RISK - 3 Rising Risks To The Markets

The 3 Rising Risks To The Markets 10-03-13 Lance Roberts of STA Wealth Management via ZH

Bill Gross' Advice On Why You Should "Run For The Hills" 10-03-13 Twitter via ZH

PATTERNS - Treasury Warns Current "Herding" Threatens US Financial System

Treasury Warns Asset Manager "Herding" Threatens US Financial System 10-02-13 Bloomberg via ZH

Just two weeks ago we explained how when there is only one driving factor for market performance and "too-many coat-tail clinging asset managers chasing too few real alpha opportunities" then problems can arise. Critically, we showed the correlation between the S&P 500 and hedge fund returns has never been higher and is approaching 1. So it is refreshing that the Treasury Department agrees in a recent report that this "herding into popular assets" by asset managers could pose a threat to the US financial system.

Via Bloomberg,

Money managers could pose threats to the U.S. financial system when reaching for higher returns, herding into popular asset classes... and can contribute to asset price increases and magnify volatility during sudden shocks, a report by the Treasury said today.

...

“A certain combination of fund- and firm-level activities within a large, complex firm, or engagement by a significant number of asset managers in riskier activities, could pose, amplify or transmit a threat to the financial system,” the Treasury’s Office of Financial Research said in the report.

...

“The council will review the study closely as it considers potential next steps relating to asset management activities and firms,”

...

Exchange-traded funds “may transmit or amplify financial shocks originating elsewhere” by pooling assets into illiquid investments.

“Herding into more illiquid investments may have a greater potential to create adverse market impacts if financial shocks trigger a reversal of the herding behavior,” the OFR said.

Well given the charts below... we'd say the systemic threat has never been higher...

As we noted previously,

Hedge fund managers have become high cost version of their index-tracking ETF brethren...

And performance advantages have dwindled...

as Stan Druckenmiller previously noted:

On why Hedge Fund managers are less successful:

“There are too many, there were eight to ten back then. Somehow, 9000 people are pricing their product off of eight to ten people historic performance. I noticed a lot of the smart early investors and hedge fund clients were leaving, but they were more than replaced by state pension funds, sovereign wealth funds and so far they have been perfectly happy to get returns that our early investors would have never tolerated.”

FINANCIAL REPRESSION - The U.S. (and global economy) may have to get used to financially repressive – and therefore low policy rates – for decades to come.

Bill Gross' Monthly Thoughts: Expect The "Beautiful Deleveraging" To Conclude... Some Time In 2035 10-02-13 PIMCO

A week ago, we first reported that Bridgewater's Ray Dalio had finally thrown in the towel on his latest iteration of hope in the "Beautiful deleveraging", and realizing that a 3% yield is enough to grind the US economy to a halt, moved from the pro-inflation camp (someone tell David Rosenberg) back to buying bonds (i.e., deflation).

This was music to Bill Gross' ears who in his latest letter, in which he notes in addition to everything else that while the Fed has to taper eventually, it doesn't actually ever have to raise rates, and writes: "The objective, Dalio writes, is to achieve a “beautiful deleveraging,” which assumes minimal defaults and an eventual return of investors’ willingness to take risk again. The beautiful deleveraging of course takes place at the expense of private market savers via financially repressed interest rates, but what the heck. Beauty is in the eye of the beholder and if the Fed’s (and Dalio’s) objective is to grow normally again, then there is likely no more beautiful or deleveraging solution than one that is accomplished via abnormally low interest rates for a long, long time." How long one may ask? "the last time the U.S. economy was this highly levered (early 1940s) it took over 25 years of 10-year Treasury rates averaging 3% less than nominal GDP to accomplish a “beautiful deleveraging.” That would place the 10-year Treasury at close to 1% and the policy rate at 25 basis points until sometime around 2035!... A highly levered U.S. and global economy cannot deleverage “beautifully” without repressive future policy rate." In the early 1940s there was also a world war, but PIMCO's bottom line is clear: lots and lots of central planning for a long time.

From PIMCO:

Survival of the Fittest?

William H. Gross

YOUTH UNEMPLOYMENT - Millennials Devastated As American Dream Becomes Nightmare For Most

Millennials Devastated As American Dream Becomes Nightmare For Most 10-01-13 The Generations Initiative, Georgetown University

"It seems to me that if you went to college and took on student debt, there used to be greater assurance that you could pay it off with a good job," sums up one 'millennial', adding - sadly - "but now, for people living in this economy and in our age group, it's a rough deal." As WSJ reports, only about a third of adults in their early 20s works full-time - the lowest rate in 40 years - as the combination of structural changes and this recession "is devastating for millennial." Despite think-tanks demanding more of employers in terms of workplace rules and minimum wages, the reality is workers are expected to do more for less and be grateful - "this is a huge problem when think of where demand is going."

The young are earnings less and less relative to the average earnings in the US...

as the younger generation's participation in the labor force fell more than 3 times as fast in the "lost decade" as in the previous two decades...

Summing it all up - where the priority is:

Via WSJ,

The on-ramp to adulthood is delayed and harder to reach for young people today, a reality that is changing the country's society and economy, according to a new report.

More demanding job requirements, coupled with the pressures of the recession, have delayed the transition to adulthood for young people in the past decade and earned them the title of "the new lost generation," according to the report from the Georgetown University Center on Education and the Workforce, published Monday.

...

"It seems to me that if you went to college and took on student debt, there used to be greater assurance that you could pay it off with a good job," said the Colorado native, who majored in English before dropping out. "But now, for people living in this economy and in our age group, it's a rough deal."

...

Through analyzing about three decades of census data—from 1980 to 2012—the study found that on average, young workers are now 30 years old when they first earn a median-wage income of about $42,000, a marker of financial independence, up from 26 years old in 1980.

About a third of adults in their early 20s work full time, a proportion that rises to about half of adults in their late 20s. The labor-force participation rate for young people last year declined to its lowest point in about 40 years, according to the report.

...

In recent decades, the U.S. has seen a gradual outward shift in people's professional lives: Americans today tend to start work later and continue working longer than in past generations. A decade ago, a boy in his late teens was twice as likely as a man his grandfather's age to hold a job; today, the teen is actually less likely to be working.

...

"The combination of structural change plus this particular recession has been devastating for millennials," ... "It has really knocked them back, and some of these losses are permanent."

...

"The millennial generation was the generation to confront this structural change first," said Mr. Carnevale. "It has sorted them out in ways that have made them more unequal than any generation before. For those who didn't get the traction [for a job], it's not clear that they will get the traction."

And the full report is below:

Workforce 092913

YOUTH UNEMPLOYMENT - 30 Mindblowing Statistics About Americans Under The Age Of 30

30 Mindblowing Statistics About Americans Under The Age Of 30 10-04-13 Michael Snyder of The Economic Collapse blog via ZH

Why are young people in America so frustrated these days?  You are about to find out.  Most young adults started out having faith in the system.  They worked hard, they got good grades, they stayed out of trouble and many of them went on to college.  But when their educations where over, they discovered that the good jobs that they had been promised were not waiting for them at the end of the rainbow.  Even in the midst of this so-called "economic recovery", the full-time employment rate for Americans under the age of 30 continues to fall.  And incomes for that age group continue to fall as well.  At the same time, young adults are dealing with record levels of student loan debt.  As a result, more young Americans than ever are putting off getting married and having families, and more of them than ever are moving back in with their parents.

It can be absolutely soul crushing when you discover that the "bright future" that the system had been promising you for so many years turns out to be a lie.  A lot of young people ultimately give up on the system and many of them end up just kind of drifting aimlessly through life.  The following is an example from a recent Wall Street Journal article...

James Roy, 26, has spent the past six years paying off $14,000 in student loans for two years of college by skating from job to job. Now working as a supervisor for a coffee shop in the Chicago suburb of St. Charles, Ill., Mr. Roy describes his outlook as "kind of grim."

"It seems to me that if you went to college and took on student debt, there used to be greater assurance that you could pay it off with a good job," said the Colorado native, who majored in English before dropping out. "But now, for people living in this economy and in our age group, it's a rough deal."

Young adults as a group have been experiencing a tremendous amount of economic pain in recent years.  The following are 30 statistics about Americans under the age of 30 that will blow your mind...

#1 The labor force participation rate for men in the 18 to 24 year old age bracket is at an all-time low.

#2 The ratio of what men in the 18 to 29 year old age bracket are earning compared to the general population is at an all-time low.

#3 Only about a third of all adults in their early 20s are working a full-time job.

#4 For the entire 18 to 29 year old age bracket, the full-time employment rate continues to fall.  In June 2012, 47 percent of that entire age group had a full-time job.  One year later, in June 2013, only 43.6 percent of that entire age group had a full-time job.

#5 Back in the year 2000, 80 percent of men in their late 20s had a full-time job.  Today, only 65 percent do.

#6 In 2007, the unemployment rate for the 20 to 29 year old age bracket was about 6.5 percent.  Today, the unemployment rate for that same age group is about 13 percent.

#7 American families that have a head of household that is under the age of 30 have a poverty rate of 37 percent.

#8 During 2012, young adults under the age of 30 accounted for 23 percent of the workforce, but they accounted for a whopping 36 percent of the unemployed.

#9 During 2011, 53 percent of all Americans with a bachelor’s degree under the age of 25 were either unemployed or underemployed.

#10 At this point about half of all recent college graduates are working jobs that do not even require a college degree.

#11 The number of Americans in the 16 to 29 year old age bracket with a job declined by 18 percent between 2000 and 2010.

#12 According to one survey, 82 percent of all Americans believe that it is harder for young adults to find jobs today than it was for their parents to find jobs.

#13 Incomes for U.S. households led by someone between the ages of 25 and 34 have fallen by about 12 percent after you adjust for inflation since the year 2000.

#14 In 1984, the median net worth of households led by someone 65 or older was 10 times larger than the median net worth of households led by someone 35 or younger.  Today, the median net worth of households led by someone 65 or older is 47 times larger than the median net worth of households led by someone 35 or younger.

#15 In 2011, SAT scores for young men were the worst that they had been in 40 years.

#16 Incredibly, approximately two-thirds of all college students graduate with student loans.

#17 According to the Federal Reserve, the total amount of student loan debt has risen by 275 percent since 2003.

#18 In America today, 40 percent of all households that are led by someone under the age of 35 are paying off student loan debt.  Back in 1989, that figure was below 20 percent.

#19 The total amount of student loan debt in the United States now exceeds the total amount of credit card debt in the United States.

#20 According to the U.S. Department of Education, 11 percent of all student loans are at least 90 days delinquent.

#21 The student loan default rate in the United States has nearly doubled since 2005.

#22 One survey found that 70% of all college graduates wish that they had spent more time preparing for the "real world" while they were still in college.

#23 In the United States today, there are more than 100,000 janitors that have college degrees.

#24 In the United States today, 317,000 waiters and waitresses have college degrees.

#25 Today, an all-time low 44.2 percent of all Americans between the ages of 25 and 34 are married.

#26 According to the Pew Research Center, 57 percent of all Americans in the 18 to 24 year old age bracket lived with their parents during 2012.

#27 One poll discovered that 29 percent of all Americans in the 25 to 34 year old age bracket are still living with their parents.

#28 Young men are nearly twice as likely to live with their parents as young women the same age are.

#29 Overall, approximately 25 million American adults are living with their parents according to Time Magazine.

#30 Young Americans are becoming increasingly frustrated that previous generations have saddled them with a nearly 17 trillion dollar national debt that they are expected to make payments on for the rest of their lives.

And this trend is not just limited to the United States.  As I have written about frequently, unemployment rates for young adults throughout Europe have been soaring to unprecedented heights.  For example, the unemployment rate for those under the age of 25 in Italy has now reached 40.1 percent.

Simon Black of the Sovereign Man blog discussed this global trend in a recent article on his website...

Youth unemployment rates in these countries are upwards of 40% to nearly 70%. The most recent figures published by the Italian government show yet another record high in youth unemployment.

An entire generation is now coming of age without being able to leave the nest or have any prospect of earning a decent wage in their home country.

This underscores an important point that I’ve been writing about for a long time: young people in particular get the sharp end of the stick.

They’re the last to be hired, the first to be fired, the first to be sent off to fight and die in foreign lands, and the first to have their benefits cut.

And if they’re ever lucky enough to find meaningful employment, they can count on working their entire lives to pay down the debts of previous generations through higher and higher taxes.

But when it comes time to collect… finally… those benefits won’t be there for them.

Meanwhile, the overall economy continues to get even weaker.

In the United States, Gallup's daily economic confidence index is now the lowest that it has been in more than a year.

For young people that are in high school or college right now, the future does not look bright.  In fact, this is probably as good as the U.S. economy is going to get.  It is probably only going to be downhill from here.

The system is failing, and young people are going to become even angrier and even more frustrated.

So what will that mean for our future?

CRISIS OF TRUST - Continues to Worsen

Trade Of The Decade: Short 'Trust' 10-01-13 Zero Hedge

The sad truth is that, based on Gallup survey data, Americans have never trusted other Americans less. Is this the "short" that catalyzed the real trade of the decade - "long gold" - as a hedge for the lies and liars that run the nation...

(h/t @Not_Jim_Cramer)

GOVERNMENT SHUTDOWN - Key Dates

The Debt-Ceiling Fight "Could Get Ugly" - Key Dates And Implications 09-30-13 Zero Hedge

Even though there is no technical link between the two main fiscal issues – the continuing resolution (CR) and the debt ceiling bill - there is a link in the minds of market participants because prompt resolution of the CR could spell a favorable outcome for the debt limit. On the other hand, a government shutdown tonight could lead the market to be more pessimistic on the chances of a debt default. As BofAML notes, the link between the two issues is fairly complex but the shutdown battle is just the beginning - and, as they suspect "the fight could get ugly."

As BofAML notes,

In Washington, the link is viewed differently, with the House Republican leadership seeing an immediate deal on the CR leaving more negotiating room on the debt limit, but a shutdown having an immediate negative political impact and increasing the chances of a political capitulation on the debt limit. The link between the two issues is fairly complex.

Debt ceiling – paying the bills

The shutdown battle is just the beginning. At the time of this writing, the House decided to delay any action on an initial version of the debt limit extension, with numerous extraneous provisions attached, including a one-year delay in implementing the ACA, the Keystone pipeline, energy policy, financial regulation, and others. These extra provisions could be a basis for giving the Republicans some political cover in passing a debt limit extension.

However, disagreements among House Republicans have delayed this initial vote on the debt limit for at least several days. The president continues to insist there will be no negotiations over the debt limit. The divisions among House Republicans, as well as the relative political weakness of the president, who has seen his approval ratings decline, increase the difficulty of finding a path that would lead to a solution. We expect a solution will be reached before the deadline because the political costs of a debt default would be significant.

Important dates, mechanism of debt ceiling raise

The deadline dates pertinent to the debt limit have been narrowed considerably. The Treasury released an estimate that extraordinary accounting maneuvers allowing public debt issuance at the debt limit would be exhausted by October 17, at the latest. The CBO also estimated that the cash balance would be run down sometime between October 22 and the end of the month. In our view, there are three relevant dates, using our estimates of the path of the debt outstanding subject to the limit and the Treasury cash balance.

October 15 We estimate that the Treasury exhausts its accounting maneuvers on October 15. This date is the settlement of the mid-month coupon auctions, in the 3y, 10y, and 30y maturities. Any uncertainty in the ability to settle the entire auction without breaching the debt limit would require one of three choices:

• delaying the auctions and issuing cash management bills instead,
• scaling down the auction sizes to only roll over maturing issues,
• or auctioning the full amount and scaling down the regular bill sizes ahead of time to create enough headroom,

with the last alternative being the most likely in our view. According to our estimates, this date would be a fairly close call, but maneuvers are certain to be exhausted in the next day or so, with a mid-October payment into the Highway Trust Fund.

After this date, the Treasury would be in rollover mode, issuing just enough at each auction to roll over maturing debt, while paying for outlays using withholding tax revenues and steadily draining the outstanding cash balance. In our view the Treasury may have enough cash balance to make it to the end of the month and make the month-end interest payment, although there is substantial uncertainty.

November 1 Treasury will fail on its scheduled spending obligations on November 1, having almost certainly exhausted its cash balance. A total of $67bn in payments for social security, Medicare, Medicaid, military pay, and veterans programs will be due on this date. After this, the Treasury could only spend money as it comes in via tax revenues, with scheduled payments being delayed or only paid partially. It is uncertain how the Treasury will prioritize spending programs.

November 15 The first large coupon interest payment of $31bn is paid on November 15. If the debt limit is not raised by then, the Treasury is likely to fail to pay bond interest and will be in technical default.

Key Factors

There are four key factors while analyzing possible market implications of the upcoming fiscal debates, in our view.

Higher market sensitivity to fiscal discussions: Given that both Chairman Bernanke (in his September FOMC press conference) and NY Fed President Dudley referred to the upcoming discussions as a risk factor for their outlook, market sensitivity to these headlines is likely to be more than initially anticipated. Tapering expectations priced into the market may change depending on the severity of the outcome.

The fight could get ugly: As our economics team points out, by shifting the focus of the debate to the funding of the ACA (instead of specific spending cuts), the Republicans have found a less politically dangerous strategy. At the same time, President Obama perceives himself in a stronger negotiating position given that he does not face reelection this time, reducing the effect of some of his own declining approval polling numbers and other recent polls that show equal blame adhering to both sides in a shutdown.

The result is unlikely to be near-term fiscal tightening: Given the gradually improving deficits over the last few years, the discussions on the current episode are unlikely to result in near-term fiscal tightening (unlike 2011, which led to the sequester). This is evident in that most Republican proposals no longer attach near-term cuts to spending. Instead, they are focused on health care and entitlement spending.

External factors that affected us in 2011 unlikely to repeat: This episode is unlikely to be of the same scale as the debt ceiling crisis in 2011. At that time, economic data were very weak, the Fed strengthened its forward guidance and was contemplating Operation Twist, European peripheral spreads were widening dramatically, and there was novelty around the debt ceiling and possible downgrades of the US sovereign credit rating. None of these one-time factors are in play this time.

Even though there is no technical link between the two issues, there is still a link in the minds of market participants because a government shutdown next week may lead the market to be more pessimistic on the chances of a debt default.

While comparing the market reactions from 2011, we caution investors to be aware of certain key differences. There was a novelty to dealing with the ceiling in 2011. The US in recent history had not experienced such a bitter showdown on whether to pay the nation’s bills, and markets likely had greater uncertainty premiums.

GOVERNMENT SHUTDOWN - The Next Step In The Collapse Of The Dollar

Government Shutdown: The Next Step In The Collapse Of The Dollar? 09-30-13 Brandon Smith of Alt-Market blog, via ZH

There is a considerable amount of debate in alternative economic circles as to whether a federal government shutdown would be a “good thing” or a “bad thing”.  Frankly, even I am partially conflicted.  I love to read mainstream news stories about how a shutdown in the capital would be “horrible” because Barack Obama might have to reduce the White House cleaning staff and wash his own laundry:

http://www.bloomberg.com/news/2013-09-27/obama-stripped-to-skeleton-staff-in-a-government-shutdown.html

It's about time that sellout bastard did something to clean up his own act.  I also love the idea of the federal government out of the picture and removed from the U.S. dynamic.  Americans need to learn again how to live without the nanny state, even if only for a few weeks, and what better way than to go cold turkey.  I can hear the tortured sobs of the socialists now, crying for their SNAP cards and low grade government healthcare.  It's like...beautiful music...

That said, as much as centralized government needs to be erased from the face of the planet, there are, indeed, consequences that must be dealt with.  It is foolish to believe otherwise.  No social system, and I mean NO SOCIAL SYSTEM, changes without pain to the population.  I am not among those that cheer a federal shutdown, because I understand that the only people to ultimately feel suffering will be average citizens, not the establishment itself.  The sheeple may be ignorant and blind, but no one deserves the kind of unmitigated hellfire that could rain down upon our country if a shutdown continues for an extended period of time.  Call me a humanitarian...

As I write this, mainstream media projections estimate a 90% chance of government shutdown by midnight on September 30th.  Though technically, government funds will not run out until October 17th:

http://www.usatoday.com/story/news/politics/2013/09/25/treasury-debt-limit-october-17/2867471/

We have dealt with this kind of talk before over the past few years, and it's interesting to see the kind of cynicism that has developed over the idea of a shutdown event.  After all, the last time a government shutdown occurred was at the end of 1995, lasting only a couple of weeks into 1996.  The GOP has folded so many times over the U.S. budget and debt ceiling that most of the public expects they will obviously do it again.  It is certainly possible that the Republicans will roll over, however, I am not so sure of that this time around.  Why?  Not because Obamacare is on the table.  Obamacare is just a distraction.  No, I'm far more interested in the circumstances surrounding the U.S. dollar. 

Obamacare is designed to fail.  Anyone with any financial or mathematical sense could look at the real national debt and deficit projections of the U.S. and understand that there is no money and never will be enough money to fund universal healthcare.  The GOP could simply let the program take effect, sit back, and watch it crash and burn over the next three to five years.  This would entail, though, watching the whole of our economy crash and burn with it. 

What we have developing in front of us is the recipe for a new false paradigm.  Already, the MSM is discussing the possibility of debt default and who will be responsible under such circumstances.  Not surprisingly “Tea Party” conservatives have been named the primary culprits if a shutdown goes south; even former Democratic president Bill Clinton is getting in on the blame game:

http://abcnews.go.com/blogs/politics/2013/09/bill-clinton-when-it-comes-to-obamacare-gop-begging-for-america-to-fail/

All the bickering over Obamacare is fascinating, I'm sure, but lets set the Affordable Care Act aside for a moment and look at the bigger and more important picture.  The private Federal Reserve Bank has just announced to much surprise a complete reversal on its suggested QE “taper” measures, resulting in a shocked and confused marketplace.  If the U.S. fiscal system is stable and sound, as the Fed has been suggesting for the past year, then why continue stimulus measures at all?  Could it be that most if not all positive economic numbers released by the Fed and the Labor Department are actually fake, and that investors have been duped into assuming overall growth when America is actually in an accelerated decline?   Wouldn't that be a high speed excrement storm straight out of left field!

The first day rally over the Fed announcement faded quickly, resulting in a slow bleed of the Dow ever since.  The magic of Fed stimulus is wearing off, and the investment world is not happy.  If I were a member of the Federal Reserve Bank, I suppose I would appreciate a large scale distraction designed to take attention away from me and my elitist club-mates as the primary culprits behind the greatest currency implosion in the history of the world.

Sadly, a government shutdown is sizable threat to the American financial system, and few people seem to get it.  Perhaps because the expectation is that any shutdown would only be a short term concern.  And, this assumption might be correct.  But, if a shutdown takes place, and, if “gridlock” continues for an extended period of time, I have little doubt that the U.S economy will experience renewed crisis.  Here's why:

Exponential Debt

Obamacare only tops a long list of already existing “unfunded liabilities” (otherwise known as entitlement programs).  These programs are not counted in the government's official calculations of national debt or deficit spending, but they cost taxpayers money all the same.  True deficit costs and national debt costs expand every year without fail.  If the debt ceiling does not rise in accordance with this exponential debt, a default is inevitable.  No amount of increased taxes could ever fill the black hole already created by negative government spending. 

A long term government shutdown will eventually require cuts in entitlements, if not a total overhaul of certain aid programs.  Imagine an end to all disability payments, including veterans disability payments.  Imagine federal employee pensions put on hold for an undesignated period of time.  Imagine food stamps placed on hiatus for 50 million people.  Imagine how many states now rely on federal funding just to keep municipalities from bankruptcy.  Get the picture now? 

End Of Foreign Faith In U.S. Treasuries

In a disgusting display of propaganda, media outlet Reuters has released an article claiming that, default or not, Asian investors and central banks are “hostage” to U.S. debt:

http://www.reuters.com/article/2013/09/29/us-usa-debt-asia-analysis-idUSBRE98S0GY20130929

Their argument essentially revolves around the lie that Asian investors believe an American default to be “unthinkable”.  Surely, the unnamed Japanese investment source they cite as an “insider” truly represents the whole of Asia.   

The reality is, the Asians (the Chinese in particular) have been preparing for a calamity in the U.S. Treasury market for years.

Most foreign investors in U.S. Treasuries have converted their long term bond holdings to short term bond holdings; meaning, they are ready to liquidate their bonds at a moment's notice.  Overall purchase levels of treasuries are either static, or falling depending on the nation involved.

China has been internationalizing its currency, the Yuan, since 2005.  China has opened Yuan “clearing houses in multiple countries to allow faster convertibility of the Yuan, quietly supplanting the dollar as the world reserve currency.  These clearing houses now exist in London, Hong Kong, Singapore, Taiwan, and Kenya.  The Federal Reserve and international banks like JP Morgan are heavily involved in the internationalization of the Yuan.

The assertion that Asia is somehow hostage to U.S. debt is a lie beyond all proportions.  In truth, the U.S. economy is actually hostage to Asian holdings of U.S. debt.  A call for a dump of U.S. treasury bonds by China, for example, in the face of a U.S. default, would immediately result in a global chain reaction ending in the destruction of the dollar as the world reserve currency.  This is not speculation, this is mathematical fact.  China is not going to sit back and do nothing while their investment in U.S. debt quickly disintegrates.  Why would they take the chance when they could could just sell, sell, sell!

The very idea that Reuters is attempting to twist the fundamentals surrounding a default event leads me to believe a default event may be preordained. 

What Will Be Defunded?

Non-essential personnel (which apparently includes Obama's maids), will be the first to receive a pink slip from the federal government.  Extra Pentagon staff, EPA staff, FDA staff, IRS staff, etc will all be cut.  Good riddance.  But what will follow will not be so pleasant. 

If a shutdown stretches for months, expect cuts in all support programs and entitlements.  Veterans disability checks, social security, Medicare, employee pensions, even the Postal Service is likely to undergo defunding.  National Parks, and schools that receive federal aid will discover immediate cash-loss.  In fact, any state or city that relies on federal funds should plan for the possibility that those funds will disappear. 

Military cuts would be at the bottom of the list, but I would not discount the chance of that either.

It cannot be denied; an enormous subsection of the American public is dependent on federal money.  If that money dries up, chaos will ensue.  I don't like it, but it is a concern.

Controlled Reaction

A long term shutdown will be catastrophe no matter how you slice it.  Foreign creditors will react harshly.  The bond market will see a haircut not unlike that given to investors in Greek treasuries.  Austerity will become an American way of life.  The only mitigating factor will be the Federal Reserve, which I believe may institute “extraordinary measures” without congressional consent in order to continue feeding stimulus into government regardless of whether the debt ceiling is raised or not.  Given enough desperation, the American public might even applaud such an action and praise the Fed as “heroic”.

In this situation, the U.S. would be facing a Weimar-style currency collapse, rather than a debt default.  But in either scenario, the dollar is the final target.  

Unfortunately, too many economic analysts presume that the only threat to the dollar's value is hyperinflation (these are the same people that quote the Fed's crooked CPI numbers).  But the dollar is just as vulnerable to a debt default and loss of reserve status.  Devaluation seems to be inevitable regardless of the outcome of the funding debate. 

The Republicans could still surrender, and even if they don't, real damages will not be felt until after October 17th.  This is plenty of time to manipulate the public into demanding more spending even when more spending is not in our best interests in the long term.  Our greatest concern, though, should be whether or not the establishment is ready to pull the plug on the dollar altogether, using the debt ceiling crisis as cover in order to distract away from the involvement of international banks in the overall problem.  There is no doubt given the facts at hand that America is on the edge of a terrible pyre.  Is this the event that will finally trigger collapse?  We'll know more in a week...

PATTERNS - This Secular Bear Has Only Just Begun

A Nightmare On Wall Street - This Secular Bear Has Only Just Begun 10-04-13 Ed Easterling of Crestmont Research - via dshort.com, via ZH

Secular bull markets are great parties. Investors arrive from secular bears really wanting to take the edge off. As the bull proceeds, above-average returns become intoxicating. By the time it is over, the past decade or two has delivered bountiful returns.

In contrast, secular bears seem like hangovers. They are awakenings that strip away the intoxication, leaving a sobering need for an understanding of what has happened.

Conventional wisdom explains these periods as irrational or coincidental periods. In reality, secular bulls and bears are periods driven by longer-term trends in the inflation rate. A trend away from low inflation, whether to high inflation or deflation, drives the value of the market lower. That leaves investors with below-average returns. The return trip -- when the inflation rate trends toward low inflation -- drives the value of the market higher. That provides investors with above-average returns.

Then there was the "party" in the late 1990s! Intoxication!! Can you imagine a party so extreme that you end the next day feeling just as groggy as when you first woke up? A long, long day of frustration and misery? That day was the past decade. In stock market terms, it has been twelve years of pain that just now brings investors to the starting line.

Wake-up...this must be a nightmare.

Oh no, it's not!!!

This is a moment of consternation -- an eerie tension between hope and fear. You find yourself saying, "It's not fair... It doesn't seem right... Secular bear markets average eleven years, don't they? Isn't this one supposed to be over by now? Some pundits are saying there might be just a few more years left in this nasty old bear... What do you mean this secular bear has only just begun?" We'll get to that in a moment; but for now, please step back from the edge.

Even if a big bull is not around the corner, there's plenty of opportunity. In fact, it is conditions like these that provide the greatest potential for astute investors. First, they must understand the environment. Then, investors can use that knowledge to their advantage. This discussion is about the first part -- understanding. The upcoming charts will explain why we are actually early in the current secular bear and how we got here. There are many other resources for the second part -- what to do about it.

SECULAR CYLES IN PERSPECTIVE

Let's start with a look at secular bull markets over the past century. Figure 1 presents all four secular bulls since 1900. Each line represents the price/earnings ratio (P/E) annually over the life of the four secular bulls. The level of P/E is displayed on the vertical axis. Time, in years, is displayed on the horizontal axis.

To reduce the distortions to P/E caused by the earnings cycle, earnings (E) have been normalized using the approach popularized by Robert Shiller at Yale. The index for the numerator (P) is the year-end value for the S&P 500. Therefore, the P/E displayed on the chart is the year-end Shiller P/E (i.e., Year-end P/E10).

Figure 1. Secular Bull Markets

First, note that secular bulls start when P/E is low and end when P/E is high. The low points for all secular bulls have been quite similar. In the chart, the low range is designated with green shading. The high point for all secular bulls had also been fairly similar, until the late 1990s. It is as though the 1980s/1990s secular bull ran its course through the mid-1990s, then the party started and P/E more than doubled again. The already high P/E ascended to the stratosphere. Pundits often compare the late 1990s to 1929. Yes, the valuation of the market (as measured by P/E) was fairly high in 1929. But 1999 is in a league of its own.

As the new millennium opened, the bubble stopped expanding -- but it did not pop. An immediate decline of fifty percent would have been required to correct the excesses and to reach a typical secular bear start. Instead, the stock market see-sawed for about a decade. With each decline, it bounced back. As the underlying economy and baseline earnings level grew, the market slowly whittled its P/E back to levels associated with typical secular bull ends and secular bear starts. So it has taken more than a decade to wear away the effects of the late 1990s extremes.

BEAR!

Who says that markets are not considerate? A sudden decline in 2000 would have been a cruel polar bear plunge. Instead, the market tip-toed lower, allowing time for investors to adjust. Some investors have known for over a decade that we are in a secular bear market. Many of them, however, may not have realized just how elevated P/E was when this secular bear began.

Figure 2. Secular Bear Markets

Figure 2 shows just how far we had to go. P/E is on the left axis; time is across the lower axis. The chart presents all of the secular bear markets from the past century. The format is similar to that in Figure 1.

Pause for a moment to reflect upon Figure 2. Contrast it back and forth with Figure 1. Every secular bear cycle prior to our current one followed a secular bull that ended with P/E in or near the red zone. That set the starting point for every adjacent secular bear. But this time, the super secular bull of the late 1990s ended nearly twice as high -- it was a major bubble. Therefore, it is realistic to expect that our current secular bear might last a lot longer or be twice as gnarly as past secular bears.

Because the Fed and other factors have kept the economy in a state of relatively low inflation, the current secular bear has ground its way back to the reality of the red zone.

What goes up, must come down. Figure 2 is noteworthy for highlighting the lofty start of the current secular bear. Now after almost fourteen years, the market P/E is down, but only into the red zone. That level, however, is not overvalued. It was overvalued in 2000 and at many points over the past decade. There were not plausible economic and financial conditions to justify P/E near 30, 40, and more.

Now, finally, the stock market is fairly-valued for conditions of low inflation and low interest rates (assuming average long-term economic growth in the future). But what about the future? If inflation remains low and stable indefinitely, then this secular bear will remain in hibernation until the inflation rate runs away in either direction.

A period of hibernation, however, does not cage the bear and allow a bull to roam. Rather, it means that investors will receive returns consistent with relatively high starting valuations -- nominal total returns for the stock market of around 5%-6%. Hibernation avoids the declining P/E of a secular bear. It is the decline in P/E that causes secular bears to deliver near zero return.

Hibernation also means that there is almost no chance of better returns. Average and above-average returns require a significant increase in P/E. From the red zone, higher P/E requires an irrational bubble. That is never a prudent assumption for a financial plan.

HOW & WHY

The economy experiences periods of rising inflation, disinflation (i.e., declining inflation), deflation (i.e., negative inflation), reflation (i.e., increasing inflation inside of deflation), and price stability (i.e., low, stable inflation). The periods run in a natural sequence around the starting point of price stability.

To illustrate, the cycle starts with low inflation. Then, due to excess money supply growth or other factors, the inflation rate rises. At some point, economic policies or factors reverse the trend, thereby starting a period of disinflation (i.e., declining inflation). Once back at price stability, the trend can either hold in a state of low inflation or it can move upward or downward across another cycle.

The P/E for the stock market is driven by the trend in and level of the inflation rate. As a result, there is a cycle for P/E based upon the inflation-rate cycle. High inflation and deflation drive P/E lower. Price stability drives P/E higher.

The P/E cycle creates secular bull and secular bear markets. Some secular periods have been long, yet others have been relatively short. Time does not drive secular periods. Rather, the inflation-rate cycle determines whether they will be relatively quick or quite extended. Inflation-rate trends can last a few years or they can extend for decades.

Secular bull markets transition into secular bears, which are followed by secular bulls. Neither secular bulls nor secular bears are isolated periods. Instead, they necessarily precede and follow each other. This is why they are designated as cycles rather than simply as periods.

They are called secular because they have a common characteristic and driver that extends over an era. The term secular is derived from a Latin word that means an era, age, or extended period. Actually, an original Latin variation of the word has been closer to hand than most people realize.

On the back of the American one-dollar bill is the Great Seal of the United States. One part of the seal is the circle on the left-hand side bearing a pyramid topped with an eye. Look closely under the pyramid: there is a banner with the phrase "novus ordo seclorum."

In 1782, Charles Thomson, a Founding Father of the United States, and secretary of the Continental Congress, worked as the principal designer of the Great Seal. There is extensive symbolism included in the seal. When Thomson proposed the seal to Congress, he described the meaning of novus ordo seclorum as "the beginning of the new American Era."

When the word secular is used to describe stock market cycles, it expresses that the cycle is an extended period with something in common throughout. Secular bull markets are extended periods that cumulatively deliver above-average returns. These periods are driven by generally rising multiples of valuation as measured by the price/earnings ratio (P/E). Secular bear markets are the opposite: extended periods with cumulative below-average returns driven by a generally declining P/E for the market. Thus the secular aspect of these periods relates to the generally rising or falling trend in P/E over an extended period of time.

THE FUTURE: DECADES

If history is a guide, the inflation rate will at some point trend away from the present price stability. The result will be a significant declining trend in P/E. If this occurs over a few years, the market losses will be dramatic.

More likely, it will take a decade or longer. That will enable the underlying economy and baseline earnings to grow, thereby offsetting the decline in P/E. As we have seen from history, that means another decade or longer of near-zero returns.

When the adverse inflation-rate trend reaches its nadir, we will mark the end of this secular bear and the start of the next secular bull. As the economy or the Fed reverses the adverse inflation-rate trend back toward price stability, P/E will trough at its lows and begin the long climb that drives secular bull markets.

These processes take many years. Be careful not to let hope for the next secular bull mask the reality of the current secular bear. Many more years of vigilant investing will be required for portfolio success. As Robert Frost so aptly wrote:

The woods are lovely, dark, and deep, But I have promises to keep, And miles to go before I sleep, And miles to go before I sleep.

PATTERNS - Margin debt is up 100 times in the last 39 years

Margin debt, incredibly, is up 100 times in the last 39 years (see the chart above). It was $4 billion back in 1974; it's nearly $400 billion today. That is a big reason why stock prices are in the stratosphere. You might think that there's a lot more money around, thereby justifying the rise. ... Let's normalize this indicator to GDP and see what we have. ... [M]argin debt as a percentage of annual GDP is still 10 times the 1974 level. ... The current ratio is also 3 times what it was at previous major tops in the stock market in the 20th century.

-- The Elliott Wave Theorist, July-August 2013

Margin debt levels are not a precise market timing indicator, but one major financial firm advises caution.

"Investors have rarely been more levered than today," said Deutsche Bank, warning that the spike in margin debt is a "red flag" and should be watched closely. ... It said the equity rally may have further legs but it cited "astonishing similarities" between the latest patterns and events preceding prior market crises.

-- The Telegraph, August 13

PATTERNS - Spotting Potential TRIGGER$

• When stocks are in an Uptrend, normally the 50 DMA (green) will offer support.
• When stocks Begin to Top the 100 DMA (red) will offer support as the 50 and 100 DMA flatten.
• When the 50 DMA breaks the 100 DMA (Death Cross) support is normally found at the 200 DMA.

Now see where we are to determine a potential TRIGGER$:

Broker Parlance: BTFD = Buy The F... Dip!

PATTERNS - Cognitive Dissonance

Cognitive Dissonance Chart Of The Day (Year) 10-03-13 Zero Hedge

Faith, hope, and central bank charity... that's all there is left in the new normal.

(h/t @Not_Jim_Cramer)

Source: Gallup and Bloomberg

DERIVATIVES & HEDGING - Markets being Manipulated Through the VIX

The late-day collapse in VIX Tuesday evaporated and was smashed higher, divergent from stocks on Wednesday afternoon, until another pathetic ramp into the close lifted the S&P to its day-session highs but closed down for the 8th of the last 10 days.

Someone somewhere feels the need to test the market at 330ET and then smash VIX lower levitating stocks into the close... smells like algos igniting momentum to enable blocks to exit to us... Welcome to our new "efficient" markets...

But here is what you need to watch carefully.

Look what happend the moment the cash market closes.

Do You feel used?

CLEARLY THE VIX IS BEING USED AS AN INSTRUMENT TO MANIPULATE THE MARKET.

REMEMBER: VIX is an OPTIONS pricing metrics and therefore is directly related to Derivatives of almost all forms and additionally most Hedging Algos.

VOLATILITY INCREASING IN PRECIOUS METALS

EARNINGS - Q3 Earnings Warnings Second-Worst Since 2001

Q3 Earnings Warnings Second-Worst Since 2001 09-30-13 Zero Hedge

US companies are warning about Q3 earnings at the second highest level since 2001, with estimates well below what they were just three short months ago. Of course, the US equity markets don't care - having rallied aggressively in the face of this collapse; lubricated by multiple-expanding QE and rev. repo. As Reuters reports, companies issuing negative outlooks outnumber positive ones by 5.2-to-1, the most negative since the 6.3-to-1 ratio in the second quarter, when however the "second half recovery" (which has been once again indefinitely delayed, perhaps to the third half?) was said would take place momentarily and lead to another mythical rebound. Industrials, Materials, and Tech top the list for negative pre-announcements.

Via Reuters,

Third-quarter earnings for S&P 500 companies were expected to increase by 4.6% compared with a year ago, down from a forecast of 8.5% on July 1.

...

Technology is the sector with the highest number of third-quarter negative outlooks, with 27 warnings. Among them was Autodesk Inc, which anticipates lower demand for its computer-aided design software used in construction, manufacturing and engineering.

Consumer discretionary companies have the second highest number of warnings, including Target Corp. Target said in August that shoppers remained cautious and that its new Canadian stores were not doing as well as anticipated.

...

"there's a lot of noise right now that's driving sector performance, and not the fundamentals."

Of course, the complete disconnect between corporate profitability and forward earnings, has been well-documented, but just in case some have forgotten here it is again.

(h/t @Not_Jim_Cramer)

VALUATIONS - Largest 2 Year Multiple Expansion Since Late 90's

Charting The Bubble In Multiple Expansion 09-30-13 Barclays via ZH

The equity market has discounted a large portion of any improved outlook that the always-optimistic sell-side strategists believe is just around the corner. As Barclays notes, we have just witnessed the largest two-year expansion of P/E multiples since the late 90’s. This 'bubble' of optimism, sparked by a repressive Fed policy, combined with historical valuation metrics that are above their long-term averages, implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014.

Via Barclays,

The improved outlook is fully discounted in share prices... Given that historical valuation metrics are above their long-term averages it is difficult to make a case to the contrary.

...and the largest two-year expansion of PE multiples since the late 90’s implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014.

PRECIOUS METALS - Winners in Q3

Gold and Silver handily outperformed US equities on the quarter

Click to Expand