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AUGUST 2012: GLOBAL MACRO TIPPING POINT - (Subscription Plan III)

MONETARY MALPRACTICE : BIS & IMF Issue warnings to Global Central Bankers

As we reported last month, Global Economic Risks have taken a noticeable and abrupt turn downward over the last 60 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggested the global economic condition is at a Tipping Point. Though we stated "Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses" nothing has occurred even after the 19th disappointing EU Summit to address the EU Crisis. Some event is soon going to push the global economy over the present Tipping Point. The IMF recently warned and reduced Global growth to 3.5%. This is just marginally above the 3% threshold that marks a Global recession. This would be the first global recession ever recorded.

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AUGUST 2012: MONTHLY MARKET COMMENTARY (Subscription Plan II)

MONETARY MALPRACTICE : Moral Hazard, Unintended Consequences & Dysfunctional Markets - Monetary Malpractice has had the desired result of driving Investors into becoming Speculators and are now nothing more than low-odds Gamblers. There is a difference between investing, speculating and gambling. At one time these lines were easy to comprehend and these distinctive groups separated into camps with different risk profiles in which to  seek their fortunes. Today investing has become at best nothing more than speculating and realistically closer to outright gambling.

The reason is that vital information is either opaque, hidden or manipulated. Blatant examples such as: the world of off balance sheet debt, Contingent Liabilities, Derivative SWAPS, Special Purpose Vehicles (SPV), Special Purpose Entities (SPE), Structured Investment Vehicles (SIV) and obscene levels of hidden leverage make a mockery out of public Financial Statements. Surely if we get our ego out of this for a moment we can see that stockholders are now nothing more than gamblers? What is worse is that the casino is rigged. With Monetary Policy now targeting negative real interest rates, it is forcing the public out of interest bearing savings and investing, and into higher risk vehicles they would have shunned historically. They have no choice as the Monetary Malpractice game is played against them.

There is an old poker player adage: "when you look around the table and can't determine who the patsy with the money is, it is because it is you." MORE>>

MARKET ANALYTICS & TECHNO-FUNDAMENTAL ANALYSIS

AUGUST 2012: MARKET ANALYTICS & TECHNICAL ANALYSIS - (Subscription Plan IV)

The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops.  This is all part of a final topping formation and a long term right shoulder technical construction pattern.  - The "Peek Inside" shows the detailed coverage available this month.

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	PART I - Understanding FINANCIAL REPRESSION
	PART II - FINANCIAL REPRESSION in Europe
	PART III - FINANCIAL REPRESSION in the US & ASIA
	PART IV - Preparations for FINANCIAL REPRESSION

Password: macro

DEBT MATURITY WALL - ECB Just Making It Worse

The "Maturity Crunch"

Central Bank Policy Implementation and the ECB's Plan

In order to avoid the appearance that its plan to buy bonds of peripheral governments does indeed amount to 'funding of governments by the printing press', the ECB has tied the plan to the condition that it has to happen in parallel with EFSF/ESM rescues. However, that was not all – there was another  stipulation mentioned by Mario Draghi during the press conference. We briefly remarked on this already in our summary and analysis of the ECB decision last week. 

The other part of the plan,  which is supposed to make the operation more akin to a 'monetary policy' type intervention,  is to concentrate the buying on the short end of the yield curve. The thinking behind this is that in 'normal times', the central bank is mainly aiming to manipulate overnight rates in the interbank funding markets as well as other very short dated interest rates rates. Hence intervention in the short end of the curve closely resembles this 'normal' implementation of monetary policy. With this, the ECB probably also tries to differentiate its actions from those of the Fed and BoE.

Usually, the central bank determines a 'target rate' for overnight funds, and whenever credit demand wanes and interbank rates drift below this target, it is  supposed drain liquidity. Whenever credit demand threatens to push interbank rates above the target rate, it will add liquidity.

During boom times, very little 'draining' tends to happen. As a rule, central bank target rates will be too low, and as speculative demand for short term credit keeps increasing during a boom,  its liquidity injections – which provide  banks with the reserves required to keep the credit expansion going – will aid and abet the growth in credit and money supply initiated by the commercial banks.

In the euro area, this method of overnight rate targeting has produced roughly a 130% expansion of the true money supply in the first decade of the euro's existence – about twice the money supply expansion that occurred in the US during the 'roaring twenties' (Murray Rothbard notes in 'America's Great Depression' that the US true money supply expanded by about 65% in the allegedly 'non-inflationary' boom of the 1920's).

This expansion of money and credit is the root cause of the financial and economic crisis the euro area is in now. This point cannot be stressed often enough: the crisis has nothing to do with the 'different state of economic development' or the 'different work ethic' of the countries concerned. It is solely a result of the preceding credit expansion.

Since long term interest rates are essentially the sum of the expected path of short term interest rates plus a risk and price premium, the central bank's manipulation of short term rates will usually also be reflected in long term rates.

In the euro area's periphery, the central bank has lost control over interest rates since the crisis has begun. The market these days usually expresses growing doubts about the solvency of sovereign debtors by flattening their yield curve: short term rates will tend to rise faster than long term ones. This in essence indicates that default (or a bailout application) is expected to happen in the near future. It is possible that this effect has also influenced the ECB's decision to concentrate future bond buying on the short end of the yield curve. However, as is usually the case with such interventions, there are likely to be unintended consequences.

The Rollover Problem

Recently the bond maturity profile of Italy and Spain looked as depicted in the charts below. Note that the charts are already slightly dated (this snapshot was taken at the beginning of the year), so there may have been a  few changes in the meantime, but they probably still represent a reasonably good overview of the situation. There has been an enormous shift in the maturity schedule of the debt of both governments when we compare these charts to the situation as it looked in May of 2010, when the following snapshots were taken:  

ITALY: As of mid 2010, Italy had €168.2 billion of debt coming due in 2012. At the beginning of 2012, this had increased to € 319.6 billion – a near doubling. In Spain, the change is even more extreme:

SPAIN: In Spain, the change is even more extreme. As of mid 2010, Spain had €61.2billion of debt coming due in 2012. At the beginning of 2012, this had increased to € 142.2 billion –nearly 2.5 X

What accounts for this enormous change? When interest rates began to rise sharply, the governments of Spain and Italy ceased to issue long term debt, opting to shorten the maturity spectrum of their debt instead. This was  done because long term interest rates had become too high for their taste. It was no longer considered affordable to finance the government at these rates when they exceeded 6% and later temporarily even 7%.

Thus panic began to set in when short term interest rates began to rise sharply  as well in November of 2011 and again from March 2012 onward.

Now we can already see what the problem with the ECB's plan is: it will tend to shorten the average maturity of peripheral debt even further once it is implemented. In fact, it already has this effect even before the ECB has bought a single bond, as rates on the short end of the curve have recently fallen sharply in reaction to the announcement.

As Bloomberg reports:

“European Central Bank President Mario Draghi’s bid to bring down Spanish and Italian yields may spur the nations to sell more short-dated notes, swelling the debt pile that needs refinancing in the coming years.

[…]

“In a way what the ECB has done is making the situation worse,” said Nicola Marinelli, who oversees $160 million at Glendevon King Asset Management in London. “Focusing on the short-end is very dangerous for a country because it means that every year after this they will have to roll over a much larger percentage of their debt.”

The average maturity of Italy’s debt is 6.7 years, the lowest since 2005, the debt agency said in its quarterly bulletin. The target this year is to keep that average at just below seven years, according to Maria Cannata, who heads the agency. In Spain, where the 10-year benchmark bond yields 6.94 percent, the average life is 6.3 years, the lowest since 2004, data on the Treasury’s website show.

“Driving down the short-dated yields provides a little bit of comfort and encourages Spain and Italy to issue more at the short-end,” Marc Ostwald, a strategist at Monument Securities Ltd. in London, said. “The problem is that you are building up a refinancing mountain.”

(emphasis added)

Even if the ECB buys the bonds of Italy and Spain, they will still have to repay them and regularly roll them over at maturity. By inducing them to shorten the average maturity of their debt further, the ECB creates new risks, especially as the economic downturn remains in full swing and is likely to worsen the fiscal situation of both countries in the short to medium term.

Interestingly, a similar shortening of average debt maturities can be observed in the euro area's 'core' countries. France is certainly considered a 'core' country and is currently treated as a 'safe haven' by bond investors. However, this is a tenuous situation, as it can still not be ruled out that the government will eventually be called upon to bail out the country's banks. At the moment all is quiet on that front, but it was only in November last year when the market was extremely worried about the risk these banks face in view of their enormous balance sheets and potential funding problems.

RETAIL SALES - All in the Seasonal Adjustments

Retail Sales: At Last, an Improvement! 08-14-12 Doug Short

By this analysis, adjusted retail sales ex gasoline was up 0.7% in July from the previous month and up a modest 2.9% year-over-year. However, it's down 8.5% from its all-time high in June 2005.

The Great Recession of the Financial Crisis is behind us, but a close analysis of retail sales suggests that the recovery has been weak and had been showing signs of contraction. Let's hope that the July improvement is the beginning of a sustained reversal of the recent trend. But the more sobering reality is that, in "real" terms — adjusted for population growth and inflation — consumer sales remain at the level we saw in around the midpoint of the last recession.

Retail Sales Rise? Not in California Where Sales Tax Collections Plunge Amazing 40% Year-Over-Year 08-15-12 Mish

SENTIMENT - Small Business Optimism

Small Business Optimism Hits 9-Month Low 08-14-12 Bloomberg Chart via Zero Hedge

Despite the majestic efforts at jawboning 'markets' higher with constant reassurance that infinite QE will come 'we promise', it seems the real economy - full of small businesses and job creators - hasn't got the message. As while equities trade at multi-year highs, small business optimism just printed at its lowest in 9 months. Trickle-down QE doesn't seem to be taking hold among the dismal reality in which we all actually live - as opposed to the vacuum tune hyperplane that stocks exist on.

GLOBAL GROWTH - Central Bank Intervention Results

It's A Centrally-Planned World After All, With Ever Diminishing Returns 08-11-12 Zero Hedge

By now it is no secret that the primary beneficiary of the over $7 trillion pumped by global central banks into the financial system in just the past 4 years, and countless other trillions in miss-spent fiscal stimuli has been the stock market. But what about the global economy: after all five years after BNP Paribas stopped withdrawals from their investment funds - the unofficial start of the Great Financial Crisis - whose primary beneficiaries have been corn, gold, silver and brent - we should have seen at least some sustained impact in the economy if all Econ 101 teaches us about the virtuous business cycle is true, and if any of this countless money out of ZIRP air actually made its way into the economy instead of just the stock market. Well, let's take a look shall well. Courtesy of Bridgewater we present a chart of coordinated interventions and their impact not on the stock market, but on the economy. What we find is that it was, is, and will be a centrally planned world after all.

Click to Enlarge

Bridgewater's take:

The three contractions in global growth that have occurred since the financial crisis were offset by heavy blasts of fiscal and monetary stimulation by global governments and central banks. But each wave of support has also had less impact on global conditions than the previous wave. We remain concerned that the ability of those policy responses to stabilize the situation is diminishing. The third wave stabilized global growth after last summer’s dip and allowed for the bounce in global conditions and markets over the early part of this year – but its impact on global conditions was more modest than that of earlier waves of stimulation. As the third wave has ended, global growth has again rolled over.

The scariest thing about the above chart? The ever lower global growth bounce as a result of ever increasing, or exponential, central bank intervention.

Click to Enlarge

In other words, not only is conventional economics wrong about virtually everything, but the impact of whatever the real underlying story is, certainly not one that can be captured by econometric models which continue to falsely model out what is essentially a system of infinite complexity and soaring fragility, has increasingly diminishing returns.

Also, when we get to the point on the chart above where global growth is at or below zero irrelevant of how much "money" is pumped into the system, that will be the moment to shut the lights out, because it is then that the central planning fat finger which has to date mostly impacted various intraday inflection points in the S&P, will simply press CTRL-P. And not let go.

INVESTOR SENTIMENT - A Lost Deccade & Not Returning Soon

Charting The Lost Generation Of Investors 08-13-12 Charts: BofAML - Zero Hedge

There is a segment of the Baby Boomers that will never return to investing in equities because the last 12 years has produced a lack of returns with relentless volatility and scary headline news. BofAML's Mary Ann Bartels notes that equity holdings as a percentage of financial assets peaked in 2000 and have been declining ever since. This same behavior occurred last time the market traded sideways from 1966-1984 (16 years) and we clearly face the risk of more years of sideways trading to come as cumulative bond and equity flows show no sign of letting up at all.

DISTORTIONS - M2 Money Velocity

On Inflation, M2, and the Velocity of Money 08-10-12 Zero Hedge

We often hear that the central banks printing money in order to keep the stock market inflated and broke countries afloat for just a few days longer is nothing to worry about. The reason we are given, is that even though the central banks are pumping trillions into the economy, inflation isn't an issue. And after all, the velocity of money has actually declined. That's the message from the "smart" people anyway. This chart shows that as M2 grows (Red), so does inflation ie: CPI (Green) - yes, this is the government's calculation, we'll leave it there for this chart's purpose. Also of note is the monetary base without the banking ponzi scheme of fractional reserve banking (Blue).

So as you can see, inflation actually follows M2 growth, even as the velocity of money (below) declines. Don't be fooled by those who tell you that printing money isn't causing inflation, because it is doing just that each and every day.

There are those who believe that velocity of money is a product of fast growing inflation (not a cause). Inflation has been rising consistently with the growth in money supply, but the velocity of money has declined. You can imagine what happens once velocity of money actually starts to turn (hint: something ZH has been warning about for years).

EARNINGS - Q2 Recap

Q2 earnings seasons is now (with 93% of firms reporting) over, and it is time for post mortem. The bottom line for those strapped for time is the following: In order to salvage the 2012 earnings consensus for the S&P, the sell side crew and asset managers, as wrong but hopeful as ever, are now expecting Q4 2012 earnings to grow 15% versus 4Q 2011, which is more than twice as fast as any other quarter. Indicatively, Q2 2012 earnings rose at a rate of 3% compared to Q2 2011. Elsewhere, revenues came 2% lower than consensus estimates at the start of the earnings season.

And the kicker: The S&P 500 bottom-up consensus EPS estimate for 3Q fell 4% during the past five weeks and management guidance has been more negative than usual. Consensus expectations imply no earnings growth for the S&P 500 versus 3Q2011. This number will certainly drop more and will be the first Y/Y EPS decline since the Lehman failure.

In other words, the entire year is now a Hail Mary bet that in Q4, the time when the presidential election, its aftermath, as well as the debt ceiling and fiscal cliff acrimony will hit a peak, a Deus Ex Machine will arrive and lead to a 15% rise in earnings. Why? Because global central bankers will have no choice but to step in and thus lead to a surge in EPS multiples even if the underlying earnings are collapsing. With the presidential election around the corner making Fed QE before 2013 now virtually impossible, with Spain (and Italy) refusing to be bailed out and cede sovereignty thus precluding ECB intervention, and with China spooked by what may be a surge in food costs, this intervention, and any hope that the Hail Mary pass will connect, all look quite impossible.

As the chart below shows, in this bizarro market, the lowest 2012 consensus earnings to date can only be matched by the highest PE multiple. Brilliant.

From Goldman:

2Q earnings results disappointed across the globe. In the US and Europe, P/E multiples have expanded more than fund managers might realize because earnings estimates are too high. The divergence between trends in earnings and valuation is likely to  become more pronounced as profit forecasts continue to be reduced in the coming months. In the US, our 2Q earnings season takeaways are: (1) disappointing sales; (2) in-line earnings; (3) margins are still declining; (4) 3Q estimates imply no growth while  4Q estimates imply significant growth; (5) earnings estimates are falling, driven by Energy and Materials.

2Q Results by Geography

For the US, sales disappointed more than earnings. 18% of ex-Financials and Utilities companies have posted positive revenue surprises by beating consensus sales expectations by at least one standard deviation, half the historical average. The number of firms that missed sales estimates was twice the historical average. Sales surprises were the worst since 1Q2009. The frequency of earnings beats and misses are largely in line with history.

In Europe, earnings season misses were driven by margins not sales. 239 companies, 54% of market cap, have reported. So far, the frequency of earnings beats, a surprise of 5% or more, is below the three-year average (33% vs. 43%), and misses are slightly higher (40% vs. 37%). Sales results have been modestly positive. Analysts significantly revised down Banks earnings. FY2012 estimates are down 9% over the past month.

In Japan, companies reported further earnings declines. 90% of TOPIX companies (95% of market cap) have reported earnings. Results so far have been disappointing especially in context of the April-June 2011 quarter. Last year, supply chain problems following the March 2011 earthquake resulted in a weak earnings season. Yet operating earnings for the April-June 2012 quarter are down 7.4% year over year. Revisions and guidance have remained muted, which our Japanese strategists see as a sign of  caution in the face of macro uncertainty going into 2H.

Across Asia, Consumer Discretionary companies posted stronger results relative to consensus estimates. Similar to results in the  United States, Energy and Materials posted the weakest results relative to consensus estimates. Singapore posted the strongest results relative to consensus while Taiwan was weaker.

In the US and Europe, P/E multiples have expanded more than fund managers might realize because earnings estimates are too high.

1. Global EPS forecasts are too high. Our top-down, full-year earnings forecasts imply further downside to consensus estimates in the US, Europe and Japan. In each region, the difference between our top-down 2012 EPS growth forecast and bottom-up consensus growth is about 3pp. Our MSCI Asia Pacific ex-Japan earnings growth estimate is in line with consensus.

2. In the US and Europe, P/E multiples have expanded more than fund managers realize. The strong rally in global equity markets during the past five weeks means portfolio managers have re-rated stocks based on policymaker promises rather than fundamentals. On consensus NTM EPS, the S&P 500 P/E multiple expanded from 12.6X to 12.9X. The Stoxx multiple rose from 10.0X to 10.7X over that same period of time.

3. Consensus earnings estimates declined in all regions over the last month. Full-year 2012 estimates fell 4% for the Stoxx 600 while Topix (FY) and MSCI AP ex Japan forecasts each fell 3%. S&P 500 estimates fell 1%.

4. Meanwhile, despite weak earnings season, the S&P 500 is up 3.6% since July 6. Other global indices have also rallied sharply with Stoxx up 6.2% and MSCI Asia Pacific ex Japan up 4.0%. TOPIX is down 2.6%.

Details of 2Q Earnings Results for S&P 500

A total of 456 firms in the S&P 500 have now released 2Q 2012 results representing 93% of the equity cap. Below we highlight our takeaways:

1. Sales disappointed. Realized sales are 2% lower than consensus estimates at the start of the season. 2Q2012 sales for S&P 500 (excluding Financials and Utilities) grew by 3% year over year.

2. Earnings in line with expectations. S&P 500 realized 2Q EPS is tracking at $25.49, a 2% positive surprise versus the consensus estimate at the start of reporting season. On a quarterly basis, 2Q2012 EPS will post year over year growth of 3% vs. 2Q2011. Telecommunication Services and Financials EPS grew by 26% and 14%, respectively. On a trailing four-quarter basis, 2Q2012 will establish a new EPS peak of $99.

3. Margins beat, but LTM margins are declining. With earnings beats and sales misses, 2Q quarterly margins are 20bp higher than expected (9.1% vs. 8.9%). Year over year, quarterly margins are flat to negative in most sectors. The trailing-four-quarter net margin for the S&P 500 is tracking at 8.8%.

4. Earnings expectations are falling and 3Q estimates imply no growth. The S&P 500 bottom-up consensus EPS estimate for 3Q fell 4% during the past five weeks and management guidance has been more negative than usual. Consensus expectations imply no earnings growth for the S&P 500 versus 3Q2011. Energy and Materials are the most significantly negative.

5. Over half of consensus 2012 EPS growth is from strong 4Q forecasts. 4Q earnings are expected to grow 15% versus 4Q2011, more than twice as fast as any other quarter. 4Q2011 growth was about half that of the other 2011 quarters, which explains some of the growth discrepancy between quarters in 2012. Analysts forecast a sudden jump in LTM margins to a new peak of 9.0% in 4Q2012 while we forecast further slippage to 8.7%.

EARNINGS - Earnings follow US$ which follows QEIII Expectations

Bernanke's Dilemma: How US Corporations Became Addicted To Endless QE 08-13-12

While many argue that corporate profitability in the US knows no bounds as cost-cutting amid 'slow' growth will fill the gap, we offer this quite compellingly nerve-jangling chart of the increasing dependence of S&P non-financial operating profits and the weakness of the US Dollar. The negative correlation between macro-level EPS and the U.S. dollar is both theoretically and empirically clear. As Citi points out, profits earned abroad are reported in depreciating or appreciating terms, boosting or reducing profits; and as the negative correlation between the USD and global growth can result in 'double counting' of earnings influences - this leads to too much hope at 'turning points'. What is more critical is the trend higher in the USD - whether due to EUR break-up fears and safe-haven flows OR courtesy of Draghi's EUR weakening QE/LTRO promises - is tending to push Bernanke's hand to act to weaken the USD (do NEW QE) to 'strengthen' corporate profits and the economy.

However, with inflation-expectations now high and macro data stabilizing, his justification is far from clear - no matter how high the hopes and dreams have become. Without the Fed's NEW QE, the Q4 hockey-stick of hope in earnings is finished thanks to implicit USD strength. The irony is that time inflation is supply constrained - due to food limitations (global warming notwithstanding) - and adding QE 'demand' to that fire will only have potentialy violent repurcussions.

US corporate profitability has become increasingly dependent on USD weakness (implied by the Fed's QE actions)

... and as US macro surprises remain weak but have tended to stabilize/improve recently... It seems like a much tougher call from the Fed to plunk down another $500billion at this time. Source: Citi

CRONY CAPITALSIM - Enriching the Financial Sector Through Monetary Policy

Does Easy Monetary Policy Enrich The Financial Sector? 08-08-12 JOHN Aziz (Azizonomics)

Easy monetary policy enriches the financial sector at the expense of the wider society.

When the central bank engages in monetary policy, the financial sector gets the new money first and so receives an ex nihilo transfer of purchasing power (the Cantillon Effect).

FIRST: The effects of quantitative easing (monetary base expansion) on equities (S&P500 Index), corporate profits and employment.

While quantitative easing has dramatically reinflated corporate profits, and equities, it has not had a similar effect on employment (nor wages). However there are lots other factors involved (including government layoffs), and employment (and wages) is much stickier than either corporate profits or equities. It will be hard to fully assess the effects of quantitative easing on employment outcomes without more hindsight (but the last four years does not look good).

SECONDLY: Following QE, financial sector profits have rebounded spectacularly toward the pre-2008 peak, while nonfinancial sector profits have not:

THIRDLY: This disparity has not been driven by growth in the monetary base, which lagged behind until 2008. Instead it has been driven by other forms of money supply growth, specifically credit growth.

FOURTHLY: As interest rates have been lowered credit creation has spiked, and vice verse:

• This is the relationship between financial sector asset growth, and growth of the money supply:
  

• Growth of the money supply inversely correlates with changes in the Federal Funds rate:

FIFTH: The easing of credit conditions (in other words, the enhancement of banks’ ability to create credit and thus enhance their own purchasing power) following the breakdown of Bretton Woods — as opposed to monetary base expansion — seems to have driven the growth in credit and financialisation. It has not (at least previous to 2008) been a case of central banks printing money and handing it to the financial sector; it has been a case of the financial sector being set free from credit constraints.

This would seem to have been accentuated by growth in nontraditional credit products (what Friedrich Hayek called pseudo-money, in other words non-monetary credit) in the shadow banking sector:

• SHADOW BANKING

• DERIVATIVES

Monetary policy in the post-Bretton Woods era has taken a number of forms; interest rate policy, monetary base policy, and regulatory policy. The association between growth in the financial sector, credit growth and interest rate policy shows that monetary growth (whether that is in the form of base money, credit or nontraditional credit instruments) enriches the recipients of new money as anticipated by Cantillon. This underscores the need for a monetary and credit system that distributes money in a way that does not favour any particular sector — especially not the endemically corrupt financial sector.