RISK - Even Goldman Can't Explain Away The Market Exuberance

Even Goldman Can't Explain Away The Market Exuberance 12-02-13 Goldman via ZH

From the start of 2012, the S&P 500 up over 40% with the bulk of that surge coming since QE3 (and 4EVA) was unleashed. Until that point, Goldman's global risk and macro models had stayed relatively well synced with stock market 'reality' but once that torrent of liquidity was released, all bets were off. As the following chart shows, more than half the equity market performance is due to factors unrelated to risk, macro fundamentals, or country-specific factors. So, BFTATH of course?

Chart: Goldman Sachs

RISK IS A funny old thing at the best of times, and even funnier when it is supposed to be correctly priced.

Most of us grew up with the understanding that the correct price for credit – my main area of expertise – was a function of the default probability, adjusted for the expected recovery rate.

Perhaps the simplest and cleanest example of risk pricing is to be found in the credit card industry, where your “bucketing” is of paramount importance. The lower your perceived risk is, the better a risk bucket you get lumped into and the lower your interest rate is. That’s banking 101, but it still isn’t clear to everyone that the net earnings from each bucket are expected to be similar, based on higher spreads being matched to higher defaults. Excess returns are generated when the expected defaults do not occur at the forecast rate.

So far, so good. But then how does one extrapolate that basic rule of lending to the way credit markets have been performing of late?

My old chum Suki Mann, living legend and credit strategist at Societe Generale here in London, highlighted the point – albeit probably not intentionally – in a piece he wrote this week. He asked, rhetorically, whether it would be possible for the credit markets to repeat this year’s performance in 2014 – wondering, in other words, whether a further 8.4% of returns on 220bp of spread tightening in high-yield or 2.4% returns with 22bp of spread tightening in investment-grade were possible.

“We’d concur with the former,” he wrote, “but up to 7% is not impossible off 100bp of spread tightening; while in IG, we think 2%-plus is possible with tightening in [iBoxx] index spreads of around 30bp.”

Although I don’t entirely disagree with Suki, I can’t detect too much science going into his pricing model, if that is what it is. The sole point of reference seems to be the all-time low spread of the iTraxx Main index, which was registered at 20bp in June 2007. As recently as early October it was trading at 100bp but is now marking around 75bp. Hence, his rather confident assertion that a further 20bp of tightening should not be a problem.

Are risk assets now riskless assets or are they risk assets disguised as riskless?

PERHAPS, BUT ONLY because the first rule of investing now appears to have become: if the worst is about to occur, then the monetary authorities will make sure that it doesn’t.

Let’s face it, Saint Mario Draghi did not only say that he will do “whatever it takes”, the bit of his assertion everyone remembers, but also, and perhaps more importantly, “…and believe me, it will be enough”.

In doing so, he removed huge swathes of what we once called risk – a concept that used to be known as a four-letter word. This raises the question: are risk assets now riskless assets or are they risk assets disguised as riskless?

What goes for bonds appears to go for equities too, even though we did experience something of a wobble in the summer when the US Fed seemed set to taper its bond buying programme. Since then, though, the Fed, in its own inimitable way, appears to have let equity markets believe that it will do nothing that might hurt share prices and hence shareholders. If anything, the velocity of the rally now appears to be increasing rather than decreasing.

Either the Fed is deceiving markets into believing that there is nothing to fear, or it is not making itself clear enough. To be frank, I doubt it is the latter.

SO WHAT HAS become of risk pricing? Well, one might try to argue that if there is no risk, then there can be no price for it. But that would be perhaps taking it a little bit too far – even for me.

Nevertheless, pricing risk has become so alien that even non-monetary policy-related risks are being disregarded. The little tiff between China and Japan (and by proxy the Americans) over a group of uninhabited islands never even caused a ripple in financial markets. And although it was written that oil prices had fallen in the aftermath of the interim agreement between Iran and the West, if one looks at the charts, WTI was trading well below its 300-day moving average long before the news broke – and the Geneva breakthrough doesn’t appear to have even registered.

Is there no risk or has the way in which authorities prevented the fallout from the credit bubble and the events that led to its formation led a generation of traders and investors to believe that it is a thing of the past?

One hedge fund manager once proudly stated that life is a bull market intersected by corrections. In the midst of the credit crisis I laughed at him.

Looking at the state of the world now, he might be laughing back, having concluded that the 2007 financial crisis and the 2008 fall of the House of Lehman were nothing more than bigger corrections and hence thumping buying opportunities that could only have been missed by idiots.

I guess that puts me in my place. Either that or there is something lurking out there that we have forgotten how to identify – and hence how to value.

JAPAN - The Abe-nomics Failure

This Inflation Is Supposed To Be GOOD For Japanese Workers? 11-30-13 Wolf Richter   www.testosteronepit.com   www.amazon.com/author/wolfrichter via ZH

Japan’s new economic religion, lovingly dubbed Abenomics, relies mostly on a money-printing binge that monetizes the entire government deficit plus a chunk of its public debt, month after month. Printing yourself out of trouble and to wealth works every time. For the elite. This is a lesson learned from the Fed. But how are workers and consumers faring? And by implication the real economy?

We keep getting juicy morsels of data on this phenomenon. Abenomics is accomplishing its two major goals – watering down the yen and stirring up inflation – pretty well. Over the last 12 months, the yen has been devalued by 20% against the dollar that the Fed is trying to devalue as well. So this is quite a feat! It's been devalued by 28% against the euro. And inflation is heating up.

The consumer price index, released today, rose 0.1% in October and is now up 1.1% for the 12-month period. Less “imputed rent,” inflation rose 1.4% year over year. Service prices were up 0.4%, but goods prices jumped 1.9%. At this rate, Abenomics will have no problems meeting or exceeding by March, 2015, its “2% price stability” target, as the Bank of Japan has come to call it with bitter cynicism.

WAGE INCREASES

What isn’t happening: wage increases!

The Japanese Statistics Bureau just reported incomes and expenditures of households with two or more persons. This is by far the largest category of households in Japan. Due to the cost of housing in large urban areas – and due to remnants of tradition – a large number of singles live with their parents. This category is further divided into “workers’ households,” “no occupation” households, and “other” households.  

Incomes of the all-important “workers’ households” rose a measly 0.1% from a year ago to ¥482,684. In nominal terms. But adjusted for inflation – yes, here is where the benefits of Abenomics are kicking in – incomes fell 1.3%. Disposable incomes fell 1.4%. The details were ugly: “Current income” (salaries and wages) dropped 1.2% and “temporary bonuses” plunged 19.5%. Income from self-employment and piecework plummeted 20.8%.

So these strung-out workers’ households whose belts are being tightened by Abenomics and whose real incomes are being whittled away by inflation, how can they spend more to perk up the economy? Turns out, they don’t. Spending rose a scant 0.4% in nominal terms from a year ago – but adjusted for inflation, spending fell 1.0%.

And this despite rampant frontloading of big-ticket purchases. The consumption-tax hike from 5% to 8%, to take effect on April 1, is motivating households to buy big-ticket items now and save 3%. It has turned into a frenzy. Durable goods purchases, the primary target of frontloading, jumped 40.4% in October from a year ago. While it’s goosing the economy now, it will create a hole starting next spring. Japan has been through this before.

When the consumption tax hike from 3% to 5% was passed in 1996, Japanese consumers went out on a buying binge of big-ticket items to avoid paying the extra 2% in taxes, and the economy boomed. The hangover came around April 1, 1997, when the tax hike became effective. The economy skittered into a recession that lasted a year and a half. Now Japanese households are frontloading to avoid an additional 3% in consumption tax. The hangover next year is going to be painful.

But frontloading of a few big-ticket items is hitting day-to-day expenditures. These households spent 1.8% less on non-durable goods and 2.0% less on services, compared to prior year. Hence, the drop of 1% in overall spending by these households, despite their splurging on a few big items.

This is the benefit of inflation without compensation! A process that ever so slowly hollows out the middle class and pushes the lower classes deeper in the quagmire. It’s hurting workers and consumers. It’s constraining the real economy. Yet, holders of assets that the central bank inflates into the stratosphere benefit. Japan isn’t the only country that is practicing this large-scale redistribution of wealth from workers to holders of inflated assets. Abenomics is following the playbook of the Fed. But it’s pushing it further to the extreme.

The dogfight over Japan’s biggest problem, its gargantuan government deficit, entered its annual ritual of leaks and pressure tactics that usually lead to a pre-Christmas draft budget with an even bigger deficit. But this time, it’s different. Very different. Read..... Japan Is Used To Natural Disasters, But This One Is Man-Made

SENTIMENT - Crisis of Trust

Two-Thirds Of Americans Can't Be Trusted 12-01-13 AP via ZH

Only one-third of Americans say their fellow countrymen can be trusted according to a recent AP-GfK poll, down from over half 40 years ago. Americans are suspicious of each other in everyday encounters and who can blame them with the government appearing to bless any and all surveillance and intervention in the interests of the status quo. "I'm leery of everybody," warns one respondent, and as AP reports, this is a potential problem for economic growth as "social trust" brings good things. A society where it's easier to compromise or make a deal; where people are willing to work with those who are different from them for the common good, appears to promote economic growth. Distrust, on the other hand, seems to encourage corruption and there's no easy fix.

Via AP,

You can take our word for it. Americans don't trust each other anymore.

We're not talking about the loss of faith in big institutions such as the government, the church or Wall Street, which fluctuates with events. For four decades, a gut-level ingredient of democracy - trust in the other fellow - has been quietly draining away.

These days, only one-third of Americans say most people can be trusted. Half felt that way in 1972, when the General Social Survey first asked the question.

Forty years later, a record high of nearly two-thirds say "you can't be too careful" in dealing with people.

...

Does it matter that Americans are suspicious of one another? Yes, say worried political and social scientists.

What's known as "social trust" brings good things.

A society where it's easier to compromise or make a deal. Where people are willing to work with those who are different from them for the common good. Where trust appears to promote economic growth.

Distrust, on the other hand, seems to encourage corruption.

Even the rancor and gridlock in politics might stem from the effects of an increasingly distrustful citizenry

...

"It's like the rules of the game," Clark said. "When trust is low, the way we react and behave with each other becomes less civil."

There's no easy fix.

...

Trust has declined as the gap between the nation's rich and poor gapes ever wider, Uslaner says, and more and more Americans feel shut out. They've lost their sense of a shared fate. Tellingly, trust rises with wealth.

"People who believe the world is a good place and it's going to get better and you can help make it better, they will be trusting," Uslaner said. "If you believe it's dark and driven by outside forces you can't control, you will be a mistruster."

African-Americans consistently have expressed far less faith in "most people" than the white majority does. Racism, discrimination and a high rate of poverty destroy trust.

Nearly 8 in 10 African-Americans, in the 2012 survey conducted by NORC at the University of Chicago with principal funding from the National Science Foundation, felt that "you can't be too careful."

...

Can anything bring trust back?

Uslaner and Clark don't see much hope anytime soon.

VENEZUELA - President Maduro Lays Out Socialist Vision On National TV

New vision for the country was being presented on national TV just before A NATIONAL blackout struk. Via Bloomberg:

Venezuela President Nicolas Maduro, speaking in national address on television and radio, says decree will be ready “within 24 hours.”

* Individuals will be able to open FX accounts in euros or dollars in state banks to import cars: Maduro
* Law decree will lower prices for used, new cars: Maduro
* Govt will set prices for new cars: Maduro
* Manufacturers must inform of weekly car production: Maduro
* Prices for used cars can’t exceed prices for new cars: Maduro
* Venezuelans must save more, consume less: Maduro
* Venezuela economy needs fair prices, reasonable profit margins: Maduro

GOLD - Below Cash Cost, Approaches Marginal Production Costs

Gold Drops Below Cash Cost, Approaches Marginal Production Costs 12-02-13 Zero Hedge

The marginal cost of production of gold (90% percentile) in 2013 was estimated at between $1250 and $1300 including capex. Which means that gold is now trading well below not only the cash cost, but is rapidly approaching the marginal cash cost of $1125.

VALUATIONS - PE's At Historical Regression Boundary Condition

Stealth Bubble 11-29-13 Decison Point Carl Swenlin

This chart shows the S&P 500 Index (black line) in relation to its normal P/E range. A P/E of 10 is undervalue, a P/E of 20 is overvalue, and a P/E of 15 is considered to be fair value.

STATISM - Spain And Japan Move To Criminalize Protests

War On Democracy: Spain And Japan Move To Criminalize Protests 12-02-13 Michael Krieger of Liberty Blitzkrieg blog,via ZH

As might be expected as political and economic policy failures pile up and citizens become increasingly mad, the status quo is becoming increasingly authoritarian (recall blogger “Mish” was just fined 8,000 euros for a blog post).

In the latest disturbing news from a desperate power structure, the conservative government in Spain has passed an Orwellian bill titled the Citizens’ Security Law, which allows for fines of up to 600,000 euros ($816,000) for “unauthorized” street protests, and a 30,000 fine for merely having signs with “offensive” slogans against Spain or for wearing a mask.

This law is a perfect example of the increasing neo-feudalism being implemented across the globe by a corrupt, decadent and depraved status quo. Such laws must be immediately resisted or they will only get worse, much worse. It is quite obvious what the power structure in Spain in trying to do. It is putting into place an egregious punishment framework that could bankrupt a person by merely protesting. Such a threat is intended to make people not even consider their rights as human beings to express grievances to a crony government.

Instead of eye for an eye, it is like 25 eyes and a limb for an eye. If this does’t tell the Spanish people all they need to know about their government I don’t know what will. Below are some excerpts from a Reuters story covering the law:

(Reuters) – Spain’s conservative government agreed on Friday to toughen penalties for unauthorized street protests up to a possible 600,000 euro ($816,000) fine, a crackdown that belies the peaceful record of the anti-austerity protests of recent years.

Street protests and strikes have became increasingly frequent in recent years following huge cuts to education and health spending aimed at shrinking Spain’s public deficit to adhere to European Union demands.

But in contrast to Greece and elsewhere, where many similar protests have turned violent, Spain’s have remained largely peaceful, despite unemployment of 26 percent, rising poverty, and changes in labor laws that make firing easier.

Among other measures, protesters who cover their faces at demonstrations could be fined up to 30,000 euros while “offensive” slogans against Spain or its regions could reap a similar sanction.

The government also plans a new law restricting labor protests.

“This law … attempts to criminalize the act of protest,” said United Left lawmaker Gaspar Llamazares, questioning whether it complied with Spain’s constitution. “The government is trying to turn its political opponents into delinquents.”

”Compare events in Spain with those of other countries around us,” wrote conservative columnist Jose Antonio Zarzalejos on the website El Confidencial. “This security law … will add the stigma of authoritarianism to the political failure of the PP.”

It’s not just Spain though. This sort of panic attack from desperate members of the status quo is popping up elsewhere. Japan is another example, and over the weekend I read that Liberal Democratic Party Secretary-General Shigeru Ishiba compared demonstrations to “acts of terrorism.” From the Japan Times:

Citizens demonstrating against the controversial state secrets bill are committing “an act terrorism,” according to Liberal Democratic Party Secretary-General Shigeru Ishiba.

In a blog post Friday, he wrote: “If you want to realize your ideas and principles, you should follow the democratic principles, by gaining as much support as you can. I think the strategy of merely shouting one’s opinions at the top of one’s lungs is not so fundamentally different from an act of terrorism.”

My take is that people worldwide will not stand for such nonsense. Increasingly citizens have very little to lose and if they all say no together, there is not much the state can do. Just look at how Ukrainians responded to a ban on protests. Hundreds of thousands of them filled the streets in defiance. Below is a video of just one of the many incredible street scenes from over the weekend. In this case we see demonstrators using a tractor to break police barricades.

Interesting times indeed.

PATTERNS - A Negative, Low-Probability Outcome May Quickly Become Exaggerated

Negative, Low-Probability Outcomes Are Consistently Exaggerated 11-30-13 LPL Financial Research's Outlook 2014

The well-known bias of weather forecasters to exaggerate fears of negative, low-probability outcomes, such as the likelihood and amount of snowfall, also often appears in the forecasts of non-weather-related issues. We saw this bias in the media over the antics in Washington, D.C., fixating on the threat of a default on U.S. Treasury debt during the debt ceiling discussions, or a return to recession due to the impact of the sequester spending cuts. This bias could also be seen in events beyond the United States’ borders in the exaggerated attention devoted to the threat of another financial crisis stemming from the Cyprus bank bailout, the risk of the outcome of the Italian elections plunging the Eurozone debt markets into chaos, and the risks of a strike on Syria turning into a major geopolitical military engagement.

Of course, the probabilities of those outcomes were very low, and the markets did not dwell on those potential outcomes. Market participants tuned them out, and the S&P 500 moved steadily higher throughout the year without experiencing more than a 6% pullback at any point [Figure 11]. We believe it will be safe in 2014 to again tune out much of the antics in Washington, D.C. as the mid-term elections turn up the volume but not the impact.

The LPL Financial Research forecast: In the nearterm, Washington may be washed up when it comes to driving the markets.