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

RACE TO DEBASE : The "Race to Debase" Accelerates in a "Race to the Bottom"

The November GMTP issue discusses the Regional Macro Economic Issues in Europe, Japan, China and the Emerging Economcis and BRICS countries. The IMF, World Bank and BIS have all warned of heightened economic and financial risk. The IMF cut the grwoth rate of the advanced economies by 25% taken it down to levels not seen since 2009. The World Bank released a study indicating theat 600 million new jobs must be created over the next 15 years to meet economic and social demands. Meanwhile global growth is falling at rates not seen since the early stages of the 2008 financial crisis.

Currency Wars have entered a new stage has global economies fight for a shrinking piece of export/import demand. Any Geo-Politicl event, an unresolved US Fiscal cliff or unexpected corporate financial failure could be the catalyst to push the world into its first global recession.

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NOVEMBER 2012: MONTHLY MARKET COMMENTARY (Subscription Plan II)

THE P/E COMPRESSION GAME: An Old Game with a Different Twist to Misprice Risk

We are manipulating markets metrics in such a fashion as to intentionally Misprice, Misrepresent & Hide RISK. Prior PE reference boundary conditions which reflected risk have decoupled. Never has the game of forward operating earnings (versus historically trailing earnings) been more inappropriate than presently. Forward PE's can only be of value in rapid revenue and profit growth eras. This is not what we have presently. It is the wrong tool for the wrong job! Unless you are a sell side analyst, then it is exactly the right too for the difficult selling job you have. We have an era of Peak earnings growth RATES, slowing profit growth RATES and Peak PEs which are reflective of rapidly contracting PE's. We have a secular bear market in REAL terms but PE's are not contracting at a sufficient enough rate to reflect this. Though PEs in nominal terms net out inflation, they don't reflect the underlying downward trend in real terms. MORE>>

MARKET ANALYTICS & TECHNO-FUNDAMENTAL ANALYSIS

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

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OCTOBER 2012: TRIGGER$ (Subscription - Plan V)

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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

CHINA: Signalling it is 'Officially' Increasing Gold Reserves

China Gold Reserves “Too Small” - Ensure “National Economic and Financial Safety”  11/14/12 GoldCore Gold Bullion

"China needs to add to its gold reserves to ensure national economic and financial safety, promote yuan globalization and as a hedge against foreign- reserve risks"

• China’s gold reserve is “too small”, Gao said and while gold prices are currently near record highs, China can build its reserves by buying low and selling high amid the short-term volatility, Gao wrote.
• The People’s Bank of China is accumulating significant volumes of gold under the radar of many less informed market participants which is bullish.
• The Chinese government is secretive about its gold diversification and buying and does not disclose gold purchases to the IMF.
• No official update to their holdings since the barely reported upon announcement four years ago that Chinese gold reserves had risen from just over 500 tonnes to over 1,000 tonnes.
• In 2009, State Council advisor, Ji said that a team of experts from Shanghai and Beijing had set up a task force to consider expanding China’s gold reserves. Ji was quoted as saying:

"We suggested that China's gold reserves should reach 6,000 tons in the next 3-5 years and perhaps 10,000 tons in 8-10 years”.

• China is likely to have been quietly accumulating another 1,000 or 2,000 tonnes in recent years.

China Says It Must Add To Gold Reserves To Promote Yuan Globalization And As An FX Hedge 11/13/12

"Current run-rate of accumulation which is just shy of 1,000 tons per year, it is certainly within the realm of possibilities that China is now the second largest holder of gold in the world, surpassing Germany's 3,395 tons and second only to the US."

Two days ago we showed that the relentless importing of gold in China continues, yet what has been missing is an update direct form the horse's mouth how China feels toward gold (because we certainly know how it feels toward US Treasury paper). Today, we finally got one straight from Beijing, and that during a very carefully supervised time when the 18th Communist Congress is still in session, and every word out of China has profoundly telegraphic implications.

The time to worry would be when China was starting to give indications it is prepared to tell the world what its true gold holdings are (by now certainly well over 1000 tonnes). And the above piece from Wei is just that: because in saying very little, the Chinese official with a key political post has just given the first hint that China is preparing to give its official gold far greater focus. And from there, the time until China releases an IMF update on its official reserve holdings will be measured in days if not hours. Because all the gold will have long been accumulated.

And once that happens it will be too late to buy any incremental gold.

CHINA - What's Up With Chinese GOLD Accumulation?

Chinese Gold Imports Surge In September, YTD Total Surpasses Official Indian Holdings 11/11/12

Anyone who may have been concerned by the slowdown in Chinese gold imports in August, when the country imported "only" 53.5 tons of gold from Hong Kong (down from 75.8 in July), can breathe a sigh of relief. According to the Hong Kong Census Bureau, in September Chinese gross imports soared by 30% reverting to the long-term trendline of 65 tons in gross imports per month, and rising to a total of 69.7 tons. Net imports were 40% less, although that excludes organic Chinese gold mining and recirculation, which is why for all intents and purposes the gross number is the apples to apples one. And using that, Year-To-Date China has now imported a whopping 582 tons of gold, more than the official holdings of India at 558 tons, and which through November has certainly surpassed the holdings of the Netherlands, and make China's gross imports in just 2012 nominally the equivalent of Top 10 largest sovereign holder of gold.

This way at least we know where China is recycling all that vast trade surplus, which incidentally in October just printed, goalseeked or not, at the highest level - $32 billion - since January of 2009. Too bad China no longer recycles all those excess reserves into US Treasury paper (as we showed previously here).

YTD China gross imports from Hong Kong:

And in historical perspective: the recent surge in demand for gold is quite unmistakeable:

China Buys North Korea's Gold Reserves As South Korea Increased Gold Reserves By 30%  9/26/12 GoldCore Gold Bullion

Nations bought 254.2 tons in the first half of 2012 and may add close to 500 tons for the year as a whole, the London-based World Gold Council said earlier this month. 

The trend among central banks to diversify their foreign exchange reserve holdings with gold continues. This trend is very sustainable considering the still tiny allocations creditor nation’s banks, with massive foreign exchange reserves, have to gold.

NORTH KOREA:

• Desperate North Korea has exported more than 2 tons to gold hungry China over the past year to earn US $100 million.
• Even in tough times during the Kim Il-sung and Kim Jong-il regimes, North Korea refused to let go of its precious gold reserves.
• Chosun media reports that “a mysterious agency known as Room 39, which manages Kim Jong-un's money, and the People's Armed Forces are spearheading exports of gold, said an informed source in China.
• "They are selling not only gold that was produced since December last year, when Kim Jong-un came to power, but also gold from the country's reserves and bought from its people."
• This is a sign of the desperation of the North Korean regime and also signals China’s intent to vastly increase the People’s Bank of China’s gold reserves

SOUTH KOREA: Gold reserves rose a sharp 16 tonnes for a 30% increase in total gold reserves.  

PARAGUAY: Became the latest central bank to begin diversifying into gold. Their gold reserves rose sharply - from a few thousand ounces to over 8 tonnes.

TURKEY: Turkey’s gold reserves gained 6.6 tons to 295.5 tons, Ukraine’s rose 1.9 tons to 34.8 tons.

KAZAKHSTAN: Assets rose 1.4 tons to 104.4 tons last month.

GERMAN GOLD RESERVES - German Court Demands Bundesbank Audit Offshore Holdings

WHAT HAPPENS IF THE PERIPHERALS DEFAULT/

IS THE BUNDESBANK SOLVENT?

ONLY IF the BUNDESBANK'S GOLD RESERVES ARE IN FACT THERE!

German gold report reveals secret sales that likely were part of swaps 10/23/12 GATA via Zero Hedge

The gold vaulted by the German central bank, the Bundesbank, with the Bank of England "has fallen 'below 500 tons' due to recent sales and repatriations. ..." So despite the lack of official announcement, Germany lately has been selling gold from London -- perhaps as part of the secret "strategic activities" grudgingly acknowledged two years ago by the Bundesbank to GATA's friend, the German financial journalist Lars Schall:

http://www.gata.org/node/9363

The lack of announcement of the sale of the German gold in London suggests that the sale was actually part of a gold swap with another central bank -- like the New York Fed. That is, the powerful implication here is that German gold in London was sold at the behest of the United States and in exchange Germany took title to United States gold vaulted in the United States -- or title to gold supposedly vaulted in the United States. This way the Bundesbank could continue to claim ownership of the same amount of gold without lying, at least not technically.

As for the Federal Reserve and the U.S. Treasury Department, when you rig every market you can't worry so much about lying.

Of course such gold swaps were the target of GATA's federal freedom-of-information lawsuit against the Federal Reserve in U.S. District Court for the District of Columbia, a lawsuit concluded somewhat successfully last year, having pried from the Fed an admission that it has secret gold swap arrangements with foreign banks:

http://www.gata.org/node/9917

-- The Bundesbank is resisting accountability and has censored part of the auditors' report in the name of protecting secrets of the central banks storing the German gold. But why should there be any secrets about it? Nobody's asking for the combination numbers to the vaults, and the combination wouldn't do anyone any good anyway, as the vaults are guarded. Do these secrets involve gold loans and leases and other legerdemain? That seems to be the case.

German Court Demands Bundesbank Audit Sovereign Gold Holdings 10/22/12

The German court of auditors (Bundesrechnungshof) has demanded that the Bundesbank undertake an audit of its gold reserves.  In an 'audit-the-fed' style effort, the court wants to ensure that the nearly 3400 tons of gold is in fact in existence - 'because stocks have never been checked for authenticity and weight'. Furthermore, the Bundesbank's gold is stored in three other vaults around the world: The Bank of England, The Bank of France, and the US Federal Reserve. The court questions the practice of relying on a written confirmation from the custodians (foreign central banks). The decision means negotiating with the three foreign central banks for physical verification but in anticipation, the Bundesbank has begun the process of shipping 50 tons per year from the Fed back to Germany for the next three years.

Germany's apparent (unchecked and unverified) gold holdings are second only to the USA's (just as unaudited levels)...

Via Spiegel:

Germany has the second largest gold reserves in the world, nearly 3400 tons. Supposedly, anyway. Because stocks have never been checked for authenticity and weight. Now, the Federal Court has asked the Bundesbank to examine the gold reserves abroad regularly.

The German central bank gold is safely stored in vaults in Frankfurt, New York, Paris and London. Checked really but apparently no one. The Federal Court has the Bundesbank now anyway required regular inspection and inventory of the vast gold reserves abroad. The auditors explain this in a report on Monday has become known to the budget committee of the Bundestag with the "high value of gold holdings."

The samples stored at other German banks stocks were also never by the Bundesbank itself or by other independent auditors "added physically and for authenticity and weight" checked. Actually talk on the subject numerous theories - so should the U.S. gold reserves at Fort Knox have long been looted.

The Bundesbank has on the USA's second largest gold reserves in the world. End of 2011 there were 3396 tons, worth 133 billion euros. After the soaring price of gold is likely to reach about 142 billion euros currently even. Secures the gold bars by the Bundesbank in own vaults in Frankfurt as well as at three bearing points abroad: The U.S. Federal Reserve Bank in New York, Bank of France in Paris and the Bank of England in London.

Bundesbank gets tons of gold from New York

The Court had determined BY order of the Bundestag that the Federal Bank reviews its overseas gold reserves stored exactly. It is disputed whether the Bundesbank experienced for years practice sufficient to rely only on a written confirmation to the gold bars by the foreign central banks.

The Court recommends that the Bundesbank to negotiate with the three foreign central banks the right to physical verification of stocks. With the implementation of this recommendation, the Bundesbank has begun according to the report. They also decided to bring in the next three years to 50 tons each of the past at the Fed in New York gold to Germany to get it here to undergo a thorough examination. In the report, several points are blackened. In effect, the paper is not clear exactly how much gold is in which foreign central bank.

The information held in the Federal Bank headquarters holdings consist of 82,857 according to the report bullion stored mostly in sealed containers with 50 bars, which are kept in four separate locked safe boxes. Part of it (6183 bar) stored on open shelves, therefore in a separate vault - the so-called gold chamber. To secure the gold it says in the report: "The vault closure is double, the inner seals and the gold chamber under a triple lock."

What Is The Actual Book Value Of Germany’s Gold Reserves 10/23/12

German Federal auditors handed in a report slamming the Bundesbank for not inspecting their foreign held gold reserves to verify their book value.

The report says the gold bars "have never been physically checked by the Bundesbank itself or other independent auditors regarding their authenticity or weight." Instead, it relies on "written confirmations by the storage sites." 

The lion’s share of Germany's gold reserves (nearly 3,400 tons estimated at $190 billion) are housed in vaults of the US Federal Reserve, the Bank of England and the Bank of France since the post-war days, when they were worried about a Cold War Soviet invasion.

The Bundesbank stated, “There is no doubt about the integrity of the foreign storage sites in this regard".

In contrast with best industry practices Germany’s gold reserves do not seem to be independently verified by a third party.

Philipp Missfelder, a politician from Merkel’s own party, has asked the Bundesbank for the right to view the gold bars in Paris and London, but the central bank has denied the request, citing the lack of visitor rooms in those facilities, German’s daily Bild reported.

The Bundesbank won't let German parliament members inspect the German gold vaulted abroad because the central bank vaulting facilities supposedly lack "visiting rooms." And yet one of those vaults, the Federal Reserve Bank of New York, offers the public tours that include "an exclusive visit to the gold vault".

With German elections around the corner (and this a politically sensitive issue) the central bank decided last month to repatriate about 50 tons of gold per year over the next 3 years from New York to its headquarters in Frankfurt for "thorough examinations" regarding weight and quality, the report revealed.

The auditor’s report stated that the German Central Bank’s gold in London has dropped "below 500 tons" due to recent sales and repatriations, but it did not specify how much gold was held in the U.S. and in France. German media have widely reported that some 1,500 tons — half of their total is stored in New York. 

The lack of an announcement of the sale of the German gold in London suggests that the sale was actually part of a gold swap with another central bank -- like the New York Fed. The only question is the lack of transparency surrounding the fall in London.  Was German gold sold at the behest of the US and in exchange Germany took title to US gold vaulted in the New York? Or was title to gold supposedly vaulted in the United States?  

German economists have led a rally to “bring home our gold” and the news article listed below was circulated by the AP.

Some Follow-Up Questions For The Bundesbank, And Its Gold 10/28/12

Yesterday we posted the official statement of Bundesbank executive board member Carl-Ludwig Thiele, which in turn was a response to a recent surge in concerns about the safety and sanctity of German sovereign gold, held mostly abroad (if a major part of it held in London had been secretly repatriated), and demands by the general public - i.e., those who actually own the gold - for either an audit, or full repatriation, or both. There are, however, some problems with the official Bundesbank statement: the statistics cited in it, as well as the various explanations, are wrong, incorrect or misleading. Below we present some of the "facts" stated by Herr Thiele, and what the truth is.

The statistics, and facts, Thiele quotes in the interview are either patently wrong or indicate a major lack of understanding about the gold market.

1. Thiele says:

"By 1956, the gold reserves had risen to DM 6.2 billion, or 1,328 tonnes; upon its foundation in 1957, the Bundesbank took over these reserves. No further gold was added until the 1970s"

This is factually incorrect. From a documented source such as Timothy Green's gold reserves report from 1999 (source), we find that German gold reserves were 1,328 tonnes in 1956 and contined to rise every year until 1969 when they hit 4034 tonnes, an increase of 200% since 1956! Offical German gold in 1970 was 3,537 tonnes and declined to 2,963 by 1979. Since then it has increased by just 400 tonnes.

2. Thiele says:

"At the beginning of the last decade, we brought 930 tonnes of gold to Frankfurt from London and subjected it to a painstaking inspection. Part of the gold was melted down in order to create new bars which conform with the “Good Delivery Standard”.

Fact: All gold stored at the Bank of England has to be London Good Delivery Standard. Bars that do not conform are not accepted. That is how the LBMA system works. There is an accepted refiner list. There would be no need to melt down anything from the Bank of England unless the Bundesbank had been duped with coin bars or similar and/or does not have faith in the BOE in the first place.

3. Thiele says:

"We have at our disposal fully documented lists of the bars, and our partner central banks send us every year confirmation not only of the bars’ existence but also of their quality. We receive confirmation of our gold reserves, measured in troy ounces."

Which is it: on a bar basis or on a fine ounce basis? They are two very different things. One is covered by bailor/bailee law, the other is covered by a debtor/creditor relationship.

Fact: The gold reserves built up and stored on behalf of the Bundesbank at the Bank of England were earmarked on a bar basis in the Bundesbank's set-aside account. Set-aside accounts were not accounted for on a fine ounce basis. Thiele does not seem to be aware of this difference between a set-aside bar basis and a fine ounce basis.

A lot of gold in the FRBNY vaults is in the form of US assay office melts. These have a history of losing fine ounces on re-smelting, so with the Fed he is explicitly off base.

All of this, of course, excludes Thiele's emotional appeal to German heartstrings to please trust the New York Fed and the BOE (whose British Pound apparently is still a reserve currency by the Buba's offered logic), while completely leaving out the ECB (that other bank in Frankfurt, whose currency is what Germany currently does use). It also excludes his disturbing statement that "when push comes to shove, we can have it available as a reserve asset as soon as possible." The fact that "gold is not money", at least according to the Chairman, aside, one wonders just what signal is, or rather was, the Bundesbank sending by reclaiming its gold: is the need for gold to be used as a reserve assets once again approaching? (this is, obviously, rhetorical).

Finally, all of this begs the question: was the German writing while under the influence when he posted the official Bundesbank retort, or was he simply truly ignorant about some very simplistic facts about gold, official gold reserves and the gold industry, which anyone could fact-check on their own in 5 minutes or less. Or was he simply being disingenuous in hopes that nobody would actually question his authority and thus, his "facts"?

Because if anything, the Bundesbank response only opens up even more question about the credibility, not to mention the validity, of the official German stance, which logically implies that the fundamental hypothesis: that German offshore gold is in good hands, is also debatable at best and null and void at worst.

We hope that this ongoing dialogue between the German Central bank and its people continues, as it is one that is urgently needed in a world in which the old form of currency - fiat - is rapidly losing its credibility around the entire developed, and developing, world.

Bank Of England To The Fed: "No Indication Should, Of Course, Be Given To The Bundesbank..." 11-09-12 Zero Hedge

EU - Austerity is the Wrong Political Strategy in a Democracy

Why Politicians Hate Austerity - In One Simple Chart 11-15-12 Citi via ZH

Just as our political class in the US is spending its time focused on the tax-'em-til-they-bleed side of the equation as opposed to the cut-em-to-the-bone austerity side of the income statement; so the evidence is clear (thanks to the following chart) - austerity doesn't get you re-elected. When all that matters is your next government paycheck for your 'elected' position, far from being for the people, austerity is avoided as vehemently as possible. Not only does social unrest increase (as the 'people' have become used to unsustainable standards of living) but incumbent popularty sinks - rapidly.

FINANCIAL REPRESSION - Fed Model of' Equity Risk Premium' is Broken

The 'Broken' Fed Model In 3 Simple Charts 11-15-12 Barclays via ZH

One of the most commonly cited 'bullish' memes for stocks is the so-called Fed Model (or Equity Risk Premium) or more simply - the fact that earnings yields are not catching up to Treasury yields (i.e. why put your money in government bonds at such low rates when there is smorgasbord of yummy equities with 'attractive' dividend yields). There are three key problems with this perspective:

1) No concept of 'risk' is imbibed in this return-based differential (as we have discussed before here and here);

2) Longer-term historical context is critical (as we discussed here - must read); and most importantly

3) Financial Repression breaks the 'Fed Model'. As Barclays shows in the following three charts (and we pointed out recently) normalization of the equity risk premium will not occur until Financial Repression ends.

The Fed Model has broken - what are asset allocators to do? This occurred two other times in history...

As it seems in reality, the perceived risk differential between bonds and stocks is indeed critical in confirming the Fed Model... and that differential has become majorly disconnected since the crisis began (*and rightly so)...

Critically, just as we saw with the Great Depression, once the Fed removed itself (or reduced itself) by ending its then QE program of financial repression, then markets can clear and signal capital to move into not incorrectly-attractive investments...

So the next time someone throws the "So what you gonna do? Put your money in Treasuries at 2% yields?" line at you; kindly stroke your chin (reflectively), pause (philosophically), and tell them that until the Fed takes its boot off the interest-rate neck of the nation and stops buying every bond in sight, the risk-reward favors non-equities - and as any good entrepreneur putting their hard-earned capital to work knows 'a fed-induced period of mal-investment' can only end one way - and if you are patient, there will be plenty of 'opportunities' when that end begins.

Charts: Barclays

GLOBAL DERIVATIVES - BIS Report

Q2 Total Gross Notional Derivatives Outstanding: $639 Trillion 11-13-12 BIS -via ZH

Earlier today, the BIS, which has been doing everything in its power today to defend the 1.27 support in the EURUSD since the market open this morning, released its H1 OTC derivatives presentation update. There was little of material note: total OTC derivatives were virtually unchanged at $639 trillion gross, representing $25 trillion in net outstanding (market value), and $3.7 trillion in gross credit exposure. Here the PhD theorists will say gross is irrelevant because Finance 101 said so, while the market practitioners will point to Lehman, counterparty risk, and less than infinite collateral to fund sudden implosions of weakest links in counterparty chains, and say that it is gross (which until a recent revision of BIS data had been documented at over $1 quadrillion) that mattered, gross which matters, and gross which will always matter until finally everything inevitably collapses in a house of missing deliverable cards. Because not even the most generous sovereigns and central banks can halt the Tsunami once there is a failure of a major OTC Interest Rate swap counterparty. And whereas Basel III had some hopes it would be able to bring down the total notional in derivative notionals slowly over the next few years with a gradual deleveraging across all financial firms, the bankers fought, and the bankers won, because the last thing the current batch of TBTFs can afford it admit there is any hope they can ever slim down. The will... but never voluntarily.

Visually:

Click Image to Enlarge

And in tabular form:

Click Image to Enlarge

Some details from the OTC:

Total notional amounts outstanding of OTC derivatives amounted to $639 trillion at end-June 2012, down 1% from end-2011 (Graph 1, left-hand panel, and Table 1). The appreciation of the US dollar against key currencies between end-2011 and end-June 2012 contributed to the decline by reducing the US dollar value of contracts denominated in euros in particular. The overall decline was driven by interest rate contracts (–2%). Credit derivatives notional amounts also continued to decline (–6%). In contrast, foreign exchange contracts outstanding rose by 5% to $67 trillion.

Gross market values, which measure the cost of replacing existing contracts, dropped by 7% to $25 trillion (Graph 1, right-hand panel). This amounts on average to slightly less than 4% of notional amounts outstanding.

Gross credit exposures, which measure reporting dealers’ exposure after taking account of legally enforceable netting agreements, mirrored the decline in total market values, falling to $3.7 trillion, which represents 14% of the total market value of OTC derivatives. Since the end of 2008, gross credit exposures have tended to move in a narrow band of 14–16% of market values. This compares with a range of 19–24% in the mid-2000s. Gyntelberg and Vause (2012) calculate that about half of dealers’ gross credit exposures are covered by collateral.

Since gross notionals in most categories declined (boring) except for FX, here is the breakdown of what drove this rise:

Click Image to Enlarge

Full report link

SOVEREIGN DEBT - Life Cycle Stages

The Five Stages Of A Sovereign's Life-Cycle 11-12-12 Bridgewater via ZH

Four factors DRIVE relative economic growth:

1. Competitiveness,
2. Indebtedness,
3. Culture, and
4. Luck.

The returns from his machine-like investment process clearly indicate he is on to something as he notes that the most powerful INFLUENCES of this relative income (and power) are

1) Psychology that drives people’s desires to work, borrow and consume and

2) War (which we measure in the “luck” gauge).

Via Bridgewater:

Throughout history, Dalio advises these two influences have changed countries’ competitiveness and indebtedness which have caused changes in their relative wealth and power. He goes on to add that since different experiences lead to different psychological biases that lead to different experiences, etc., certain common cause-effect linkages drive the typical cycle of a nation's growth, power and influence.

To summarize, we believe that countries typically evolve through five stages of the cycle:

1) In the first stage countries are poor and think that they are poor.

In this stage they have

• Very low incomes,
• Most people have subsistence lifestyles,
• Don’t waste money (because they value it a lot),
• Don’t have any debt to speak (because savings are short),
• Nobody wants to lend to them.
• Are undeveloped.

2) In the second stage countries are getting rich quickly but still think they are poor.

At this stage they behave pretty much the same as they did when they were in the prior stage but,

• Because they have more money and still want to save, the amount of this saving and investment rises rapidly.
• Because they are typically the same people who experienced the more deprived conditions in the first stage, and because people who grew up with financial insecurity typically don’t lose their financial cautiousness, they still
  • a) Work hard,
  • b) Have export-led economies,
  • c) Have pegged exchange rates,
  • d) Save a lot, and
  • e) Invest efficiently in their means of production, in real assets like gold and apartments, and in bonds of the reserve countries.

3) In the third stage countries are rich and think of themselves as rich.

• Per capita incomes approach the highest in the world as their prior investments in infrastructure, capital goods and R&D are paying off by producing productivity gains.
• Prevailing psychology changes from
  • a) Putting the emphasis on working and saving to protect oneself from the bad times to
  • b) Easing up in order to savor the fruits of life.
• This change in the prevailing psychology occurs primarily because a new generation of people who did not experience the bad times replaces those who lived through them.
• Signs of this change in mindset are reflected in statistics that show reduced work hours (e.g., typically there is a reduction in the average workweek from six days to five) and
• Big increases in expenditures on leisure and luxury goods relative to necessities.

4) In the fourth stage countries become poorer and still think of themselves as rich.

This is the leveraging up phase – i.e., debts rise relative to incomes until they can’t any more.

• The psychological shift behind this leveraging up occurs because the people who lived through the first two stages have died off or become irrelevant and those whose behavior matters most are used to living well and not worrying about the pain of not having enough money.
• Because the people in these countries earn and spend a lot, they become expensive, and because they are expensive they experience slower real income growth rates.
• Since they are reluctant to constrain their spending in line with their reduced income growth rate, they lower their savings rates, increase their debts and cut corners.
• Because their spending continues to be strong, they continue to appear rich, even though their balance sheets deteriorate.
• The reduced level of efficient investments in infrastructure, capital goods and R&D slow their productivity gains.
• Their cities and infrastructures become older and less efficient than those in the two earlier stages.
• Their balance of payments positions deteriorate, reflecting their reduced competitiveness.
• They increasingly rely on their reputations rather than on their competitiveness to fund their deficits.
• They typically spend a lot of money on the military at this stage, sometimes very large amounts because of wars, in order to protect their global interests.
• Often, though not always, at the advanced stages of this phase, countries run “twin deficits” – i.e., both balance of payments and government deficits.

5) In the last stage of the cycle they typically go through deleveraging and relative decline, which they are slow to accept.

After bubbles burst and when deleveragings occur, private debt growth, private sector spending, asset values and net worths decline in a self-reinforcing negative cycle.

• To compensate, government debt growth, government deficits and central bank “printing” of money typically increase.
• In this way, their central banks and central governments cut real interest rates and increase nominal GDP growth so that it is comfortably above nominal interest rates in order to ease debt burdens.
• As a result of these low real interest rates, weak currencies and poor economic conditions, their debt and equity assets are poor performing and increasingly these countries have to compete with less expensive countries that are in the earlier stages of development.
• Their currencies depreciate and they like it.
• As an extension of these economic and financial trends, countries in this stage see their power in the world decline.

So the US (and much of the advanced economies of the world) are clearly in Stage 5 (or perhaps delusional still in Stage 4) and now we hope for a 'beautiful deleveragin vs an 'ugly deleveraging'

RISK - Fixed Income Investor Risk Perceptions

One Big Risk People Have Forgotten Thanks To The Fiscal Cliff 11-12-12

The fiscal cliff has completely dominated the headlines since the presidential election was decided last Tuesday. BofA Merrill Lynch's latest client survey of fixed-income investors confirms that the fiscal cliff is the biggest thing on the market's mind right now:

As fiscal cliff concerns have risen between September and November, many others have waned – especially that regarding  oil prices. In fact, less than half of those who called an oil price shock emanating from a conflict in the Middle East a big concern in September did so in November.

BofA Merrill Lynch credit strategist Hans Mikkelsen and his team say that's the biggest thing that investors are underappreciating:

The one risk that appears to us under appreciated by investors is the risk of higher oil prices - mentioned by only 6% of investors as a major concern - especially as there are significant risks of an escalation of the geopolitical situation in the Middle East.

On the other hand, BofA equity strategists peg the risk of an oil shock owing to a potential military conflict between Iran and Israel at below 10 percent. Here is what they had to say in a recent report on the subject:

Although tighter sanctions and the blockade of crude exports from Iran have reduced the country’s oil exports, Iran is still OPEC’s fourth largest oil producer, exporting about 1 million barrels a day. According to Commodity Strategist Francisco Blanch, a full blown Iranian oil supply disruption could push Brent oil prices up by $20-40/bbl and have twice the impact of Libya on global supplies and prices.

Indeed, the potential fallout from an Iranian strike could be much, much greater given that the oil market is already tight and that 20% of the world’s oil is transported through the Strait of Hormuz. A sustained rise in oil prices above $150/bbl would likely result in a recession and necessitate a significantly more defensive asset allocation. 

That scenario wouldn't be pretty, but given that BofA's equities team labels this a "tail risk" with less than a 10 percent chance of happening, maybe the bank's credit clients aren't so far off the mark.

JAPAN - Deep -3.5% Recession and A Negative Current Account Balance

Japan Plunges Into Deep Recession; GDP Shrinks 3.5% Annualized; Japan Current Account Turns Negative First Time in 30 Years; Watch the Yen 11-12-12 Mish

EARNINGS - Anaylsts apparently Surprised?

Here's Why The Market Has Been Tanking 11-14-12 SocGen via BI

US ECONOMY - Fiscal Tailwinds

Sector Surplus' Is The Key Force That Will Keep The Economy Growing For Years 11-13-12 Goldman Sachs via ZH

PATTERNS - Arithmetic versus Geometric Progressions

Sometimes a picture paints a thousand words. In the case of this chart, it paints an expectation of around 300 S&P points (to the downside). The strange symmetrical exponentiality of the last four years can only be marveled at in its reflection of greed and fear catalyzed by the machinations of an increasingly impotent central banking cartel. Trade accordingly.

The irony of the coincident timing of the plunge and the pending fiscal cliff decision - which as we noted here, will not be solved until the market pushes the politicians to 'compromise' - should not be lost on those who poo-poo such silly chartist ramifications...

(h/t Ivan The Terrible @SqueezedEquity)

PE RATIO - The Shiller P/E

An Old Friend: The Stock Market’s Shiller P/E Clifford S. Asness, Ph.D. AQR Capital MAnagement November 2012

In particular, though we will touch on some of the other possibilities, we will focus primarily on two measures at the forefront of today’s argument: A market P/E calculated using standard one-year trailing total earnings vs. what has come to be called the “Shiller P/E.”3 The idea of the Shiller P/E arose from the observation that one-year earnings are highly volatile and probably mean-reverting. Thus, at times of very high earnings, the one-year P/E might look “too low” (stocks too cheap) and when earnings are very low, the opposite can occur and the one-year P/E might look “too high” (stocks too expensive). At extremes, like very bad recessions, earnings can get so low as to approach or pass zero, making the oneyear P/E obviously silly (this almost happened in 2008/09). What the Shiller P/E does to adjust for this problem is simple and effective, if obviously imperfect. Instead of using oneyear trailing earnings, it uses the average of the prior 10 years of trailing earnings (inflation adjusted).4 Ten years is, of course, arbitrary. You would be hard-pressed to find a theoretical argument favoring it over, say, nine or 12 years. However, it struck its creators and many of us as reasonable and intuitive. It extends over one or two typical business cycles without going too deeply into the very distant past. Put simply, one-year P/E’s represent what an investor pays for the last years’ worth of S&P 500 earnings, again a very volatile number. In contrast, the Shiller P/E represents what an investor pays for the last 10 years’ average real S&P 500 earnings. The hope is that this is a more stable measure that is more relevant to long-term future stock returns and earnings. So, what do Shiller P/E’s look like over history up until today?

PE RATIO - Election Year Trends

Post-Election Performance: Dip-Buyer's Dream Or Valuation Slump 11-12-12 Bloomberg via ZH

With the S&P 500 down a staggering 6.5% from its post-QEtc highs, the world and their wealth adviser is beginning to get that Deja Deja Deja Vu feeling all over again. The commission-takers are being trotted out left, right, and center to spew forth every market myth from "money-on-the-sidelines" to "markets-hate-uncertainty"; from "valuation is cheap" and "whatcha' gonna do - buy bonds at 1.5% yield?"; and from "healthy retracement" to "long-term horizon". In today's episode of epic realizations of the truth, we thought we would look at year-end multiple expansion (contraction) seasonals - since we suspect earnings expectations (which are still running dramatically high; even though recently trending lower) - remain exorbitantly hopeful of a fiscal cliff resolution bringing joy and happiness to the world. Fact: post-election-year multiples have on average contracted around 1x versus a 0.6x expansion in non-election years.

The chart below shows the change in P/E multiple for the S&P 500 on average through the year - in election years, non-election years, and the current year...

Chart: Bloomberg

PATTERNS - Climatic Readings Signaling Exhaustion

Climactic Readings Usually Signal Exhaustion 11-09-12 Decision Point

PATTERNS - 2012 v 1987

S&P 500: 2012 vs 1987 10-23-12 Bespoke

There's nothing like a sharp sell off in the equity market during the month of October to bring out the worst of investor fears.  With last Friday marking the 25th anniversary of the 1987 Crash, those fears are even more apparent.  Making matters worse is the fact that the pattern of 2012 bears more than a passing similarity to 1987.

As shown in the charts below, in both years, the S&P 500 started off strong, saw a first half peak in the Spring, and then sold off.  In both years, the market regainged its footing around Memorial Day weekend, kicking off a Summer rally.  In 1987, the S&P 500 peaked in late August and had two successive failed rallies where each subsequent sell off made a lower low.  Likewise, this year the S&P 500 peaked in mid September and has since had two successive failed rallies where the index has made lower lows.

While the patterns between 1987 and 2012 are similar, there are two key differences.  First, the S&P 500 was up considerably more at its peak in 1987 (+39%) than it was at the 9/14 peak this year (+16.6%).  Secondly, in terms of valuation, the S&P 500's P/E ratio is considerably lower now than it was in 1987.  In 1987, the S&P 500's P/E ratio at the low after the crash (14.37) was still higher than it is now (14.28).

PE COMPRESSION - In Process

P/E Ratios Contract 11-08-12 Bespoke

The market pullback during a relatively strong earnings season for bottom line numbers has caused P/E ratios to contract recently.  Below we highlight one-year P/E ratio charts (trailing 12-month) for the S&P 500 and its ten sectors.  As shown, the S&P 500's current P/E stands at 13.92.

We've really seen a pullback in P/Es for three defensive sectors lately -- Consumer Staples, Telecom and Utilities.  This summer we noted the big increase in valuations for the Utilities sector as investors plowed into dividend paying stocks.  But with an increase in dividend taxes on the horizon, we're starting to see an exodus out of the inflated higher yielding names, and it's bringing P/E ratios down with it.  Even with the drop, however, the Utilities sector still has a higher P/E than the Technology sector, which is having its own problems lately.

MARGINS - No Cash Available for Margin Calls

And Now Come The Margin Calls: NYSE Margin Debt At 16 Month High 11-07-12 Zero Hedge

A stock sell off is usually a healthy, cathartic thing: one sells, pockets the proceeds, books a loss, and comes back to fight another day. The big problem, however, is when speculators and traders are already massively overleveraged, and not only don't have a positive Net Worth (defined as Free Credit Cash Account and Credit Balances in Margin Accounts less Margin Debt) but their Margin Debt is so high it commences a toxic loop of selling merely to fund margin calls which usually start popping up in the last hour of trading (and when trading desks put their phones straight to VM), leading to more forced selling, more margin calls, and so on. And therein lies the rub: according to the most recent NYSE margin debt data, the market complacency recently hit such high levels, that speculators virtually went all in, but solely in their margin accounts without holding any cash buffer to pay for potential margin calls. As can be seen on the table below, Margin Debt as of 9/30 hit $315 billion: a jump of $30 billion from the prior month, and the highest since March 2011, just before the market tanked. And confirming that there is simply no cash on hand to pay for margin calls when they start pouring in after today's massive sell off, is the total Net Worth, which in September was the lowest since April. Because with record complacency, and the Fed guaranteeing no further shocks are possible, who needs to hold cash? Today, we will find out: just as soon as the margin calls start coming around around 3PM Eastern...

CANARIES - Micro Weakness Indicating Major Macro Problems

Is Micro Weakness Smelling A Macro Collapse? 11-09-12 Goldman Sachs via ZH

Last week we suggested a reason why the market was unable to hold on to the Bernanke bid. The relative plunge in Goldman Sachs 'bottom-up' Analysts Index (GSAI) suggested that the macro 'strength' that market-savants were so focused on, could perhaps be election-biased (blasphemy). It seems this macro 'strength' divergence (highest since 1996!) from micro 'weakness' reality was enough to get the Goldmanites thinking - and unfortunately for all the cautiously optimistic managers out there, they are not hopeful. As Jan Hatzius explains,  "the GSAI remains closely correlated with other bottom-up measures, including the S&P 500 sales guidance diffusion index; and while one possible explanation is that S&P 500 companies are more exposed to non-US demand than the US economy at large, and the US has been a relative outperformer. But it is unclear whether this accounts for all of the weakness, or whether the bottom-up weakness also holds some additional leading information for the macroeconomic data."

Via Goldmans Sachs' Jan Hatzius:

• Our Goldman Sachs Analyst Index (GSAI)—which is based on our equity analysts' assessment of conditions in the industries they cover—has sharply underperformed the macroeconomic data, to a degree not seen since its inception in 1996.
• Has the GSAI gone off track? We don't think so, as it remains closely correlated with other bottom-up measures, including the S&P 500 sales guidance diffusion index compiled by our Portfolio Strategy group. It seems that the bottom-up message is simply gloomier.
• One possible explanation is that S&P 500 companies are more exposed to non-US demand than the US economy at large, and the US has been a relative outperformer. But it is unclear whether this accounts for all of the weakness, or whether the bottom-up weakness also holds some additional leading information for the macroeconomic data.

Since 1996, we have conducted a monthly poll of the Goldman Sachs equity analysts about business conditions in the industries under their coverage. In general, the resulting Goldman Sachs Analyst Index (GSAI)—a weighted average of analyst diffusion indexes for orders, shipments, and other activity measures—has matched macroeconomic indicators such as the ISM manufacturing and non-manufacturing index quite closely, and has at times even provided leading information. Partly for that reason, we typically release the GSAI two days before the ISM manufacturing index.

Over the past year, however, the historical relationship between the GSAI and the ISM has weakened, and anyone who has tried to use the GSAI to get an early read on the ISM has been disappointed (see Exhibit 1). The October 2012 release was the most striking example. The GSAI fell to 32.9, a reading that historically would have been consistent with an all-industry ISM in the mid- to high 40s. However, the all-industry ISM was broadly flat at 53.9.

Exhibit 1: Relationship between GSAI and ISM Has Weakened

What lies behind this divergence? One possible explanation is that the GSAI has simply become a less useful indicator over time, perhaps because of fluctuations in the sample size or divergence between our analyst coverage and the broader equity market. But on closer inspection, it seems that the weakness in the GSAI can be explained by more fundamental factors. While it has departed from the ISM, its weakness matches other "bottom-up" measures of economic activity quite closely, as also noted by our European Portfolio Strategy team. A good example is the revenue guidance index compiled by our US Portfolio Strategy group. It is defined as the percentage share of S&P 500 companies that guide consensus revenue estimates higher minus the percentage share that guide consensus estimates lower. Exhibit 2 shows that the GSAI has tracked the revenue guidance index closely since the latter was introduced in 2006, and both have weakened in lockstep in the past year. It seems that the bottom-up message from S&P 500 companies and the analysts that cover them is simply more negative than the macro data would suggest.

Exhibit 2: GSAI Still Tracks Revenue Guidance Closely

It is less clear why the bottom-up message is so weak. One reason is probably that S&P 500 companies are more exposed to international factors than the US economy as a whole, and non-US economies have slowed more sharply than the US. Regarding the first point, non-US sales account for 33% of the total sales of S&P 500 companies, but exports account for only 14% of US GDP. Regarding the second point, Exhibit 3 shows that the all-industry non-US purchasing managers index (based on data from our Global Economics group) has underperformed the all-industry ISM index for the US over the past year. Moreover, Exhibit 4 shows that while the GSAI has underperformed the composite ISM sharply, it has actually tracked the new export orders sub-index of the ISM (which is not included in the composite) reasonably well.

Exhibit 3: Weaker Conditions Outside the US

Exhibit 4: GSAI Still Tracking ISM Exports Closely

At the same time, the domestic/foreign split is probably not sufficient to explain the entire micro/macro divergence. Although there is little evidence for a systematic lead/lag relationship between the micro and macro data, and although other measures of overall activity such as the labor market and various GDP-type spending measures also point to decent growth, the micro data do provide an independent read on activity and may be pointing to slower growth ahead. Our forecast remains for a deceleration in real GDP growth to a 1.5% pace in early 2013, despite positive bounce-back effects from both Hurricane Sandy and the 2012 droughts. The main reason lies in the step-up in the pace of fiscal restraint and the uncertainty effects that may already have started to hit capital spending.

It is possible that indicators such as the GSAI and S&P 500 revenue guidance have picked up signs of such a slowdown at an earlier stage than the macroeconomic indicators.

SECTOR RETURNS - Total Return Performance of Obama's First Term

The Returns Of Every Major Financial Asset In The World During Obama's Presidency 11-06-12 Deutsche Bank via ZH

PATTERNS - Global Market Comparisons

Why Global Investors Love The US Stock Market 11-07-12 Mrgan Stanley via ZH

Gerard Minack, Morgan Stanley's head of developed market strategy, created this chart to show how 2013 earnings expectations for Australia's stock market — the S&P/ASX 200 — have deteriorated through out the year.  Australia's economy is largely driven by a mining industry, which has been supplying the emerging markets.  Those emerging markets have slowed significantly.

It's worth noting, however, that the Nasdaq has had net upward EPS revisions.  And S&P 500 EPS revisions have been revised down only modestly.

The lack of earnings expectations volatility is certainly welcome by investors.

Below is the chart from Minack.

• DM EX-US: Developed Markets excluding the US
• MSCI EM: Emerging Markets
• EURO STOXX: Europe

FINANCIAL REPRESSION - Driving Investors into Higher Risk Assets

The Most Compelling Reason To Buy Stocks David Rosenberg via BI

MONETARY MALPRACE - Moral Hazard & Unintended Consequences

Welcome To The Nuthouse: How Private Financial Fiat Creates A Public Farce 11-13-12 Charles Hugh Smith

Farce #1: “Market value” and “free markets” have become a joke.

Farce #2: Private, self-assigned, fake value is being traded for public money at 100 cents on the dollar.

Farce #3: Printed money is backed by nothing.

Farce #4: We have a “free” enterprise system dominated by monopolies that force people to buy inferior goods and services at exorbitant rates.

Farce #5: High-level financial crimes, no matter how egregious or widespread, are not being prosecuted.

Farce #6: Risk is gone. Now there is only liability borne by citizens.

Farce #7: Productivity has been supplanted by parasitism.