CREDIT GROWTH - It Will End Badly

It Will End Badly... We're In A Worse Position Than 2008" 11-11-13 Marc Faber CNBC

On the inevitable endgame:

"It will end badly and the question is whether we will have:

• a minor economic crisis and then huge money printing or
• get into an inflationary spiral first,

On China's explosive credit growth:

"Look at China, its credit as a percent of the economy has increased by 50 percent in the last 4-1/2 years. This is the fastest credit growth you can imagine in the whole of Asia,"

On the hidden inflation impacts around the world:

"Why are so many product prices in Singapore and Hong Kong more expensive than in the U.S.? It's because when you have asset inflation and high property prices, shops have to pay higher rents, so they charge more for their products. So asset inflation can flow into consumer inflation,"

FED POLICY - QE Proves to be the "Sham" We All Knew it was!

Andrew Huszar: Confessions of a Quantitative Easer 11-11-13 WSJ

We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a feast for Wall Street.

I can only say: I'm sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed's first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I've come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.

Five years ago this month, on Black Friday, the Fed launched an unprecedented shopping spree. By that point in the financial crisis, Congress had already passed legislation, the Troubled Asset Relief Program, to halt the U.S. banking system's free fall. Beyond Wall Street, though, the economic pain was still soaring. In the last three months of 2008 alone, almost two million Americans would lose their jobs.

The Fed said it wanted to help—through a new program of massive bond purchases. There were secondary goals, but Chairman Ben Bernanke made clear that the Fed's central motivation was to "affect credit conditions for households and businesses": to drive down the cost of credit so that more Americans hurting from the tanking economy could use it to weather the downturn. For this reason, he originally called the initiative "credit easing."

My part of the story began a few months later. Having been at the Fed for seven years, until early 2008, I was working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on the Fed's trading floor? The job: managing what was at the heart of QE's bond-buying spree—a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to quarterback the largest economic stimulus in U.S. history.

This was a dream job, but I hesitated. And it wasn't just nervousness about taking on such responsibility. I had left the Fed out of frustration, having witnessed the institution deferring more and more to Wall Street. Independence is at the heart of any central bank's credibility, and I had come to believe that the Fed's independence was eroding. Senior Fed officials, though, were publicly acknowledging mistakes and several of those officials emphasized to me how committed they were to a major Wall Street revamp. I could also see that they desperately needed reinforcements. I took a leap of faith.

In its almost 100-year history, the Fed had never bought one mortgage bond. Now my program was buying so many each day through active, unscripted trading that we constantly risked driving bond prices too high and crashing global confidence in key financial markets. We were working feverishly to preserve the impression that the Fed knew what it was doing.

It wasn't long before my old doubts resurfaced. Despite the Fed's rhetoric, my program wasn't helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn't getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

From the trenches, several other Fed managers also began voicing the concern that QE wasn't working as planned. Our warnings fell on deaf ears. In the past, Fed leaders—even if they ultimately erred—would have worried obsessively about the costs versus the benefits of any major initiative. Now the only obsession seemed to be with the newest survey of financial-market expectations or the latest in-person feedback from Wall Street's leading bankers and hedge-fund managers. Sorry, U.S. taxpayer.

Trading for the first round of QE ended on March 31, 2010. The final results confirmed that, while there had been only trivial relief for Main Street, the U.S. central bank's bond purchases had been an absolute coup for Wall Street. The banks hadn't just benefited from the lower cost of making loans. They'd also enjoyed huge capital gains on the rising values of their securities holdings and fat commissions from brokering most of the Fed's QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was starting off in much the same way.

You'd think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2. Germany's finance minister, Wolfgang Schäuble, immediately called the decision "clueless."

That was when I realized the Fed had lost any remaining ability to think independently from Wall Street. Demoralized, I returned to the private sector.

Where are we today? The Fed keeps buying roughly $85 billion in bonds a month, chronically delaying so much as a minor QE taper. Over five years, its bond purchases have come to more than $4 trillion. Amazingly, in a supposedly free-market nation, QE has become the largest financial-markets intervention by any government in world history.

And the impact? Even by the Fed's sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed El Erian at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output). Both of those estimates indicate that QE isn't really working.

Unless you're Wall Street. Having racked up hundreds of billions of dollars in opaque Fed subsidies, U.S. banks have seen their collective stock price triple since March 2009. The biggest ones have only become more of a cartel: 0.2% of them now control more than 70% of the U.S. bank assets.

As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a structurally unsound U.S. economy. Yes, those financial markets have rallied spectacularly, breathing much-needed life back into 401(k)s, but for how long? Experts like Larry Fink at the BlackRock investment firm are suggesting that conditions are again "bubble-like." Meanwhile, the country remains overly dependent on Wall Street to drive economic growth.

Even when acknowledging QE's shortcomings, Chairman Bernanke argues that some action by the Fed is better than none (a position that his likely successor, Fed Vice Chairwoman Janet Yellen, also embraces). The implication is that the Fed is dutifully compensating for the rest of Washington's dysfunction. But the Fed is at the center of that dysfunction. Case in point: It has allowed QE to become Wall Street's new "too big to fail" policy.

Mr. Huszar, a senior fellow at Rutgers Business School, is a former Morgan Stanley managing director. In 2009-10, he managed the Federal Reserve's $1.25 trillion agency mortgage-backed security purchase program.

OUR "TAPER CAPER" REPORT - Proof Comes Out

Here's What The "Hint" Of A Fed Taper Did To Global Growth Hope 11-12-13 Zero Hedge

Whether or not one believes the Fed will taper (then almost instantly un-taper based on the market's reaction) or not in the coming months, Bernanke's "tease" in the early summer this year should give most pause for thought as to just how dependent 'everything' is on the Fed's money printing. As the following chart from Bloomberg's Michael McDonough shows, things changed when big Ben dropped the hint that the punchbowl will not be here forever. There is one region, however, that for now has improved its outlook for 2014 GDP growth since the taper-tease...

The largest decline occurred in Latin America, where the 2014 GDP growth consensus diminished to 3.21 percent from 3.99 percent on Jan. 1. and EMEA (the most dependent on abundant, cheap foreign capital to fuel their economic growth). Western Europe, which experienced the largest improvement, is forecasted to grow 1.39 percent in 2014, compared to 1.33 percent at the start of the year. Global growth is anticipated to total 2.85 percent in 2014.

The U.S. 2014 growth forecast has fallen modestly to 2.6 percent from 2.8 percent at the start of the year.

Though  U.S. GDP growth is forecasted to accelerate to 3.0 percent quarter-on-quarter SAAR by the fourth quarter of next year.

Hope - it's always just around the corner...

Charts: Bloomberg

CURRENCIES - EURUSD Cross

Excerpted from: Citi Expects "A Significant Fall In EURUSD" As Currency Wars Escalate 11-08-13 CITI via ZH

Following the surprize ECB rate cut, this leaves the EU with only two major tools for further stimulative activity:

Renewed ECB bond buying (They can no longer rely on an LTRO transmission mechanism inducing financial institutions to buy European sovereign bonds especially as they have shown the propensity for haircuts when things go wrong)…this would likely then transmit into...

A sharp external devaluation of the EURO. Given the poor economic dynamics in Europe, the collapsing inflation, global feedback loop concerns regarding tapering, some concerns about the ability of China (A major export market for Europe and Germany in particular) to maintain the prior pace of economic growth etc. there should be no concern in Europe about this. The authorities have to stop viewing a weaker EURO as part of the problem (financial crisis) and more as part of the solution (External devaluation is stimulative to the MCI (monetary conditions index) and supports export led growth). Even Germany should embrace this given the sluggishness of the EURO area economies and sharply lower and falling inflation. When we look at the longer term EURUSD chart it is very supportive of this outcome in a fashion very similar to the 1995-2000 period.

EURUSD monthly chart: A very compelling historical perspective

We continue to expect a significant fall in EURUSD over the next 2+ years as we saw in 1998. We believe Europe needs and should embrace this dynamic given the ongoing danger of a deep recessionary/depressionary/deflationary environment as a consequence of fiscal austerity and the sharp internal devaluation dynamics already seen.

Within this we believe Europe should (and ultimately will) embrace the stimulative effects of such a move in conjunction with further traditional (refinancing rate) easing (Albeit at these levels the move is more psychological than anything) and non-traditional (bond buying).

On top of this the position of both the relative economic and monetary policy dynamics leaves the US further down the road and closer to a potential turn than Europe (Despite those dynamics still being weak by historical recovery standards)

VALUATIONS - Excessive on A Historical Basis

Be Prepared For Stocks To Crash 40%-55% 11-09-13 Henry Bloget, Business Insider

The stock market continues to set new highs, which is exciting and fun for those of us who own stocks.

I own stocks, so I'm certainly enjoying it.

I hope stocks continue to charge higher, but I can't find much data to suggest that they will. I only have a vague hope that the Fed will continue to pump air into the balloon and corporations will continue to find ways to cut more costs and grow their already record-high earnings.

Meanwhile, every valid valuation measure I look at suggests that stocks are at least 40% overvalued and, therefore, are likely to produce lousy returns over the next 10 years.

Which valuation measures suggest the stock market is very overvalued?

These, among others:

• Cyclically adjusted price-earnings ratio (current P/E is 25X vs. 15X average)
• Market cap to revenue (current ratio of 1.6 vs. 1.0 average)
• Market cap to GDP (double the pre-1990s norm)

How lousy do these measures suggest stock returns will be over the next decade?

About 2.5% per year for the S&P 500 — a far cry from the double-digit returns of the past 5 years and the ~10% long-term average.

If stocks just park here for a decade and return 2.5% a year through dividends, that wouldn't be particularly traumatic. But stocks rarely "park." They usually boom and bust. So the farther we get away from average valuations, the more the potential for a bust increases.

So the higher we go, the less surprised I will be to see the stock market crash. 

How big a crash could we get?

According to the aforementioned valuation measures, and the work of fund manager John Hussman of the Hussman Funds, 40%-55%.

A 50% crash would take the S&P 500 below 900 and the DOW below 8,000.

Is that going to happen?

No one knows.

And, just as importantly, no one knows when. (Valuation is unfortunately not helpful in predicting short- or intermediate-term market moves.)

But a careful study of history suggests that a crash is increasingly likely and that long-term stock returns from this level are likely to be crappy.

I've explained in detail here why I think the odds of a crash are increasing. And I've also explained why, despite this, I'm not selling my stocks. (In short, because I am a long-term investor, I am mentally prepared for a crash, and I am planning to ride out any crash, the same way I did with the 2008-2009 crash. And also because there isn't anything else compelling to invest in.).

Here's a chart from Mr. Hussman that lists many of the reasons why he (and I) are bracing for a crash. And, below that chart is an excerpt from Mr. Hussman's latest note, in which he explains the valuation concern in more detail.

And here's the excerpt:

Stock Valuations – an unrecognized bubble

Recently, as part of his book promotion tour, Alan Greenspan has hit the media circuit. His remarks include the assertion that stocks are still attractively valued, based on his estimate of the “equity risk premium.” See Investment, Speculation, Valuation, and Tinker Bell for a full discussion of the Fed Model, “equity risk premium” calculations, and a variety of far more reliable valuation methods that are tightly associated with subsequent S&P 500 total returns.

The simple fact is that on metrics that have been reliable throughout history, and even over the past decade, stock market valuations are obscene. Importantly, these same valuation metrics were quite optimistic about prospective market returns at the 2009 low.

As a side-note, one should not confuse the message with the messenger here. It’s no secret that my insistence on stress-testing our return/risk estimation methods against Depression-era data resulted in missed returns in the interim (2009-early 2010), but none of that reflects our valuation metrics, which indicated prospective 10-year S&P 500 total returns in excess of 10% annually at the time. The real concern in 2009 was that even after similar valuations were observed during the Depression, the stock market still went on to lose two-thirds of its value. So I’m quite open to criticism about my insistence on stress-testing (which I still believe was a fiduciary obligation given the events at the time). But one should be careful in concluding that this removes the ominous implications of present valuations.

On the basis of a wide variety of historically reliable fundamentals, we currently estimate 10-year S&P 500 nominal total returns of just 2.5% annually. Notably, the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) is now at 25. Prior to the late-1990’s bubble, the only time the Shiller P/E was higher was during three weeks in 1929 that accompanied the extreme peak of the market before stocks crashed. Meanwhile, the price/revenue ratio of the S&P 500 is presently 1.6 – a level that is double its pre-bubble norm, and even further above levels historically associated with bear market lows.

Shiller P/E

We observe similar extremes in other reliable measures that aren’t dominated by cyclical movements in profit margins. The apparently “reasonable” market valuations based on margin-sensitive fundamentals (e.g. forward operating earnings) implicitly assume that all of history can now be ignored: profit margins will no longer be highly cyclical; margins will no longer vary as the mirror image of deficits in combined household and government savings (see Taking Distortion at Face Value); and they will instead permanently remain more than 70% above their historical norm.

Aside from the fact that we can fully explain the present surplus of corporate profits as the mirror image of deficits in the household and government sectors, the other reason to focus on normalized earnings, cyclically-adjusted earnings, revenues, and other “smooth” fundamentals is simple: they are strikingly accurate guides across history. Another such measure is the ratio of stock market capitalization to nominal GDP, based on Federal Reserve Z.1 Flow of Funds data. Again, the present multiple is about double the historical pre-bubble norm.

Capitalization to Nominal GDP

While the valuation of the S&P 500 Index itself was higher in 2000, it’snotable that the overvaluation of the S&P 500 was skewed in 2000 by extreme overvaluation in very large-capitalization stocks, while smaller capitalization stocks were much more reasonably valued. In contrast, we have never in history observed the median stock as overvalued as we observe presently. Indeed, the median price/revenue ratio of stocks in the S&P 500 now exceeds the 2000 peak. Likewise, as Damien Cleusix has observed, if we examine valuations by quartiles (25% of stocks in each bin), the average price/revenue ratio of the two middle quartiles also exceeds the 2000 extreme.

For the sake of completeness, I should also note that virtually every “overvalued, overbought, overbullish” syndrome we define is on red alert. I hesitate a bit on this point, because in contrast to nearly a century of market history where these syndromes were reliably associated with deep losses, the emergence of these syndromes since late-2011 has repeatedly been followed by yet further speculation (see the chart in The Road to Easy Street). My impression remains that this is not a permanent change in market dynamics, but simply reflects an anvil that has not yet dropped. So these syndromes have admittedly done us no favors in the more recent period. Still, it remains our job, and our discipline, to view market action within its full historical context.

Among the many largely equivalent ways to define an overvalued, overbought, overbullish syndrome, the blue bars on the following chart present one of the many we observe at present:

• Shiller P/E anywhere above 18 (overvalued),
• S&P 500 at a 5-year high and at least 8% over its 40-week smoothing (overbought), with
• bullish sentiment greater than 50% and
• bearish sentiment less than 20% based on Investors Intelligence figures (overbullish).

Notice that we did not observe this particular variant in 2000 because bearish sentiment never fell below 20% in that year. Also, while sentiment data was not available in 1929, we can impute sentiment reasonably on the basis of past price movements. Using imputed sentiment, we can also include 1929 in the set of instances here.

Notice that we’ve observed three instances this year – in May, in August, and today. Given the lack of follow-through from recent syndromes, we have to at least allow for the possibility of a further blowoff, as the seduction of quantitative easing has encouraged investors to ignore these conditions. On the economy, the best we can say is that while some widely-followed Fed surveys and Purchasing Managers indices  have improved modestly in recent months, the most recent rolling correlation between these measures and actual economic outcomes (employment growth, industrial production) has become even more negative at the same time (see When Economic Data is Worse than Useless). Again, my impression is that this is not a permanent change in economic dynamics, but a temporary effect of distortions from quantitative easing, but it does force us take a more agnostic view of the economy than we might otherwise have.

In any event, I continue to believe that it is plausible to expect the S&P 500 to lose 40-55% of its value over the completion of the present cycle, and suspect that whatever further gains the market enjoys from this point will be surrendered in the first few complacent weeks following the market’s peak. That’s how it works. If all of this seems like hyperbole, please recall my similar concern at the 2007 peak (see Fair Value – 40% Off), and the negative 10-year return projections – even on best-case assumptions – that we correctly estimated for the S&P 500 in 2000. These numbers relate to the striking gap between present valuation levels and normal historical precedent, not to personal opinion.

None of our own challenges in this decidedly unfinished half-cycle relate to our consistent ability to correctly assess long-term investment prospects. We may yet see some amount of further short-term speculation, but already for the median stock, the long-term investment outlook has never been worse.

You can read the whole thing here

LIQUIDITY - Signs of Stress

There's A Liquidity Crunch Developing 11-10-13 Alasdair Macleod of GoldMoney.com via ZH

This week an article in Euromoney points out that liquidity in bond markets is drying up.

1. CAPITAL RATIOS: The blame is laid at the door of regulations designed to increase banks' capital relative to their balance sheets.
2. REPO GEARING: Furthermore, the article informs us, new regulations restricting the gearing on repo transactions are likely to make things worse, not only reducing bond market liquidity further, but also affecting credit markets. The reason this will be so is that in a repurchase agreement a bank supplies credit to non-banks for the period of the repo.

• POLICY 'ARB' RISK: One could take another equally valid point of view: the reason for deteriorating liquidity in bond markets is due in part to yields being unnaturally low. If you price bonds too highly, which amounts to the same thing, few investors want to buy them without the unconditional support of the central bank as a ready buyer. This, after all, is why just the hint of tapering recently was enough to derail the markets. So here again we come up against the same choice: if the Fed insists on mispricing the market with its interventions and zero interest rate policy it must fully support the market with both QE and also twist applied to the yield curve to maintain market liquidity.

For the investment analysts and commentators that still expect tapering this must come as something of a surprise. The underlying point they have missed is that

Once a central bank embarks on a policy of printing money as a cure-all, it is impossible to stop, or even to just taper without risking a liquidity crisis.

Increasingly illiquid markets are now telling us that QE should be increased.

ECB RATE DECISION

The point was rammed home this week by the ECB's decision to lower interest rates. The move was sold to the financial press as designed to stimulate inflation and reduce the risk of deflation. However, central to the deflation argument is the need to stimulate liquidity in the secondary markets, which according to the Euromoney article "are now close to breakdown".

At least the ECB rate cut should defuse tapering expectations in US markets, making it easier for the Fed to back down from its failed experiment. The Fed now needs to plant the suggestion that QE will have to be increased, or a similar mechanism designed to boost liquidity introduced.

This will not be difficult in the prevailing economic conditions. Even though GDP remains a positive figure, concerns over deflation abound and are preoccupying more and more analysts. These are concerns which analysts can readily accept as an immediate and greater risk than inflation.

MARGIN DEBT - Problem Combination of Low Mutual Fund Cash Levels

Chart Spotlight - Alan M Newman 11-05-13

PROFIT MARGINS - Margin Growth Running out of Runway

Here's Why Rising Interest Rates Won't Crush Corporate Profit Margins 11-10-13 Business Insider

First, American companies have deleveraged their balance sheets after getting burned by the recent credit crisis.

"[A]lthough we could see interest raters rise from current depressed levels, we would still expect them to remain well below history," said Bank of America Merrill Lynch's Dan Suzuki earlier this year. "We also do not see any rush for corporations to meaningfully re-lever their balance sheets for the foreseeable future."

Second, American companies have locked in lower interest rates. 

"The impact of higher rates should be muted, as companies have termed out their debt," said RBC Capital Markets' Jonathan Golub

PATTERNS - The Stock Market Is Not The Economy Anywhere In The World

The Stock Market Is Not The Economy Anywhere In The World 11-06-13 Business Insider

The stock market and the economy are not the same thing.

They may be related, but their growth rates differ because they are based on and driven by very different things.

"It is not unreasonable for an investor to associate rapid economic growth with strong stock market returns," write Vanguard's Joseph Davis, Roger Aliaga-Diaz, Charles Thomas, and Ravi Tolani. "And anyone who regularly follows the financial markets probably has the sense that economic data releases can drive market performance."

In a report titled "The Outlook For Emerging Market Stocks In A Lower-Growth World," the authors examined long-run equity market returns and real GDP growth for 46 countries and found the correlation to be very weak and inconsistent.

"At 4.0% per year, the average real equity market return for the countries with the three highest GDP growth rates was slightly below the 4.2% average return for the countries with the three lowest GDP growth rates, despite the considerable difference in those rates (8.0% a year versus 1.6%, on average)," they found. "It is clear that the correlation between these two variables is weak."

"These results may not quite line up with investor intuition," they write.