Midwest Drought Continues

At what point does a drought become a famine?

From the Columbia Tribune:
Those outside of the winter wheat growing region might not be thinking about the recent U.S. drought this time of year, but precipitation is desperately needed to recharge the aquifer and replenish subsoil moisture in Kansas, Nebraska and north Texas. This region is just west of the states that sustained the worst dryness in recent history in the Corn Belt this past growing season.
The latest version of the Palmer Drought Index shows much of Kansas and Nebraska dealing with extreme drought conditions with more than a 9-inch precipitation deficit. This area of North America produces hard red winter wheat used primarily for flour for breads.

Stocks Rocket Higher On Black Friday

Stocks are up 135 and still rising on no economic news today. Oh, that's right! It's just Black Friday! The WSJ attributes it to the tech sector, but it's not because of any good news; it's because that's the sector moving most sharply higher! Sounds like a feeding frenzy!

 Straight up! More "wealth effect", I suppose!

EU Summit Disbands With No Agreement

But stocks are up 100+ points!

EZ Doom Deepens

from WSJ:
"Business activity in Germany and the broader euro zone continued to shrink in November, indicating the region's economic downturn is steepening even as other major economies such as the U.S. and China show signs of resurgence."

But stocks are modestly higher.

EU Budget Brawl

Happy Thanksgiving! More Meltup!

Pessimism Prevails

We All Go Down Together

Stocks Dead Pre-Holiday

Stocks Bounce Back

HP announced a huge write-off today, sending stocks lower, but the indexes have now bounced back to the flat line.

Crude Oil Crashes

Oil prices slipped Tuesday as some traders booked profits after sharp gains Monday, when Brent and Nymex crude surged over $2 a barrel, reflecting concerns over the escalating Israel-Palestine conflict and hopes that the U.S. fiscal cliff might be resolved.

No Follow-Through on Stocks

Stocks have just dropped into the red, breaking through the day's earlier lows and showing no follow-through from yesterday. The day still has more than 2 hours to go, so anything can happen, but this is a disappointment after the Dow's 200-point rally yesterday.

Moody's Downgrades France

Another dose of reality.

Dow Rallies 200

Why does this feel like a dead cat bounce to me?

False hopes! Even if the cliff doesn't come today, it will soon!

Capital Spending Ignored

Housing Hullabaloo

Dow up 150 today!

Not Just Stocks, Either!

So food and energy prices are rallying, also!

Stocks Up Like a Rocket

Dow up 160 so far. S&P up 19 points. No end in sight.

WSJ: Investors Run for Cover

Uncertainty abounds! It's only going to get worse from here:

Half of the nation's 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next, according to a review by The Wall Street Journal of securities filings and conference calls...
Nationwide, business investment in equipment and software—a measure of economic vitality in the corporate sector—stalled in the third quarter for the first time since early 2009. Corporate investment in new buildings has declined. 
Uncertainty around the U.S. elections and federal budget policies also appear among the factors driving the investment pullback since midyear. It is unclear whether Washington will avert the so-called fiscal cliff, tax increases and spending cuts scheduled to begin Jan. 2.
Companies fear that failure to resolve the fiscal cliff will tip the economy back into recession by sapping consumer spending, damaging investor confidence and eating into corporate profits. A deal to avert the cliff could include tax-code changes, such as revamping tax breaks or rates, that hurt specific sectors.
"Given the timing of the drop-off in business investment," he said, "you have to think it's not just a coincidence with the timing of the fiscal cliff."
Unless the business investment slowdown reverses quickly, it could weigh further on growth prospects and the stock market.

Confidence Collapse

WSJ headline:

Wall St Bets Big on Fiscal Fix

Despite that no "fix" is in sight, stock futures rose on Friday, even following more bad economic data. However, once Congressional leadership reported a "constructive" meeting with President Obama, stocks leaped out of the red and into the black.
Stock futures continued to rise Sunday evening and into the European session, rising modestly during the session. This, even though Spanish debt continues to deepen.

from Business Insider:
"One of the darkest parts of the Spanish economy, and therefore the European economy, the bad loans held by the banking system continues to get worse.
"From Reuters:

Spanish banks' bad loans rose to 10.7 percent of their outstanding portfolios in September, reaching a fresh record high, Bank of Spain data showed on Monday, up from 10.5 percent a month earlier.

"The total pile of bad debt is now a staggering $182.2 billion."

Goldman's Kostin: "Clear and Present Downside Risks"

"Uncertainty swirling around the ‘fiscal cliff’ that must be resolved by year-end, the pending jump in capital gains taxes at the start of 2013, and the debt ceiling that will be reached in late February represent clear and present downside risks to the market in the near-term," writes David Kostin in US Weekly Kickstart.

Hussman: Finger In the Dyke

In the Mary Mapes Dodge book titled Hans Brinker, there is a fictional story within the story of a little Dutch boy who, on his way to school, notices a hole in the dyke. Having nothing else to fix the leak, he plugs the hole with his finger and stays there through the night until workers come to repair it. We are now into the fourth year of efforts to print trillions of little Dutch boys out of dollars and euros in order to stop a tide from crashing through a fundamentally damaged dyke. All of this has bought time, but no workers have arrived, and no real repairs have been done.

The holes seem only loosely related: non-performing mortgages, widespread unemployment, massive U.S. budget deficits, a “fiscal cliff” sideshow, inadequate European bank capital, European currency strains, a surge of non-performing loans in China, and unexpected economic softness in Asia and global trade more generally. All of this gives the impression that these problems can simply be addressed one-by-one. The truth is that they are all intimately related to a single central issue, which is the utter unwillingness of politicians around the globe to accept and proceed with the inevitable restructuring of bad debt, and their preference to defend the bondholders of a fundamentally rotted financial system.

But haven’t things improved? No doubt, bank balance sheets have been relieved of transparency through changes in accounting rules. Nonperforming loans have been easy to kick down the road thanks to an interminable “amend and pretend” process whereby a month or two of mortgage service is exchanged for extensions that tack delinquent payments onto the back of the loans. Meanwhile, banks have recouped some of their losses through wider interest spreads, by refusing to refinance higher interest mortgages, and by paying lower interest costs as a result of monetary policies that provide zero interest compensation to savers.

But aside from the appropriate equity wipeout, debt writedown, contract renegotiation and reissuance of General Motors, very little debt restructuring has occurred anywhere else in the economy – certainly not in financial or mortgage debt. Meanwhile, the European banking system faces major capital inadequacies, particularly in Spain, where delinquent loans have surged to record highs. The Federal Reserve just altered its annual stress tests for too-big-to-fail banks to now include the risk of a slowdown in Asia. The U.S. budget deficit remains near a peacetime high, with little prospect of substantial reduction even if the so-called “fiscal cliff" is resolved. The European economy is clearly in a fresh recession. We continue to infer that the U.S. also entered a recession during the third quarter. This will not be helpful to deficit reduction efforts.

In recent months, our estimates of prospective return/risk in the stock market have moved to the lowest 1% of historical data. In September, and again last week, those estimates dropped to the worst two observations in a century of historical data. Importantly, our concerns about global recession, unrestructured debt, European banking strains, and other issues are not at all responsible for those negative estimates. If anything, the continued (and I believe, misguided) speculation in low quality debt and credit-sensitive corporate bonds is keeping those estimates from being as negative as they would be otherwise. The end result here is a combination of global recession, massive and pervasive deficits, growing volumes of unserviceable and unrestructured debt, a financial picture marked by rich valuations, depressed risk premiums, and record-low yields-to-maturity across the menu of investment alternatives, deterioration in market internals such as breadth (advances vs. declines) and leadership (new highs vs. new lows) and a variety of trend-following measures, all alongside a deep-seated complacency of investors that everything will turn out just fine once the minor sideshow of the “fiscal cliff” is resolved.

Getting past the “fiscal cliff” is the comparatively easy part. What it requires is for both aisles of the U.S. political system to agree on a mutually acceptable (but likely still intolerably large) federal deficit. Whether this happens before December 31 or after is not terribly meaningful because there is not an irreversible outcome on that date. So whatever might happen automatically would be meaningless shortly thereafter anyway. There will likely be a combination of modest spending cuts, modest high-income tax increases, and limits on deductions for second homes. None of these will have a material impact on the size of the deficit. Despite the bluster, few in Congress really appear to see deficit reduction as important as their core interests, which for Democrats is to preserve spending and for Republicans is to maintain tax cuts. Some inadequate compromise seems probable, there will be a brief episode of joy and celebration by investors that they have been released from their chains, and shortly thereafter the data will remind us that the global economy is in recession, and that the U.S. economy entered a recession during the third quarter – well before Sandy was even on the weather map.

Ultimately, three outcomes would improve the global economy more durably. The first would be a process of debt restructuring that might be highly disruptive over the intermediate-term, but would exert the costs of bad debt on the holders of that debt rather than the general public. My expectation is that a large portion of the European banking system will be restructured in the next few years – meaning receivership, a wipeout of equity value, a writedown of liabilities to bondholders, and an eventual recapitalization as the restructured entities are sold back to private ownership. It isn’t clear that Spain or Italy will be forced to default, as long as Germany, Finland, and other relatively strong countries depart from the euro and allow the ECB to monetize as it pleases. Greece is a basket case in that it seems likely to default again regardless of whether the euro remains intact. In the U.S., efforts to create standardized, marketable mechanisms to restructure mortgage debt (e.g. debt-equity swaps such as marketable property appreciation rights in return for principal reductions) remain long overdue.

It would also be advisable for the next Treasury Secretary to significantly extend the maturity of U.S. debt, because we are now too far along to resolve the U.S. debt burden through fiscal austerity alone, and some level of inflation will have to be tolerated in the back-half of this decade (and possibly beyond) to reduce the real burden. This can’t be done if the debt is so short-term that the interest rate can be quickly reset to reflect inflation.

A second beneficial outcome would be a realignment of the prices of financial assets to more adequately reflect risk, to provide an incentive to save, and to raise the bar on rates of return – so that investments with strong prospective returns are funded while those with low prospective returns are not. Probably nothing in the past 15 years has been as damaging to the interests of the global economy as the constant distortion of the financial markets by central banks, which has encouraged bubble after bubble, elevating speculation over the thoughtful allocation of scarce capital toward productive uses.

Finally, we need innovation in new industries that have large employment effects. During periods of economic weakness, a common belief seems to emerge that the government can simply “get the economy moving again” through appropriately large spending packages – as if the economy is nothing but a single consumer purchasing a single good, and all that is required is to boost demand back to the prior level. In fact, however, recessions are periods where the mix of goods and services demanded becomes out of line with the mix of goods and services that the economy had previously produced. While fiscal subsidies can help to ease the transition, the sources of mismatched supply – dot-com ventures, housing, financial services, obsolete products, brick-and-mortar stores – generally don’t come back. What brings economies back is the introduction of desirable new products and services that previously did not exist. This has been true throughout history, where the introduction of new products and industries - cars, radio, television, airlines, telecommunications, restaurant chains, electronics, appliances, computers, software, biotechnology, the internet, medical devices, and a succession of other innovations have been the hallmarks of long-term economic growth. Fiscal policies are part of the environment, but their effect should not be overstated.

No stimulus package or tinkering with tax rates will produce growth in an economy as distorted by misguided monetary policy and unrestructured debt as our global economy has become. What is required is to restructure the burden of past errors, stop the recklessness and distortion of monetary policy, and allow the financial markets to adjust and clear, without safety nets, so that they both allocate capital toward productive investments and are allowed to punish misallocation. Then – deficit or no deficit – refrain from bleeding the patient, and do everything possible to encourage (private) and fully-fund (public) research, development, innovation, investment, and education.

In my view, we are likely to experience some difficult disruptions in the global economy in the transition from an unsustainable economic environment to a sustainable one. Underneath the veneer of a relatively stable U.S. economy is the fact that government deficits presently support about 10% of that activity, the Fed has pushed the monetary base to the largest fraction of GDP in history, and financial assets have been driven to some of the lowest prospective returns ever observed. Absent unsustainable levels of government “stimulus,” the present configuration of U.S. economic activity and asset pricing is also unsustainable. These policies have bought time, but we have done nothing with it, because somehow everyone has become convinced that the house of paper is real even though we all watched it being built.

All of this will change, and despite major challenges over the intermediate-term, there is no reason to lose long-term optimism for the U.S. or the global economy. The problem is that in our view, long-term assets are priced in a way that ignores the prospect for significant disruptions, and allows for inadequate return even in the event that the long-term works out very well. So we do have long-term optimism for the global economy, but also believe that financial assets are mispriced even if that long-term optimism is entirely correct. In bonds, yields-to-maturity remain near record lows. In stocks, valuations only appear tolerable because profit margins remain about 70% above long-term norms, largely because of low savings rates coupled with massive federal deficits (see Too Little to Lock In for the accounting relationships).

Meanwhile, the intermediate-term challenges are daunting, and should not be underestimated. Europe will not likely resolve its challenges without major dislocations and restructuring, Asia is likely to experience the exaggerated supply-chain disruption of a global recession (the Forrester effect, or what ECRI calls the “bullwhip effect”), and though the U.S. will probably move quickly past its immediate “fiscal cliff,” that resolution is unlikely to significantly reduce the deficit, nor to avert a recession that we believe already started in the third quarter.