Arlan Suderman calls this a short-covering rally.
Intraday
Daily
Monday, July 13, 2009
And Even More Bounce -- Back to Bullishness!
Good earnings reports have reversed stocks and sentiment, if it holds. Volume suggests it will!
John Mauldin: Buddy, Can You Spare $5 Trillion?
There is no doubt that the US is in financial trouble. Those talking of a strong recovery are just not dealing with reality. But the US is in better shape than a lot of countries. This week, we begin by looking at Japan. I have written for years about how large their debt-to-GDP ratio is, yet they keep on issuing more debt and seemingly getting away with it. But now, several factors are conspiring to create real problems for the Land of the Rising Sun. They may soon run into a very serious-sized wall. And it is not just Japan. Where will the world find $5 trillion to finance government debt? We look at some very worrisome graphs. Those in the US who think that what happens in the rest of the world doesn't matter just don't get it. There is a lot to cover in what will be a very interesting letter. I suggest removing sharp objects or pouring yourself a nice adult beverage.
This Is Outrageous
But first, I want to direct the attention of those in the US finance industry to a white paper written by Themis Trading, called "Toxic Equity Trading Order Flow on Wall Street." Basically, they outline why volume and volatility have jumped so much since 2007; and it's not due to the credit crisis. They estimate that 70% of the volume in today's markets is from high-frequency program trading. They outline how large brokers and funds can buy and sell a stock for the same price and still make 0.5 cents. Do that a million times a day and the money adds up. Or maybe do it 8 billion times. It requires powerful computers, complicity of the exchanges (because the exchanges get paid a lot), and highly proximate computer connections. Literally, the need for speed is so important that to play this game you have to have your servers physically at the exchange. Across the river in New Jersey is too slow. Forget Texas or California. This is a game played out in microseconds.
The retail world doesn't get to play. This is a game only for big boys who can afford to pay for the "arms" needed to fight this war. But the rest of us pay for the game, as that half cent is like a tax on transactions, not to mention the increased daily volatility, which skews pricing. Think it doesn't affect you? That "tax" is paid by mutual funds, your pension fund, and every large institution.
Frankly, this is outrageous. The more I read the madder I got. And it is going to get worse as computers get faster and software more intelligent. We need rules to level the playing field. Themis suggests one simple one: just make it a rule that all bids have to be good for at least one second. That would cure a lot of problems. One lousy second! In a world of microseconds, that is an eternity.
Goldman Sachs went after an employee who stole some of their latest and greatest software this last week. The US assistant attorney general said in the courtroom that the software had the potential to manipulate the market. Imagine that. I am shocked. There is gambling going on in the back room? Gee, commissioner, I had no idea.
All this "algo" (algorithmic) trading also gives a very false impression of volume. If you are a fund and see 10 million shares a day traded, you might feel comfortable that you could hold one million shares and exit your trade easily. But if 80% of the volume is false "algo" trading, that volume isn't really there. You may have a position that will be a problem if you want to exit, and not know it.
"High-frequency trading strategies have become a stealth tax on retail and institutional investors. While stock prices will probably go where they would have gone anyway, toxic trading takes money from real investors and gives it to the high frequency trader who has the best computer. The exchanges, ECNs and high frequency traders are slowly bleeding investors, causing their transaction costs to rise, and the investors don't even know it." (Themis Trading)
We are literally talking billions of dollars here. The SEC needs to step in and stop this, and soon. This is a lot more important than the salaries of investment professionals, for which the Obama administration today suggested new rules, which would allow the SEC to oversee salaries at member firms. Seriously? They don't have enough to do already?
The link to the white paper is http://www.themistrading.com/article_files/0000/0348/Toxic_Equity_Trading_on_Wall_Street_12-17-08.pdf. Themis Trading is at http://www.themistrading.com/.
Read the paper. Then, if you like, drop the very nice folks at the SEC your thoughts at tradingandmarkets@sec.gov. And now, let's start off with Japan.
The Land of the Setting Sun
One of the real benefits of writing this letter is that I get to see a lot of really interesting information from readers and meet with very savvy investment professionals. This week I had the privilege of sitting with a team of analysts from Hayman Capital here in Dallas. Hayman runs a global macro hedge fund, so they spend a lot of time thinking about how all the different aspects of the global markets fit together.
A one-hour meeting stretched to three hours, as the discussion was quite lively. I learned a lot more than I contributed (which is not unusual). After I made my presentation, they showed me a presentation they had been using. Some of the graphs were quite eye-opening. While I had seen some of the data in different places, there were a lot of new ideas, and having it all in one place was extremely helpful. There was a lot of work (as in months) done here; and Kyle Bass, the founder of the firm, graciously allowed me to share some of it with you (and kudos to Wes Swank, who pulled this together). The graphs are theirs, and my discussion about them is certainly informed by our meeting; but I am using the material as a launching point, so they are not responsible for my conclusions and interpretations.
Over the years, I have written about Japan often. Its economy is very important to the world, and its banks have funded and loaned a great deal to companies outside of Japan. Global growth would have been a lot slower without the Japanese. Up until recently, their population has saved a great deal of its disposable income, and those savings have allowed the Japanese government to run massive deficits.
And we are talking truly massive. Over the last ten years, the government has seen the level of debt-to-GDP rise from 99% to over 170%, not including local governments. They ran those deficits to try and pull themselves out of the doldrums of their Lost Decade of the '90s, following the crash of their real estate and stock markets, starting in 1989. They built bridges and roads to nowhere, all sorts of programs, quantitative easing, etc. Sound familiar?
Of course, they were coming out of two really large bubbles, far larger than those recently in the US. I think I remember reading that at one point the land on which the Imperial Palace in Tokyo is built was valued at more than all of the real estate in California. Why not buy Pebble Beach or a few iconic buildings in New York, when they were so cheap? Today, Japanese real estate is still massively down (on the order of 50-80%, depending on location). And the Nikkei is still down roughly 75%, 20 years later. Do you think the Dow will be at 3,500 in 12 years?
As late as 1999, personal savings plus pensions were running at 12% and had been as high as 16%. And much of those savings went into government debt. The government kept borrowing, and rates stayed in the area of 1%. Today, a ten-year bond yields 1.3% in Japan, so they could run up a very large debt and the interest-rate cost was not a big factor in the budget.
But now things are changing. Demography is starting to change the landscape. Japan is a rapidly aging nation. The population is shrinking, and the birth rate is among the lowest in the world. And the dependency ratio is starting to rise. There are currently 1.2 nonproductive citizens (under 15 years old and over 64) for every productive Japanese; the ratio will reach 2.0 by 2020 and will continue to grow thereafter. (See chart below.)
This also means that the ability to save is dropping, since so many retirees now need to dip into savings to live. Notice in the chart below that savings have dropped from 18% to 1.8%. Also notice that annual net savings is now down to 5 trillion yen.
But this year, the Japanese will want to issue roughly 33 trillion yen in debt! Also note that the national pension fund has informed the government that this year they will for the first time be net sellers of debt. Look at the chart below. Notice that as debt was increasing through 2006, actual interest-rate expense for government debt was decreasing, because rates were dropping, getting to 0.1% in 2001. Yet with no more room to cut rates, interest-rate expenses have started to rise. Total government debt is now close to 900 trillion yen.
Interest-rate expense is now about 18% of the Japanese government budget. What if rates went to a lofty 2%? That would over time double the interest-rate expense. And the Japanese are borrowing between 30-40% of their annual budget. The total debt is rising rapidly.
Ok, let's go over these points:
Japan's population is shrinking, and the number of workers per retiree is rising. Japan has the highest ratio of debt to GDP in the developed world. And that debt is growing by 7-8% a year, and does not include local debt. Interest rates cannot go lower. Savings are falling rapidly and will not be able to cover the need for new debt issuance, by a long shot. Within a few years, because of the aging of the population, savings will go negative. Social security payments are rising. GDP is shrinking, and export trade is off about 30-40%, depending on the industry. Machine tools are down 80%!
If rates were to go up by 1%, let alone 2%, over time Japan's percentage of tax revenue dedicated to interest payments would double to 18% and then to 40% and then just keep going up. It is conceivable that it will take 100% of tax revenues in less than ten years, at the current trajectory. Why? Because Japan is going to have to start to compete with the rest of the world to sell its bonds. Who but the Japanese would buy a Japanese bond at 1.3%? From a country that is rapidly going to 200% of debt-to-GDP? Doesn't really seem like a smart trade to me. And as the data shows, the ability of the Japanese consumer to buy more debt is rapidly waning.
The Japanese government is coming to a crossroads with no good exits. Cut the budget drastically in the face of a deflationary recession? Monetize the debt and let the yen go the way of all fiat currencies? Can someone say Zimbabwe? Increase already high taxes in a very weak economy?
And yet the yen has been getting stronger over the last month. It is now at 92 to the dollar, up from 120 just two years ago. Why would a country with such bad fundamentals have such a strong currency? Shouldn't the yen be a screaming short?
Let me offer two speculations that are mine alone. First, it is well-known that the Japanese are very involved in the reverse carry trade. That is, since they can't find yield in Japan, they convert to another higher-yielding currency for income. So, maybe the retirees actually need to spend some of that money they have outside of Japan to live, so they have to convert to yen.
Second, Japanese corporations are getting hammered. Could it be that they are bringing yen home to pay for current transactions like rent and payroll? Japanese corporations dependent on exports desperately need the yen to fall, yet the central bank can't seem to engineer a falling yen. I wrote about five years ago that the Japanese Central Bank has to rank as one of the most incompetent of all central banks, because they can't even destroy their own currency.
But I think the central bank is going to figure it out. If they do not monetize the debt, rates will have to rise over time (say the next 2-3 years), and that is most definitely a problem. Monetizing the debt would mean the yen would fall in value, which is something they actually want to happen. How much monetization? When? I don't know, and I doubt they do. If I were the head of the central bank or the government, I would not sleep easy.
Japan is the second largest economy in the world. There is a rule in economics: "If something can't continue, then it won't." Japan can't continue down this path. All the trends are going against them. Sadly, Japan is going to hit the wall, maybe some time in the next few years. This will be very bad for the world, as they have financed much of Asian growth. They do in fact buy a lot of world goods, and their buying power is going to fall. This is going to mean fewer US and European jobs. Not to mention fewer jobs in the countries that are Japan's neighbors.
And unless we change things in the US, this will be us in less than ten years. As in hit the wall, serious depression, etc. I am hopeful that we can actually get our act together. But then I am an eternal optimist.
Buddy, Can You Spare $5 Trillion?
I have been writing for months that I don't think the US can find $2 trillion dollars this year and then come back to the well for another $1.5 trillion next year without serious disruption in the markets. Where do you find that much money when all the rest of the world also wants to borrow massive amounts? How much are we talking about? The friendly folks at Hayman actually spent the time to add it all up. This is not a comforting graph.
The graph shows the US will need to issue $3 trillion in debt. "Wait," I asked, "I thought it was only 1.85" The answer is that the number has grown to almost $2 trillion (as I wrote it would). Then you need to add in off-budget items like TARP, state and municipal debt, etc. Pretty soon it adds up to another trillion. All told, Hayman estimates that the world will need to find $5.3 trillion in NEW government financing. Never mind the needs of corporations or individuals or commercial mortgages, etc.
I am still trying to get my head around this. Let's hopefully assume that they made a mistake and it is "only" $4 trillion. Where do you find that kind of money in a global deleveraging recession?
The World Bank says that total world GDP in 2008 was $60 trillion (http://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP.pdf).
That means we need to find almost 9% of world GDP to fund the new government debt. Gentle reader, this is a serious problem. And now the next chart. Remove sharp objects or take another drink.
This one is titled "The Potential Shortage of Capital to Fund Treasuries." They take into account the need for corporate borrowing, new corporate equity issuance, real estate debt, capital inflows and outflows, household savings, etc.
Bottom line? There is simply not enough available capital under current conditions to do it all. Something has to give. More household savings? More foreign investment (flight to safety, as the rest of the world looks even worse)? Reduced corporate borrowing and thus less GDP growth? Higher rates to attract more foreign and US investment?
The combinations are infinite, but none of them bode well. Increased household savings means less consumer spending. To attract more foreign investment (in the amounts that will be needed) will mean higher rates. And this is 2009. What happens in 2010? And 2011?
One trillion dollars is 7% of US GDP. And we will be running trillion-dollar deficits for a very long time.
Just a thought: Do you want to be a senator or congressman running for office next year with unemployment nearing 11% (my estimate), with all of the problems mentioned above, and with a record of having voted for the largest unfunded deficits in history? It is going to be a very interesting election cycle.
I will close here, as going into the next slides will make the letter way too long, but we will get to them next week. As a teaser, they asked me what my number-one concern was. I said Europe and European banking. Interestingly, that was also their number-one concern for "exogenous" risk. It will make a great launch for next week's letter.
Japanese Opposition Party Wants To Dump Dollar Too
from Bloomberg:
July 13 (Bloomberg) -- Japan’s opposition party, leading in polls ahead of next month’s election, said the nation should consider shifting its $1 trillion of foreign reserves away from the dollar and buying International Monetary Fund bonds.
“In the medium to long term, we need to do what we can to avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing,” Masaharu Nakagawa, the shadow finance minister in the Democratic Party of Japan, said in an interview in Tokyo on July 9. “Many countries are starting to diversify their reserves.”
Japanese investors are the biggest foreign holders of Treasuries after China with $685.9 billion of the securities in April, and Finance Minister Kaoru Yosano said last month his trust in the bonds is “unshakable.” The DPJ yesterday beat the ruling Liberal Democratic Party in elections for Tokyo’s city assembly, boosting its prospects ahead of national polls that Prime Minister Taro Aso today called for Aug. 30.
“The current reality of Japan’s foreign-currency reserves is that their heavy weighting toward dollar assets means any fall in the dollar’s value leads to valuation losses,” said Susumu Kato, chief economist in Tokyo at Calyon Securities, the investment banking unit of Credit Agricole SA. “The DPJ is opposed to a foreign-currency reserve policy that is so wholly skewed to the dollar.”
Yen Is Barometer of Risk Aversion
The yen is often seen as a global barometer of risk aversion. The graph below demonstrates the strong inverse relationship between the movements of the yen (against the euro, in this case) and those of the Dow Jones World Index. As shown, a falling yen indicates risk tolerance (and a willingness to buy risky assets) and a rising yen shows risk aversion (and an indisposition towards risky assets). A downturn in the yen exchange rate could be a good indicator to keep an eye out for confirmation of better times ahead for stocks and commodities.
Richard Russell: "Bailouts Stink to High Heaven"
“The whole bailout campaign stinks to high heaven. It was created and run by Wall Street - FOR Wall Street. Again, I say, personally, I wouldn’t have lifted a finger to bail Wall Street out. Let all these Wall Street thieves stew in their own toxic juices. Thieves should be out on the street or in jail, not luxuriating in government bailout money.
“In the end, the bailouts will simply extend the bear market in stocks and the economy. The Wall Streeters will be richer, and the nation will be poorer, choking on trillions in debt that will keep future generations struggling to deal with the sins of Wall Street. Too bad Obama didn’t have the courage (or knowledge) to tell the nation what was going on. Obama should have said, ’sit tight’ and ‘this too shall pass’. Unfortunately, after the trillions spent in bailouts, ‘this too will not pass’.
Baltic Dry Index Turning Bearish Again
I noticed that the shipping index ETFs have been amongst the most bearish of all over the past month or so.
from the Daily Telegraph:
“Port statistics are revealing. They were a leading indicator before the production collapse in the Japan, Europe, and the US over the winter, and they may be telling us something again.
“Amrita Sen at Barclays Capital says the number of Baltic Dry ships waiting to berth - mostly in China and Australia - has begun to fall after peaking at 154 in mid-June.
“The Capesize Iron Ore Port Congestion Index is replicating the pattern seen a year ago just before the commodity boom tipped over.
“‘The anecdotal evidence we are hearing is that vessel queues have been falling. There are reports of cancelled tonnage from China pointing to a slowdown in Chinese buying of coal and iron ore.
“‘We are definitely expecting a correction. People have been building stocks of iron ore too quickly in anticipation of the stimulus package in China,’ she said.
“The Baltic Dry Index measuring freight rates jumped 450% in the first half of the year on the China rebound, but has begun to fall back over the last two weeks. (Sen doubts freight rates will recover much since 1000 new ships are hitting the market this year and again next year, compared to 300 in normal years. There is obviously a horrendous shipping glut).”
Debt Explosion Coming
“In a 2003 paper, Thomas Laubach, the US Federal Reserve’s senior economist, calculated the impact on long-term interest rates of rising fiscal deficits and soaring national debt. Applying his assumptions to the recent spike in the US fiscal deficit and national debt, long-term interests rates will double from their current 3.5%.
“The impact would be devastating by making it punitively expensive to finance national borrowings and leading to what Tim Congdon, founder of Lombard Street Research, called a ‘debt explosion’. Mr Laubach’s study has implications for the UK, too, as public debt is soaring. A US crisis would have implications for the rest of the world, in any case...
“Should the cost of raising or refinancing public debt in the markets double, ‘the debt could just explode’, he said, adding that it would come to a head in ‘five to 10 years’.”
Roubini: Brown Manure, Not Green Shoots
“The June employment report suggests that the alleged green shoots are mostly yellow weeds that may eventually turn into brown manure. The employment report shows that conditions in the labor market continue to be extremely weak, with job losses in June of over 460,000. With the current rate of job losses, it is very clear that the unemployment rate could reach 10% by later this summer - around August or September - and will be closer to 10.5%, if not 11%, by year-end. I expect the unemployment rate is going to peak at around 11% at some point in 2010, well above historical standards for even severe recessions.
“It’s clear that even if the recession were to be over anytime soon - and it’s not going to be over before the end of the year - job losses are going to continue for at least another year and a half. Historically, during the last two recessions, job losses continued for at least a year and a half after the recession was over. During the 2001 recession, the recession was over in November 2001, and job losses continued through August 2003 for a cumulative loss of jobs of over 5 million; this time we are already seeing more than 6 million job losses and the recession is not over.
“The details of the unemployment report are even worse than the headline. Not only are there large job losses right now, but as a way of sharing the pain, firms are inducing workers to reduce hours and hourly wages. Therefore, when we’re looking at the effect of the labor market on labor income, we should consider that the total value of labor income is the product of jobs, hours and average hourly wages - and that all three elements are falling right now. So the effect on labor income is much more significant than job losses alone.”
Job Loss Numbers Worse Than Depicted
“Net of the Concurrent Seasonal Factor Bias and net of distortions built into the reporting by the Birth-Death Model, the June jobs loss likely exceeded 700,000.
“John Williams (Shadow Government Statistics) on the goofy B/D Model: ‘The system was not designed to accommodate recessions, but the benchmark revisions tended to show a pattern of fairly consistent overstatement with the annual revisions, regardless of the business cycle. During the reporting cycle covering the 1990 to 1991 recession, a particularly large downward benchmark revision in previously reported payrolls levels was blamed partially on the BLS assuming that companies that had stopped reporting during the recession still were in business, with proportionate payroll employment attributed to them by the BLS. The problem was that much of the non-reporting reflected companies going out of business. The bulk of that modeling was based on periods of economic growth.
“‘The unadjusted annual decline in June payrolls was the deepest since a similar decline at the trough of the 1958 recession, but still shy of the 4.9% trough seen in the 1949 downturn. When the 1949 annual low growth is broken, possibly next month, the annual percentage contraction in payrolls will be the most severe since the production shutdown following World War II.’”
HELOC Deliquencies Still Rising
from Bloomberg:
“Late payments on home-equity loans rose to a record in the first quarter as 18 straight months of job losses and a slumping economy left more borrowers unable to pay their debts, the American Bankers Association reported.
“Delinquencies on home-equity loans climbed to 3.52% of all accounts from 3.03% in the fourth quarter, and late payments on home-equity lines of credit climbed to a record 1.89%, the group reported today. An index of eight types of loans rose for a fourth straight quarter, to 3.23% from 3.22% in October through December, the group said.
“‘The number one driver of delinquencies is job losses, which we’ve seen build and build,’ James Chessen, the group’s chief economist, said in a telephone interview. ‘Delinquencies won’t come down without a dramatic improvement in the economy and businesses will have to start hiring again.’”
Commercial Real Estate Continues to Degrade
from Bloomberg:
“Commercial properties in the US valued at more than $108 billion are now in default, foreclosure or bankruptcy, almost double than at the start of the year, Real Capital Analytics said.
“There were 5,315 buildings in financial distress at the end of June, the New York-based real estate research firm said in a report issued today. That’s more than twice the number of troubled properties at the end of 2008.
“Hotels and retail properties are among the most ‘problematic’ assets following bankruptcy filings by mall owner General Growth Properties and Extended Stay America, according to the report. The scarcity of credit is causing property defaults in all regions and among every investor type, Real Capital said.
“‘Perhaps more alarming than the rapid growth in the distress totals is the very modest rate at which troubled situations are being resolved,’ the report said.
Sunday, July 12, 2009
Richard Russell: "Sorry, President Obama,You Are Wrong"
from Richard Russell, one of the most experienced and longest-running veterans on Wall Street:
Richard Russell (Dow Theory Letters): March lows to be tested
“I’ve given this next statement a lot of thought. I don’t think most analysts understand the amazing power and tenacity of the great primary trend of the market. Most of today’s analysts have had no experience with bear markets. We’re now in a primary bear market. Most people believe that if the government or the Fed does this or that, the bear market can be halted or reversed. Nothing could be further from the truth.
“The fact is that in the market, nothing is more powerful or insistent than the great primary trend. The primary trend can best be compared with the tide of the ocean. All man’s efforts to thwart or turn the tide are like so many sand castles built on the edge of the nearest waves. The incoming tide will wash all the sand castles away, if not with the first wave then with the second or the third. Thus, the incoming tide will conquer all.
“This is why all of Obama’s and Bernanke’s and Geithner’s ’sand castles’ will be washed away by the bear market. All that will be left will be crippled corporations and monster debts.
“Obama believes that Roosevelt with his spending and alphabet agencies ended the Great Depression. Sorry, President Obama, you are wrong. The Great Bear market and Depression finally ended when the bear market died of exhaustion on July 8, 1932. That was the day when the D-J Industrial Average halted its decline at Dow 41.22. At that time, the Dow provided a dividend yield of 10.2%. That’s when the bear market actually ended. It ended the way all bear markets do - in utter exhaustion.
“On another subject, I’ve felt all along that the government and the Fed should have allowed this bear market to run its course, rather than wasting trillions of dollars in an attempt to halt the bear market. Perhaps politically, this would have been impossible, but in the end it would have been better for the nation.
“Accordingly, although I certainly do not want to see the March lows violated, my studies suggest that the odds favor an eventual breaking of the March lows and then a much lower bear market.
“Sorry, those are my deepest and most truthful thoughts.”
Grains Open Stronger, Then Sag on Firmer Dollar
US Dollar Index
Grains (wheat slightly higher, corn and soybeans both opened higher, then dropped below Friday's close)
Stocks Sink Below Previous Week's Lows
In Sunday evening trading, stock index futures have continued to sink to new lows, breaking through last week's lows on Wednesday, July 8th, and Friday, July 10th. I wouldn't be surprised to see a bounce off those lows, with low overnight trading volume, but it doesn't bode well for the direction of the stock market.
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