CHINESE GOLD IMPORTS - Rate through Hong Kong

US HOUSING - Rate of Mortgage Application Increase Rolling Over

Still Think The Housing Recovery Is Sustainable? 04-11-13 Zero Hedge

While hope springs eternal that the US housing sector 'record-inventory-compression and foreclosure-stuffed' 'recovery' will become self-sustaining, there are two rather disappointing 'facts' to ruin the 'fiction' that all is well. As Gluskin Sheff's David Rosenberg notes, not only are mortgage applications for new purchases stalling rather notably from a 'red-hot' +16% YoY in January to a mere +3% in the last week; but an even more critical indicator of housing's health just turned negative after providing hope for the last 14 months. The year-over-year growth in bank-wide real estate credit has turned down again - after first turning positive in February of 2012. So the first (and second) derivative of real-estate credit is now on the down-swing - not the stuff of sustainable housing recoveries.

Mortgage applications for new home purchases are fading fast...

But real estate loans outstanding is now negative YoY and falling...

Charts: Bloomberg

US HOUSING - Recovery Misleading

Cheap Mortgages: Misleading Home Price Watchers 04-11-13 Ritholtz

We are currently in a carnival funhouse mirror. Homes seem quite affordable when at base they are not.”
-Stan Humphries, chief economist at Zillow.

Nice piece in Business Week explaining how ultra low mortgage rates are creating a misleading sense of the housing market . . .

Source:
Cheap Mortgages Are Hiding the Truth About Home Prices
Karen Weise
Businessweek, April 10, 2013 

PE RATIO - A Long Term Adjustment Process

Broad Market Lagged Price to Earnings Ratio 04-11-13 Ritholtz

Source:
BEA, Federal Reserve Board, Wilshire Associates, J.P. Morgan Asset Management
March 31, 2021

PATTERNS - A Historic Short Squeeze

A VERY TIGHT CHANNEL

WHY - RELENTLESS SHORT SQUEEZE

The 'most shorted' names in the Russell 3000 are up a remarkable 1.4% today compared to 0.45% in the index itself. The short-squeeze off the NFP gap-down lows is impressive indeed. From the open last Friday, the 'most short' names are up 6.6% against the index up only 3.5% as the dash for trash continues in the face of increasingly dismal data. The last 2 times that the 'most short' index was this squeezed relative to the index was late-December (before the equity dip) and mid-Fed (before the equity dip). Just as we warned here and here, the inexorable flow of easy money means the dash-for-trash (as remarkably ridiculous as it seems - though as now know nothing is allowed to fail ever again) has been the winning trade; though as we note below, there is a limit to the 'squeezability' and we appear to be there in the short term.

The 'most short' names have been smashed higher in the last few days with Tuesday and today being more epic squeezes...

and the last two times the squeeze got this wide...

But it is remarkable that this rally has provided a 30% rally off the November lows among the most-shorted names - almost double the performance of the index itself...

Finally, for those who missed it the first time around in February (since when the basket has returned well over 10%), here again are the most shorted Russell 2000 stocks: TABLE

Carmen Reinhart: "No Doubt. Our Pensions Are Screwed." 04-11-13 Zero Hedge

"The crisis isn't over yet," warns Carmen Reinhart, "not in the US and not in Europe." Known for her deep understanding that 'it's never different this time', the Harvard economist drops the truth grenade a number of times in this excellent Der Spiegel interview. Sweeping away the sound and fury of a self-serving Federal Reserve or BoJ, she chides,

"no central bank will admit it is keeping rates low to help governments out of their debt crises. But in fact they are bending over backwards to help governments to finance their deficits,"

and guess what, "this is nothing new in history."

After World War II, all countries that had a big debt overhang relied on financial repression to avoid an explicit default. After the war, governments imposed interest rate ceilings for government bonds; but, nowadays, she explains, "monetary policy is doing the job. And with high unemployment and low inflation that doesn't even look suspicious.

Only when inflation picks up, which is ultimately going to happen, will it become obvious that central banks have become subservient to governments."

Nations "seldom just grow themselves out of debt,"

as so many believe is possible,

"you need a combination of austerity, so that you don't add further to the pile of debt, and higher inflation, which is effectively a subtle form of taxation,"

with the consequence that people are going to lose their savings. Reinhart succinctly summarizes, "no doubt, our pensions are screwed."

This will take 3 minutes to read - read it. Understand what she is saying.

Via Der Spiegel,

... governments are incapable of reducing their debts and that central banks are now stepping up to resolve the crisis themselves. In the end, she argues, everyday savers will pay the price.

...

PORTUGAL - Courts Blow Planned Austerity Apart

Two Weekend Developments: Portugal and Italy 04-07-13 Marc To Market via ZH

NEED TO KNOW

• In Portugal the Constitutional Court has now struck down part of the government's austerity measures.
• The court ruled that the Portuguese government violated that constitutional requirement for an equitable distribution of austerity and prevents the discrimination of state workers over the private sector.  Four of nine austerity measures were rendered unconstitutional.  
• These include the suspension of civil servants holiday pay, the cut in pensions, the tax on unemployment and health benefits and the cuts salaries for teachers, researchers, and scholarship holders.  All told around 1.3 bln euros of savings (~1% of GDP) were disallowed and it is not just about what happens going forward, the court decision is retroactive to the start of the year and the government will have to compensate the state workers and pensioners.  
• The government expressed shock at the decision and met on Saturday.  Last year the court blocked the intended reduction in state workers' pay in 2013 and 2014 (though allowed the cuts in 2012). The new measures were devised to replace those that had been struck down last year. 

The implications can be momentous.  

1. It could jeopardize the next tranche of aid payment.  
2. It could jeopardize the government's effort to return to the capital markets.  
3. It could deter the euro group of finance ministers from agreeing to extend the maturities on Portugal's EFSF/ESM borrowings, which was possible toward the end of next week.  
4. The court ruling could embolden the opposition and strengthen trade union pressure, after the government survived a vote of confidence in the middle of last week.  

The Wall Street Journal reports that the government was considering several measures in response. The one that was capturing the imagination of many was the possibility of paying civil servant workers and pensioners one month's salary in the form of T-bills.  The press report suggests that doing so would save the government as much as 1.1 bln euros in expenses.  

Portugal Considers Paying Public Workers In Treasury Bills Instead Of Cash Zero Hedge

As reported late on Friday, just as the market closed, the Portuguese constitutional court decided that several provisions of the country's 2013 budget were not constitutional. According to the high court, cuts in wages and pensions of public employees were unfair (there's that word again) because they targeted only the public sector. The court rejected plans to cut one of the 14 paychecks that public workers usually get each year and to slash 6.4% from pensions for retirees.  This coincided with the government warning that the court's decision would put into question the country's ability to fulfill its €78 billion international bailout program, which in turn would send bondholders of Portuguese sovereign debt scrambling for the exits as suddenly the country may find itself in the ECB's "dunce" corner, with Draghi preparing to pull a "Berlusconi" on a government which can't even whip its judicial branch in line. However, of more immediate concern is how will the government now plug a hole of up to €1.3 billion in its €5.3 billion 2013 budget. A solution has, luckily, presented itself: bypass the unconstitutional provisions by paying government workers not in cash, but in government bills!

From the WSJ:

The Portuguese government is considering a plan to pay public workers and pensioners one month of their salary in treasury bills rather than cash after a high court ruled out wage cuts, a person familiar with the situation said Sunday.

"This is one of the ideas being considered," the person said.

By paying one month of salary in T-bills to public workers and pensioners, the government would save an estimated €1.1 billion in expenses, narrowing the budget gap significantly.

Incidentally, this plan makes perfect sense: with every central bank openly monetizing its debt, it has effectively made debt and cash equivalent.

Now if only Portuguese public workers had access to the same shadow transformation pathways and government bond repo collateralization opportunities afforded to the big banks, then every bill thus obtained would be able to serve as a source of nearly infinite rehypothecation potential, and thus, a DIY fractional reserve banking system provided to every individual.

Coming next: the full convertibility of Spanish Spiderman towels backed by the full faith and credit of the Rajoy kickback scandal, and fully convertible into chorizo.

All joking aside, the fact that this absurd option is even being contemplated shows just how deep into the rabbit hole event horizon the modern completely insolvent financial system has traversed. 

EMPLOYMENT - 110M Working Age Americans Not Working

Unemployment Rate Drops on Declining Participation 04-08-13 AlphaNOW

The headline US unemployment rate fell to 7.6% in March as a 206k decline in employment on the household survey was more than offset by a 496k drop in the size of the labour force. As a result, the participation rate fell to 63.3% – its lowest level since 1979. If participation had remained flat in March, the unemployment rate would have actually increased. If it was unchanged over the past five years, the unemployment rate would now be 11.5%.

Refresh Chart   Edit Chart

The US population can be decomposed in three:

1. The employed: people who have jobs;
2. The unemployed: people who do not have jobs, but are available for work and are actively seeking employment;
3. Those not in the labour force: the rest.

Many tend to associate a falling unemployment rate with strong employment growth. But that need not be the case. The unemployment rate is calculated by looking at the level of joblessness relative to the size of the labour force. Should those who are out of work opt not to seek employment, the unemployment rate will decline, without any necessary improvement in labour market conditions. That is what happened in the most recent payrolls report.

Total employment, on the household measure, actually fell in March, by 206k. But the size of the labour force fell more quickly – by 496k. Without this decline in the participation rate, unemployment would have actually risen from 7.7% to 7.9%. Instead, it fell to 7.6%. Over the past five years the participation rate has fallen from 66.1% to 63.3%. Had it remained flat over this period, all things being equal, the unemployment rate would be 11.5%.

It should be noted that the participation rate has been on a downward trend since the turn of the century, and some of this is related to the ageing population. We estimate that demographics alone are acting to lower the participation rate by at least 0.2 percentage points each year. Meanwhile, the Federal Reserve forecasts that this will increase to 0.3 percentage points in the coming decade. The annual decline over the past five years, however, has been almost double that. This suggests that some of the current weakness has been driven by cyclical forces.

What happens to this ratio as we move forward? It is to be hoped that many of the non-participants will have used their time out of the labour force to improve their skills, perhaps by pursuing further education. If the jobs market continues to recover, this cohort should eventually begin to seek work once again. While this would put upward pressure on the unemployment rate, it should be welcomed. The potential benefits to growth and social cohesion far outweigh any temporarily sticky headline jobless numbers.

PUBLIC POLICY - Misdirected Policy Leads to Economic Stagnation

NEED TO KNOW

• There are innumerable factors responsible for the decline of the US. Only three important ones will convey why the economy is dying:

  1. The rule of law and property rights are under attack.
  2. Obamacare has raised costs
  3. Government policies have made the dole more lucrative than worK

• As government grows the private sector shrinks. As the private sector shrinks there are fewer goods and services produced (government produces no goods and few services).
• I believe it was Dick Armey who described this situation with the wagon analogy: there are more people riding in the wagon and fewer pulling the wagon. As the wagon becomes heavier, the remaining pullers must work harder to move it.
• That is what is happening in this country. If it is not reversed, the economy will stagnate and eventually implode.
• 110 million privately employed workers; 88 million welfare recipients and government workers and rising rapidly.
• for now, just stick head in sand, and pretend all is good. Self-deception is now the only thing left for the entire insolvent entitlement-addicted world.

GLOBAL CENTRAL BANKS - Balance Sheeet Expansion versus CPI

Click to Enlarge

GLOBAL INDICATORS - Macro Surprises Tell the Story

US Macro Data Plunges Most In 10 Months 04-05-13 Zero Hedge

The last two weeks have not been pretty for the 'it's different this time' crowd. Day after day has brought miss after miss in macro-economic data for the US; from PMIs to NFPs, no matter how hard you try, there is not even enough for an 'anecdotal' strategist to pin his BTFD thesis on. Quantitatively, the US macro surprise index has seen its biggest 10-day drop in 10 months, completely reversing all the 'seasonally-adjusted' difference from the 2011 'Deja-Vu' market and macro behavior. So with the first pillar of bullishness (macro data is 'supportive'), it is up to earnings (but but but profitability is at highs) to hold up the market - good luck with that.

Biggest 2-week drop in macro data in 10 months...

is reverting all the 'seasonally adjusted' green shoots that made this time different from last year...

and once again, just for fun, someone explain how the market is not solely dependent upon the Fed for this to occur?

Charts: Bloomberg

PUBLIC POLICY - Failure of Economic Policy

This is Not A Rally...It's a Credit Bubble of Epic Proportions 04-08-13 InsideInvesting Daily

An explosive rise in asset prices always generates concern that a bubble may be developing and that its bursting might lead to broad and deep economic distress.

– Fed governor Frederic Mishkin, August 2007

On Friday, the Bank of Japan ushered in a new era of monetary stimulus.

Under new governor Haruhiko Kuroda... and under massive pressure from new prime minister Shinzo Abe... the BoJ promised a $1.4 trillion debt monetization program.

This will start next year and will double the country's monetary base (currency in the hands of the public plus commercial bank deposits at the Bank of Japan).

Following the news, the Nikkei 225 ended the session up +1.6%. The yen fell more than -2% versus the dollar... and -4% versus the euro. And the yield on the 10-year JGB hit a record low.

We are in unchartered territory regarding monetary easing. We are living through a giant academic-led monetary experiment – the largest in history by far – that is being pursued without regard for the potential for nasty unintended consequences.

The central banks of the "big three" developed economies – the US, the EU and Japan – are now committed to doing "whatever it takes" to keep bond yields low. They have no choice. If yields go higher, stock market gains will evaporate and rising interest costs on sovereign debt would put huge pressure on governments. We would see another giant asset bubble deflate and have no monetary "ammo" in reserve to ease the pain it would cause.

Relative to the size of its economy, the BoJ's stimulus plan is now even more intense than the Fed's. As Japan bond bear Kyle Bass points out, "The BoJ is now monetizing at a rate around 75% of the Fed on an economy that is one-third the size of the US."

NOT REACHING MAINSTREAM What many don't understand... or don't want to see... is that in Japan (and in the US), this stimulus is not reaching "Main Street" by way of bank lending. Although monetary base is rising, wider measures of money supply have been flat or are falling.

This means that credit easing ends up exclusively boosting asset prices (most notably, equities) by way of

1. cheap leverage,
2. margin buying and
3. "carry trades."

But the fundamentals are not keeping up... As former Reagan budget advisor David Stockman pointed out in a recent piece in The New York Times, "State-Wrecked: The Corruption of Capital in America":

600%: Since the S&P 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during that stretch,

• 1.7%: Economic output has grown by an average of 1.7% a year (the slowest since the Civil War);
• 0.8%: Real business investment has crawled forward at only 0.8% per year;
• 0.1%: and the payroll job count has crept up at a negligible 0.1% annually.
• -8.0%: Real median family income growth has dropped 8%, and
• the number of full-time middle-class jobs, 6%.
• -25.0%: The real net worth of the "bottom" 90% has dropped by one-fourth.

• 200%: The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.

Of course, Stockman's views have gone down like a lead balloon in the corridors of power and in the mainstream media – which abhor his hard-money views and which cling to a painless Keynesian solution to the 2008 credit collapse.

What should you do in the current environment? Exercise extreme caution. Try to

• think independently of the crowd. And
• remember your history...

As barometers go, stock markets, under conditions of high levels of margin borrowing and other forms of leverage, are less than perfect. Otherwise, the much-feted 1929 rally would not have happened – a full year after commodity price deflation had set in.

Fast-forward to 2013, and we see that the three best-performing sectors in the US equity rally are the anti-cyclical and defensive health care, consumer staples and utilities (with an average year-to-date gain of 14%). The three worst-performing sectors are the highly cyclical and growth-sensitive materials, tech and energy (with an average year-to-date gain of less than 3%).

This is not a rally. It's a credit bubble of epic proportions.

US MACRO - Divergence Supports "Rolling-Over" Pattern

US Macro Data Plunges Most In 10 Months 04-05-13 Zero Hedge

The last two weeks have not been pretty for the 'it's different this time' crowd. Day after day has brough miss after miss in macro-economic data for the US; from PMIs to NFPs, no matter how hard you try, there is not even enough for an 'anecdotal' strategist to pin his BTFD thesis on. Quantitatively, the US macro surprise index has seen its biggest 10-day drop in 10 months, completely reversing all the 'seasonally-adjusted' difference from the 2011 'Deja-Vu' market and macro behavior. So with the first pillar of bullishness (macro data is 'supportive'), it is up to earnings (but but but profitability is at highs) to hold up the market - good luck with that.

Biggest 2-week drop in macro data in 10 months...

is reverting all the 'seasonally adjusted' green shoots that made this time different from last year...

and once again, just for fun, someone explain how the market is not solely dependent upon the Fed for this to occur?

Charts: Bloomberg

FALSE ECONOMIC DATA - The Archilles Heels of the Deception

NEED TO KNOW

• CHINA: Chinese data manipulation has its Achilles heel in the form of monthly electricity consumption (and to a lesser extent, production) updates.
• US: US has its Achilles heel in the form of weekly updates from the Energy Information Administration, whose data on barrels of US product supplied of both total petroleum products and just gasoline are as indicative of the true state of the energy-hungry beating heart of the US economy as any other data set, and is likely a far more accurate representation of what is really going on between the lines.
• on a blended 52-week average basis, the total product supplied of motor gasoline is back to 2003 levels (black line on chart below).
• the total product supplied category, which includes gasoline and all other product such as heating oil, propane, and kerosene. As the chart below shows, the US economy, whose GDP we are led to believe has never been higher, now has the same total consumption of all petroleum products (red line) as it did... back in 1997!

Source: Weekly US Product of Finished Motor Gasoline (EIA), and Total Petroleum Product (EIA).

The same disturbing story is revealed when looking at various other EIA charts of sales, and thus demand, such as this one showing that 52 week average sales and deliveries of gasoline by prime supplier in the US has also tumbled to levels last seen in the late 90's.

Source: Total Gasoline All Sales/Deliveries by Prime Supplier (EIA)

But maybe it is just the usage of more efficient modes of transportation, and a higher MPG as more Americans shift to electric cars and some such. Sure, maybe. Of course, that would not explain why the total miles driven has hardly budged for the last decade, and is far off the all time high recorded when the economy was indeed humming on all fours, if moments before it imploded in 2007...

Source: Moving 12-Month Total Vehicle Miles Traveled (St. Louis Fed FRED)

... but the biggest question we have is just how did the biggest boost in energy and engine efficiency occurred at two key junctions: Just after the Lehman Failure, and just after the US downgrade and the first debt ceiling crisis, when the total sales of gasoline by US retailers literally went off the charts, and which data series is now languishing at levels not seen since the 1970s (unfortunately we can only estimate: not even the EIA's data set goes back that far).

Source: US Total Gasoline Retail Sales by Refiners (EIA)

Perhaps, just perhaps, Occam's razor applies in this situation as well, and the collapse in energy demand in the US has little to do with MPG efficiency, higher productivity, and throughput mysteriously achieved just when the entire economy was imploding in the months after the Lehman failure, and despite the re-emerging proliferation of cheap Fed debt funded SUVs and small trucks (discussed here), and everything to do with the US consumer being slowly but surely tapped out?

Of course, if that is the case, than the US economy is far, far weaker than even we could have surmised, although it certainly would explain the desperation with which the Fed is doing everything in its power to preserve the levitation of the S&P, i.e., the confidence that all is well despite all signs to the contrary. Because should the market finally be allowed to reflect the underlying economy - not the administration represented economy, but the real one - then everything that has transpired in the past five years will be child's play compared to what's coming.

HELICOPTER MONEY - Central Bank Bond Purchases are Forever

Helicopter QE will never be reversed 04-03-13 Ambrose Evenas-Pritchard

Readers of the Daily Telegraph were right all along. Quantitative easing will never be reversed. It is not liquidity management as claimed so vehemently at the outset. It really is the same as printing money.

CENTRAL BANK BALANCE SHEET EXPANSION - Theoretical Path to SPX of 1950

Bernanke & Kuroda Capital LLC: Overweight S&P 500, 2013 Target 1950 04-10-13 Zero Hedge

Given that the Fed and the BoJ has our back (and will add a further $1.75tn or so to their balance sheets by 2013 year-end), we should expect US equity prices to rise to infinity and beyond. As one smart chap on the television noted, "stocks won't go down again," but given expectations for earnings in 2013 (which include the remarkable hockey-stick in Q4 - which surely would only occur if things were strong enough to warrant the Fed pulling back in a reflexive vicious circle), the S&P 500 will trade at a rather expensive 19.5x P/E at end-2013 (which we are sure we will be told is still cheap).
If it was just up to the Fed, the 1950 is an obvious target - dump your bonds and get some...

but the Europeans are seeing LTRO-payback reducing the size of their balance sheet and the Chinese are 'anxious' so factoring in the BoJ riding to the rescue as well, it seems a much more conservative 1900 target for S&P 500 is warranted by year-end...

The question is - at what point is an equity market multiple representative of exuberance and what if the correlation breaks - what if the herd realizes that none of it is wealth until you take profits. And with that kind of 'wealth' creation, will inflation pop up its ugly head?

Given correlations, Gold would trade at $2200 by year-end (and WTI Oil over $140)...

Charts: Bloomberg

SEARCH FOR YIELD - Treasury-Corporate Spread Bigger than S&P Yield

Moody’s Corporate AAA bond yields vs US 10yr Constant Maturity Yield to 1857 04-10-13 Ritholtz

There is a tendency to look at the S&P500 Dividend Yields vs US 10 year, but in many ways, that is a less than ideal comparison. Corporate Bonds are more of an apple to apple comparison.

Note that there is an almost 200 bps spread over the US 10yr — nearly double the dividend yield of the S&P500.

We keep talking about how the “Great Rotation” into equities from bonds has not yet happened, but folks looking for yield may wish to pay more attention to AAA rated corporates.
Source:
Ralph M Dillon (rdillon@globalfinancialdata.com)
www.globalfinancialdata.co

Dow Hits Record Amid ‘Absence of Attractive Alternatives’ to Equities  04-09-13 WSJ

PATTERNS - Consumer Discretionary Showing Real Strength

Why is S&P500 Consumer Discretionary Hitting Highs? 04-09-13 AlphaNOW

Here is another one of those things I find perplexing:

I keep hearing that healthcare, utilities and consumer staples are doing well — and that this rotation is usually caused by fear of an economic slowdown.

But what if its something else? Might healthcare be part of a secular move caused by the aging of the baby boomers? Utilities and Staples both have high dividends — might these be an alternative to 10 year Treasuries yielding 1.73 today?

To those people expecting a recession, how can we explain the Consumer Discretionary sector hitting highs?

I don’t have the answers, but my curiosity leads me to these questions.

And the chart above, via MER — showing that Consumer Discretionary sector is in a “secular bull market on both an absolute and relative price basis.  The big breakouts from early 2012 remain intact and the sector achieved new all-time absolute and relative price highs yesterday.”

Merrill notes that “this is a bullish back-drop for the sector and for the US equity market longer-term.”

FUNDAMENTALS - Hussman: Earnings Excessive by Historical Norms

U.S. Stock Market Is ‘Overvalued, Overbought and Overbullish’: John Hussman 04-10-13 The Daily Ticker

VALUATIONS - CAPE and TOBIN Suggest 50 Percent Overvalued Markets

This Chart Should Scare The Bejeezus Out Of Stock Investors 04-04-13 BI

Now that the stock market is hitting new highs, everyone's suddenly excited about buying stocks again. Meanwhile, four years ago, when stocks were at a decade low, no one wanted to have anything to do with them. It is ever thus.

Warren Buffett is fond of observing that, when any other item in the economy goes on sale, folks get stoked about buying it. ("It's cheap! I'm getting a deal!") When stocks go on sale, meanwhile, folks are appalled by the idea of buying them. Instead, everyone wants to wait until stocks have gone up steadily for many years and, therefore, seem "safe."

The good news about this bizarre and return-destroying attitude is that it creates an opportunity for investors who can manage their own emotions and buy when others are fearful, as they were four years ago, and sell (or at least get cautious) when others are greedy. And right now, after four years of amazing gains in stocks, investors are getting greedy.

Does this mean the market is about to crash? No. Nothing means that the market is about to crash. Crashes are just a risk that you have to accept if you want to invest in the stock market. And for long-term investors, these crashes aren't actually a big or bad deal. They create the opportunity to invest more money in stocks at lower prices.

But investors who are now feeling comfortable with the stock market because stocks just keep going up should keep a couple of things in mind. First, when measured on valid valuation measures--measures that take into account the business cycle and have shown an ability to predict future returns--stocks are very expensive.

As fund manager John Hussman notes this week, two of these measures--

1. Robert Shiller's "cyclically adjusted P/E ratio" and
2. "Tobin's Q"

Suggest that stocks are about 50% overvalued.

Hussman includes the following chart, which is from the excellent strategist Andrew Smithers in London. See how high stock valuations are relative to most of the last century?

Smithers & Co.

Again, this overvaluation does not mean that stocks are about to crash. But it does suggest that future returns are likely to be very low relative to long-term averages.

John Hussman estimates that stocks will only return about 3.5% per year over the next decade, which is a far cry from the 10% long-term average and the even greater returns of the past few years. So, even barring a crash, investors should keep their long-term return expectations in check.

One thing that might actually cause stocks to crash, meanwhile, is a return of corporate profit margins to their long-term averages.

Those who say today's stock market is "cheap" are comparing today's price to this year's earnings.

The problem is that this year's earnings are benefitting from record-high profit margins.

American companies have never made as much money per dollar of revenue as they are making now. And, in the past, when profit margins have spiked to levels that are even approaching today's levels, the margins have suddenly and violently reverted to the mean.

Importantly:

1. No one sees these profit-margin collapses coming.
2. The mean-reversion is generally sudden and violent.
3. It creams the stock market.

At some point, today's record-high profit margins will almost certainly revert to the mean. If this happens suddenly, the way it has always happens in the past, the stock market will almost certainly crash.

Now, there are many good reasons for long-term investors to keep a healthy percentage of their portfolios in stocks:

• Expected stock returns, however paltry, are still higher than the expected returns from bonds and cash
• Stocks are a good inflation hedge (if inflation picks up, it can destroy the value of bonds and cash)
• Just because stocks are "overvalued" doesn't mean they will fall, and profit margins could always go higher before they collapse.

But investors who aren't really long-term investors--and who are, instead, buying stocks because they're finally comfortable that stocks aren't risky anymore--should find this chart very unnerving.

EARNINGS - Expect Contraction in earnings over the next 4 years at a rate of roughly 12% annually. 

HUSSMAN: Wake Up, People — The Economy's Lousy And Earnings Are Going To Tank 04-08-13 John Hussman via BI

Fund manager John Hussman of the Hussman Funds sounds the alarm again in his most recent weekly note.

Specifically, he suggests that the economy is much weaker than most people realize and may, in fact, be in a recession.

And then he observes that corporate earnings, which have driven the stock market to a record high (without adjusting for inflation) are based on record-high profit margins that will almost certainly drop.

First, here's Hussman on the economy:

While there is no shortage of smug observers who believe that recession risk does not exist and never did, the fact is that the strongest leading indicators, as well as the most timely coincident data, have deteriorated and danced along the border between economic expansion and economic recession for more than two years. Meanwhile, repeated rounds of QE have produced little but short-lived bounces to defer a recession that historically would have followed such deterioration more quickly. The chart below offers a good picture of this process.

John Hussman, Hussman Funds

 

Notice the successively lower levels, as each round of quantitative easing has smaller and smaller effects on real economic activity (speculative activity in the financial markets aside). The question at present is whether the recent bounce will prove to be temporary as well. This expectation is certainly consistent with the series of rapid-fire misses from the Chicago Purchasing Managers Index (particularly the new orders component), the national PMI reports for both manufacturing and services, and the unexpected weakness on both payroll and household employment surveys. 

For my part, I continue to expect the U.S. economy to join a global recession that is already in progress in much of the developed world (assuming a U.S. recession has not already started, which we can’t rule out, but would require knowledge of eventual data revisions to confirm). Suffice it to say that the realistic case for a sustained economic expansion here remains terribly thin. 

And then there are corporate earnings. As we've noted frequently, they are based on record-high profit margins, and profit margins have a very strong tendency to suddenly and violently revert to means.

Yes, corporate profits are benefitting from a major contribution from international profits, and this could end up muting the mean-reversion (by raising the "mean"). But U.S. corporations have been generating international profits for many decades, and this has not changed the profit-margin mean reversion that we see in Hussman's chart.

Here's Hussman:

On the earnings front, my concern continues to be that investors don’t seem to recognize that profit margins are more than 70% above their historical norms, nor the extent to which this surplus is the direct result of a historic (and unsustainable) deficit in the sum of government and household savings (see Two Myths and A Legend for an analysis, including more than a half-century of data on this). As a result, investors seem oblivious to the likelihood of earnings disappointments not only in coming quarters, but in the next several years. We continue to expect this disappointment to amount to a contraction in earnings over the next 4 years at a rate of roughly 12% annually. 

John Hussman, Hussman Funds

"... A contraction in earnings over the next 4 years at a rate of roughly 12% annually."

Imagine what will happen to stock prices if Hussman is even half right.

HFT AVOIDANCE - Dark Pools Now 40%, InternaLiization 60% Of Off-Exchange Trading

As Market Heats Up, Trading Slips Into Shadows 03-31-13 New York Times

As the stock market continues to climb, trading has increasingly migrated from established bourses like the New York Stock Exchange to private platforms, including dark pools, that are largely hidden from public view. The shift is helping big traders hide what they are doing in the markets, and regulators are worried that the development could obscure the true prices of stocks and scare away ordinary investors.

The movement, under way for several years, has gathered force recently. The portion of all stock trading taking place away from the public exchanges hit new highs over the last few weeks, amounting to close to 40 percent on several days, up from an average of 16 percent in 2008, according to Rosenblatt Securities.

The trend has bucked the government’s broad effort in recent years to move more of the financial industry out of the back rooms and into the light. The increasing opacity of stock trading in the United States, long the most transparent place in the financial world, is troubling for investors and regulators.

“We’ve been having a lot of discussions about whether we are reaching a tipping point between lit and unlit markets,” said Thomas Gira, head of market regulation at the Financial Industry Regulatory Authority, the industry-financed regulator.

In March, Australia introduced new rules to limit trading off-exchange, following the lead of Canada, which put regulations in place last fall. In the United States, the Securities and Exchange Commission has so far declined to act.

The concerns are also evident in the industry itself, where a few dark pools have recently been advertising tools that promise to keep out “gaming” and “toxic” trading practices going on in other dark pools.

Dark pools, like public exchanges, give investors a place to connect with buyers and sellers of stock, but the pools are subject to less stringent regulations than public exchanges. Often run by big banks, dark pools do not require buyers and sellers to publicly announce their intention to trade stocks, allowing traders and investors to hide behind a veil that only the operator of the pool can penetrate.

That appeals to a pension fund that wants to buy a million shares of Ford stock, for instance, because it allows the fund to avoid tipping off competitors who could push the price of the stock up.

Investors also have said that they have moved more of their trading into the dark because they have grown more distrustful of the big exchanges like the N.Y.S.E. and the Nasdaq. Those exchanges have been hit by technological mishaps and become dominated by so-called high-frequency traders.

But the biggest factor pushing trading away from the public exchanges is the ongoing decline in volatility in stock prices, traders say. When share prices are rising or falling sharply, investors want to quickly and reliably get their trade done, leading to a preference for the safety of an exchange. In calmer trading, on the other hand, the anonymity of dark pools is more attractive. What’s more, dark pools are generally cheaper to use than an exchange.

Other places besides the 30-plus dark pools are stealing the business of stock exchanges. A handful of firms including Citigroup and Knight Capital pay retail brokers like TD Ameritrade and Scottrade for the opportunity to trade with ordinary retail investors before the orders can reach an exchange, a phenomenon known as internalization. This type of off-exchange trading has also been growing, in part because of the recent revival of interest in the stock market among ordinary investors.

In recent weeks, internalization has accounted for about 60 percent of off-exchange trading and dark pools for about 40 percent.

The complicated structure of the stock markets makes it hard to get reliable numbers on the exact amount of trading going on in the different entities. Some operators of dark pools say that the most widely used numbers misrepresent the amount of trading going on in the dark, and ignore the fact that on public exchanges some types of trading happen out of the public eye.

Dan Mathisson, the operator of the nation’s largest dark pool, Credit Suisse’s CrossFinder, said that American regulators should not introduce new rules just because of the fears surrounding dark pools. Mr. Mathisson also said that dark pools have not had the technology problems that have done real harm to investors.

Trading in the dark is just one of the facets of the turbocharged stock market that lawmakers have been examining. High-frequency trading has often grabbed the public spotlight. But while high-speed traders have been dialing back their activity, trading in the dark has kept rising.

Canada has been among the most aggressive countries in confronting dark trading, introducing rules last fall that allow trades to take place in dark pools only if brokers are getting customers a significantly better price than is available on the public exchange. Within months, dark pool trading in Canada dropped to about a third of what it was before the rule, according to Rosenblatt Securities.

Regulators and long-term investors fear that the movement away from exchanges will diminish part of what has made the American stock market the envy of the world: the public auction process. In off-exchange trading, investors cannot see what trades are available and as a result are not encouraged to offer a better price.

A recent study by researchers in Australia found that the cost of trading went up for all traders when more trading happened in the dark, backing up an earlier study by an economist at Rutgers, Daniel Weaver.

“If long-term investors are being siphoned off and sent away from the exchanges, there will be less competition and prices will get worse,” said Mr. Weaver.

Because most dark pools and internalizers are operated by banks, Finra, the industry-financed regulator, is also worried that the banks can provide a sneak peek of the trading their customers are doing to their own traders and selected customers. Last September, Finra began gathering information from 15 of the largest dark pools and is now trying to determine whether the banks have improperly shared information about the customers in their dark pools.

“We’ve seen some problematic activity when we’ve looked at” dark pools in trading exams, said Mr. Gira, Finra’s head of market regulation.

Among long-term investors, 67 percent said that they have “trust issues” with dark pools, according to a survey last year by the Tabb Group.

Kevin Cronin, the top trader at the mutual fund provider Invesco, said that to buy and sell stocks in his firm’s mutual funds he has to dedicate an increasing amount of time and money navigating the dark pools. There is too much trading going on there to avoid it, he said.

Last month, Invesco hired a top trader from Mr. Mathisson’s company, Credit Suisse, to keep up with the latest technological developments.

But Mr. Cronin said that he worries as he and other traders escalate the amount of business they are doing out of the public eye.

“It’s just not an efficient market if a fair amount of orders never see the light of day,” he said. “We should all be concerned about this.”

CHINA FURIOUS - Calls It Japanese Monetary Blackmail

"Livid" Top Chinese Economists Call BOJ Decision "Monetary Blackmail", Demand "Currency War" Retaliation 04-08-13- Zero Hedge

The Chinese Central Bank has so far stoically endured the monthly injection of $85 billion in boiling hot money for the past seven months, lovingly delivered by the inhabitants of the Marriner Eccles building, even if it meant a proportionate hawkish response which has pushed the Shanghai Composite red for the year, and having to deal with a property market that is on the verge of another inflationary blow off top. But while the PBOC will grudgingly take this kind of monetary abuse from Bernanke, now that it has to deal with another de novo created $70+ billion in monthly central bank liquidity (poetically called Carry-O-QE by Deutsche's Jim Reid), this time coming from that loathed neighbor and one time invader across the East China Sea, China won't take it any more. As the SCMP reports, "Many of China's top economists are livid at what they view as an effective currency devaluation by Japan and are calling on the People's Bank of China to retaliate by weakening the yuan to defend itself in what they see as a new currency war." 

Of course, calling on the PBOC to "do something about it" is one thing, and certainly China whose GDP is still extremely reliant on net exports for economic growth would like nothing more than to crush the CNY, boost its exports and hurt Japan in the process. However, if it does that, it will merely accelerate already rampant home price inflation, which in the aftermath of the recent chicken culling birdflu outbreak and what is already a scracity of pork meat after last year's corn drought, will then spread to food prices and lead to mass social instability (something Japan, and its docile, irradiated population apparently has little to worry about).

More from South China Morning Post:

These economists, including Tsinghua University professor Li Daokui and ANZ Bank's Liu Ligang, see Japan's plan to double its monetary base within two years as "blackmail" and have criticised the Japanese central bank's decision to open the liquidity floodgates to bump up the economy.

Liu said Japan's unprecedented easing programme, aimed at ending more than two decades of deflation, was "a monetary blackmail" targeted at other export-driven Asian countries such as China and that the central bank should sell more yuan and buy the US dollar to push down the yuan.

He also called on authorities to guard against a fresh wave of hot money into China's fragile financial markets, warning that Japan's move would reignite the so-called carry trade, under which investors borrow in low-interest yen and invest in high- interest markets.

"The massive monetary stimulus by the Japanese central bank could spell doom for other nations in the region," said Tsinghua's Li, a former adviser to the People's Bank of China.

All spot on, and all well-known in advance, but apparently all the brilliant minds in the world forget that trade is a zero-sum game, and that Japan's current account and trade surplus gain (if any, recall both hit record lows recently) facilitated by a plunging yen, will come at the expense of other very angry exporting nations. This also ignores what happens to Japanese import energy and food prices, already exploding as has been documented here previously. The BOJ's hope: companies will promptly hike wages to make up for rising staples costs. We hope the central banker often confused with a Yankees pitcher is not holding his breath on that one...

As for countries hating Japan's guts right now, China may have to wait in line: if there is one country that has to be truly livid at Japan it is South Korea, whose net exports account for nearly 60% of its GDP. So yes: the next currency war salvo will come most likely not from China, which is already caught between a rock and a hard place, but from Seoul, where the perfect storm of a totally nutjob neighbor to the north has emerged just in time for Japan to do everything in its power to crush its economy.

In conclusion, if there is one thing Japan has done, is to make sure all the overnight angst so carefully focused on Europe in 2011 and 2012 (and where it is pretty much game over now following news that "success-story" Portugal will pay public workers in bonds not in cash, all it takes is someone to put down the time of death) shift forward, with the attention now focused not on the 3 am European open, but on what promises to be a daily 8 pm Eastern JGB volatity explosion each and every day.