that investors seem to hope will save bad investments and sustain elevated valuations. Instead, our hope is that in 2012, the market will finally "clear," in the sense that bad debt will be recognized as bad and restructured; that overleveraged financials will be taken into receivership instead of forcing austerity on every corner of the economy in order to make them flush again; that rates of return will rise enough to compensate and encourage saving - and high enough to encourage borrowers and other users of capital to allocate the funds productively. Of course, in order to restructure bad debt, someone has to accept a loss. In order for rates of return to rise, valuations must decline. In short, our hope is for events that will unchain the global economy from an irresponsible past and open the gates toward a prosperous future. Maybe that is too hopeful, but we are not entirely convinced that bailouts and "big bazookas" will be as easily procured in the year ahead as a confused public has allowed in recent years.
We begin 2012 with the S&P 500 priced at valuations from which we estimate 10-year total returns of just 4.9% annually. This figure would be less discouraging if it were not for the fact that valuations - properly normalized for the cyclicality of earnings - have been tightly related to subsequent returns as far back as one cares to look, and as recently as the past decade. It is true that rich valuations did not prevent the late 1990's bubble (corresponding to late 1980's 10-year total return projections), but the ultimate and predictable outcome of that bubble has been more than a decade of stagnant returns. Back in 2000, it seemed inconceivable that we could be projecting negative 10-year total returns, but that outcome was the natural result of the valuations we observed at the time. Weak returns over the coming decade (hopefully front loaded as a few years of negative returns, followed by normal or above-average returns in the out-years) are likely to be an equally natural result of present conditions.
With 10-year Treasury yields below 2%, 30-year yields below 3%, corporate bond yields below 4%, and S&P 500 projected 10-year total returns below 5%, we presently have one of the worst menus of prospective return that long-term investors have ever faced. The outcome of this situation will not be surprisingly pleasant for any sustained period of time, but promises to be difficult, volatile, and unrewarding. The proper response is to accept risk in proportion to the compensation available for taking that risk. Presently, that compensation is very thin. This will change, and much better opportunities to accept risk will emerge. The key is for investors to avoid the allure of excessive short-term speculation in a market that promises - bends to its knees, stares straight into investors' eyes, and promises - to treat them terribly over the long-term.
Again, we enter the year with great hope. But our hope is not for continued speculation and the maintenance of rich valuations (that only look reasonable because long-term cyclical profit margins are at a short-term peak about 50% above their historical norms). At present, we have a situation where saving is discouraged by desperately low interest rates, where unproductive uses of capital are not discouraged because the bar is so low, and where central banks recklessly facilitate economic stagnation by bridging the gap between a puddle of unrewarding savings and a mountain of unproductive speculations. So our hope this year is for a return to a proper investment opportunity set - where saving is encouraged and rewarded by sufficiently high prospective returns, and the cost of capital is high enough to discourage high-risk, low-return investments and unsustainable fiscal deficits. The longer policy makers wait to begin the orderly restructuring of bad debt and overleveraged financial institutions, the greater the risk of a disorderly restructuring.
Europe Update
The Eurozone Purchasing Managers Index (Markit) is already well into recessionary territory. Notably, production and new orders continued to hit fresh lows in the latest report - the slight uptick in the index reflects only a slowing in the rate of decline. The accompanying commentary observed "Production declined for the fifth consecutive month. The fall was less sharp than the 29-month record seen in November, though it remained steep compared with previous downturns prior to the financial crisis. Output and new business fell across the consumer, investment and intermediate goods sectors, with the latter reporting the strongest declines in both cases. For the second consecutive month, all of the nations covered by the survey reported lower levels of output... the fall in production at euro area manufacturers reflected a seventh successive monthly decline in new orders received." Markit's chief economist noted that the latest data "suggests that operating capacity will be slashed in coming months unless demand revives."
Meanwhile, the European Central Bank is more tapped out than we suspect investors recognize. The balance sheet of the ECB now stands at about $3.55 trillion (2.73 trillion euros), compared with EU GDP of about $16 trillion. This puts the European monetary base at about 22% of EU GDP, which is even greater relative to the economy than the Fed's balance sheet ($2.97 trillion on $15 trillion of GDP as of December 28, which works out to 21 cents for every dollar of GDP). Forget the "zero bound" - given the bloated size of the ECB balance sheet, combined with the lack of credible safe-havens in Europe, distrust of the banking system, and an apparent aversion to cash-stuffed mattresses, German 3-month debt is now sporting a yield of -0.17%, which means that investors pay the German government for holding their money.
As noted in Why the ECB Won't, and Shouldn't Just Print (see the section on inflation and the value of fiat currencies), this expansion in the central bank's balance sheet is not necessarily inflationary provided that market participants are firmly convinced that it is temporary. The value of one unit of currency stems from the stream of transactional and value-storage "services" that the currency unit is expected to throw off over time (as measured against the marginal value of other goods and services). If a large volume of new currency is created, but only for a short period of time, the expected long-term value of the existing currency stock is not seriously diluted, and you shouldn't expect to see inflation. It's when the currency creation is effectively permanent that you see large dilution of the value of existing currency units, which is another name for inflation. The ECB will not purchase unlimited amounts of distressed European debt precisely because nobody would expect the ECB to have the ability to reverse the transaction, and worse, if the debt were to default, the result would be immediate and rapid inflation because the money stock would suddenly be viewed as permanently high.
In lieu of printing euros to buy distressed debt, the ECB initiated a massive round of 3-year loans to European banks last month, taking securities from those banks as collateral. It's important to recognize that the ECB does not take credit risk by doing this. Regardless of how the collateral fluctuates in value, the ECB has a claim to repayment of the original loan, plus interest, and that claim stands ahead of the claims of existing bank bondholders and certainly stockholders.
While some observers hope that the massive round of ECB loans to European banks will spur bank purchases of distressed European debt in an attempt to "arbitrage" the higher interest rate on that debt against the 1% rate charged by the ECB, this really isn't what investors should expect. What's actually happening here is that European banks, already spectacularly over-leveraged against their own capital, can no longer successfully access the commercial paper markets for funds, so have had to turn to the ECB for this liquidity. The sheer size of the recent operation was not an indication of potential new bank demand for distressed European debt, but instead was an indication of how strapped the market for short-term and unsecured funding has become for European banks. Moreover, the whole "arbitrage" idea is flawed in the sense that it implies that the capital shortfall of European banks can reliably be bridged out of the pockets of the most distressed EU member countries.
Let's be clear about this - if European banks were to use the funds from the ECB to make significant new purchases of European debt, their capital ratios would become further strained, their portfolios would become more unbalanced, the market for new short-term and long-term bank funding would become even more deserted, and the timeline for European bank receivership and restructuring (a phrase that we prefer to "failure") would simply be accelerated.
I expect that we will see some further progress toward a "fiscal union" among European member states, but without explicit changes to the EU Treaties ratified by all of its members, we will not see any move toward unlimited ECB buying of European debt. At best, the ECB will act as a collateral-taking intermediary in an attempt to ease increasingly frequent liquidity strains in the banking system. On fiscal union, the real issue is credibility - how do you really impose fines and other penalties against countries who are already unable to pay their bills? In the end, hopefully sooner than later, it would be best for European member states to begin adding convertibility clauses into their debt, giving them the option to convert the debt from the euro into their legacy currencies. This would substitute credible market discipline for ineffective political sticks, and given that the average maturity of European debt is only about 7 years, much of it front-loaded, it would also remove the specter of massive sovereign defaults within a fairly short period of time.
That said, it is important to remember that the attempt to rescue distressed European debt by imposing heavy austerity on European people is largely driven by the desire to rescue bank bondholders from losses. Had banks not taken on spectacular amounts of leverage (encouraged by a misguided regulatory environment that required zero capital to be held against sovereign debt), European budget imbalances would have bit far sooner, and would have provoked corrective action years ago. The global economy has not been well-served by the financial companies that leaders are trying so desperately to protect. Our vote is for receivership and restructuring so that losses can be taken by those who willingly accepted the risk of loss, and the legacy of bad investments and poor capital allocation doesn't have to be converted into a future of suppressed economic growth.
Europe Could Go From Bad in 2011 to Even Worse in 2012
by Charles Forelle at WSJ:
Bouts of panic. Moments of elation. Vertiginous plunges. Markets lurching on the scantiest fragment of news from a Parliamentary committee in a minor-league country.
That was investing in Europe in 2011. Be prepared in 2012 for at least more of the same.
The rocky road was thanks to weakening economic performance across the continent and, most of all, to the euro-zone debt crisis.
The economic story is almost certain to be worse. Europe saw modest growth in the first quarter of 2011, and then the slowdown began. Most economists now project recession in 2012.
As for the debt crisis, it is far from over. At the end of 2011, European leaders all but gave up their bid to build a giant bailout fund—they just don't have enough cash—and instead scrambled to assemble the underpinnings of a tighter fiscal union, in the hope of giving a reluctant European Central Bank confidence to step in and offer support for government-bond markets.
But Europe has only touched its toe on the fiscal-union path, the faraway end of which is common debt issuance for the 17-nation bloc. A lot could go wrong before it gets there.
The peril starts in January, when euro-zone governments plan to issue a wall of debt. "It's going to be hard to take it all down," says Nick Firoozye, senior European rates strategist at Nomura Holdings Inc. in London.
Then come the fraught negotiations over Greece's debt restructuring. Euro-zone leaders and big creditors agreed in October that bondholders would take a 50% haircut, but the mechanics of the complex restructuring aren't finished. Greece may try to push for a better deal. "It's in Greece's interest not to reach an agreement," Mr. Firoozye says.
But there is pressure to complete a deal before mid-March, when Greece is scheduled to repay a €14.4 billion ($18.7 billion) bond. Any hiccups could unnerve markets.
Across asset classes, investors should expect volatility and uncertainty. Here's a guide:
Bonds
European government bonds have been the asset class most affected by the crisis so far. It has been "an environment punctuated by bit of optimism and bits of pessimism," says Nicholas Gartside, international chief investment officer for fixed income at J.P. Morgan Chase & Co.'s asset-management arm. "You've had both extremes, and our view is you are likely to see those extremes continue into the next year."
After a year of stops and starts in trying to resolve the debt crisis, France's Nicolas Sarkozy and Germany's Angela Merkel, shown at a June meeting, face another year of without resolution.
Performance of "peripheral" euro-zone bonds—a category that probably now includes Italy, the third-largest economy in the bloc—is likely to be hugely volatile. The yields are enticing, but the investment isn't for the faint of heart.
The giant risk is a sudden stop in financing to Italy. The ECB has tried to prevent that with a modest program of bond buying and big injections of liquidity into the banking system. But many analysts are skeptical that banks will take that cash and finance Italy. Regulators are pressuring them to reduce their exposure to the wobbly periphery, not increase it.
At the same time, Mr. Gartside says the outlook remains bright for Germany. There is little visible threat from bond investors' two chief villains—inflation and higher interest rates—and Germany should continue to be a haven.
The Euro
One of the head-scratchers of the debt crisis so far has been how well the euro has held up amid all the frantic fretting about the dissolution of the currency zone. The euro started 2011 at $1.34 and ended it at $1.30 (with rounding). Yes, there have been ups and downs in between, but the common currency never broke $1.50 and only barely sank below $1.30.
There are more-subtle factors. Stephen L. Jen, managing partner of London hedge fund SLJ Macro Partners and a currency watcher, says European banks and corporations have been repatriating overseas assets—helping to offset flight out of the euro zone. And much movement has been "south-to-north" migration, he says—investors pulling out of Greece, but piling into Germany and the Netherlands. That is neutral for the currency.
What to expect in 2012? A crucial dynamic will be the recession everyone expects is coming. If it is nasty, the ECB may cut rates and, some analysts believe, even hold its nose and adopt a quantitative-easing policy where it buys bonds to provide monetary stimulus to the economy. That would erode the interest-rate advantage the euro has over the dollar and implies a weaker euro.
Of course, the ECB isn't the only one with these concerns: If the U.S. Federal Reserve embarks on a third round of quantitative easing, or QE3, the pressures are potentially reversed.
And there is always the threat of policy stumbles by European leaders jolting the markets.
All in all, "trading euro-dollar will require a lot of care," Mr. Jen says.
Stocks
European equity investors probably wish 2011 were just a bad dream. The U.K.'s FTSE 100 was off 5.6%, Germany's DAX fell 15% and France's CAC-40 lost 17%.Can investors hope to wake up in 2012? Maybe.
Domestic economic performance will likely be bad, but the big companies in Europe's major indexes are world-wide players, and they can benefit from a brighter picture in Asia and even the U.S.
"The rest of the world is in a much better place," says Nick Nelson, UBS AG's European equities strategist. "It's a European recession, not a global recession."
A somewhat weaker euro, he expects, will also aid the region's exporters.
The downside? The debt crisis has been an albatross for equities. Mr. Nelson notes that the price-to-earningsmultiple investors have been willing to pay for European stocks correlates inversely with an index of European sovereign credit-default swaps—a measure of the risk of government debt default. In other words, when the debt crisis rears up, investors are less likely to take a gamble on stocks.
That was on full display in August, when Italy tumbled into the maw of the crisis. The Milan exchange was pummeled, but so too were bourses in Paris and Frankfurt and London. The DAX had three days in August on which it fell by more than 5%; before August, the last such single day was in March 2009.
Mr. Nelson predicts a small rise in European indexes in 2012—but it is an outlook dimmed by uncertainty. "Volatility," he says, "is massive."
Cool Crude!
Company's Breakthrough Technology Uses Captured CO2 and Natural Gas to Make Ultra-Clean and Environmentally Friendly Synthetic Crude Oil
SANTA BARBARA, CA -- (Marketwire) -- 01/03/12 -- Carbon Sciences Inc. (OTCBB: CABN), the developer of a breakthrough technology to make liquid transportation fuels from natural gas and carbon dioxide, today announced that its breakthrough technology could also be used to make CarbonCrude™, the company's version of an ultra-clean and environmentally friendly synthetic crude oil. The ultimate goal of most gas-to-liquids (GTL) operations is to produce finished liquid transportation fuels from natural gas. But in many situations, such as certain oil fields and offshore platforms, the associated natural gas stream is often too limited for conventional GTL fuel production, and too substantial to be released into the atmosphere. Flaring (burning) this excess gas, resulting in carbon dioxide emissions, is not politically acceptable in many parts of the world. Converting the associated natural gas into liquefied natural gas (LNG) is a costly process and requires LNG infrastructure that is not readily available near most oil field operations. Therefore, the existence of associated natural gas in oil fields often makes those reserves uneconomical to develop or costly to operate.
The CarbonCrude process consists of two steps. The first step relies on the company's breakthrough natural gas reforming catalyst that consumes carbon dioxide to produce syngas. The carbon dioxide required for this step can often be found in the natural gas stream, by flaring some of the gas and capturing the CO2, or by capturing CO2 from local power generators. The second step is a low-intensity Fischer-Tropsch process that converts syngas into low cost CarbonCrude, instead of a high cost complete fuel.
Byron Elton concluded, "Associated gas is a big problem for resource holders and can negatively affect oil field economics. By converting this excess gas into synthetic crude oil using our low capital, clean-tech solution, we believe we can deliver both economic and social value to oil field operators. We intend to aggressively target oil field operators with our CarbonCrude solution."
About Carbon Sciences Inc. Carbon Sciences has developed a breakthrough technology to make liquid transportation fuels from natural gas. We believe our technology will enable the world to reduce its dependence on petroleum by cost effectively using natural gas to produce cleaner and greener liquid fuels for immediate use in the existing transportation infrastructure. Although found in abundant supply at affordable prices in the U.S. and throughout the world, natural gas cannot be used directly in cars, trucks, trains and planes without a massive overhaul of the existing transportation infrastructure. Innovating at the forefront of chemical engineering, Carbon Sciences offers a highly scalable, clean-tech gas-to-liquids (GTL) process to transform natural gas into transportation fuels such as gasoline, diesel and jet fuel. The key to this cost-effective process is a breakthrough, methane dry reforming catalyst that consumes carbon dioxide. Our proprietary catalyst is now undergoing rigorous commercial testing to meet the needs of the natural gas industry and will be available for use in pre-feasibility studies of new GTL plants. To learn more about Carbon Sciences' breakthrough technology, please visit www.carbonsciences.com and follow us Facebook at http://www.facebook.com/carbonsciences.
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