Trade Deficit Explodes, GDP Revisions Sharply Lower

The recent Obama initiative to push exports to double in 5 years has started off, just like all other administration efforts, as an abysmal failure. The June balance of trade plunged to ($49.9) billion, on expectations of ($42.1) billion - a surge of $8 billion compared to May's ($42) billion. This number was the highest since October 2008, and just $28 billion away from the all time record. At least we now know who the mystery "importer", that extracted Europe from the economic abyss, was in the past 3 months. And courtesy of the Current Account equation, what this surge in deficits means is that Q1 GDP will now likely be revised to well under 1.0%! As JPM reported earlier, revision in BEA assumptions on wholesale and non-durable inventory alone will push Q1 GDP from the official 2.4% to 1.3%. Today's data is the last nail in the Q2 GDP number, and according to analyst will take out another 0.4% from the GDP, meaning that when all is said and done, Q2 GDP will come out to sub-1%. And this was in a quarter when the stimulus was still expected to be boosting GDP. We now fully expect that the final reports of Q3 and Q4 GDP, some time in 2011, to be solidly negative, as the economy is now officially contracting once again. In other words, the Double Dip is (even more) official.

Headlines Foretell Ugly Open

The Fed's QE program didn't convince Wall Street. I'm sure Main Street won't be very convinced either!

from Fox Business:
Futures were down sharply Wednesday as Wall Street continued to react to the Federal Reserve's downgrade of its forecast for the U.S. economy along with disappointing economic data out of Asia.

The Federal Reserve at its Tuesday policy meeting warned the economic recovery that had started in Summer 2008 had waned and "the pace of economic recovery is likely to be more modest in the near term than had anticipated."

And while the Fed announced it was taking some additional stimulus measures by purchasing treasuries in the two-year to 10-year range keep yields low, the fear among investors remains the possibility of a double-dip recession.

Fed Announcement: More QE

Hint From Buffett: Prepare for Inflation!

BREAKING! Not every major investment guru is walking further out on the yield curve in a bet on deflation.
Bloomberg:

Twenty-one percent of holdings including Treasuries, municipal debt, foreign-government securities and corporate bonds were due in one year or less as of June 30, Omaha, Nebraska-based Berkshire said in a filing Aug. 6. That compares with 18 percent on March 31, and 16 percent at the end of last year’s second quarter.

The report goes on to speculate that this may be a reaction to heightened inflation expectation, which would be in violent disagreement with the cool-kid investors these days, who are almost uniformly deflationistas these days.
But Buffett has maintained a fairly standard-issue stance on the subject.
Back to Bloomberg:

Buffett, 79, urged Congress last year to guard against inflation as the U.S. economy returned to growth. In an August 2009 op-ed in the New York Times, the Berkshire chief executive officer said government must address the “monetary medicine” that was pumped into the financial system after the 2008 crisis.

“The United States is spewing a potentially damaging substance into our economy -- greenback emissions,” Buffett wrote. “Unchecked greenback emissions will certainly cause the purchasing power of currency to melt.” Buffett didn’t return a message for comment left with an assistant.

For what it's worth, Buffett may have other ideas in mind, including a move towards liquidity and stability, and if he's made a ton of money betting on long-bonds, then it makes sense to take something off the table. Still, it's an interesting shift.

Read more: http://www.businessinsider.com/buffett-shortens-bond-portfolio-duration-2010-8#ixzz0wE6JV23f

Declining Domestic Demand in China

HONG KONG (MarketWatch) -- Chinese shares suffered their worst fall in more than a month on Tuesday as weaker-than-expected July imports data raised concern that consumption on the mainland was slowing. The Shanghai Composite dropped 2.9% to 2,595.27, it worst percentage fall since June 29, while the Shenzhen Composite index tumbled 3.3% to 1,085.63.

Dollar Reverses, Takes It On the Chin Following Fed Statement

OECD Leading Indicators Turn Negative

Latest OECD Composite Leading Indicators are out (here) – with the June data slipping into the red indicating according to the OECD “a possible peak in expansion”.

‘Possible peak’?  Looks pretty much like it is a near certainty.  With Europe yet to feel the effects of the communal belt tightening and the US struggling to come to terms with its deteriorating government balance sheet, the economic momentum is favouring the downside.

Why Quantitative Easing Is Bad Policy

from Aleph blog:
The world’s largest hedge fund, the Federal Reserve, is trying to decide whether it should expand its operations.  Unlike most hedge funds, the Federal Reserve has a big advantage in that it can fund itself cheaply, and for the most part, at its own discretion.

• Unlike most hedge funds, it issues 0-day 0% Commercial Paper, which is accepted almost everywhere as a means of completing transactions.
• Banks affiliated with them must place reserves with the Fed, on which they earn interest of around 0.25%
• The affiliated banks, not finding as many opportunities as they would like to lend privately on a risk-adjusted basis, leave more money than they have to at the Fed, again earning about 0.25%.

What a cheap funding base.  They can buy almost any asset and make money, so long as equity/credit risk is limited, and so long as the yield curve doesn’t hit new records for steepness.  Given that the Fed does not have to mark most of its positions to market, and does not have to worry about margin calls in the conventional sense of the term, they make money year after year, and hand most of the profits over to the US Treasury, which keeps accounts for the Fed’s main owner, the US Congress.
Life is tough when you have to serve multiple conflicting interests.

• They demand that you create conditions for full employment, something beyond your control.
• They ask that you restrain inflation, which is possible.
• They ask that you lend, because the banks affiliated with you are not lending, and an increase in lending is always a good thing, right?

So, like Keynes, the fools that think that a lower rate of interest is always better urge that the Federal Reserve should expand its balance sheet and buy up more Treasuries, Agencies and Agency MBS, forcing rates lower.  What good can come from forcing high-quality long rates lower?
My answer is, not much.  Existing debts if non-callable, will be worth more.  If debtors are solvent, and can refinance, they  can lower their debt service costs, though that is a minority of borrowers.  Beyond that, it will lead the favored debtors to borrow more — Treasury, Fannie, Freddie, etc.  We need more borrowing, right?
But a greater effect can be the speculative frenzy engendered by dropping the rate that savers earn to such a low level, leading them to invest more aggressively to meet their income targets.  As with any other sort of speculation, the game is over when people rely on the occurence of capital gains.
I think quantitative easing is a mistake; I also think it does not help matters much.  It transfers resources from creditors to debtors in a funky way.  That is not the right way to go if you want a country to grow.  (Which, contrary to the received wisdom, would mean that raising short term rates would be better for the US and Japanese economies than engaging in quantitative easing.  There would be short-term pain, but there will be pain regardless of how this policy is conducted.)
If the Fed makes a bow in the direction of quantitative easing on Tuesday, such as reinvesting the proceeds of MBS in more MBS, the markets will rally, but I would fade it, because it will have no long-term beneficial  impact on the economy.
There is no free lunch.  Any action that seems to cost nothing on the part of the Fed or the Federal Government will have no long-term effect on the economy.  Quantitative easing is one of those comforting fairy tales that is a fraud, whether intentionally so, or not.

How to Invest During Deflation

First, the good news: all those fears about runaway inflation following from the massive injections of capital into financial markets appear to have been overblown. Now for the bad news: the alternative may be much worse.
For months wary investors have been eagerly watching CPI reports, fearful of the release indicating that price increases are beginning to accelerate, presumably spiraling out of control in the not-so-distant future. But instead of racing towards the double digits, CPI figures have slipped closer and closer to negative territory. That has sparked fears of deflation, a rare but serious economic condition that has some of the world’s most prominent investors legitimately concerned.
PIMCO chief Mohammed El-Erian recently told Bloomberg that the U.S. faces a 25% chance of deflation and a double-dip recession. “I do not think the deflation and double-dip is the baseline scenario, but I think it’s the risk scenario,” said El-Erian. Jan Hatzium of Goldman Sachs, another in a growing group of “deflationistas,” sees CPI increases near zero in the near future and views a decline in prices as a very real possibility. Hatzius contends that the deleveraging process is still in the early stages, and notes that the tremendous amount of spare capacity in the U.S. economy will make it difficult for companies to raise prices (thereby increasing the risk of deflation).

What’s So Bad About Deflation?

With all the talk about deflation, there is some confusion among investors as to why such a scenario would be a negative economic development. In periods of rising prices consumers see their discretionary income decline; as a greater percentage of income is spent on food, gas, and other staples, there is less room available in the budget for electronics, vacations, and other luxuries. So some view deflation as a positive; when prices are falling, their dollars will go further.
From a higher level macroeconomic perspective, however, deflation can be devastating. When prices are falling, consumers are likely to delay purchases, waiting for costs to slide further before making a cash outlay. In a deflationary environment, sitting on a pile of cash becomes an attractive investment option with a positive real yield; the prospect of investing that money becomes rather unappealing. Moreover, borrowing money becomes undesirable because any loan will have to be repaid in dollars that are worth more than the dollars borrowed.
There are other reasons why deflation is generally an unwanted development. Falling prices increase the burden of debtors. Finally, when prices are falling wages often decline too–either in the form of nominal cuts or upticks in unemployment. James Stewart summed up the risk of deflation nicely in a recent WSJ column:

Maybe deflation would be a nice thing for people with secure, steady incomes. But deflation erodes profits and asset values. People wait to buy expecting lower prices, reducing demand. Lower profits cause companies to cut expenses, including employees. It is a downward spiral that, if Japan’s experience is any indication, is difficult to arrest.

ETF Ideas For Combating Deflation

For investors looking to add some “deflation defense” to their portfolios, there isn’t necessarily a silver bullet that will thrive as prices slide. But there are a number of options that tend to perform relatively well:

1. Long-Term Bonds

Deflationary environments are generally bad for stocks, since profits tend to decline as prices fall. But deflation can be good news for fixed income investors. That’s because of the implications of the “fixed” part of the asset class name; as prices slide the real value of fixed coupon payments rises. In general, longer duration securities will perform better in deflationary environments, since the coupon payment is locked in for an extended period of time. Using the ETF Screener to identify long-term bond ETFs yields a number of results:

• iShares Barclays 20+ Year Treasury Index Fund (TLT)
• Vanguard Long Term Corporate Bond ETF (VCLT)
• Market Vectors Long Municipal Bond ETF (MLN)

Zero coupon bonds, known as “strips,” can provide solid returns if deflation kicks in; these securities allow investors to lock in fixed rates and reinvest at those rates. PIMCO’s 25+ Year Zero Coupon U.S. Treasury Index Fund (ZROZ) is the best option for establishing exposure to this corner of the government bond market.

2. Dividend-Paying Equities

Some investors embrace equities of companies that make significant dividend payments as an alternative means of protecting against deflation; the dividend payments made by these securities are similar to the coupon payments made by bonds. Because most companies seek to avoid reducing dividend at all costs, dividend streams are unlikely to dry up unless equity markets enter into a severe depression. There are a number of ETFs that focus exclusively on companies that offer the most attractive dividend yields; some of the most popular include:

• Claymore/Zacks Dividend Rotation ETF (IRO)
• PowerShares Dividend Achievers Portfolio (PFM)
• First Trust Dow Jones Global Select Dividend Index Fund (FGD)
• iShares Dow Jones Select Dividend Index Fund (DVY)
• SPDR S&P Dividend ETF (DWX)
• WisdomTree’s suite of dividend-weighted ETFs

[see How To Find The Right Dividend ETF for a more complete list].

3. Cash

In deflationary environments, cash is king. Even when the yield is close to zero, the purchasing power of a dollar increases as prices slide. For investors looking to part assets in a low risk security that essentially strives to achieve capital presentation, there are some interesting ETF options. Currently, there are six ETFs in the Money Market ETFdb Category, including:

• PIMCO Enhanced Short Maturity Fund (MINT)
• Barclays Short Treasury Bond Fund (SHV)
• SPDR Barclays Capital 1-3 Month T-Bill ETF (BIL)

4. Inverse ETFs

Because deflationary environments are bad for equities, some more risk tolerant investors may be intrigued by the idea of establishing short exposure to stock markets. The funds in the Inverse Equities ETFdb Category offer a way to short most major indexes, including both domestic and international benchmarks:

• ProShares Short S&P 500 (SH)
• ProShares Short Russell 2000 (RWM)
• ProShares Short MSCI EAFE (EFZ)

Another interesting idea is short exposure to commodities; natural resources are always vulnerable to falling prices. There are a number of funds in the Inverse Commodities ETFdb Category, including

• PowerShares DB Agriculture Short ETN (ADZ)
• PowerShares DB Base Metals Short ETN (BOS)
• PowerShares DB Commodity Short ETN (DDP)

5. Other Ideas

In addition to the general ideas outlined above, there are some other intriguing ETF ideas for deflation protection. Most investors view IndexIQ’s CPI Inflation Hedged ETF (CPI) as an inflation hedge, but because this ETF seeks to generate a “real return” above the CPI, it can be a valuable tool in deflationary environments. There’s also the volatility ETNs from iPath; the S&P 500 VIX Short-Term Futures ETN (VXX) generally exhibits a strong negative correlation with equity markets. Because deflation is bad news for stocks, it may give VXX a boost.
Again, none of the funds profiled above are surefire solutions to deflation; the economic conditions that often accompany falling prices can be complex, and can have unpredictable impacts on financial markets. But for investors looking to protect against deflation, they may be worth a closer look.

Marc Faber: Fed Is Committed to Inflation

If Marc Faber had to choose one asset class for the next 10 years it woud be gold. Cash and US treasuries would be be his least preferred decennial investment. US equities would be a reasonable choice for wealth protection, though not necessarily grow much when adjusted for inflation.
This was the broad message that the author of The Gloom, Boom and Doom Report delivered to a CPA Institute meeting last night in Abu Dhabi, home of the world’s biggest sovereign wealth fund the Abu Dhabi Investment Authority.
No deflationary bust
He began by explaining why extreme deflation scenarios are extremely unlikely under the Bernanke Fed, comparing the Fed chairman’s commitment to an anti-deflation strategy to Hitler’s Mein Kampf, a book that also clearly stated a policy program in advance but was not widely believed until it was too late.
Likewise Dr Faber believes Mr. Bernanke is committed to printing money and will in any case have very little choice because of entitlements and the US constitution. Thus he could see the S&P 500 dropping back from current levels to say 950 in this autumn but by then Fed monetary policy would be strongly inflationary and bring the market back up.

Inflation is easy to create except when you really need it!

Choppy Pre-Fed Announcement Trading, Stocks Down

I just noticed that stocks have traded sideways for the past five days. I suspect that this is all in anticipation of a much-awaited Fed statement this afternoon. Perhaps we'll see a relief rally at that time. Trading is very choppy right now, and difficult to predict.

Finally a Dollar Rally!

I know of no fundamental reason why this is happening.

NEW YORK—The dollar rallied broadly as investors abandoned currencies closely tied to the pace of global economic growth after a report indicated slowing domestic consumption in China ahead of a Federal Reserve statement on the future path of U.S. monetary policy.
Investors turned to the perceived safety of the dollar ahead of the afternoon meeting of the Fed's rate-setting committee, which could announce on Tuesday new measures to stimulate a sagging U.S. economy.
"The old adage 'better safe than sorry' definitely applies," said Dan Cook, senior market analyst at IG Markets in Chicago of investors fleeing riskier currencies.

U.S. Productivity Collapses

WASHINGTON (MarketWatch) - Productivity of the U.S. non-farm business sector fell at a 0.9% annual rate in the second quarter from a 3.9% gain in the first quarter, the Labor Department estimated Tuesday. Economists were expecting productivity to decline 0.4% in the second quarter. Output increased at a 2.6% annualized rate while hours worked rose 3.6% in the second quarter. Unit labor costs - a key inflationary signal - rebounded at an annual rate of 0.2% in the second quarter after a sharp 3.7% decline in the first quarter. Real hourly compensation was flat. On a year-on-year basis, productivity slowed to a 3.9% increase after a 6.3% rate in the first quarter.

U.S. productivity unexpectedly fell in the second quarter, the first drop in 18 months, amid slower output growth and an increase in labor costs.
Separately, wholesalers' inventories rose in June far less than expected as sales fell, a strong indication that businesses think the economic recovery is tapering.

Obama - A Modern-Day Ancien Regime

Washington Examiner: Time to Admit Obamanomics Has Failed

No kidding! What took America so long? Collectivism always fails! Progressivism, socialism, or whatever "ism" they are calling it this week has destroyed every civilization it has ever touched! But fools keep trying to make it work! Collectivism fails because it is based upon false principles, not because it was implemented incorrectly! Obamanomics is only its latest iteration of economic ugliness!

Dollar Perched On the Abyss

from WSJ:

With the U.S. recovery clearly faltering, the dollar appears likely to go only one way against its major competitors: down.
Friday's nonfarm payrolls data for July came in well below economists' estimates. The release is the most glaring setback in a recent string of reports that cast further doubt on the strength of the recovery in the world's biggest economy for the second half of 2010.
The chances the Federal Reserve will deploy new measures to support the economy—mere murmurs at midweek—have increased. Tuesday's rate decision and accompanying statement will take center stage in framing investor sentiment toward the greenback.

Michelle Antoinette!

"Let them eat cake, anyone?"

Zero Hedge Digs Deeper Into Jobs; Real Rate At 14.7%

When it comes to pointless (and bullish) reversion to the mean exercises,it seems nobody has a problem with saying stocks have to go back to 1,500 just because that's where they were, and the unemployment rate has to go back to 5% cause that's how we know the Fed is the immaculate and flawless piece of art it is, and always gets things under control to near-peak efficiency. Well, here at Zero Hedge we (again) decided to take the reversion to the mean approach and flip it, instead applying it to a deteriorating indicator, the labor force participation rate. The first chart below demonstrates the LFP rate, which a derivative of the chart we presented earlier, has now plunged to the lowest level in over 25 years, or 64.6% (gotta go back to December 1984 for the first time this was passed). So we decided to "normalize" the LFP by keeping it at the peak achieved at the turn of millennium, or December 1999, when it hit a peak of 67.1%. Now as everyone knows the US population has been soaring since then, and with the cost of living increasing ever more with each day, and as more and more family members are forced to join the work pool, it makes sense that in a normal economy, the LFP should continue rising instead of declining. We thus kept it constant at the 67.1% level (instead of doing the conservative thing and pushing it higher along the trendline), and ran the unemployment numbers through, assuming this part of the jobless equation was constant. To our surprise, we found that the U-3 rate (not the U-6), which today was supposed to be 9.5%, in fact turns out to be 13.0% as of July: an all time record save for the 13.6% recorded in December 2009. And if instead we use the trendline number of a 68.5% LFP rate, the unemployment rate today would be 14.7%. In retrospect we sympathize with Christina Romer's decision to get the hell out of Dodge. 
Reported and adjusted labor force participation rate:

Running these numbers through the actual unemplyment calculation, reveals the following: while assuming a declining LFP rate we obviously get the 9.5% unemployment rate, assuming a peak 67.1% LFP results in a 13.0% unemployment rate. And if the labor force participation rate were to grow according to trendline, the jobless rate in the US today would have been reported at 14.7%, just about where the U-6 was reported, but based on an entirely different methodology.

Further Analysis of Jobs Shows Deeper Bad News

from Reuters:

(Reuters) - Friday's employment report provided an odd mix of unpleasant surprises that add another question mark to the pace of economic recovery.
Companies cut back on temporary hires, a segment normally considered a harbinger of future hiring. Government jobs dried up much faster than anticipated and not just because it saw the end of short-term census jobs.
The jobless rate held steady at 9.5 percent, defying expectations for a slight increase, but that was only because thousands more people dropped out of the labor force.
* Temporary jobs dropped by 5,600, reversing a streak of strong gains that economists had viewed as a hopeful sign that hiring would pick up.
* Normally, companies load up on temps at the beginning of a recovery when they are waiting for confirmation that growth is gaining momentum. This recovery has been unusual in that temporary hiring did not herald a jump in private hiring.
* Private hiring totaled a lackluster 71,000 in July, below expectations for 90,000 in a Reuters poll. June's tally was revised down to just 31,000 from an initially reported 83,000.
* Government hiring was another worrisome sign. The loss of 202,000 positions reflected the loss of 143,000 temporary Census jobs.
* The total also included 38,000 jobs lost in local government. For most municipalities, the fiscal year began on July 1, and government associations have been warning that huge budget gaps would force aggressive job and spending cuts. July's report suggests local governments got a quick start.

Note that temp jobs, which are a leading indicator, are also slowing appreciably!
and WSJ:
One worrisome sign from Friday's report: Temporary-help jobs, typically a leading indicator for the rest of the labor market, fell in July. Temporary employment declined 5,600 after nine straight months of growth.
Public reports from the largest staffing firms still show growth in the temporary sector.
The government's figures would suggest "momentum has slowed dramatically," says Adecco's Mr. Gilliam. "If that's the case and that's where we're going for the next couple of months, it suggests a step back in the job-market recovery."
A weak labor market will keep incomes—and consumer spending, which accounts for 70% of U.S. economic output—under pressure. The Fed said Friday that consumer credit declined at a 0.7% annual rate in June as consumers continued to pay down debt. Revolving credit, which is mostly credit-card borrowing, fell at a 6.5% rate, the Fed said.
About 6.6 million people were jobless for more than 27 weeks in July, accounting for 44.9% of all unemployed. Workers who are finding positions after long searches are taking pay cuts to make ends meet.