STALL SPEED : Any Geo-Political, Economic or Financial Event Could Trigger a Market Clearing Fall
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 unless major globally coordianted policy initiatives are undertaken. 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. The World Bank is "unpolitically'projecting 2.5%. The situation is now deteriorating so rapidly, as to be impossible to hide anylonger.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY
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>>
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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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
We received the 2nd estimate of the 2nd Quarter 2012 GDP. The good news is that the original 1.5% estimate was revised up to 1.7% which is only slightly lower than the Federal Reserves estimated 2% growth rate for 2012. The bad news is that the increase in the GDP report puts the final nail into the QE3 coffin for the time being. While the media quickly glossed over the surface of the report there were very important underlying variables that tell us much about the economy ahead. The first chart below shows the differences between the 1st and 2nd estimate of the 2nd quarter GDP.
I have put the basic formula of the GDP calculation at the top of the chart and labeled the relevant green bars. The revisions to the first estimate of GDP showed that personal consumption expenditures were $4.9 billion stronger than originally thought with the revision primarily driven by a surge in spending on services which was increased by $7.7 billion. Exports also continue to save corporate profit margins (exports have made up roughly 40% of corporate profits since the end of the last recession) with exports being revised up by $3.1 billion.
However, big negative revisions came to the Private Investment segment which was revised lower by a whopping $24.8 billion dollars. Furthermore, equipment and software spending, in a sign that businesses are pulling back on capital investment, was revised down $6.6 billion tacking on additional declines to the 1st quarter report. Adding continued pressure to China, and other emerging market exporters, the weak U.S. consumer continues to shun buying non-necessities as imports came in much weaker than originally estimated, revised down $16.7 billion, primarily in the produced goods.
These are not small details. The next chart shows a clear trend change for the consumer as measured by Personal Consumption Expenditures (PCE). When the recovery began in 2009 it was led primarily by consumption and production (inventory restocking). Given that consumption is currently making up more than 70% of GDP - understanding where consumption is occurring is relevant to future direction of economic growth.
The decline in PCE, Goods and Durable Goods beginning in the third quarter of 2010 led to a near ZERO growth rate of the economy in the 1st quarter of 2011. Fortunately, the economy was saved from a recession with a manufacturing restart, and inventory restocking process, post the Japanese tsunami/earthquake in March of 2011. That boost, combined with the warmest winter in 65 years and sharply falling oil prices, lifted the economy into the 1st quarter of 2012. Those tailwinds now appear to be fading.
With GDP currently at 1.7%, as of the latest estimate, the decline in overall PCE, Goods, and Durable Goods, is very concerning about the next couple of quarters ahead. While the pick up in services spending (haircuts, accounting, legal, etc.) is currently keeping the current quarters GDP afloat - service related spending does not lead to substantially stronger economic output in the future. The real economic drivers are the manufacturing of goods, and unfortunately, that is where weakness is developing.
Equipment And Software - A Notable Concern
In the quest to keep employment as low as possible in recent years while maximizing the return of each employee, (the highest costs for businesses are employee related - payroll, benefits, healthcare), the expenditures on equipment and software has boomed since the end of the technology bust. During this century spending on equipment and software has become a significantly greater share of GDP than in the past. When spending in this area declines it implies that businesses are not only not hiring but also becoming extremely conscious of overall spending. The chart below shows four very important items.
First, I just want to dispel the whole current myth about the importance of a housing recovery relative to the economy. At one point in our history, housing was a very important component of economic growth, currently at a mere 2.6% of GDP, that is no longer the case. So, while we spend billions upon billions of taxpayer dollars trying to bailout homeowners, forgiving bankers of their criminal misdeeds, and not dealing with defunct government agencies all in the name of saving the economy - in reality it has very little effect. Ditto for automobile manufacturing, and the billions of taxpayer dollars wasted on GM, under the lie that without a bailout American auto manufacturing would have been lost.
The important focus here, however, is watching equipment and software spending as well as exports. As stated above, with exports now making up 40% of corporate profits, and more than 13% of GDP, a decline in exports due to the recession in Europe, and slow down in China, will quickly resonate in the domestic economy. Furthermore, the direction of trend of equipment and software spending is indicative of corporate forecasts about the economy ahead. Cut backs in spending occur as forecasts for economic growth weakens, and concerns about profitability, heighten. The chart above clearly shows that both exports and equipment and software spending as a percentage of GDP have declined just prior to the onset of the last two recessions. The recent decline in equipment and software spending may be telling us something.
The Recovery That Wasn't
This has by far been the weakest economic recovery of any post-WWII period. Employment remains elevated but has declined recently primarily due to the massive numbers either giving up looking for work, or going onto some sort of welfare program, that excludes them from being counted. Economic growth, such as it has been, can be primarily attributed to continued rounds of artificial interventions and stimulus programs designed to pull forward future economic activity. Of course, that begs the question of what will happen when we reach the future? Wages have remained stagnant, household net worth has declined for the longest period since the depression era and consumers are again being forced into debt to make ends meet. This all leads to a sub-par economic growth rate as shown by the output gap between the real economy and what the economy should be producing.
Clearly the economy, while not technically in a recession, is operating at levels that are normally associated with recessions. Without the artificial interventions, suppressed interest rates and continued housing supports - it is likely that the economy would be operating at far lower levels of activity. This is also evident if we look at real final sales for the economy.
Real final sales, measures GDP less the change in private inventories, is a better measure of what is occurring within the economy. The recent builds in inventories are likely unwanted as product sits on the shelves collecting dust as consumer demand wanes. The final sales number is a better indication of actual activity. Real final sales declined from a quarterly change of .59% in the 1st quarter to .49% in the second quarter. This brings the year over year growth rate of real final sales to 2.06% down from 2.17% in the first quarter.
Final sales continue to flirt with the 2% annual change level. Historically, when real final sales has fallen below 2% on a year-over-year basis the economy has either been in, or was entering, a recession. With the current decline in PCE it is likely that we will see real final sales decline into recessionary territory in the next two quarters.
No QE 3 For Now - But Later For Sure
Today's release, very likely, will keep the Fed sidelined through the election with regard to further rounds of stimulative action. As stated recently - with the markets near highs for the year, and the economy not falling off the ledge, there is very little benefit to further rounds balance sheet expansion programs at the moment. The Fed knows they are running low on ammunition so, it is likely, they will wait until either the economy is threatening a recession or a more systemic event occurs. Both are likely in the future.
For investors this is not a time to be taking on tremendous amounts of risk within portfolios. While markets can sometimes do irrational things in the short term - it is the underlying economics, and fundamentals, that drive long term portfolio returns. Taking on risk at the wrong times, trying to chase returns, can lead you into devastating losses that take the entire next upswing to recover. This has happened twice already since the turn of the century and it will happen again - it is only function of time. The important point for investors, who have a limited amount of time to plan and save for retirement, is that "hope" and "getting back to even" are not successful investment strategies.
The incoming Obama Administration's projections for what the unemployment rate would be if no stimulus was enacted in the depths of the financial crisis (red).
The Obama Administration's projections for what the unemployment rate would be with the President's stimulus plan (blue).
The actual unemployment rate (green).
The actual unemployment rate ind the chart, you will note, is much higher than the "nightmare scenario" initially envisioned by the Obama Administration (with no stimulus). In either case--stimulus or no stimulus--the unemployment rate was supposed to be down to 5.5% by now. And it's actually still 8.3%.
As a quick glance at debt-to-GDP charts show, this recession was not a run-of-the-mill cyclical recession. It was a debt-fueled balance sheet recession. And if there's one thing history shows about those, they take a long time to fix. (See Japan and the Great Depression).
But Obama could have given himself a better chance to get re-elected despite the horrible economy. If Obama had recognized how bad things were, asked for a much bigger stimulus than he ended up asking for, and, importantly, set the appropriate expectations, he'd probably have been able to pin the blame for the mess where it belongs: On the three decades of decisions that facilitated the debt build-up that eventually culminated in the financial crisis--decisions that, importantly, were made by both Democrats and Republicans.
The U.S. capital stock is in decline. This is the first time post-war we've ever seen it. We don't know what the repercussions are because we have nothing in history to look back on.
CAPITAL STOCK: American companies' investments in new equipment and software – one of the four main components in GDP – less the depreciation of existing equipment.
The implication of a drop in the capital stock is that potential growth is much lower than it could be if businesses were investing more in new capital. As a result, economy-wide return on assets can be expected to be much lower.
Here is a chart showing the growth of the U.S. capital stock from 1947 to 2011 (the most recent data point). Note the lone dip at the end:
And here is a chart of the annual growth of the capital stock. Note the only time it's ever been negative since 1947:
As evidenced in the chart, the capital stock isgrowing at nowhere near average rates we've seen in the past.
Coffin explained to Business Insider the significance of the negative growth shown at right in the chart above and the subsequent yet feeble return to positive territory we've now seen:
It's more of a longer-term story. What it suggests is that productivity growth going forward isn't as likely to be as great because we haven't made as much capital investment as we otherwise would have.
It's sort of a symptom of the slow growth we've seen – except that there have been periods of slow growth in the past when we've seen more capital stock increase. But more importantly, it's just a lack of deepening of the capital stock that suggests lower trend growth ahead unless we work on it.
It's still going along at a pretty slow pace, and probably not enough to make up for the depreciation of the existing capital stock. It's on track for another very soft year in 2012.
The second quarter GDP numbers released yesterday didn't provide much to get excited about going forward, either. Coffin told Business Insider that based on those numbers, we could even see a dip in the capital stock again:
Looking at equipment and software investment – 5.4 percent and 4.7 percent over the last two quarters at an annual rate – that's a good deal slower than last year, and probably doesn't keep up with depreciation.
So, we're looking so far at a probable decline again in the capital stock in 2012, or at least very slow growth, if there is any.
Note: The data behind these charts were updated for 2011 on August 15 and can be found here. A brief review of the numbers reveals that the oil and gas industry contributed to 15 percent of the drop in the capital stock between 2008 and 2009. This is perhaps due to the rapid collapse of oil prices in July of 2008.
09-01-12
CYCLE GROWTH
CATALYST EMPLOYMENT
US ECONOMY
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - August 16th - Sept. 1st, 2012
The chart only includes the periphery, the UK and Germany but that’s where most of the NPLs are right now. The total from 2010 was 965 billion euros. In 2011 it was 1.048 trillion euros.
Some of these countries are clearly underreporting their NPLs. But, as a whole 1 trillion euros is a lot of bad loans to cover. That’s one reason European bank shares are so depressed. And as the current deflationary policy path has continued, expect these numbers to get even bigger in 2012 and 2013.
Paul Krugman said he would be concerned if government spending hit 50% of GDP. The trend does not look good, but by Krugman's measure there is a ways to go.
Nonetheless, I think we should be concerned now. The numbers ignore exploding national debt and interest on national debt. Interest on national debt will skyrocket if rates go up or growth estimates penciled in do not occur. Both of those are likely, although Japan proves that amazingly low interest rates can last longer than anyone thinks.
The figures also ignore ever-escalating costs of Medicare, Social Security, and pension promises, all of which are guaranteed to soar in the not so distant future. Romney says Unfunded liabilities amoint to $520,000 per household.
I will point out that those liabilities are not debt yet. So might Krugman. However, I am comfortable in reducing benefits and slashing spending while Krugman is not.
Clearly there are many ways to spin this data but please note that government spending in France exceeds 50% of GDP. Also note that French unemployment is 10.2% and Hollande is poised to hike the top marginal tax rate to 75%.
One of the ugliest charts of the year has been the Shanghai Composite, which continues to sink to new lows as other global stock market indexes near their highs.
Tom Fitzpatrick, Citi's top technical analyst thinks that the Shanghai Composite is setting up for another huge leg down.
Here's an excerpt from his latest report via King World News:
We believe the Shanghai or Chinese stock market is now breaking through the last vestiges of support (see chart below). If we do push decisively through this area, around 2,050 on the composite, we think there is a real danger that it could open up the way to take us all the way back to the lows that were posted in 2008, around 1,665, or an additional plunge of roughly 19% on the Shanghai Index.
If we get a close through this support, then the bias would be for an acceleration to the downside.
Many industries have massive excess capacity - after years of aggressive expansion that ran way ahead of demand growth - which eventually has to be eliminated. This process will take some time, during which faster depreciation in the form of deleveraging and consolidation will be unavoidable; and while expectations of an imminent hard landing may be overdone, the landing will nevertheless be multi-year and bumpy in their view.
According to the China Banking Regulatory Commission (CBRC), total NPLs at China's commercial banks reached CNY 456.4bn at end-Q2, 4.2% qoq and up 11.9% (or CNY 48.6bn) from the trough in Q3 11. The NPL ratio was unchanged at 0.9%, due to a similar pace of loan growth. However, special-mention loans that are doubtful but still performing increased to CNY 1.5tn, while the total loan loss reserves set aside were CNY 1.3tn.
The number of stories on companies in default or with severe cash flow problems has surged since early Q2.
The economic slowdown does not seem to be the only cause, and, in many cases, not even the major one. The common mistakes include
involvement in speculative activities (eg. property speculation or commodity trading),
massive capacity expansion (eg. shipbuilding and solar panel manufacturing),
outsized commitments to complicated webs of mutual loan guarantees and
High exposure to underground banking (eg. many SMEs in Zhejiang).
The history of banking crises suggests there is no definitive linear correlation between the peak of NPL ratios and the scale of the pre-crisis credit boom, as it also depends on how the situation is contained and resolved. In the sample of 42 crisis episodes complied by Laeven and Valencia (2008), average annual credit growth to GDP prior to the crisis was about 8.3%. Between 2009 and 2010, this same ratio for China reached 27.8% and 20%, respectively. It is hard to see how China’s NPL ratio could stay at the current level.
There is also a structural element in China’s NPL cycle. Many industries have massive excess capacity after years of aggressive expansion that ran way ahead of demand growth. Eventually, China has to eliminate these inefficient capacities. This process will take some time, during which faster depreciation in the form of deleveraging and consolidation will be unavoidable (and margin compression has already begun).
Acute agony or chronic pain
The exact trajectory and the end point of the NPL issue will be difficult to predict. Economies with less government intervention, such as the US, usually see NPLs peaking one or two quarters after growth troughs. In contrast, Japan was very slow in recognising and resolving its NPL problem – a problem which started in the early 1990s. The NPL ratio didn’t peak until 2002, and much damage was done in the meantime to the banking system and indeed to the overall economy. China, where the government is even more involved in the economy, is running a clear risk of a prolonged NPL cycle. Local governments have poured millions of capital into rescuing failing corporates.
We think, at the end of the day, the central government will have to take the burden onto its own balance sheet as the NPL cycle reaches its final days of reckoning. The fiscal cost will only be higher the longer the process drags on, and a bigger concern is that more resources may be locked in these non-performing assets.
China has two problems... well more than two we are sure, but these seem critical.
First, there is a significantly slowing economy that 'desperately' needs the hand-of-god Central-Banker to stimulate it with free-money - but is hand-cuffed by the huge disconnect between 'apparently' low CPI and extreme highs in food and energy prices which will only exaggerate spending retrenchment should any money-printing be enabled.
and with Corn stocks at a stunningly low level (lowest since 1995 and nearing 1975 levels) things are only going to get worse...
Which leaves the PBOC somewhat powerless to do the kind of massive stimulus hole-digging-and-re-filling that is required to plug the economic demand slack.
Second, it seems for many investors the writing is on the wall as money is flowing out of the world's growth engine faster than oil from a wok. While at the surface USDCNY appears to be doing its 'stable' thing - the PBOC is soaking up unprecedented amounts of CNY as the market 'sells' out.
This chart (that we previously discussed in detail here) shows the difference between market-driven movements in USDCNY (red) and PBOC-driven (blue) - clearly the market is selling its CNY and running away and while we are sure China would like a lower Yuan (to help exports etc.) it is nevertheless band-ridden and needs to maintain some stability or trade-wars or worse will escalate - so the PBOC is soaking up massive amounts of Yuan (and selling out its USD?) to maintain that illusion of control...
These 'adjustments' which are now on an unprecedented scale started right after LTRO2 ended and are accelerating...
which is leading to forward-Yuan trading at post-crisis high discounts...
This combination of slowing (and seemingly unstoppable) economic trajectory with significant negative money-flows is a vicious circle - evidenced by the efforts of the PBOC with stealth reverse repos and the 'easing' of their Yuan trading bands (chart below - as per Bloomberg's Chart of the Day) as perhaps they revert back to a weaker Yuan policy (and implicit strong USD mercantilist vendor-financing model).
China’s Ministry of Commerce blamed the increase in vegetable prices on “strong winds and rainfall in the country’s eastern regions” that “disrupted production and logistics.” Nevertheless vegetable prices are up 15.4% over the past four weeks.
China Daily: – The wholesale prices of 18 types of vegetables in 36 cities rose for the fourth consecutive week, up 2.9 percent week-on-week and 15.4 percent cumulatively over the past four weeks, according to the MOC.
A Bloomberg article this week even suggested that China may postpone some policy easing due to renewed inflationary concerns .
Bloomberg: – China’s slower-than-forecast cuts in banks’ reserve requirements show authorities are reluctant to shake their concern inflation will quicken, three months after Premier Wen Jiabao shifted priorities to boosting growth.
China has left the reserve ratio for the biggest banks at 20 percent since mid-May while lowering interest rates in June and July, bucking forecasts from HSBC Holdings Plc and Societe Generale SA that the government would build on three ratio reductions since Nov. 30.
The ISI Group had this to say on the topic of rising food prices, particularly in Emerging markets (discussed here a month ago) :
“This is an unexpected, supply-related problem for both consumers and policymakers around the world.”
The Markit/JMMA Manufacturing Purchasing Managers Index fell to 47.7 in August. This is down from 47.9 in July.
This is the sharpest rate of contraction in manufacturing activity since April 2011, a month after the tragic earthquake and tsunami devasted the country.
Key points from Markit;
Output and new orders down at accelerated rates
Near-stagnation of employment
Purchasing costs fall to greatest extent since November 2009
From Markit economist Alex Hamilton:
Japan’s manufacturing sector downturn continued in August, according to PMI survey findings. The data provide further evidence to suggest that growth in the world’s third largest economy is faltering in the face of weakening global demand conditions. Overall new business (exports plus domestic) declined at a solid rate, while the index measuring trends in factory output fell further over the month.
There was more deflationary news on the price front, with average input costs and output charges decreasing simultaneously for a third month running. Meanwhile, a muted labour market picture was signalled by the latest survey, with employment stagnating.
There are some new patterns in the employment trends that suggest we may be going through a generational transformation, led by both demographics and technology. And while it is ultimately positive, the transition will be harder on some groups than others.
NEED AN ADVANCED DEGREE
OLDER MEANS EXPERIENCE, TRAINING & STABILITY
08-27-12
CATALYST JOBS
7
7 - Chronic Unemployment
GEO-POLITICAL EVENT
8
NON-PERFORMING LOANS (NPL) - HELOC and Student Loans
The majority of the debt 'reduction' for the third year running is due to debt discharge, i.e., forced reductions in debt arising out of default, bankruptcy and other contract termination events, and not due to actually generating incremental equity (cash) used to repay debt.
Consumers may be getting their mortgages and credit cards discharged, because these are non-recourse, and the only trade off is a hit to one's credit rating, but their student loans keep piling up, and according to the Fed was just shy of $1 trillion at the end of Q2, a number which has since surpassed the psychological barrier.
Note the surge in HELOC delinquencies now that the HELOC product is no longer a fad, and consumers can't wait to stop paying back debt which will never be worth even one cent courtesy of the secular loss of real estate value and pervasive underwater prices. The flat line is student loan delinquencies. Soon to quite soon the black line will start imitating the red one. At that moment, run.
NY FEDERAL RESERVE REPORT - Household Dent & Credit Q2 Credit Report
08-31-12
HOUSING
12
12 - Residential Real Estate - Phase II
FOOD STAMPS - Program Reflects Real Inflation & Cost of Living Increase
Consumer confidence in the euro area slumped to the lowest in three years at minus 24.6, according to the final estimate for August. The 3.1 deterioration in August represents the sharpest decline in a year. The index has been lower in only two periods over the past three decades. Not unexpectedly the least unconfident is Germany, while Greeks are urgently trying to find new reasons to keep pushing the rock uphill day after day.
Consumer confidence missed big in August falling to 60.6.
The reading is the lowest since November 2011. Meanwhile, July's reading was revised down to 65.4.
"Consumers were more apprehensive about business and employment prospects, but more optimistic about their financial prospects despite rising inflation expectations," according to Lynn Franco, Director of Economic Indicators at The Conference Board.
"Consumers' assessment of current conditions was virtually unchanged, suggesting no significant pickup or deterioration in the pace of growth."
But the number is still above 60, showing the report wasn't a complete disaster. Here are some highlights from the report:
The percent saying business conditions are "good" climbed to 15.2 percent, from 13.7 percent.
The percent saying business conditions are "bad" was unchanged at 34.4 percent.
The percent saying jobs are "plentiful" fell to 7 percent, from 7.8 percent.
The percent saying jobs are "hard to get" eased to 40.7 percent from 41 percent.
The percent of consumers expecting business conditions to improve over the next six months fell to 16.5 percent, from 19 percent.
The percent jobs to increase in the months ahead declined to 15.4 percent from 17.6 percent.
The percent expecting fewer jobs climbed to 23.4 percent from 20.6 percent.
This chart from Eric Platt shows consumer confidence is at its lowest since November 2011:
Expectations: The Conference Board's consumer confidence index is expected to ease slightly to 65.8 in August, from 65.9 in July.
While consumer confidence and consumer spending don't necessarily track each other, investors watch the number to gauge where spending might go.
The survey polls 3,000 households across the country on their perceptions of current business and employment conditions and their expectations going six months into the future.
A succinct primer on how broken the status quo is and the 'euphoric' economy that very few could see through their Keynesian "debt doesn't matter" blinders, Steve Keen's introductory lecture at UWS is perhaps the most complete soup-to-nuts discussion we have seen recently. From the OECD's total ignorance to Bernanke's 'Great Moderation' miss; from economic 'religion' to science; and from Keynes to Minksy, Keen explains, in language even Chuck Schumer could understand, how more debt doesn't solve too much debt, how stability breeds instability, and why the US won't be finished deleveraging until 2025 (at this rate).
This brief lecture seems extremely apropos given we appear to be on the eve of yet another embarkation on the Keynesian 'stimulate' experiment - as everyone waits with baited breath for the next morsel of Fed/ECB/BoE/BoJ/PBOC juice...
08-30-12
RISK
GLOBAL MACRO
US ECONOMIC REPORTS & ANALYSIS
REAL GDP - Cummulative GDP Growth
08-28-12
CYCLE GROWTH
US ECONOMY
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
We anticipate a relatively dovish speech that signals a high probability of additional easing at the September FOMC meeting. But "easing" and QE3 are not synonymous. In our view, a change in the Fed's rate guidance is very likely, but Bernanke is probably not ready to preannounce QE3. Indeed, he is unlikely to front-run his Committee, so we would expect a speech that is long on historical defense of the Fed's easing to-date but short on details of any future actions. Given that the markets have priced in a high probability of QE3 (Chart of the Day), in our view that could be a disappointment.
A hawkish dove
In our view, more unconventional policy is just a matter of time. Thus, we expect Bernanke to emphasize three key points, without actually signaling the Fed's next steps.
First, he is likely to underscore the bias statement in the minutes: if the economy does not improve substantively, the Fed will ease further.
Second, he may discuss the Fed's options in more detail, building on some of the discussion already noted in the minutes.
Third, he is likely to argue vigorously that unconventional policy is both necessary and effective.
The Bernanke Fed has not been shy about introducing new ways to use language or its balance sheet to stimulate the markets. However, we do not expect an outright signal of QE3. Keep in mind that "easing" and QE are not synonymous. When Fed policymakers signal that they are ready to ease, they mean not only changes in their balance sheet but also changes in their forward rate guidance and other language changes. Further, Bernanke will likely remind everyone that monetary policy is not a panacea - without naming names, he will likely point to the pressing need to deal with the fiscal cliff. He is also likely to note that unconventional policy comes with costs as well as benefits.
Rates market implications
In our view, the rates market could be disappointed by Bernanke's speech. Our model currently indicates that a greater than 85% chance of QE3 is priced into the market in the near term (3-4 months). This probability is at recent highs, indicating that the market is likely expecting some explicit signal of further QE by the Chairman at Jackson Hole - and the lack of one is likely to be taken as a disappointment by the market.
One could argue that selling nominal 10y Treasuries may be the way to position for a Bernanke disappointment trade. However, at 1.61%, we do not believe that nominal Treasury levels are extreme by any means. A return to risk aversion or disappointment on the economic data can lead 10y rates lower: just a month ago, 10-year Treasuries were at 1.39%. Selling 10y real rates, at close to all-time lows of -0.72%, offers more compelling risk-reward, in our opinion.
A significant portion of the rates market reaction will also depend on the reaction in risky assets. A risky asset sell-off triggered by the lack of a strong signal for QE could also mute the reaction of higher nominal rates, in our view. In this case, inflation expectations as priced in by TIPS breakevens should head lower. We recommend that investors tactically short 10y real rates and 10y TIPS breakevens to position for a disappointment from Chairman Bernanke.
The link between nominal interest rates, inflation breakevens, and stocks has changed; especially with regard the last few years' seemingly increased dependence on the Central Bank to keep an anti-deflationary floor on breakevens (or conversely the Bernanke Put under stocks). UBS' macro team, while humbly professing not to be experts in corporate earnings (which have been dismal) or balance sheet ratios (which are positive but have deteriorated in recent months) believe in a big picture macro perspective that we have been vociferously commenting on for a year or two now.
SPX (green) vs 10Y Treasury rates (red) and 10Y TIPS Breakevens (blue-dots)
As official policy rates are frozen near zero and the Fed is likely to keep them there for at least two more years, one would need to look for different indicators quantifying market expectation of a future success or failure of the Fed’s stimulative effort. Breakeven inflation is a good candidate. The logic is pretty straightforward: we have been living in the low inflation environment for the past several years, and the Fed is quite intent on preventing deflation, so “successful” monetary policy should boost future inflation. The TIPS market reflects changing inflation expectations by repricing breakevens. Breakevens have reacted to the introduction of traditional and non-traditional policy measures, from new bond purchase announcements to extending the language regarding super low policy rates.
Specifically, they have noticed a potentially curious link between the way the market interpreted monetary policy signals and the large cap stocks in the US: the breakeven inflation rate on 10yr TIPS has tracked the S&P 500 very closely this year.
When the Fed is perceived to be successful in stimulating the economy, stocks benefit and breakevens also rise.
When the Fed’s potency is called into question, stocks fade and breakevens decline.
We have checked historical data to see if a similar pattern existed for the relationship between SPX and the nominal 10y Treasury yield in 2012. We found that relationship to be very statistically weak. We can point out to a pair of dates in 2012 when the 10y benchmark yield was essentially the same (1.83% vs.1.88%) while the S&P500 was 158 points higher on one date than the other.
Nominal Treasury rates have lost their 'signal' as UBS agrees with the point we have been making for a long time: central bankers and politicians, not economic fundamentals and inflation expectations, currently drive the nominal rate and equity markets.
08-27-12
PATTERNS
ANALYTICS
COMMODITY CORNER - HARD ASSETS
THESIS Themes
FINANCIAL REPRESSION
CORPORATOCRACY -CRONY CAPITALSIM
INSURANCE SECTOR - In 2008 Reserves were cut by 5 X Without Publically Announcing it.
State insurance regulators are considering changes that would require U.S. insurers to hold more capital against some of the riskier mortgage bonds they have been scooping up lately as high-yielding investments. The moves under discussion could increase by billions of dollars the total amount industrywide that insurers must hold to protect policyholders.
Strong investor demand for those securities recently helped the Federal Reserve Bank of New York to profitably sell two large portfolios of subprime and other mortgage bonds it acquired in the 2008 bailout of AIG.
Many insurers "are looking for ways to enhance yield" and mortgage-bond yields are very attractive relative to other assets.
regulatory capital treatment is "important" in insurers' decision to buy these securities.
In 2011, insurers invested over $26 billion in residential mortgage-backed securities that aren't guaranteed by government agencies
the appeal of the mortgage bonds is
their high yield in today's low interest-rate environment,
discounted prices and
potential for gains in a housing recovery.
At the end of 2011, the insurance industry held $3.2 billion in capital to back a total of $123.2 billion in residential mortgage bonds, according to NAIC data. If the old credit ratings-based system were in place, insurers would have needed $18.3 billion in capital for those same bonds.
18.3/123.2 = 1 to 6.7 or 15% coverage versus 3.2/123.2 = 1 to 38.5 or 3% coverage
Since bond yields are already at record lows, could it be that Fed officials have concluded that the only transmission mechanism they have left between monetary policy and the economy is the stock market? Recall that the Fed Chairman mentioned stock prices twice in his 11/4/10 Washington Post op-ed explaining why the Fed implemented QE2 the day before: “Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. … And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”
If nothing is done by Congress to avert the fiscal cliff at the start of next year, the Congressional Budget Office (CBO) projects a recession during the first half of next year, with the unemployment rate remaining above 8% through 2014: “The increases in federal taxes and reductions in federal spending, totaling almost $500 billion, that are projected to occur in fiscal year 2013 represent an amount of deficit reduction over the course of a single year that has not occurred (as a share of GDP) since 1969. ... Real GDP is projected to fall at an annual rate of 2.9 percent in the first half of next year and then to rise at an annual rate of 1.9 percent in the second half.”
“The magnitude of the slowdown we’re discussing next year is significant,” CBO Director Douglas Elmendorf said at a morning briefing yesterday. He warned that going over the cliff could cost the nation about 2 million jobs.
JACKSON HOLE
"The latest FOMC minutes noted: “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” There was no similar comment about taking action "fairly soon" in the minutes of the previous meeting during June 19-20."
I think there’s a chance that he might announce during his August 31 speech at Jackson Hole that the Fed will launch an open-ended QE3 program with the hope of turbocharging the economy so that it can leap over the cliff. San Francisco Fed President John Williams, a voting member of the FOMC, was the first to advocate this stunt in an interview reported in the 7/23 FT.
He floated the idea again in an interview reported in the 8/10 issue of the San Francisco Chronicle. When he was asked whether QE3 should be saved to cushion the fall off the cliff early next year, if necessary, he responded: "We want to position the economy to be strong in advance of that. If you are really worried about running out of ammunition, you want to act more aggressively, more quickly and better prepare yourself for that eventuality."
Boston Fed President Eric Rosengren, who is a non-voting member of the FOMC, seconded Williams’ motion for open-ended QE3 in an interview reported in the 8/7 WSJ. According to the minutes of the July 31-August 1 FOMC meeting, released yesterday, "Many participants expected that such a [QE] program could provide additional support for the economic recovery both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly."
WILL IT WORK?
Michael Oliver, a seasoned stock market technician and a good friend, asks an interesting question about Bernanke’s highly anticipated stunt: “Prior [Fed] interventions came at market lows when the technicals were oversold, hence ripe for some upside relief. So, with that ‘difference’ this time around, with the market if anything technically stretched and measurably overbought on the upside, will a new QE work or blow up in their face?”
Great question. All the more reason to save the big QE3 stunt for early next year, if necessary, in my opinion. For now, why not just extend NZIRP until the unemployment rate drops below 7%? The FOMC discussed such a policy option at its last meeting:
“Given the uncertainty attending the economic outlook, a few participants questioned whether the conditionality of the forward guidance was sufficiently clear, and they suggested that the Committee should consider replacing the calendar date with guidance that was linked more directly to the economic factors that the Committee would consider in deciding to raise its target for the federal funds rate, or omit the forward guidance language entirely.”
08-27-12
MONETARY
CENTRAL BANK
STATISM
CURRENCY WARS
STANDARD OF LIVING
CONSUMPTION - Personal Savings May Now Be Funding Consumption
Personal Spending rose 0.4% MoM, its first rise in three months, but this seems to have been 'funded' by consumers dipping into savings mode with the rate of growth of income rising at the same level as last month and as expected +0.3%. The Spending rate of increase missed expectations however and with the savings rate dropping for the first time in 5 months (to 4.2%) - it suggests a 'man on the street' who is perilously close to the edge to meet his needs.
08-31-12
CATALYTST CONSUMPTION
STANDARD OF LIVING
GENERAL INTEREST
TO TOP
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TODAY'S TIPPING POINTS
State insurance regulators are considering changes that would require U.S. insurers to hold more capital against some of the riskier mortgage bonds they have been scooping up lately as high-yielding investments. The moves under discussion could increase by billions of dollars the total amount industrywide that insurers must hold to protect policyholders. 
