As the world's Reserve Currency the US has enjoyed what is referred to as "Exorbitant Privilege". The US has been able to 'print' money but not suffer the consequences of the associated inflation and currency debasement that comes with such irresponsibility. This is because the 'exorbitant privilege' effectively allows the US to export its inflation. This inflation returns initially as higher import costs, but eventually as hyperinflation, as the world slowly abandons the US dollar and its reserve currency status. This 'exorbitant privilege' continues to work until something which was well understood prior to the US going off the gold standard no longer works. That is a concept referred to as the "Triffin Paradox".
The US Council on Foreign Relations aptly describes why Triffin's dilemma becomes unsustainable: "To supply the world's risk-free asset, the center country must run a current account deficit and in doing so become ever more indebted to foreigners, until the risk-free asset that it issues ceases to be risk free. Precisely because the world is happy to have a dependable asset to hold as a store of value, it will buy so much of that asset that its issuer will become unsustainably burdened."
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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>>
We have witnessed QEfinity "Unlimited", OMT "Uncapped', and the US Election results. Now we begin to watch the Fiscal Cliff political poker game unfold. So far it has been a Buy on the Rumor, Sell on the News scenario with markets down significantly since each event, but appearing to find support at the 200 DMA. With US government facing another downgrades to its "Risk Free" status, earnings plummeting and a clear global slowdown in progress, what should we expect before year end and more importantly in the New Year? The short answer is 'volatility' as we complete the "Right Shoulder" of a classic Head and Shoulders pattern of a major Long Term Technical structure. Once complete we then head lower.
A Santa Claus Rally is highly likely despite a rarely confirmed Hindenberg Omen and technical chart patterns that mirror the pre-1987 market crash - way too closely for this analyst. The markets are at levels of extreme risk which is not priced in. Most investors are best advised to stand aside and error on being too conservative. It is too risky at this moment to be either net long or short. Soon however there will be a lower risk entry to be net short the market for the 2013 market clearing event, which the macro charts are consistently signaling.
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
Goldman commodity analyst Damien Courvalin is out with a big call: The top in gold is in.
The firm says that the primary driver of gold prices are real interest rates (which have been super-low in the United States, in part thanks to aggressive Fed easing) and that with the economy coming back, this era is coming to an end.
Before you get the details of this specific call, you have to understand the firm's overall view of the economy.
Last Week, Goldman economist Jan Hatzius made a big economic call... that the era of sub-par, post-Financial Crisis growth would come to an end sometime in the second half of 2013. And Courvalin, in lowering his gold outlook, is keying off of this call.
Here are the two key paragraphs from the report:
Improving US growth outlook offsets further Fed easing
Our economists forecast that the US economic recovery will slow early in 2013 before reaccelerating in the second half. They also expect additional expansion of the Fed’s balance sheet. Near term, the combination of more easing and weaker growth should prove supportive to gold prices. Medium term however, the gold outlook is caught between the opposing forces of more Fed easing and a gradual increase in US real rates on better US economic growth. Our expanded modeling suggests that the improving US growth outlook will outweigh further Fed balance sheet expansion and that the cycle in gold prices will likely turn in 2013. Risks to our growth outlook remain elevated however, especially given the uncertainty around the fiscal cliff, making calling the peak in gold prices a difficult exercise.
Gold cycle likely to turn in 2013; lowering gold price forecasts
We lower our 3-, 6- and 12-mo gold price forecasts to $1,825/toz, $1,805/toz and $1,800/toz and introduce a $1,750/toz 2014 forecast. While we see potential for higher gold prices in early 2013, we see growing downside risks.
The essence of the call is boiled down to this chart, which compares gold prices to real interest rates (inverted). Given their expectation that real interest rates will rise, gold will follow the dotted line, and will decline the same way there was a decline in the 1980s
The key thing to realize is that this call is really the only natural corrolary to Hatzius' call that growth will accelerate to above-trend levels in the second half of next year.
The firm's overall stance is that the deleveraging/balance sheet economic crisis is coming to an end. THat will end this rates era, and this huge run for gold.
It's around that time of day again - when precious metals are sold hard for whatever reason you care to come up with (collateral requirements, margin calls, alchemy perfected). However, today there is a more mundane reason: Goldman Sachs has suggested its clients sell Gold on the basis that the gold cycle will turn in 2013 thanks to improving US growth offsetting the need for further Fed easing. Of course, Goldman telling its clients to 'sell gold' means Goldman is...
Via Goldman:
Gold prices range bound in 2012 despite perfect set up
Gold prices have remained range bound in 2012, despite a steady decline in US real rates and rise in central bank holdings that would ordinarily be supportive. To understand this dislocation we expand our modeling of gold prices to include the impact of the US Federal Reserve easing. We find that gold prices “look through” easing that does not require Fed balance sheet expansion –like Operation Twist – increasing instead on announcements of easing through expansion on the Fed’s balance sheet.
Improving US growth outlook offsets further Fed easing
Our economists forecast that the US economic recovery will slow early in 2013 before reaccelerating in the second half. They also expect additional expansion of the Fed’s balance sheet. Near term, the combination of more easing and weaker growth should prove supportive to gold prices. Medium term however, the gold outlook is caught between the opposing forces of more Fed easing and a gradual increase in US real rates on better US economic growth. Our expanded modeling suggests that the improving US growth outlook will outweigh further Fed balance sheet expansion and that the cycle in gold prices will likely turn in 2013. Risks to our growth outlook remain elevated however, especially given the uncertainty around the fiscal cliff, making calling the peak in gold prices a difficult exercise.
Gold cycle likely to turn in 2013; lowering gold price forecasts
We lower our 3-, 6- and 12-mo gold price forecasts to $1,825/toz, $1,805/toz and $1,800/toz and introduce a $1,750/toz 2014 forecast. While we see potential for higher gold prices in early 2013, we see growing downside risks. As a result, we find that the risk-reward of holding a long gold position is diminishing and recommend rolling our long Dec-12 COMEX gold position into a long Apr-13 position and selling a $1,850/toz call to finance a $1,575/toz put to protect against a decline in gold prices. Since 2009, this strategy achieved a better Sharpe ratio than a long gold position.
Authored by Robert Buckland, Head of Citi Global Equity:
QE Isn't Working: An Equity Perspective
The economics textbooks teach us that expansionary monetary policy, which lowers interest rates and eases credit, can be used to combat unemployment and economic recession. So, with inflationary pressures waning and the world economy slowing, policymakers around the globe have put this theory into practice and continued a "race to the bottom" for global interest rates. Many of those countries with policy rates still high enough to make it worth cutting have done so. Those where rates were already rock-bottom have resorted to increasingly creative means to lower borrowing costs even further.
Low interest rates should help to support consumer spending through reduced mortgage and credit card costs. In addition, by purchasing sovereign debt, QE policies help to reduce market pressures for governments to pursue growth-sapping austerity policies. But lower rates for overleveraged consumers and governments look more like damage limitation than growth promotion.
That leaves the corporate sector as policymakers' best hope for economic growth and especially job creation. Balance sheets are strong, profitability is high and the cash is piling up. Add ultra-low rates to the mix and surely CEOs will kick off a capex and hiring binge. But this has not really been happening, in the listed corporate sector at least. In fact, capex/sales ratios for publicly listed companies across the world have been heading downwards for much of the past decade even given a backdrop of progressively lower interest rates. Recent ultra-low rates have not noticeably reversed this trend.
Faults in the transmission mechanism
Such corporate caution is usually blamed on global economic uncertainties. Amongst these, the US fiscal cliff, China slowdown and the ongoing EMU crisis look most obvious. But we can't help feeling that there is something more fundamental going on here. The economic outlook is always uncertain at weak points in the cycle. Nevertheless, low interest rates usually prod CEOs into action.
We think one answer to this conundrum can be found in the equity market itself. As aggressive monetary policy has pushed interest rates to all-time lows, so the dividend yield available on equities becomes more attractive. The global equity market now consistently trades on a dividend yield above treasuries for the first time in over 50 years. Income-starved investors have noticed.
Turning textbooks on their head
If the global equity asset class has reinvented itself as an alternative bond market, this has profound implications for companies and, ultimately, policymakers. Textbooks suggest that investors should buy equities for growth and bonds for income. But low rates and QE have turned the traditional mantra on its head. Investors are increasingly looking to equities to fulfil their income requirements. And as the global equity market becomes dominated by these income-seeking investors, companies will become increasingly sensitive to their requirements.
Textbooks also say that the equity market exists to bring together those who capital and those who require it. Equity investors provide the riskiest capital to a company. They give up security of return in order to participate in the future growth of the business. Again, that looks less appropriate in current capital markets. Rather than providing new capital to companies, equity investors now seem more interested in extracting existing capital through share buybacks or dividends.
Another basic premise of financial theory — that lower discount rates should put a higher value in future corporate cashflows — is also being questioned by present circumstances. Low interest rates should encourage companies to invest more for the future because shareholders will value the resultant cashflows more highly. It is partly why policymakers have now set rates so low. But, again, these theoretical transmission mechanisms do not seem to be working. For the past ten years, a rising equity risk premium (ERP) has negated the supposedly positive impact of lower interest rates upon equity valuations. The ERP has now risen so far that equities have become an income asset, so increasingly attracting investors who are more interested in the next dividend than funding a new mine, drug or microchip.
It's all about the distribution
This brings us to a basic observation: companies remain reluctant to expand because increasingly income-obsessed shareholders don't want them to. If anything, ultra-low interest rates have exacerbated this theme. Policymakers should take note.
In 2011, US companies spent $650 billion on share buybacks and dividends compared to $580 billion on capex. While this is supportive of share prices, it does not help other stakeholders who would presumably prefer the capital to be spent on new investments and jobs. In markets where shareholder requirements have a greater influence upon companies, the suspicion of capex and preference for distributions is evident. In Europe, those sectors that invest the most are given lower valuations and in the US, share buyback and dividend ETFs have outperformed handsomely in recent years. It seems that the market is sending clear signals to companies "if you want your shares to outperform then distribute, don't invest."
What does this mean for policymakers?
If policymakers really do want to encourage stronger economic growth (and especially higher employment) then we would suggest that they take a closer look at the equity market's part in driving corporate behaviour. Despite high profitability, strong balance sheets and ultra-low interest rates, any stock market observer can see daily evidence of why the listed sector is unlikely to kick-start a meaningful acceleration in the global economy. A recent Reuters headline says it all: "P&G Plans to Cut More Jobs, Repurchasing More Shares".
If anything, low interest rates are increasingly part of the problem rather than the solution. Perversely, they may be turning the world's largest companies into capital distributors rather than investors. Perhaps rates should be allowed to rise back to more natural levels. This might be painful at first, but it could stop equity investors being so income-obsessed. Or maybe the real problem here is depressed equity valuations. Low PEs and high dividend yields reflect the long slow death of the equity cult. At the margin, current valuations encourage CEOs to distribute through buybacks or dividends. They discourage capex and job creation. Perhaps instead of buying government bonds, the next round of freshly minted QE cash should be used to buy the stock market instead.
Alternatively, and more menacingly for equity markets, policymakers might use the tax system to clamp down on capital returns to shareholders. "Investors are forcing companies to over-distribute and under-invest" has a certain populist ring to it. This was exactly the argument used to justify the removal of the dividend tax credit for UK investors back in 1997. Another, more equity-friendly, policy might be to give greater tax breaks to capex.
Even if economic uncertainties and shareholder constraints mean that listed companies are unlikely to embark on a capex binge soon, maybe low rates can have a more textbook impact upon unlisted companies. Having no stock listing could make them less aware of investor pressures and more willing to adopt expansive strategies. Perhaps these are the companies that offer the best hope for a pick-up in employment.
What does this mean for investors?
If policymakers hope that listed companies can help drive down current high levels of unemployment then it could be a long wait. Corporate expansion plans are likely to remain constrained by uncertainties about the global economy and a shareholder base that is more interested in share buybacks and dividends than capex and job creation. But despite our misgivings about their effectiveness, interest rates are likely to remain very low for some time.
What are the implications for investors?
Equity markets are supported despite weak growth. Income-seeking capital should help to support global equities. Even if earnings growth is held back by weak economic growth, buybacks and accretive cash bids should help EPS expand.
Inflation may come back sooner than expected. Just as equity market funded over- investment during the Tech bubble created deflationary excess capacity, so perhaps under-investment may now be creating the potential for future inflation. Bond investors should take note.
Equity income and de-equitisation strategies are still key. Premium dividend yields relative to bonds should continue to attract income-seeking investors to the equity asset class. This will keep the appetite for equity income strategies strong. Those companies that offer progressive dividend policies should be rewarded with outperformance.
Smaller growth stocks can trade at premiums. Despite the current circumstances, equity financing is still best suited to fund longer-term growth projects. But the limited amount of capital available to sponsor these projects means that growth premiums are likely to remain focused in companies down the market cap scale.
Activism is here to stay. Expansionary strategies by corporates will continue to be treated with suspicion by the equity market and subsequent share price underperformance may attract the attention of activist shareholders. Those CEOs, particularly at the largest companies, who do not give this income-seeking market what it wants may find themselves replaced by a CEO who does.
It’s estimated that the pound sterling made up around 64% of the world’s official FX reserves in 1899. It had fallen to about 48% by 1913. As you'll likely glean from the graphic below, Addogram notes that historic recurrence seems to like operating in base-100 when it comes to reserve currencies. The dollar's share of global (official allocated) FX reserves has fallen from 72% in 1999 to 62% at present. As we have pointed out before - reserve currency status doesn't last forever...
The center of each “dynamic” pie chart below shows the composition of official (allocated) foreign exchange reserves in 1999. The further you move outwards from the center, the closer you draw to the present day.
If you want to send a roomful of 100 wealth managers into an icy chill, have Russell Napier address them. This is exactly what happened at Citywire’s Smart Beta retreat at the Four Seasons Hotel in Hampshire recently.
Napier’s presentation, “Deflation in an Age of Fiat Currency,” is thought-provoking, and the precise polar opposite of investing as usual. A wry and picaresque speaker, he starts with some conclusions. Among them:
To reach record lows [akin to those on offer in 1921, 1932, 1949 and 1982], US equities will have to fall by more than 60%.
Central banks are straining to produce inflation, and developments in emerging markets (i.e. China) suggest a deflation shock is now likely.
The capital exodus from China is disrupting the creation of inflation.
In the search for yield, cash is trash ‚ so now is the time to own cash. (This is an example of his dry contrarianism.)
US Treasuries could repeat their 83% price decline of 1946-1981.
US stock markets aren’t cheap, not by a long chalk. Napier, like us, favors the 10-year cyclically adjusted price / earnings ratio, or CAPE, as the best metric to assess the affordability of the market. Unlike the traditional P/E ratio, CAPE smooths the near-term volatility by taking a 10-year average.
At around 21, the US market’s CAPE is near the top end of its historic range. There is better news, at least for non-Americans. Other markets, of course, have different
valuations. Current CAPEs include:
UK: 12.5x
Italy: 7.8x
Spain: 8.5x
Greece: 1.8x
Ireland: 6.0x
Portugal: 9.2x
Germany: 16.0x
China: 18.0x
Japan: 21.3x
The S&P 500 stock index currently trades at a level of around 1400. Napier believes it will reach its bear market nadir at around 450, driven by a loss of faith in US Treasury bonds, and in the dollar, by foreigners.
The growth of the Treasury bond market coincided with Baby-Boomers, Medicare and Social Security. Its death will be triggered by falling demand for Treasuries from emerging economies.
And it seems this rollover in the US Treasury market is already under way. Foreign central bank purchases of US treasuries have been in decline since 2009:
As Napier points out, this coincides with a disturbing decline in the growth rate of China’s foreign reserves.
In our view, investors’ fortunes will depend on how they survive the bear markets to come. I use the term ‘bear markets’ in the plural because it strikes us as almost a certainty that a grotesque bear market in western government debt is approaching. (If we knew the precise timing we’d already be on the beach.)
And if western government debt craters (pick your poison: US, UK, euro zone, Japan…they all look appalling), stock markets will not be far behind. It is inconceivable to us that equity markets could simply ignore a savage sell-off in the <cough, cough> risk-free markets of the world.
Remember, though, bear markets are not necessarily to be feared. Provided one can survive them, they bring opportunities to create significant wealth. But this is not automatically a rapid process.
As Marc Faber writes in his introduction to Napier’s excellent book, Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms:
“Conventional wisdom has it that great market bottoms, which offer lifetime buying opportunities, occur quite soon after devastating market crashes. But . . . great bear markets have long life-spans. . . At its 1921 low, the Dow Jones Industrial Average was no higher than it had been in 1899, 22 years earlier…”
In the piece I wrote over the weekend and subsequently published as an “Out of the Box” yesterday I touched upon the Fed’s buying and what it will mean for the bond markets. Today I wish to concentrate on the implications of what the Quantitative Easing will do to the fixed income markets and, to a lesser extent, to the equity markets. Many people, and erroneously, think that all of the purchasing by the Fed will go to both markets in equal amounts but this is not the case. More money for the stock markets would have to come from asset reallocations by money management firms, insurance companies, pension funds and the like and this is not going to happen anytime soon given the 2008/2009 experience. Consequently the greatest flows generated by the Fed’s recent and forward actions will affect the bond markets much more than the equity markets. What this means is a massive compression of available securities against Treasuries which continues what has been underway since early last year. The demand for Treasuries will also push down absolute yields so that my springtime prediction of a 1.25% ten year Treasury yield, the actuality is 1.38% so far so I was close enough, will be breached in 2013 as the Fed takes in and monetizes somewhere between 80-100% of all new Treasury issuance.
J.P. Morgan, in a recent piece, suggested that between the MBS purchases and the next upcoming stimulus push that the Fed would account for 90% of all new debt issuance and I then calculated a demand imbalance between $400 billion to almost $2 Trillion depending upon the actual Fed announcements. However you cut it though it means that the Fed will be purchaser of securities and that what is left is insufficient to meet demand so that
Compression and Lower Yields for anything/everything are on the horizon
There are many problems here and significant problems that will face the markets in the years ahead as the Fed will balloon its purchases so that they singularly support the financial markets. The Fed currently holds about 18% of the U.S. GDP on its books and it could bulge to 23-28% a few years out depending upon the continuation or increase in current programs. There are academic arguments to all of this and very real dangers when the Fed, if the Fed, ever turns and stops their purchasing but in the meantime we play the game to win and the strategy is simple enough. Buy every bond that is long where you can deal with the credit risk and take advantage of the compression. For those of you that do not watch the institutional bond markets like I do I can tell you that now, not off in the distance but now, there are almost no discount bonds left in the long end of the market as compression and the absolute decline in yields will push bonds to yet unseen levels and institutions are already or will be soon setting up to take advantage of these conditions.
This all works, by the way, only because all of the world’s central banks are working in concert so that there is no imbalance and money cannot be invested off-world.
In effect, we are stuck but that is the way of it these days. There is no use arguing with what is and neither wishful hope nor predictions of crash will help you in the short run. One day there may well be the question of valuation and the worth of currencies but it will not be now so that betting upon doomsday scenarios is not a good play but never close your eyes to fact of the monster that has been created. It looms out there like the great silent beast that it is and it is only the ring of nothing else to buy on this planet that curtails his rampage. The beast is currently kept in his pen but if the gate of the worth of currencies is ever opened then not even Katie will be able to bar the door.
The world will continue to operate on relative value in the meantime and the Fed, as the buyer, will destroy what absolute value there is because their intentions and goals are vastly different from investors.
Yields will not make sense empirically because of the actions of the Fed but it will make no difference; lower yields and greater compression will be the rulers of this part of the drama. The “Fear Factor” will come and go but the trend will be as I have predicted because the most fundamental of laws apply; demand will vastly be greater than the supply. The Mad Hatter rules and the Red Queen has installed a new croquet court!
6
6- Bond Bubble
BOND BUBBLE: Musical Chairs, Yield Chasing & other RISKY Children's Games
Thanks in large part to the supply-constructing yield-compressing repression of a few 'apparently well meaning' bad men running the central banks of the world, the divergence between fundamental weakness and credit spread 'strength' is at record levels. The overwhelming 'technical' flow of funds from investors combined with an 'end of equity' cult and belief that tail-risks have been removed (OMT) juxtaposes with earnings crumbling, ratings downgrades, and the exogenous fact that a complex system means a systemic crisis is inevitable (especially after such ongoing volatility suppression). As Citi's Matt King notes, while "it is almost impossible to predict exactly when they start," the desperation for yield has led to highly unstable equilibria - as what investors can't earn they will lever; via lower-quality 'levered' assets (PIKs and BB/CCCs for example) or 'levered' vehicles (CLOs and structured credit). Sure enough, margins (street repo haircuts are low and NYSE margin accounts high) look very 2007-like. While yelling 'fire' in a crowded theater will typically get the people moving, it seems the movie that is playing in corporate credit is simply too engrossing for many to listen.
Central-Bank repression and investors' demand for some safety has crushed the yields of the most liquid sovereign bond markets...
and constrained supply of even the safest of non-safe securities...
And given the size of the 'credit' markets in general, there is fewer and fewer yield opportunities to go around...
as investors faced with little choice but to 'opt for the risky upside'... no matter how concentrated that risk is...
Which led to the second best year ever for corporate credit!!
However, this technical flow and overwhelming drive for yield is completely ignorant of the fundamental shifts occurring under the surface as yet more markets become dislocated from any signaling ability...
but fundamentals are not keeping up - especially now the new normal is to borrow cheap and dividend out...
which of course will eventually be capped by an unacceptable rise in leverage...
and while ratings agencies get that credit cycles 'cycle' and have actioned ratings downgrades on a large scale, the actual defaults remain limited thanks to the ability to roll debt (due to the self-sustaining liquidity pump)...
Which, due to at least modest risk-management in the highest quality credit, has led to a drop further and further down the credit quality spectrum - that appears to be nearing its limit to some extent..
and so managers demand more leverage (and dealers are willing to provide it given their unlimited backstop)...
and its not just credit - equity managers are almost as levered at they were at the peak in 2007...
and while forecasts for 2013 appear positive in general (with perhaps some first half volatility), the modal 'numbers' being offered hide the massively distorted distribution of possibilities awaiting those over-levered and over-exposed to corporate credit...
As Citi's Matt King summarizes the firm's recent credit conference:
As much as we can feel that the market wants to rally hard, and probably will if the fiscal cliff can be surmounted, we remain just as concerned that it will reverse that rally immediately thereafter – at least until the central banks up their injection of liquidity once more and the whole cycle begins again. The tension between market exuberance and deteriorating fundamentals is simply too great. When 1100 investors have a craving, it’s hard not to think they’re going to do whatever it takes to satisfy it. But equally, when you’re in a crowd of that size, it’s probably worth keeping an eye out for the nearest exit - and long before any fire actually starts.
The thundering herd remains.. for now.
12-04-12
ANALYTICS
STUDY
6
6- Bond Bubble
BOND SHORTAGE - Potential Panic Buying
As Ayn Rand stated:
You can avoid reality, but you cannot avoid the consequences of avoiding reality.
The avoidance of reality has overtaken our society. The consequences of doing so have been building for decades and will soon overwhelm us. On our current path, much of what we knew and cared about will be destroyed.
A great friend of mine and one of the best bond traders on Wall Street said this recently: “Get ready for The Great Bond Shortage in North America. If it has a cusip and it is rated, it is going higher/tighter.” I am down with his observation. The compression in bond spreads since the Fed started all of their “made-up/newly printed money for free” antics is the root of all of this and I do not expect a change anytime soon. There are various estimations for the 2013 net new issue supply in all sectors of Fixed Income but I peg it around $400 billion. Around $800 billion will be paid to bond holders during the year in coupon payments and, if reinvested, will cause a supply deficit of about $400 billion for the year. Exacerbating all of this is the Fed, who will buy around $500 billion in MBS this year and perhaps the same amount in Treasuries which could take $1 trillion out of the market all by itself. Consequently we face a lack of bonds denominated somewhere between $900 billion and $1.4 trillion, depending upon the Fed, which will increase the rolling train of compression, lower interest rates further in all likelihood and cause great angst for investors who will find very little of value left in the Fixed Income markets. Safety; yes but yield; no.
While this is taking place we will find a different scenario in the equity markets. The Fed will not be investing money directly in equities and so the liquidity that has propped the stock markets during the Treasury buying phase and will help at the margin with the MBS purchases is not going to have such a dramatic influence in my opinion as the MBS cash is likely to flow back into other segments of the bond markets and not so much into equities. There is also the American Fiscal Cliff, the worsening recession in Europe, the slow-down in China and the possibility of some political event in Greece, Spain, Portugal or Ireland as the funding nations in Europe get strained and could break during 2013. There is a point I assure you and I think we are verging on it where the people of various nations, under their own strain of recession, just cannot afford the grand scheme of European Union and revolt. The IMF is already getting testy with Greece and when Spain shows up hat in hand, their data is found to be inaccurate and the price tag far past the ridiculous estimations of the EU/ECB then “buddy can you spare me a dime” may fall on deaf ears. It should be noted that during the worst year of the Great Depression, 1933, that America had an unemployment rate of 25% which is exactly where we find both Spain and Greece today. A telling sign of things to come perhaps?
"We all know what to do, we just don't know how to get re-elected after we have done it."
Forget the Fiscal Cliff: it is merely a much needed economic distraction for the next 3-4 months (distracting from what? Why Europe of course). Yes, it will be resolved, and yes taxes will go up, and yes, debates over it will most likely be carried over into 2013 and nothing will be compromised until the ultimate debt ceiling deadline (because it is really a Fiscal Cliff-Debt Ceiling package deal) is hit some time in March 2013, but eventually one or both parties will cave, right after the market plunges to put it all into the proper perspective as it did around the time of TARP and the August 2011 debt ceiling debate, and a resolution will materialize. The bigger issue has nothing to do with the Fiscal Cliff, which is indeed a sideshow. The bigger issue, as Art Cashin explains, has everything to do with a secular decline in the US economy, where a 1% growth rate will soon be the "New Killing It", where millions more (in part-time workers) will soon be let go, and where businesses no longer generate the cash flows needed to stay open. Art Cashin explains.
From Art Cashin
He Laughs And Smiles Like Santa But Sounds A Bit Like Scrooge – One of my most anticipated research reads is Kate Welling's package called "Welling on Wall St". It invariably provides that rare combination of insight and entertainment. Nobody gets more out of an interview than Kate and she's been doing that for decades. In the most recent Welling on Wall St, she did a marvelous interview of Bloomberg's Rich Yamarone.
Rich is a good friend (part of our occasional dining group) and a treasure trove of anecdotal insights and comments of CEOs and CFOs around the country. Their companies range from the local to the multi-national. Rich compiles the Bloomberg Orange Book monthly, reflecting the economy through those quotes and comments. He has a grueling speaking schedule as Kate drew out in the interview. Here's a bit that made me wince:
The fiscal cliff actually doesn't seem to be all that problematic. What is problematic is just that the economy is slowing and people are not coming to stores. The small retailers are saying customers are not coming into the stores. They don't have good traffic and they're losing a lot of sales to the internet.
The other thing that is actually quite disturbing is that – if I go give a speech to 400 or 500 people in a specific city, for instance a Chamber event, and it's a doom and gloom speech because I am a very big bear on the economy now – this is what has been happening: Some people will always come up and say, "Hey, you know, I agreed with this, I disagreed with that." But lately they've been adding, "But you're 100% right, this economy is much weaker than anybody in the press is letting you know or leading you to believe." And out of an audience of 400, I have recently been getting 25 to 40 people coming up to me after the event saying things like, "I didn't raise my hand because we're at an event where my competitors are sitting across the table from me and I didn't want to advertise this, but I'm folding my business after Christmas. My name is on top of the 100-year-old, four generation family business, or a 75-year-old, third-generation business, and I have to shut the doors. But I don't want to do it before Christmas because then I have to answer all these questions and I'm going to be an embarrassment to my family." That's a very powerful statement.
Under further questioning from Kate, Rich maintains that he hears that lamentable refrain from a dozen or more folks at such speeches. That's not a pretty picture at all.
12-05-12
CATALYST
EMPLOY- MENT
7
7 - Chronic Unemploy-ment
GEO-POLITICAL EVENT
8
FISCAL CLIFF - Parallels With Debt Ceiling Negotiations (The "Holy Shit" Moment)
Some policymakers (and commentators) are attempting to make a molehill out of a mountain; seemingly less worried about the outcome of negotiations in the short-term, as they believe the cliff is not a cliff, but more of a slope, since economic damage will initially be limited while any equity market sell-off will only spur a resolution. We tend to side with Barclays and BofAML that the full set of expiring measures constitutes a cliff, not a slope. In brief, here is why - automatic withholdings and in Geithner's words "no authority to delay the process." The extent to which households can buffer this higher withholding is significantly weak as recent 'savings' rates have plunged - implying a need to draw on liquid assets to smooth any consumption shortfall.
Citing Winston Churchill, BofAML sums up the siutation well -
"You can always count on Americans to do the right thing - after they have tried everything else,"
and we remain stoic that stock market weakness and severe outside criticism will be important in forcing any agreement, as the politicians appear to face six signficant hurdles ahead. It seems to us like we are following the same path as last year's debacle - what we like to call the Three 'F's of Fiscal Policy in America... Fear, Faith, and Oh F##K!!
Via Barclays:
Given the tight legislative calendar and the two parties’ gaping differences of opinion, we see a strong possibility that policymakers will “go over” the cliff, raising questions about how quickly a resolution can be reached before serious damage is done to economic activity and financial markets.
Some policymakers appear less worried about this outcome since, in their view, the cliff is not a cliff, but more of a slope, meaning economic damage will initially be limited while any equity market sell-off will only spur a resolution.
Our view is that the full set of expiring measures constitutes a cliff, not a slope. Although the full $650bn drag does not go into effect in January and will instead be phased in over the year, about $500bn of the total relates to revenues. Automatic withholding will begin to rise in January and Treasury Secretary Timothy Geithner has said his department has no authority to delay this process. Thus, additional withholding at a rate of about $40bn per month from higher marginal income tax rates, a higher payroll tax, and the alternative minimum tax (AMT), among other items, clearly point to a cliff in the BEA’s national income accounts (Figure 4).
The extent to which activity is buffered from higher withholding depends on households’ ability to smooth consumption. We believe households have limited room to maneuver. Personal saving in Q3 averaged $445bn (saar), about $100bn below the 2010-11 average and similar in size to expiring revenue provisions, suggesting households would need to draw on liquid assets. Moreover, saving is not evenly distributed throughout the population and tighter credit standards would likely limit many households’ access to credit.
Via BofAML:
Winston Churchill famously said “You can always count on Americans to do the right thing—after they have tried everything else.” This certainly seems to be the case with the fiscal cliff. Politicians have given themselves an almost impossible task. Consider the challenges:
The election has returned the same cast of characters who created the cliff. Both parties need to do a 180-degree turn to compromise.
The gap between the two parties in terms of both interpersonal relations and policy views is arguably the widest in modern history.
They need to reach a deal by year end. And yet, in the first three weeks after the election there was just one brief meeting.
The cliff involves 10 large and complex policy decisions: the Bush tax cuts and the sequester are only one-third of the cliff.
Every recent major fiscal decision has gone to the last minute, with many false signals of a deal along the way.
The debt ceiling hits shortly after the cliff. If it is not raised, the resulting austerity is more draconian than the whole fiscal cliff.
Our baseline forecast assumes a long, painful decision process followed by significant fiscal austerity. We expect a partial deal in late December where the two parties agree on some items and postpone others for several months. By the spring we expect all of the cliff items to be resolved and for there to be a process in place for negotiating entitlement and tax reform. We expect austerity equivalent to about 2% of GDP to kick in over the course of the first two quarters of the year (Table 2). We think stock market weakness and severe outside criticism will be important in forcing an agreement.
Some pundits dismiss the economic damage from the cliff. One view is that it will be resolved at the last second and the markets will quickly realize it was a nonevent. This ignores the fact that, unlike past brinkmanship moments, the cliff ends with significant fiscal tightening. Others argue that the fiscal cliff is really a fiscal slope: it will take time for austerity to impact the economy and people will largely ignore any tax increases or spending cuts because they will “know” they are temporary. This ignores the large and growing uncertainty shock from the cliff.
There has already been some belt tightening. The OECD estimates the structural deficit has already been shrinking by about 1.3 pp per year as federal stimulus fades and state and local governments cut. Assuming some slowing in cuts at the state and local level and our baseline for federal fiscal policy, the fiscal shock roughly doubles to about 2.5 pp in 2013. That’s a big hit for an economy that has had average growth of 2.2% since the recession ended back in 2009.
The cliff shock will likely rotate through the economy. Business leaders have already cut capital goods orders in anticipation of the cliff, but once the cliff is resolved we expect the release of some pent-up demand for capital. By contrast, households seem to be oblivious to the cliff. However, with the cliff now moving from business to front page news, we expect consumption to cool. Moreover, the tax increases and transfer cuts from the fiscal cliff will likely cut 1.9 pp off of income, stopping the growth in real disposable income in 2013.
In our base case, once the cliff is resolved, the economy will return to its moderate recovery. There has been substantial healing in the private sector since the 2008-09 crisis, and we are particularly encouraged by the housing healing. In other words, the 50 states are fine; the District of Columbia is the problem.
FISCAL CLIFF - Republican Counteroffer
On the fiscal cliff, Republicans made their first counteroffer. Their terms include $800 billion in new tax revenues through the closing of loopholes and deductions, cutting of $900 billion in mandatory spending, and cutting $300 billion in discretionary spending.
12-04-12
US FISCAL
ANALYTICS
PATTERNS
MATA A12
13
13 - Global Governance Failure
FISCAL CLIFF - We are Being Manipulated
6 Reasons the Fiscal Cliff is a Scam 11-22-12 James K Galbraith Alternet.org
Stripped to essentials, the fiscal cliff is a device constructed to force a rollback of Social Security, Medicare and Medicaid, as the price of avoiding tax increases and disruptive cuts in federal civilian programs and in the military. It was policy-making by hostage-taking, timed for the lame duck session, a contrived crisis, the plain idea now unfolding was to force a stampede.
In the nature of stampedes arguments become confused; panic flows from fear, when multiple forces – economic and political in this instance – all appear to push the same way. It is therefore useful to sort through those forces, breaking them down into separate questions, and to ask whether any of them justify the voices of doom.
First, is there a looming crisis of debt or deficits, such that sacrifices in general are necessary? No, there is not. Not in the short run – as almost everyone agrees. But also: not in the long run. What we have are computer projections, based on arbitrary – and in fact capricious – assumptions. But even the computer projections no longer show much of a crisis. CBO has adjusted its interest rate forecast, and even under its “alternative fiscal scenario” the debt/GDP ratio now stabilizes after a few years.
Second, is there a looming crisis of Social Security, Medicare and Medicaid, such that these programs must be reformed? No, there is not. Social insurance programs are not businesses. They are not required to make a profit; they need not be funded from any particular stream of tax revenues over any particular time horizon. Reasonable control of health care costs – public and private – is necessary and also sufficient to keep the costs of Medicare and Medicaid within bounds.
Third, would the military sequestration programmed to start in January be a disaster? No, it would not be. Military spending is set in any event to decline – and it should decline as we adjust our military programs to our national security needs. The sequester is at worst harmless; at best it's an invitation to speed the process of moving away from a Cold War force structure to one suited to the modern world.
Fourth, would the upper-end tax increases programmed to take effect in January be a disaster? No, they would not be. There is no evidence that the low tax rates on the wealthy encourage them to spend or invest, no evidence that higher tax rates would deter the spending and investment that they might otherwise do.
Fifth, would the middle-class tax increases, end of unemployment insurance and the abrupt end of the payroll tax holiday programmed for the end of January risk cutting into the main lines of consumer spending, business profits and economic growth? Yes, over time it would. But the effects in the first few weeks will be minimal, and Congress could act on these matters separately, with a clean bill either before the end of the year or early in the new one.
Sixth, what about all the other cuts in discretionary federal spending? Yes, some of these would be very damaging if allowed. Simple solution: don't allow them.
In short, Members of Congress: if you can, just pass the President's bill on middle-class taxes, and, if you can, eliminate the domestic sequester. Then, please go home. Enjoy the holidays. Come back in January prepared to extend unemployment insurance, to phase out the payroll tax holiday gradually, to restore stable funding to necessary programs and to start dealing with our real problems: jobs, foreclosures, infrastructure and climate change.
12-03-12
US FISCAL
13
13 - Global Governance Failure
TO TOP
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
GLOBAL PMI - General Improvement
Overall, the data out of Asia was strong. China's official and unofficial HSBC manufacturing PMI reports all increased and signaled growth was accelerating again in the world's second largest economy. South Korean export data also beat expectations, confirming the bullish signals out of China. For the most part, the BRICs are looking good.
In Europe, the eurozone manufacturing PMI climbed to its best level in eight months, thanks to improvements Germany, France, and Spain. Italy's PMI fell, but UK's PMI jumped. Ultimately, the message is that Europe doesn't seem to be getting too much worse.
In the US, PMI unexpectedly climbed to 52.8 from the preliminary reading of 52.4. Economists were expecting the measure to fall to 52.1. However, the more closely followed ISM manufacturing index plunged to 49.5, signaling contraction. Economists were expecting a reading of 51.4.
For much of the year, the global economic story was that the U.S. was able to maintain growth as Europe struggled and emerging Asia slowed. Today's data seems to be a reversal of that trend. SocGen's Kit Juckes writes: "The 'tail risk' of an imminent hard landing for the Chinese economy is fading, just as the conclusion of the latest Greek drama means that risk of a return to full-blown Euro Zone crisis is fading. So, two of three major risks are reduced, leaving only the dreaded 'fiscal cliff' to worry about."
The ISM mfr’g index in Nov is back below 50 at 49.5, below expectations of 51.4 and down from 51.7 in Oct. It’s the lowest since July 09 and follows the two prior months above 50 which followed the three months before that which were slightly below. New Orders softened by almost 4 pts to 50.3 while Backlogs fell a touch to 41 from 41.5 but that is the lowest since Apr ’09. After the inventory build seen in the Q3 GDP data, mfr’g inventories fell 5 pts to 45, a 5 month low and inventories at the customer level fell 6.5 pts to the lowest since Dec ’11. The Employment component fell 3.7 pts to 48.4, the 1st time below 50 since Sept ’09. Also of note, Export Orders fell 1 pt to 47, remaining below 50 for a 6th straight month. Production, which follows orders, did rise 1.3 pts to 53.7 but will be tough to sustain if New Orders slow further. Prices Paid fell 2.5 pts to 52.5 but remains above the 6 month avg of 49.3. Of the 18 industries surveyed, just 6 reported growth with 11 seeing contraction and 1 seeing no change. The ISM said this, “Comments from the panel this month generally indicate that the 2nd half of the year continues to show a slowdown in demand; respondents also express concern over how and when the fiscal cliff issue will be resolved.” Bottom line, lackluster still defines the state of manufacturing due to the issues well known. However, we know the hurricane had a pronounced impact on the economies of the northeast as seen in the NY and Philly mfr’g regions. Today’s ISM unfortunately can’t break it out to give us a better feel for the rest of the country but we know from other regional survey’s separate from the Northeast that things are just so-so. Also, export orders are just 1/2 pt from the weakest since April. This all said, a deal in the fiscal negotiations, whether good or not, could add clarity that is certainly missing. The S&P 500 above 1400 is definitely betting on it.
With the foundation of our economy now one of gluttony and excess (at all costs), the significance of the slowdown in consumer spending in the latest GDP data cannot be underestimated. As Bloomberg Briefs notes, real consumer spending fell 0.3% in October, and is only 1.3% above year-ago levels - the US economy has a propensity to slip into recession any time the 12-month pace of real consumer spending falls below 2.0%. Their so-called ‘Fab Five’ indicators of discretionary spending took a notable turn for the worse in October. Dining out fell 0.4% MoM in October and is only +1.5% YoY – its slowest pace since April 2010. Spending on cosmetics and perfumes fell 0.04% in October, continuing the negative trend from its peak registered in the summer of 2011. Spending on women’s and girls’ clothing slumped 1.8% in October, following a 0.1% decline in September. Casino gambling fell 1.6% in October, while spending on jewelry and watches fell 0.1% in the same month. All-in-all, the consumer's balance-sheet-recession continues...
Much has been made of the rise in relative positive surprises in US macro data as a support for the equity market (even as bottom-up earnings and outlooks suggest otherwise). This has as much to do with macro-strategists overly-emotional downgrades and upgrades as the data itself (in all its manipulated glory). However, four times in the last six years, the macro surprise index for the US has reached two-standard deviations above its mean - and each time has marked a top in macro surprises. Just this past week, the US macro surprise index reached two-standard deviations from its mean once again - and while bond markets have started to reflect that reality (as we noted here), the rest of the market appears not to have got the message that, perhaps, this is as good as it gets this cycle around.
Upper pane - Citi US Economic Surprise Index (and 50DMA)
Lower pane - 3 month rate-of-change and two-standard-deviation level
Thus far, the US has been the mainstay of Western recovery - the basis upon which investors' cautious optimism is espoused.
Via Sean Corrigan's Material Evidence, Diapason Commodities:
...a host of interrelated indicators are flashing red; especially when one notes that these are closely correlated with either non-financial corporate profits and/or the stock market level itself - and form the basis of an informed realist's skeptical pessimism at equity market exuberance.
Take the industrial production diffusion index, for example. This is back at its lowest reading since the slump itself and the pace of deterioration these past few months is both unmatched in a quarter of a century and barely beaten in the troubled decade and a half which preceded that stretch.
Manufacturing – supposedly the great white hope of the new America – has seen wage rates creeping up by less than 1% p.a. in nominal terms and reverting to where they were in 1998 in real terms – hardly a sign of rising productivity.
Hours worked tell a similar story: they have been flat to lower in 2012, having only recouped around a quarter of the losses suffered in the Crash. Here they rest fully a third below the stationary mean around which the first sixty years of post-WWII cycles gyrated. They are no higher now than before the Broken Window boost of Pearl Harbor and flounder not only 70% below 1953’s population-weighted high, but 45% lower than when the last pernicious wave of ‘hollowing out’ set in, in the wake of the Asian Contagion in 1998.
Core capital goods orders have suffered a summer and autumn every bit as bad as at the beginning of the Tech bust, if not suffering a decline any where near as precipitous as during the onset of GFC itself. Overlay a graph of these with the S&P500 and you will see that they have traced out a very similar pattern in the great bubble era from 1995 to date. In a like manner, durable goods shipments (which have enjoyed an r-squared of 0.7 vis-à-vis the S&P over the last 15 years) have dropped since July’s (double-top) peak at a pace only surpassed this last decade during the calamity of 2008-9 itself.
[Perhaps most incredibly - over the past 15 years, the 3-month change in Durable Goods Shipments has reached a 2-sigma drop just three times before the current plunge; the performance of the S&P 500 over the next two months was as follows:
June 1998 (from 1133 to 957) -15%
January 2001 (from 1366 to 1160) -15%
September 2008 (1282 to 968) -25%
But this time is different we are sure...?]
Turning to trade, the annual growth of container exports from Long Beach and LA is now incontrovertibly in the negative column after 2 ½ years of gains – once more, a condition associated with either regional (Pacific) or global contraction.
Finally – and a little more esoterically – the diffusion index version of the fairly reliable Chicago Fed indicator, after maintaining levels consistent with a somewhat anaemic recovery since the start of 2010, and having spent the last eight months edging ever lower, now hovers perilously close to a cut?off below which every official recession of the last half-century has been recognized to have held sway.
Some will say that the paralysis induced by the approach of the dreaded ‘fiscal cliff’ is at fault. That may well be, though bitter experience tells us that some sort of face-saving compromise will be hashed out, probably in the form of some token tax rises imposed on the friendless ‘Rich’, together with a catalog of largely illusory reductions to the currently scheduled rise in expenditures (no actual cuts are likely to be implemented in this world of Orient Express ‘Austerity’). No doubt, the latter while be concentrated conveniently out in the far years of the current projections. Both sides of the House will then claim a victory and both will make much ado about its laudable display of statesmanship and responsibility. Meanwhile, the debt will continue rising at something not that far removed from its present $1.2 trillion annual pace.
In any case, to the extent that the same arguments apply to fiscal laxity as they do to monetary – namely, that the system quickly develops a tolerance to any given level of artificial input, thereby necessitating a continual upping of the ante if the ‘stimulus’ is to remain effective – America has already jumped off a rather large cliff. We say this based on the fact that whereas the four quarters to Sep’08 saw a 7.5% percentage increase in government capital and current outlays over the earlier like-period which topped anything seen in the last 20 years (and which gave rise to a record?beating, nominal $525 billion increment in spending), the running total for the latest 12?months shows a near?zero increase in expenditures over the prior span for the first time since the end of the Korean War.
Air Force One – as a metaphor for the entire government component in the economic mix - may still be cruising at an unimaginable speed, therefore, but the afterburners are no longer propelling it to even greater prodigies of flight in the way they once were.
Ironically, equities are already trying to rally on the premise that a fudge will be achieved in the budget talks, yet unless every CEO in the land celebrates the striking of the deal by indulging in an unbridled orgy of ‘pent-up’ capex and hiring, the gathering weakness in the economy may only widen the disparity between a stock market artificially inflated by the Fed’s success at suppressing the correct pricing of capital and the underlying course of commerce and industry.
Oh, and just to make matters worse, the really disruptive ‘cliff’ we face over year-end may well be the regulatory one whereby the temporary Transaction Account Guarantee program – an FDIC scheme to extend a comprehensive safety net to deposits of more than the usual $250,000 ceiling - will finally expire and so potentially trigger a $1.4 trillion shift in the allocation of caution swollen, corporate cash balances.
Not the least of the side effects of this will be that it will render all attempts at monetary analysis moot for some appreciable period of time when clarity, not opacity, is what we so urgently need. Joy, indeed!
12 11 30 Material Evidence
12-03-12
CANARIES
MATA A12
US ECONOMY
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
Confused by the recent surge of capital into Europe (which somehow is supposed to indicate that all is well because local stock and bond markets are faring better)? Don't be: it is merely the latest and greatest manifestation of that most prevalent of New Normal investment strategies: hope. Hope that this time it is different, and that the latest injection of capital from the Fed via QE3 coupled with the OMT perpetual backstop of liquidity via the ECB (still merely at the beta stage: expansion to actual gold/production phase TBD) will kick start the European economies. Alas, it won't, at least not until Europe actually undergoes the inevitable internal devaluation which we described over the weekend (since an external one is impossible) and crushes local wages of the PIIGS, which in turn would lead to revolution, and thus will never happen. That, or somehow discharges about 40% of consolidated Eurozone debt/GDP, which it also won't as it would wipe out the global banking system. So what does this mean? Well, as Deutsche Bank explains looking simply at manufacturing output in the developed world, global markets are now overvalued anywhere between 15% and 35%. This is the hope premium now embedded in stock prices.
From Deutsche Bank:
Our view over the last two or three months has been that the great central bank liquidity promises of August/September (QE infinity and the OMT) has probably bought markets up to 6 months of grace where hope for a recovery can be as or more important than the hard evidence. However our view is that if growth doesn't materialise by around Q2 of next year markets could sharply decline again. One simple way to frame this is to look at our often used relationship between PMIs/ISM and the YoY change in equities in each country. At current PMI/ISM levels, US, Italian, German and French equity markets range between 15% and 35% overvalued using this very simplistic model. Put the other way round we are pricing in PMIs/ISM around the mid-50s level instead of the 49.5 (US), Italy (45.1), 46.8 (Germany) and 44.5 (France) we saw yesterday. Interestingly Spain's equity market is only 4% away from the -10% YoY that it's 45.3 PMI suggests it should be.
Overall as we always say these numbers should be treated with great caution but they are a useful broad guide as to whether markets are behind or ahead of the data. At the moment they are way ahead and despite the simplistic nature of this relationship we're confident with the conclusion that if PMIs aren't comfortably above 50 as Q2 2013 progresses, markets will be notably lower than current levels. Given that most economists expect the recovery to be building by Q2 then maybe markets are right but it shows that there's not much room for error on this.
In other words: all those bullish sell side research reports saying the world may get better in 2013, if it doesn't get worse: they are all now priced in, and then some. If they don't materialize, the downside is now knows.
In other words: all those bullish sell side research reports saying the world may get better in 2013, if it doesn't get worse: they are all now priced in, and then some. If they don't materialize, the downside is now clear.
No matter what you were told by the media (or your friendly 'stay fully invested' local wealth-manager), the equity market's exuberant surge of the last few days is evidently one of the clearest month-end window-dressing efforts (to desperately avoid redemptions) that we have seen recently (when put in context of the rest of the world's markets). Who is wrong? Who is right? We suspect we will see the truth (3 F's of US Fiscal Policy) shortly.
We all hear this is the next new, new thing and it will be different this time as the talking heads blather with wild abandon. Not wishing to join this group either in theory or style I am always quite reticent to walk into this space but the world since 2008 has been different than in past difficulties in one very poignant manner. The world’s three major central banks have all acted in concert and so we have been dealing with, really, just one set of responses that have been conducted on a global scale. Since we cannot invest off-planet or in some parallel universe the options that we have then are quite limited which is why, in my opinion, that the focus on Inflation or Deflation, historically always the epicenter of the discussion when major changes are made to monetary supply or fiscal policy, is not getting played out in the manner that most might suppose. I will go further, it is not Inflation or Deflation that are going to matter in the short run, though it will later; it will be the lack of bonds of any sort to purchase and a stock market that may be dangerously out of sync with the fundamentals opening the possibility of a crash and not a small one if it occurs. Institutional investors are edgy, that I can tell you with certainty, and it would not take much to see a flight from equities into bonds/commodities/gold regardless of the available yields and just because the money was relatively safe. Americans lost thirty-six percent of their wealth during 2008/2009 and while memories are short the pain of that experience has not yet been forgotten.
Inflation and Deflation, it should be noted, only work in operative systems. The question then becomes what takes place if the system breaks down and value, of any sort, is no longer present and that would be the scenario labeled “Crash.” Recently the senior spokesperson for bonds, the eminent Bill Gross, suggested buying Gold and I can well understand the rationale for his comment. If so much money is printed and so little regard is placed upon fundamental economic principles then the Real Estate crash of several years ago will look like child’s play by comparison. Then if you add in a Europe that could implode from the demands of the troubled nations, some sort of social revolution taking place in the same countries or the sounder nations refusing to fund or even being unable to fund then we have an economically impaired world that is squared and cubed by worthless currencies. Remember assets are not only relative, which is how we approach them in a functioning system, but they are absolute and indicative at the same time. All three operate in tandem and while the latter two are mostly ignored; they are there none-the-less. If gold becomes the reserve currency and is trading at $8,000 or $10,000 an ounce then the value of the Dollar, the Euro or the Yuan is close to worthless. The Inflation factor of food and other goods with costs that are prohibitive to buy basic essentials is another option but that would be even worse in my opinion. This is not the way of it yet but there is a tipping point where so much capital is created that a currency loses its value as a tool of purchase.
“Money for nothing and chicks for free” may play out for awhile in the glitter of Friday and Saturday night but Sunday through Thursday may write another story. Inflation and Deflation have another edge and that is Valuation which is why “Crash” may precede their better known cousins based upon Valuation which would be a systemic breakdown of the first order. Gold, silver and metals are really a currency option at some point if the value of paper money is found to be wanting. It won’t be the Dollar as evaluated against some other currency but the value of any and all of them that may come into question. The path would be out of equities and into bonds with yields not only falling to zero but perhaps through zero and then out of bonds and into cash and then out of cash and into gold and other metals. “Systemic Breakdown” would be the functioning words.
“As happens sometimes, a moment settled and hovered and remained for much more than a moment. And sound stopped and movement stopped for much, much more than a moment.”
-John Steinbeck, Of Mice and Men
Late Friday the Stabilization Funds of Europe lost their “AAA” rating mostly having to do with the economic deterioration in France. If Germany follows then it may be the first step in some sort of breakdown. At the same time America has been downgraded and our step over the Fiscal Cliff could have the same sort of affect here. I think that it be accurately said that easy credit, loose money and an overabundance of capital caused the events of 2008/2009 and since then the central banks have pumped even more liquidity into the system begging the very real question if we aren’t in for some sort of do-over of those events. No one is sure, I am not sure, but the possibility is no longer some other universe outlier or black swan that cannot be sniffed in the early morning breeze. If the mood changes and all currencies are viewed as lacking value then relative comparisons are hardly the point. Milton Friedman and Ben Bernanke have argued that the events of 1929 were caused by a contraction in money supply and hence our current policy but what is the other side of this coin if monetary expansion and capital supply is so great that the valuation of every currency declines as a result of their lack of worth; there is the appropriate question in my view.
Another interesting aspect of this consideration is what people do if there is no yield and the equity markets are in decline. If investors cannot generate enough income, one way or another, then what becomes of the seniors and others on a fixed income? Will it be the inability to pay mortgages, rents and then defaults and then bank failures? Some very unpleasant consequences to consider but if the expansion of money and credit are to continue unabated here and in Europe and if Draghi’s “Save the World” speech gets enacted then where does it all stop and what happens in America and Europe if there is no end in sight?
"No, you’re wrong there—quite wrong there. The bank is something else than men. It happens that every man in a bank hates what the bank does, and yet the bank does it. The bank is something more than men, I tell you. It’s the monster. Men made it, but they can’t control it.”
-John Steinbeck, The Grapes of Wrath
12-03-12
RISK
CANARIES
RISK-On-Off
ANALYTICS
COMMODITY CORNER - HARD ASSETS
THESIS Themes
FINANCIAL REPRESSION
CORPORATOCRACY - CRONY CAPITALSIM
GLOBAL FINANCIAL IMBALANCE
SOCIAL UNREST
CENTRAL PLANNING
STATISM
CURRENCY WARS
STANDARD OF LIVING
GENERAL INTEREST
TO TOP
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DISCLOSURE Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.
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TRIGGER$ publications combine both Technical Analysis and Fundamental Analysis together offering unique perspectives on the Global Markets. Every month “Gordon T Long Market Research & Analytics” publishes three reports totalling more then 380 pages of detailed Technical Analysis and in depth Fundamentals. If you find our publications TOO detailed, we recommend you consider TRIGGER$ which edited by GoldenPhi offers a ‘distilled’ version in a readable format for use in your daily due diligence. Read and understand what the professionals are reading without having to be a Professional Analyst or Technician.
