Things Fall Apart In Eurozone
By John Browne | 14 January 2010
Jan 12, 2010
As fears of a dollar meltdown have loomed ever larger in recent years, major investors, including central banks, have moved significant portions of their cash reserves into the euro, the currency of the European Union (EU). And while it is true that the euro offers some shelter from the American economic catastrophe, the currency does come with baggage that investors should not ignore. Introduced as an accounting medium in 1990, the euro became an actual currency in 1992. It is currently issued by 16 of the 27 EU member countries, representing some 329 million people. With almost $1 trillion in circulation, it is the world's largest physical currency.
The birth of the euro was a stunning example of putting the cart before the horse. When it was first issued as a physical currency in 1999, the major states that participated were not yet united. Many believe that this premature introduction was done to hasten the political union. In hindsight, the strategy was successful. The single currency removed a key psychological barrier towards unification.
As soon as it made its debut, the euro quickly became the second largest currency held in the official foreign reserves of central banks. Major corporations and investors followed suit. By September 2007, former Fed chairman Alan Greenspan said it would be "absolutely conceivable that the euro will replace the dollar as the dominant foreign reserve currency, or will be traded as an equally important reserve currency."
However, the structural problems that were so heavily debated at the birth of the EU remain unresolved. These uncertainties may undermine the euro as a viable dollar-alternative. Should recent economic strains continue unchecked, investors, institutions, and central banks may move heavily into gold as an ultimate "safe haven."
In the U.S., monetary union depends upon political union. When California faces a crushing debt burden, it can neither print its own highly inflationary currency to ease the pressure (though its "IOU's" are a haphazard attempt) nor leave the union to avoid this constraint. Thus, crises in U.S. states tend to push states toward the central government as they seek assistance from Uncle Sam. EU member states similarly lack their own printing presses and are therefore unable to monetize their problems. But in Europe, the emergency exit is always open— states can leave if they believe their interests are not being considered.
The EU does not have a common fiscal policy, so countries are free to bankrupt themselves according to their own decree. But when they do, there is no formal option of seeking a bailout from the pan-European government. Even if such a road were available under the EU treaties, the European Central Bank, modeled on the famously inflation-wary German Bundesbank, would be unwilling to monetize the additional spending.
Partially because of this stringent monetary policy, the euro has risen by some 40 percent against the dollar since its launch. This has severely hurt eurozone export economies like Spain, Portugal and Italy, who have long relied on currency devaluation to subsidize their manufacturers. While countries like Germany, the world's largest exporter, have been successful in using the benefits of a strong currency to continue selling products at a real profit, others have failed. Indeed, both Italy and Greece now have government debts in excess of GDP (115% and 113%, respectively). Furthermore, Greece, with a budget deficit of some 12.7 percent of GDP, is now threatened with default.
Although the EU, by and large, currently spurns talk of a bailout for Greece, the debate will intensify if the economy deteriorates further. If, in order to preserve union, the EU does decide to bail out an individual member state, what precedent would that set? Germany, the strongest EU economy, found it a Herculean task to bail out just 17 million people in the former East Germany. Could it even contemplate bailing out not one, but several other EU member states, without attendant political control?
There seems little room to move forward under the status quo. Though the Lisbon Treaty (read: EU constitution) just came into effect, it was [[notably: normxxx]] passed without the mandate of citizen referenda. The member states remain culturally distinct, the citizens have little allegiance to the behemoth in Brussels [[which now has the power to override mere national laws— even with regards to cultural activities, such as sex and religion, see this article by Ambrose Evans-Pritchard: normxxx]], and, therefore, it seems far-fetched that the EU would go to war to compel one of its members to remain in the club. With little to glue it together, investors are questioning whether the eurozone is strong enough to withstand the shocks that would accompany a dollar collapse.
As the credibility of the U.S. dollar has eroded and that of the euro is now suspect, it is likely that investors will continue their quiet rush into gold. If so, silver is likely to become a store of value for smaller investors and the small change of the rich. In such a world, the price of silver could rise even faster than that of gold.
Saturday, January 16, 2010
Wednesday, January 13, 2010
Investment Strategy
Investment Strategy
By Jeffrey Saut | 11 January 2010
Predictions?!
"It's tough to make predictions, especially about the future." So said Yogi Berra in an era gone by. Yet, every year, during the week of the Epiphany, we make predictions about the year ahead, write them down, and lock them up in our safety deposit box to be read the following year. This year was no exception. Accordingly, last week we opened the lockbox and placed this year's predictions in it and retrieved last year's list. Interestingly, a number of last year's "guesses" were smack on the mark. To share but a few:
Of course we jest, yet we find it just as silly that Wall Street indulges in a similar charade as pundits pontificate on what is going to happen in the new year. Indeed, every December the media trots out the same "seers" to predict where the various markets will be 12 months later. Take Barron's as an example. For as long as we can remember Barron's has polled the same Wall Street strategists as to what they were forecasting for the year ahead. And, when the equity markets were in a secular bull market (1982-1999) those forecasts were generally correct.
However, beginning in December 1999 those forecasts have been pretty wide of the mark. The most glaring "misses" were scribed in the December 2007 Barron's edition when, despite the Dow Theory "sell signal" that had been registered in November of that year, said pundits were unanimously bullish. That same "crowd" correctly remained bullish in December 2008, albeit after losing another ~30% into the March "lows," before the second strongest rally in history (as measured by price and time) vindicated those predictions.
This year's Barron's panel, while containing some new faces, also has many of the same folks from yesteryear. As in the past they are bullish, but much less so than we can ever recall. As for us, we refrain from engaging in such shenanigans, adhering to our mantra— I would rather be generally correct than precisely wrong! Verily, to state that the S&P 500 (SPX/1144.98) will be at 1350 and profits will total to $80, as the most bullish panelists suggest, is sophistry in our opinion. They might as well say those metrics will be achieved on December 27, 2010 at 3:27 p.m. Or as one savvy seer exclaimed, "They might as well flip a lucky penny". To be sure, getting "things" directionally correct is far for important than attempting to be precise.
To that "generally correct rather than precisely wrong" point; while it's true that a number of serious problems lie ahead for the economy and the various markets, monetary policy typically trumps everything else. And, when interest rates are low and money is cheap, asset prices tend to rise. This was the observation we made when the powers that be made it crystal clear they wouldn't permit any more "Lehman Brothers" type of bankruptcies in October 2008.
They subsequently instituted the aforementioned low interest rate, massive liquidity monetary policy. Recall that was when we wrote that the bottoming process was beginning. It was also when on October 10, 2008 93% of the stocks traded on the NYSE made new annual "lows," a ratio not seen in a generation! While the equity markets traded marginally lower into their ultimate March 2009 "lows," we never gave up on the belief that the bottoming process began in October of 2008.
Accordingly, on March 2, 2009 we opined that the bottoming process was complete and urged investors to "buy". During the course of that five-month bottoming process we had little doubt that America's policymakers would do everything in their power to reflate the system, which in turn would ultimately cause asset prices to rise. It is also the reason we don't expect the bull market to end anytime soon. Surely there will be a correction, but all of our longer-term indicators suggest the primary trend remains "up".
Since those March "lows" we have turned cautious a few times, but we have never turned bearish. We most recently sounded the cautious alarm coming into 2010. Our concern was that if last Friday's employment figures were as strong as the whisper estimates had them we might see a replay of January 1988, when a strong non-farm payroll number caused interest rates to rise with an attendant ~9% stock slide. The quid pro quo was that if the numbers were too weak it might also break the back of the rally on a short-term basis. Come Friday's figures and, at least on the surface, they were neither "too hot nor too cold, but just about right" to be somewhat Wall Street friendly. Indeed, while there were 85,000 job losses in December, the headline unemployment number held steady at 10% by virtue of a shockingly large shrinkage in the labor force.
Drilling down into the numbers, however, reveals some more disturbing trends. Indeed, according to the household survey, jobs lost leaped to 589,000 for the month of December, while the broad-based U-6 measurement of unemployed and underemployed edged up to 17.3%. Moreover, there was an astounding rise in discouraged workers year-over year (929,000 vs. 642,000). Most troubling is Table A-9, which shows that the duration of folks out of work for 27 weeks (or longer) totals to 6.1 million. If the U-6 report is right (15.3 million unemployed) it implies that ~40% of the unemployed have been collecting benefits for a pretty long time. Adjusting for all the "noise" suggests the true unemployment rate should have been around 10.4%, not the reported 10%.
Nevertheless, the various markets didn't seem to care as the S&P 500 rose 3.29 points on Friday and finished the week better by 2.7%. The rise brought the SPX to within sneezing distance of our long-envisioned trading target of 1150-1160. Bettering that level would suggest our strategy of "since credit spreads are back to pre-Lehman bankruptcy levels there is no reason that the SPX can't trade back to the pre-Lehman levels of 1200-1250". That said, with ~94% of the S&P 500 stocks back above their respective 200-day moving averages (read: overbought), the S&P at the top of its Bollinger Band, and the MACD rolling over, we remain cautious. We worry about the first two weeks of the new year historically being littered with "head fakes," as well as trading tops.
Dynamically, participants should still be long half of the index trading positions recommended months ago, but with close trailing stop-loss points. Strategically, we think it is appropriate to hedge, or harvest, partial positions in the investment account. Take 8.5%-yielding Daylight Resource Trust (DAYYF/$10.60), which is followed by our Canadian affiliate Raymond James Ltd. When we initially recommended DAYYF the price target was $10.50 per share. Now that the shares have exceeded that target, we think selling partial positions is a prudent strategy.
As for new investment money, last week on CNBC we focused on three of this year's Analysts' Best Picks. They were CVS (CVS/$34.00/Strong Buy), National Oilwell (NOV/$47.11/Strong Buy), and coal company Alpha Natural Resources (ANR/$51.14/Strong Buy). Interestingly, our coal analyst, Jim Rollyson, penned an excellent report on metallurgical coal this morning. We continue to invest, and trade, accordingly.
The call for this week: The most important development in the last 30 trading days has been the rally in the U.S. Dollar, which has been swift and large, suggesting the greenback is now in an uptrend. However, this morning the Dollar Index (DX.1/77.09) has broken below its recent reaction low of 77.39, putting a "bid" back into the "stuff stocks" (energy, timber, precious/base metals, agriculture, etc.). It will be interesting to see if this dollar weakness is a head fake. If it is, and the "buck" strengthens again, it has significant implications for the various markets. Stay tune.
Lessons
January 4, 2009
Year-end letters are always hard to write because there is a tendency to talk about the year gone by, or worse, attempt to predict the year ahead. Therefore, we are titling this year's letter "Lessons" in an attempt to share some of the lessons that should have been learned over the past year. We begin with this quote from an Allstate commercial featuring Dennis Haysbert:
Charles Dickens' classic novel A Tale of Two Cities begins with the quote, "It was the best of times, it was the worst of times". That quote is certainly reflective of the stock market in the year gone by as 2009 should go down in the books with that moniker. To be sure, 1Q09 was ugly with the S&P 500 (SPX/1115.11) surrendering nearly 30%. From those March "lows," however, the SPX has gained some 69%. For those that targeted the "lows" it has been a great year. For those that didn't, it has truly been "the worst of times," for after losing ~58% in the SPX from the intra-day highs of October 2007 into the intra-day lows of March 2009, they have not come close to recouping the monies lost in that downdraft.
The lesson that should have been gleaned is that if participants would have managed the risk (read: not allow positions to go too far against them before taking some kind of action; i.e., hedge, sell, etc.), they would have missed much of the SPX's 2008/2009 downside debacle and in turn done pretty well over the past two years. As often referenced in these missives, investors need to manage the risk, for as Benjamin Graham espoused in his book The Intelligent Investor, "The essence of investment management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept".
Investors should keep that quote on their walls so they don't forget the major lesson of 2008/2009. Yet, there are other lessons to be remembered. To that point, Merrill Lynch lost two of its best and brightest in 2009 as Richard Bernstein and David Rosenberg left for less constrained environments. During their final weeks at Merrill they wrote about lessons they have learned. To wit:
Richard Bernstein's Lessons:
David Rosenberg's Lessons:
There was another sage that left Merrill Lynch, but that was 18 years ago. At the time Bob Farrell was considered the best strategist on Wall Street, and while he still pens a stock market letter, his "lessons learned," written back then, are as timeless today as they were in 1992.
With these lessons in mind, we wish you good investing in the New Year.
The call for this week: Last Monday we wrote, "As we enter the New Year, we are once again turning cautious because the Treasury market is breaking down (higher rates) and the U.S. dollar is rallying… . Therefore, we think it prudent to 'bank' some trading profits and hedge some investment positions as we approach the new year." Moreover, one of the lessons we have learned is that the beginning of a new year is often punctuated with head fakes, both on the upside as well as the downside. One of the greatest upside head fakes was in January 1973 when in the first two weeks of that year the DJIA rallied to a new all-time high of 1051.70 before sliding ~20%. While we are clearly not predicting that, what we have indeed experienced since the March "lows" is the second greatest percentage rally (69%), adjusted for time (nine months), since the 1933 rally. Following that 1933 explosion of 116% in just five months came a pretty decent downside correction. Since we tend to be "odds players," prudence suggests some caution is again warranted.
The Telegraph Market
December 28, 2009
Indeed, we have been unabashedly bullish on most asset classes since March 2, 2009, although we have turned cautious a few times over the past eight months. To be sure, said asset classes were at least three standard deviations undervalued back in March. Since then, most have normalized to median valuation levels. Accordingly, as we enter the New Year, we are once again turning cautious because the Treasury bond market is breaking down (read: higher interest rates) and the U.S. dollar is rallying.
After being dollar-negative since 4Q01, we turned neutral to constructive on the "buck" in 4Q07 and recommended shutting down all negative U.S. dollar positions. More recently, we suggested the "greenback" might be in for a pretty decent rally. If so, the ubiquitous "dollar carry trade" is in jeopardy of unwinding with downside consequences for most asset classes. Therefore, we think it prudent to "bank" some trading profits and hedge some investment positions as we approach the New Year.
That said, we still believe the nascent economic recovery will gain traction in 2010, and that earnings comparisons will look good in 1H10. The question then becomes just how much of that has already been discounted by the 68% rally off of the March lows? Also worth consideration is if this is a rally in an ongoing trading range stock market, or the beginning of a new secular bull market. Currently, we don't have a clue, but are happy that we have enjoyed the eight-month rise. We think the trick from here, at least in the short/intermediate-term, is to protect the profits that have been made.
The call for this week: "Breakout, or fake out," is the question de jour on participants' minds this week as the new high recorded by the S&P 500 last week had a bunch of "hair" on it! We'll reserve our opinion until the troops return next week. Happy New Year everybody.
U.S. Dollar Index
Click Here, or on the image, to see a larger, undistorted image.
10-Year T'note
Click Here, or on the image, to see a larger, undistorted image.
By Jeffrey Saut | 11 January 2010
Predictions?!
"It's tough to make predictions, especially about the future." So said Yogi Berra in an era gone by. Yet, every year, during the week of the Epiphany, we make predictions about the year ahead, write them down, and lock them up in our safety deposit box to be read the following year. This year was no exception. Accordingly, last week we opened the lockbox and placed this year's predictions in it and retrieved last year's list. Interestingly, a number of last year's "guesses" were smack on the mark. To share but a few:
- Roman Polanski will finally be arrested.
- Illinois Governor Rod Blagojevich will be impeached.
- A plane will crash into the Hudson River and everyone will survive.
- President Obama will conduct a "beer summit."
- General Motors' CEO Rick Wagoner will resign.
Of course we jest, yet we find it just as silly that Wall Street indulges in a similar charade as pundits pontificate on what is going to happen in the new year. Indeed, every December the media trots out the same "seers" to predict where the various markets will be 12 months later. Take Barron's as an example. For as long as we can remember Barron's has polled the same Wall Street strategists as to what they were forecasting for the year ahead. And, when the equity markets were in a secular bull market (1982-1999) those forecasts were generally correct.
However, beginning in December 1999 those forecasts have been pretty wide of the mark. The most glaring "misses" were scribed in the December 2007 Barron's edition when, despite the Dow Theory "sell signal" that had been registered in November of that year, said pundits were unanimously bullish. That same "crowd" correctly remained bullish in December 2008, albeit after losing another ~30% into the March "lows," before the second strongest rally in history (as measured by price and time) vindicated those predictions.
This year's Barron's panel, while containing some new faces, also has many of the same folks from yesteryear. As in the past they are bullish, but much less so than we can ever recall. As for us, we refrain from engaging in such shenanigans, adhering to our mantra— I would rather be generally correct than precisely wrong! Verily, to state that the S&P 500 (SPX/1144.98) will be at 1350 and profits will total to $80, as the most bullish panelists suggest, is sophistry in our opinion. They might as well say those metrics will be achieved on December 27, 2010 at 3:27 p.m. Or as one savvy seer exclaimed, "They might as well flip a lucky penny". To be sure, getting "things" directionally correct is far for important than attempting to be precise.
To that "generally correct rather than precisely wrong" point; while it's true that a number of serious problems lie ahead for the economy and the various markets, monetary policy typically trumps everything else. And, when interest rates are low and money is cheap, asset prices tend to rise. This was the observation we made when the powers that be made it crystal clear they wouldn't permit any more "Lehman Brothers" type of bankruptcies in October 2008.
They subsequently instituted the aforementioned low interest rate, massive liquidity monetary policy. Recall that was when we wrote that the bottoming process was beginning. It was also when on October 10, 2008 93% of the stocks traded on the NYSE made new annual "lows," a ratio not seen in a generation! While the equity markets traded marginally lower into their ultimate March 2009 "lows," we never gave up on the belief that the bottoming process began in October of 2008.
Accordingly, on March 2, 2009 we opined that the bottoming process was complete and urged investors to "buy". During the course of that five-month bottoming process we had little doubt that America's policymakers would do everything in their power to reflate the system, which in turn would ultimately cause asset prices to rise. It is also the reason we don't expect the bull market to end anytime soon. Surely there will be a correction, but all of our longer-term indicators suggest the primary trend remains "up".
Since those March "lows" we have turned cautious a few times, but we have never turned bearish. We most recently sounded the cautious alarm coming into 2010. Our concern was that if last Friday's employment figures were as strong as the whisper estimates had them we might see a replay of January 1988, when a strong non-farm payroll number caused interest rates to rise with an attendant ~9% stock slide. The quid pro quo was that if the numbers were too weak it might also break the back of the rally on a short-term basis. Come Friday's figures and, at least on the surface, they were neither "too hot nor too cold, but just about right" to be somewhat Wall Street friendly. Indeed, while there were 85,000 job losses in December, the headline unemployment number held steady at 10% by virtue of a shockingly large shrinkage in the labor force.
Drilling down into the numbers, however, reveals some more disturbing trends. Indeed, according to the household survey, jobs lost leaped to 589,000 for the month of December, while the broad-based U-6 measurement of unemployed and underemployed edged up to 17.3%. Moreover, there was an astounding rise in discouraged workers year-over year (929,000 vs. 642,000). Most troubling is Table A-9, which shows that the duration of folks out of work for 27 weeks (or longer) totals to 6.1 million. If the U-6 report is right (15.3 million unemployed) it implies that ~40% of the unemployed have been collecting benefits for a pretty long time. Adjusting for all the "noise" suggests the true unemployment rate should have been around 10.4%, not the reported 10%.
Nevertheless, the various markets didn't seem to care as the S&P 500 rose 3.29 points on Friday and finished the week better by 2.7%. The rise brought the SPX to within sneezing distance of our long-envisioned trading target of 1150-1160. Bettering that level would suggest our strategy of "since credit spreads are back to pre-Lehman bankruptcy levels there is no reason that the SPX can't trade back to the pre-Lehman levels of 1200-1250". That said, with ~94% of the S&P 500 stocks back above their respective 200-day moving averages (read: overbought), the S&P at the top of its Bollinger Band, and the MACD rolling over, we remain cautious. We worry about the first two weeks of the new year historically being littered with "head fakes," as well as trading tops.
Dynamically, participants should still be long half of the index trading positions recommended months ago, but with close trailing stop-loss points. Strategically, we think it is appropriate to hedge, or harvest, partial positions in the investment account. Take 8.5%-yielding Daylight Resource Trust (DAYYF/$10.60), which is followed by our Canadian affiliate Raymond James Ltd. When we initially recommended DAYYF the price target was $10.50 per share. Now that the shares have exceeded that target, we think selling partial positions is a prudent strategy.
As for new investment money, last week on CNBC we focused on three of this year's Analysts' Best Picks. They were CVS (CVS/$34.00/Strong Buy), National Oilwell (NOV/$47.11/Strong Buy), and coal company Alpha Natural Resources (ANR/$51.14/Strong Buy). Interestingly, our coal analyst, Jim Rollyson, penned an excellent report on metallurgical coal this morning. We continue to invest, and trade, accordingly.
The call for this week: The most important development in the last 30 trading days has been the rally in the U.S. Dollar, which has been swift and large, suggesting the greenback is now in an uptrend. However, this morning the Dollar Index (DX.1/77.09) has broken below its recent reaction low of 77.39, putting a "bid" back into the "stuff stocks" (energy, timber, precious/base metals, agriculture, etc.). It will be interesting to see if this dollar weakness is a head fake. If it is, and the "buck" strengthens again, it has significant implications for the various markets. Stay tune.
Lessons
January 4, 2009
Year-end letters are always hard to write because there is a tendency to talk about the year gone by, or worse, attempt to predict the year ahead. Therefore, we are titling this year's letter "Lessons" in an attempt to share some of the lessons that should have been learned over the past year. We begin with this quote from an Allstate commercial featuring Dennis Haysbert:
|
Charles Dickens' classic novel A Tale of Two Cities begins with the quote, "It was the best of times, it was the worst of times". That quote is certainly reflective of the stock market in the year gone by as 2009 should go down in the books with that moniker. To be sure, 1Q09 was ugly with the S&P 500 (SPX/1115.11) surrendering nearly 30%. From those March "lows," however, the SPX has gained some 69%. For those that targeted the "lows" it has been a great year. For those that didn't, it has truly been "the worst of times," for after losing ~58% in the SPX from the intra-day highs of October 2007 into the intra-day lows of March 2009, they have not come close to recouping the monies lost in that downdraft.
The lesson that should have been gleaned is that if participants would have managed the risk (read: not allow positions to go too far against them before taking some kind of action; i.e., hedge, sell, etc.), they would have missed much of the SPX's 2008/2009 downside debacle and in turn done pretty well over the past two years. As often referenced in these missives, investors need to manage the risk, for as Benjamin Graham espoused in his book The Intelligent Investor, "The essence of investment management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept".
Investors should keep that quote on their walls so they don't forget the major lesson of 2008/2009. Yet, there are other lessons to be remembered. To that point, Merrill Lynch lost two of its best and brightest in 2009 as Richard Bernstein and David Rosenberg left for less constrained environments. During their final weeks at Merrill they wrote about lessons they have learned. To wit:
Richard Bernstein's Lessons:
- Income is as important as are capital gains. Because most investors ignore income opportunities, income may be more important than are capital gains.
- Most stock market indicators have never actually been tested. Most don't work.
- Most investors' time horizons are much too short. Statistics indicate that day trading is largely based on luck.
- Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.
- Diversification doesn't depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio.
- Balance sheets are generally more important than are income or cash flow statements.
- Investors should focus strongly on GAAP accounting, and should pay little attention to "pro forma" or "unaudited" financial statements.
- Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.
- Investors should research financial history as much as possible.
- Leverage gives the illusion of wealth. Saving is wealth.
David Rosenberg's Lessons:
- In order for an economic forecast to be relevant, it must be combined with a market call.
- Never be a slave to the data— they are no substitutes for astute observation of the big picture.
- The consensus rarely gets it right and almost always errs on the side of optimism— except at the bottom.
- Fall in love with your partner, not your forecast.
- No two cycles are ever the same.
- Never hide behind your model.
- Always seek out corroborating evidence
- Have respect for what the markets are telling you.
There was another sage that left Merrill Lynch, but that was 18 years ago. At the time Bob Farrell was considered the best strategist on Wall Street, and while he still pens a stock market letter, his "lessons learned," written back then, are as timeless today as they were in 1992.
- Markets tend to return to the mean over time.
- Excesses in one direction will lead to an opposite excess in the other direction.
- There are no new eras— excesses are never permanent.
- Exponential rising and falling markets usually go further than you think.
- The public buys the most at the top and the least at the bottom.
- Fear and greed are stronger than long-term resolve.
- Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chips.
- Bear markets have three stages.
- When all the experts and forecasts agree— something else is going to happen.
- Bull markets are more fun than bear markets.
With these lessons in mind, we wish you good investing in the New Year.
The call for this week: Last Monday we wrote, "As we enter the New Year, we are once again turning cautious because the Treasury market is breaking down (higher rates) and the U.S. dollar is rallying… . Therefore, we think it prudent to 'bank' some trading profits and hedge some investment positions as we approach the new year." Moreover, one of the lessons we have learned is that the beginning of a new year is often punctuated with head fakes, both on the upside as well as the downside. One of the greatest upside head fakes was in January 1973 when in the first two weeks of that year the DJIA rallied to a new all-time high of 1051.70 before sliding ~20%. While we are clearly not predicting that, what we have indeed experienced since the March "lows" is the second greatest percentage rally (69%), adjusted for time (nine months), since the 1933 rally. Following that 1933 explosion of 116% in just five months came a pretty decent downside correction. Since we tend to be "odds players," prudence suggests some caution is again warranted.
The Telegraph Market
December 28, 2009
- It's The Telegraph Market; Stop.
- We've Decided To Take Most Of This Week Off To Spend Time With Our Son; Stop.
- Thinking of calling us; stop.
- Thinking of emailing us; stop.
- Thinking of shorting the U.S. dollar; stop.
- Thinking of buying stocks; stop.
- Thinking of buying commodities; stop.
- Thinking of buying bonds; stop.
Indeed, we have been unabashedly bullish on most asset classes since March 2, 2009, although we have turned cautious a few times over the past eight months. To be sure, said asset classes were at least three standard deviations undervalued back in March. Since then, most have normalized to median valuation levels. Accordingly, as we enter the New Year, we are once again turning cautious because the Treasury bond market is breaking down (read: higher interest rates) and the U.S. dollar is rallying.
After being dollar-negative since 4Q01, we turned neutral to constructive on the "buck" in 4Q07 and recommended shutting down all negative U.S. dollar positions. More recently, we suggested the "greenback" might be in for a pretty decent rally. If so, the ubiquitous "dollar carry trade" is in jeopardy of unwinding with downside consequences for most asset classes. Therefore, we think it prudent to "bank" some trading profits and hedge some investment positions as we approach the New Year.
That said, we still believe the nascent economic recovery will gain traction in 2010, and that earnings comparisons will look good in 1H10. The question then becomes just how much of that has already been discounted by the 68% rally off of the March lows? Also worth consideration is if this is a rally in an ongoing trading range stock market, or the beginning of a new secular bull market. Currently, we don't have a clue, but are happy that we have enjoyed the eight-month rise. We think the trick from here, at least in the short/intermediate-term, is to protect the profits that have been made.
The call for this week: "Breakout, or fake out," is the question de jour on participants' minds this week as the new high recorded by the S&P 500 last week had a bunch of "hair" on it! We'll reserve our opinion until the troops return next week. Happy New Year everybody.
U.S. Dollar Index
Click Here, or on the image, to see a larger, undistorted image.
10-Year T'note
Click Here, or on the image, to see a larger, undistorted image.
Wednesday, January 6, 2010
Central Banks Face A Scylla And Charybdis 'Flation Challenge
Central Banks Will Face A Scylla And Charybdis Flation Challenge For Years
Click here for a link to ORIGINAL article:
By Edward Harrison | 6 January 2010
Nearly a month ago, back on May 5th, I highlighted some testimony by Federal Reserve Chairman Ben Bernanke before congress in a post labelled, "Bernanke expects recovery later this year". In his testimony, Bernanke used the phrase 'Scylla and Charybdis' to describe the Federal Reserve's policy challenge regarding deflationary and inflationary forces. I would like to highlight this characterization because I believe it goes to the core of the debate as to how the global economy and asset markets will fare over the next 5-10 years.
In my view (and apparently in Bernanke's), both inflationary forces and deflationary forces will be at work for some time to come. This will present policy makers with a problem as the reflation trade comes good. The resulting policy responses will have serious implications on the medium term outlook for the economy and asset markets.
Deflationary Forces
The problem is this: we have just witnessed one of the most serious asset bubbles in history. In fact, I would call the great housing bubble an 'echo bubble' that was merely a continuation of the bubble forces that created the technology bubble of the late 1990s. So, the world saw asset price inflation of the most severe kind for over a decade— from the mid 1990s when Alan Greenspan first voiced concern about 'irrational exuberance"' to 2007 when the housing bubble imploded. What results from the implosion of such a significant bubble is deflation.
Actually, more crisply put, what results is 'the D-process,' an outcome highlighted by Ray Dalio of Bridgewater Associates (see my post "A conversation with Bridgewater Associates' Ray Dalio" for more detail). This process involves the three D's of deleveraging, deflation and depression (outlined in my post "We are in depression").
Richard Koo goes further in his book "The Holy Grail of Macro Economics". Here, he argues that the unwind of great bubbles suffers from what he labels a 'balance sheet recession'. In essence, companies go from maximizing profits, as they had done in normal times, to a post-bubble concern of reducing debt. Regardless of how much priming of the pump monetary authorities do, the psychology of debt reduction will limit the effectiveness of monetary policy as a policy tool.
In my view, the catalyst for this change of psychology is the 'debt revulsion' that ushers in the panic phase of an asset bubble collapse. (Charles Kindleberger highlights the various stages of a bubble and its implosion in his seminal book "Manias, Panics and Crashes"). In this particular bubble, debt revulsion began post-Lehman Brothers. What we have seen, therefore, is a reduction in leverage and debt as the most leveraged players have gone to the wall.
But, more than that, the household sector has gotten religion about debt reduction as the savings rate has increased dramatically since Lehman. In fact, I would argue that companies learned their lesson about debt from the aftermath of the tech bubble. It is the household sector in the U.S. (and the U.K.) which is heavily indebted. Therefore, if the psychology of a balance sheet recession does take form, it will be the household sector leading the charge.
In sum, the psychology after a major bubble is very different than the psychology before its collapse. The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some to come.
Inflationary Forces
Meanwhile, inflation is going to be a problem too. Why? Two principle reasons come to mind: commodity prices and money supply. Now, just yesterday in my most recent post "Kasriel: 'greater risk for the global economy…is inflation'," I highlighted Paul Kasriel's view that there are several inflationary forces, both secular and cyclical which will impinge upon the economy. I want to bear down on just the two forces of commodity prices and money supply.
First, let's look at money supply. The Federal Reserve and other central banks have been pumping a lot of money into the financial system in an attempt to add reserves to the system and to take on the intermediation role the wider banking system normally serves. Nevertheless, this money is not being lent out and excess reserves are piling up at the Federal Reserve. Last April, there were only $1.8 billion in excess reserves, i.e., reserves against which loans were not being made. According to figures just released by the Fed on May 28th, this April that figure has soared to $824.4 billion, a surge of 447 times in one year. If you want to know what is wrong with the American economy, you should start here.
But, what happens when the economy returns to an environment in which those excess reserves start to be lent out? Inflation. And this is an inflation that will not be so easy to control because the Federal Reserve has embarked on a policy of 'qualitative easing' by buying up non-treasury assets, transforming its balance sheet from one dominated by treasury assets to one in which Treasury assets are in the minority. So, as the Fed has intervened and bloated its balance sheet, an increasing amount of the assets it has with which to withdraw the excess liquidity in the system is hard to sell.
So, you have a huge amount of 'excess' reserves and hard to sell assets on the Fed's balance sheet. Add in the fact that the Federal Reserve is going to be loathe to choke off an incipient recovery and you have the makings of inflation when recovery takes hold. Moreover, there is a rise in commodity prices which is adding inflation to the pipeline.
Second, much of the recent decrease in headline inflation numbers is due to the collapse in commodity prices. But, Copper is near a seven-month high. Oil is near a seven-month high. And all of the agricultural and industrial commodities are taking off again. As China ramps up its economic stimulus, the recent increases in the ISM manufacturing data in the U.S. and elsewhere point to an increasing demand for industrial commodities, and this is inflationary.
In sum, any pickup in the economy is going to be met by a host of inflationary forces. This is one reason that bond yields have been increasing. The spread between the two-year and 10-year U.S. government bond is near a record.
Scylla And Charybdis
So, how do I see this push and pull of deflationary and inflationary forces playing out? There are two outcomes I am looking for.
Outcome Number One
No policy traction. This is a sluggish muddle-through Japanese scenario where the Richard Koo thesis of the balance sheet recession comes into play. You would see an output gap and below-trend growth for an extended period. Most pundits would say it is the lack of lending that is creating the problem. However, what if it is the lack of borrowing which is at fault? Then, we are going to see no traction from monetary policy.
Outcome Number Two
Start-Stop economy. I believe Bernanke would prefer this outcome. This is one in which the Federal Reserve allows the economy to recover by keeping interest rates low. The result is a rise in inflation. We could see inflation rising to 3 percent inflation and then to 5 to 7 and 10 percent.
An example would be animal spirits coming back in 2010. And leading to 3 percent inflation followed by 7 percent including $100 oil and then interest rate hikes and another recession at which point the deleveraging begins again in earnest. Followed by more easing, and on it goes. But, of course, the problem with outcome two is it is unstable and that it invites an aggressive policy response which risks situation one as an ultimate outcome.
Neither of these scenarios is one in which asset markets are likely to benefit, one reason I see the latest uptick in share prices as nothing more than a bear market rally.
Click here for a link to ORIGINAL article:
By Edward Harrison | 6 January 2010
Nearly a month ago, back on May 5th, I highlighted some testimony by Federal Reserve Chairman Ben Bernanke before congress in a post labelled, "Bernanke expects recovery later this year". In his testimony, Bernanke used the phrase 'Scylla and Charybdis' to describe the Federal Reserve's policy challenge regarding deflationary and inflationary forces. I would like to highlight this characterization because I believe it goes to the core of the debate as to how the global economy and asset markets will fare over the next 5-10 years.
In my view (and apparently in Bernanke's), both inflationary forces and deflationary forces will be at work for some time to come. This will present policy makers with a problem as the reflation trade comes good. The resulting policy responses will have serious implications on the medium term outlook for the economy and asset markets.
Deflationary Forces
The problem is this: we have just witnessed one of the most serious asset bubbles in history. In fact, I would call the great housing bubble an 'echo bubble' that was merely a continuation of the bubble forces that created the technology bubble of the late 1990s. So, the world saw asset price inflation of the most severe kind for over a decade— from the mid 1990s when Alan Greenspan first voiced concern about 'irrational exuberance"' to 2007 when the housing bubble imploded. What results from the implosion of such a significant bubble is deflation.
Actually, more crisply put, what results is 'the D-process,' an outcome highlighted by Ray Dalio of Bridgewater Associates (see my post "A conversation with Bridgewater Associates' Ray Dalio" for more detail). This process involves the three D's of deleveraging, deflation and depression (outlined in my post "We are in depression").
Richard Koo goes further in his book "The Holy Grail of Macro Economics". Here, he argues that the unwind of great bubbles suffers from what he labels a 'balance sheet recession'. In essence, companies go from maximizing profits, as they had done in normal times, to a post-bubble concern of reducing debt. Regardless of how much priming of the pump monetary authorities do, the psychology of debt reduction will limit the effectiveness of monetary policy as a policy tool.
In my view, the catalyst for this change of psychology is the 'debt revulsion' that ushers in the panic phase of an asset bubble collapse. (Charles Kindleberger highlights the various stages of a bubble and its implosion in his seminal book "Manias, Panics and Crashes"). In this particular bubble, debt revulsion began post-Lehman Brothers. What we have seen, therefore, is a reduction in leverage and debt as the most leveraged players have gone to the wall.
But, more than that, the household sector has gotten religion about debt reduction as the savings rate has increased dramatically since Lehman. In fact, I would argue that companies learned their lesson about debt from the aftermath of the tech bubble. It is the household sector in the U.S. (and the U.K.) which is heavily indebted. Therefore, if the psychology of a balance sheet recession does take form, it will be the household sector leading the charge.
In sum, the psychology after a major bubble is very different than the psychology before its collapse. The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some to come.
Inflationary Forces
Meanwhile, inflation is going to be a problem too. Why? Two principle reasons come to mind: commodity prices and money supply. Now, just yesterday in my most recent post "Kasriel: 'greater risk for the global economy…is inflation'," I highlighted Paul Kasriel's view that there are several inflationary forces, both secular and cyclical which will impinge upon the economy. I want to bear down on just the two forces of commodity prices and money supply.
First, let's look at money supply. The Federal Reserve and other central banks have been pumping a lot of money into the financial system in an attempt to add reserves to the system and to take on the intermediation role the wider banking system normally serves. Nevertheless, this money is not being lent out and excess reserves are piling up at the Federal Reserve. Last April, there were only $1.8 billion in excess reserves, i.e., reserves against which loans were not being made. According to figures just released by the Fed on May 28th, this April that figure has soared to $824.4 billion, a surge of 447 times in one year. If you want to know what is wrong with the American economy, you should start here.
But, what happens when the economy returns to an environment in which those excess reserves start to be lent out? Inflation. And this is an inflation that will not be so easy to control because the Federal Reserve has embarked on a policy of 'qualitative easing' by buying up non-treasury assets, transforming its balance sheet from one dominated by treasury assets to one in which Treasury assets are in the minority. So, as the Fed has intervened and bloated its balance sheet, an increasing amount of the assets it has with which to withdraw the excess liquidity in the system is hard to sell.
So, you have a huge amount of 'excess' reserves and hard to sell assets on the Fed's balance sheet. Add in the fact that the Federal Reserve is going to be loathe to choke off an incipient recovery and you have the makings of inflation when recovery takes hold. Moreover, there is a rise in commodity prices which is adding inflation to the pipeline.
Second, much of the recent decrease in headline inflation numbers is due to the collapse in commodity prices. But, Copper is near a seven-month high. Oil is near a seven-month high. And all of the agricultural and industrial commodities are taking off again. As China ramps up its economic stimulus, the recent increases in the ISM manufacturing data in the U.S. and elsewhere point to an increasing demand for industrial commodities, and this is inflationary.
In sum, any pickup in the economy is going to be met by a host of inflationary forces. This is one reason that bond yields have been increasing. The spread between the two-year and 10-year U.S. government bond is near a record.
Scylla And Charybdis
So, how do I see this push and pull of deflationary and inflationary forces playing out? There are two outcomes I am looking for.
Outcome Number One
No policy traction. This is a sluggish muddle-through Japanese scenario where the Richard Koo thesis of the balance sheet recession comes into play. You would see an output gap and below-trend growth for an extended period. Most pundits would say it is the lack of lending that is creating the problem. However, what if it is the lack of borrowing which is at fault? Then, we are going to see no traction from monetary policy.
Outcome Number Two
Start-Stop economy. I believe Bernanke would prefer this outcome. This is one in which the Federal Reserve allows the economy to recover by keeping interest rates low. The result is a rise in inflation. We could see inflation rising to 3 percent inflation and then to 5 to 7 and 10 percent.
An example would be animal spirits coming back in 2010. And leading to 3 percent inflation followed by 7 percent including $100 oil and then interest rate hikes and another recession at which point the deleveraging begins again in earnest. Followed by more easing, and on it goes. But, of course, the problem with outcome two is it is unstable and that it invites an aggressive policy response which risks situation one as an ultimate outcome.
Neither of these scenarios is one in which asset markets are likely to benefit, one reason I see the latest uptick in share prices as nothing more than a bear market rally.
Friday, January 1, 2010
Eurozone Credit Contraction Accelerates
Bank Loans And The M3 Money Supply In The Eurozone Contracted At An Accelerating Pace In November, Raising The Risk That A Lending Squeeze Will Choke The Region's Fragile Recovery Next Year.
By Ambrose Evans-Pritchard, Telegraph,UK | 30 December 2009
The ECB has played down the decline in M3, believing that it reflects 'portfolio shifts' by investors. The European Central Bank said that loans to companies fell by a record 1.9% from a year earlier. The broad M3 money supply— watched closely as a leading indicator for the economy a year ahead— fell by 0.2% and has now been shrinking for several months.
Julian Callow from Barclays Capital said the decline in lending was steeper than expected and will cause the ECB to move with great care before withdrawing emergency stimulus. "This is the weakest data since the statistics began in 1970 and probably in the post-war era. It is a message about what is happening to the banking system, which is the lending nexus for the eurozone economy," he said.
Hans-Peter Keitel, head of Germany's industry federation (BDI), said there was a danger of a credit crunch next year as banks take fright at the ugly state of corporate balance sheets. He accused lenders of returning to their gambling habits— in some cases with state money— while refusing to roll over loans for companies with a good track record that have run into short-term problems. The Bundesbank is bracing for a second wave of the credit crisis as corporate downgrades by rating agencies forces lenders to set aside more money. Big companies in the eurozone have been able to tap the bond and equity markets, raising €130bn of fresh money in the first 10 months of the year.
However, smaller Mittelstand firms that form the backbone of Germany's export industry are often shut out of the credit system. Banks have chosen to restrict lending as they struggle to meet tougher capital rules rather than dilute shares by raising fresh equity or accepting the onerous terms of state support schemes. This has prompted harsh criticism from finance ministers, but Professor Tim Congdon from International Monetary Research said the authorities themselves are to blame.
"This is becoming ridiculous. How can banks raise capital asset ratios and lend more at the same time? These people are barmy," he said, comparing the new rules with policy mistakes in the early 1930s. But the longer the decline in M3 continues, the greater the concern. Mr Congdon said Club Med states will suffer the brunt of the ECB's restrictive policies. "Business surveys in these countries are getting worse, and so are property markets. Fractures in the euro system are becoming clearer by the day".
.
Charles Goodhart Warns Of Return To Recession As Bank Lending Falls
The Contraction Of Bank Lending And The M3 Money Supply In The Us And Europe Over Recent Months Has Become A Serious Concern And Raises The Risk Of A Slide Back Into Recession, According To One Of Britain's Most Celebrated Economists.
By Ambrose Evans-Pritchard | 22 December 2009
Professor Charles Goodhart, a former top official at the Bank of England now at the London School of Economics, said policymakers have neglected the flashing danger signal of the monetary data. "What has happened to all the monetarists? Growth in money holdings and lending has plummeted. Thirty, or 40, years ago they would have been forewarning doom and destruction at this juncture, and casting anathemas at the authorities," he wrote in a consultant report for Morgan Stanley.
"There is a danger that markets and authorities become obsessed about the fiscal implications of the crisis at a time when the real worries should still focus on private sector access to credit and money." The exception is China, which has the opposite problem: monetary growth is running at 30% a year. Beijing will have to slam on the brakes soon. "When that happens the locomotive will slow, and probably reveal a string of non-performing loans; it has always been thus," he said. Prof Goodhart said it was too early for the world's central bankers to congratulate themselves for averting a slump.
The US Federal Reserve has stopped publishing M3, which covers a broad range of deposits. This may have been a blunder. The data gave advance warning of bubble trouble in 2006-2007, and again before the US economy crashed in late 2008. Some blame lies with Fed Chair Ben Bernanke, a New Keynesian openly scornful of monetarist thinking.
Reconstructed data shows that M3 shrank at an annual rate of 7.2% in the three months to November. Bank loans have fallen from $7.1 trillion (£4.4 trillion) to $6.75 trillion since the end of May. In the eurozone, M3 has fallen slightly since February. Professor Tim Congdon from International Monetary Research said credit contraction on both sides of the Atlantic has been the steepest since the 1930s, risking a slide into deflation next year.
Banks are tightening credit for two reasons: losses from the crisis, and tougher capital adequacy rules imposed by regulators. Mr Congdon said it is bizarre that the European Central Bank (ECB) seems unwilling to take steps to prevent a monetary implosion in these circumstances. Optimists say that "portfolio shifts" by investors may have distorted the M3 data. If so, there is little evidence in ECB or Fed reports that they have delved deeply into this issue.
They also argue that falling credit is benign because it reflects lower demand by borrowers, not a lending crunch. Professor Goodhart said this line of argument is "not terribly comforting". Businesses stop taking out loans when terms are punitive. The economy is damaged either way.
Mr Goodhart is best known around the world as the author of "Goodhart's Law", which posits that an indicator ceases to be much use once it becomes a target.
Bank Loans And The M3 Money Supply In The Eurozone Contracted At An Accelerating Pace In November, Raising The Risk That A Lending Squeeze Will Choke The Region's Fragile Recovery Next Year.
By Ambrose Evans-Pritchard, Telegraph,UK | 30 December 2009
The ECB has played down the decline in M3, believing that it reflects 'portfolio shifts' by investors. The European Central Bank said that loans to companies fell by a record 1.9% from a year earlier. The broad M3 money supply— watched closely as a leading indicator for the economy a year ahead— fell by 0.2% and has now been shrinking for several months.
Julian Callow from Barclays Capital said the decline in lending was steeper than expected and will cause the ECB to move with great care before withdrawing emergency stimulus. "This is the weakest data since the statistics began in 1970 and probably in the post-war era. It is a message about what is happening to the banking system, which is the lending nexus for the eurozone economy," he said.
Hans-Peter Keitel, head of Germany's industry federation (BDI), said there was a danger of a credit crunch next year as banks take fright at the ugly state of corporate balance sheets. He accused lenders of returning to their gambling habits— in some cases with state money— while refusing to roll over loans for companies with a good track record that have run into short-term problems. The Bundesbank is bracing for a second wave of the credit crisis as corporate downgrades by rating agencies forces lenders to set aside more money. Big companies in the eurozone have been able to tap the bond and equity markets, raising €130bn of fresh money in the first 10 months of the year.
However, smaller Mittelstand firms that form the backbone of Germany's export industry are often shut out of the credit system. Banks have chosen to restrict lending as they struggle to meet tougher capital rules rather than dilute shares by raising fresh equity or accepting the onerous terms of state support schemes. This has prompted harsh criticism from finance ministers, but Professor Tim Congdon from International Monetary Research said the authorities themselves are to blame.
"This is becoming ridiculous. How can banks raise capital asset ratios and lend more at the same time? These people are barmy," he said, comparing the new rules with policy mistakes in the early 1930s. But the longer the decline in M3 continues, the greater the concern. Mr Congdon said Club Med states will suffer the brunt of the ECB's restrictive policies. "Business surveys in these countries are getting worse, and so are property markets. Fractures in the euro system are becoming clearer by the day".
.
Charles Goodhart Warns Of Return To Recession As Bank Lending Falls
The Contraction Of Bank Lending And The M3 Money Supply In The Us And Europe Over Recent Months Has Become A Serious Concern And Raises The Risk Of A Slide Back Into Recession, According To One Of Britain's Most Celebrated Economists.
By Ambrose Evans-Pritchard | 22 December 2009
Professor Charles Goodhart, a former top official at the Bank of England now at the London School of Economics, said policymakers have neglected the flashing danger signal of the monetary data. "What has happened to all the monetarists? Growth in money holdings and lending has plummeted. Thirty, or 40, years ago they would have been forewarning doom and destruction at this juncture, and casting anathemas at the authorities," he wrote in a consultant report for Morgan Stanley.
"There is a danger that markets and authorities become obsessed about the fiscal implications of the crisis at a time when the real worries should still focus on private sector access to credit and money." The exception is China, which has the opposite problem: monetary growth is running at 30% a year. Beijing will have to slam on the brakes soon. "When that happens the locomotive will slow, and probably reveal a string of non-performing loans; it has always been thus," he said. Prof Goodhart said it was too early for the world's central bankers to congratulate themselves for averting a slump.
The US Federal Reserve has stopped publishing M3, which covers a broad range of deposits. This may have been a blunder. The data gave advance warning of bubble trouble in 2006-2007, and again before the US economy crashed in late 2008. Some blame lies with Fed Chair Ben Bernanke, a New Keynesian openly scornful of monetarist thinking.
Reconstructed data shows that M3 shrank at an annual rate of 7.2% in the three months to November. Bank loans have fallen from $7.1 trillion (£4.4 trillion) to $6.75 trillion since the end of May. In the eurozone, M3 has fallen slightly since February. Professor Tim Congdon from International Monetary Research said credit contraction on both sides of the Atlantic has been the steepest since the 1930s, risking a slide into deflation next year.
Banks are tightening credit for two reasons: losses from the crisis, and tougher capital adequacy rules imposed by regulators. Mr Congdon said it is bizarre that the European Central Bank (ECB) seems unwilling to take steps to prevent a monetary implosion in these circumstances. Optimists say that "portfolio shifts" by investors may have distorted the M3 data. If so, there is little evidence in ECB or Fed reports that they have delved deeply into this issue.
They also argue that falling credit is benign because it reflects lower demand by borrowers, not a lending crunch. Professor Goodhart said this line of argument is "not terribly comforting". Businesses stop taking out loans when terms are punitive. The economy is damaged either way.
Mr Goodhart is best known around the world as the author of "Goodhart's Law", which posits that an indicator ceases to be much use once it becomes a target.
Thursday, December 31, 2009
US Pensions Go Bust, Gold Crashes, China Flops, Bunds Soar, Predicts Saxo
US Pensions Go Bust, Gold Crashes, China Flops, Bunds Soar, Predicts Saxo
America's Social Security Trust Fund Will Go Bankrupt; Both Gold And The Japanese Yen Will Crash; And China's Currency Will Devalue As Bad Loans Catch Up With The Over-Stretched Banking System— All In The Course Of 2010.
By Ambrose Evans-Pritchard, Telegraph,UK | 17 December 2009
AP: Saxo Bank Is Predicting A Stormy Year Ahead For The Financial World (Link To Video)
The annual "Outrageous Predictions" of Denmark's Saxo Bank are not for the faint-hearted, though there is good news for some.
Saxo Bank offers its thoughts as "Black Swan" risks that could paddle up quietly and bite you, rather than absolute predictions. Take them in the right spirit.
America's Social Security Trust Fund Will Go Bankrupt; Both Gold And The Japanese Yen Will Crash; And China's Currency Will Devalue As Bad Loans Catch Up With The Over-Stretched Banking System— All In The Course Of 2010.
By Ambrose Evans-Pritchard, Telegraph,UK | 17 December 2009
AP: Saxo Bank Is Predicting A Stormy Year Ahead For The Financial World (Link To Video)
The annual "Outrageous Predictions" of Denmark's Saxo Bank are not for the faint-hearted, though there is good news for some.
- David Karsboel, chief economist, thinks the US trade balance may go into surplus for the first time since the mid-1970s, benefiting from the delayed effects of the weak dollar.
- Yields on sovereign bonds— the goods ones, not the bonds of quasi-basket cases such as Club Med, the UK, or Japan— will plummet as deflation raises its ugly head again later in 2010. The 10-year German Bund yield will fall to 2.25%. "Bunds are the ultimate safe-haven if something goes wrong, perhaps in Greece. We may even see some safe-haven buying of US Treasuries as well, despite the irresponsible fiscal policies in the US," he said.
- The US Social Security fund will finally tip over, technically going bust. "Ever since the good years of the 1960s politicians have been taking the money and spending it instead of setting it aside for the fund, but next year it will go into deficit for the first time as US demography turns. The fund is going to need a bail-out, financed by higher taxes, more borrowing, or more printing".
- Gold will spiral down to $870 an ounce from its all-time high above $1,200 last month. "There is a lot of speculative hot money in the gold price right now that needs to be shaken out. In the long run we're bullish on gold, and think it could reach $1,500 over the next five years," he said. "In fact, we would like to see the restoration of a gold standard to prevent the sort of excesses we have seen. The world has been in a bubble since the mid-1990s. They are still blowing new bubbles to keep it all going, but each bubble is shorter and shorter. It is frightening, and is all going to end in tears," he said.
- Saxo Bank is squarely in the camp of Sino-sceptics, noting that China's alleged industrial and GDP growth does not tally with weak electricity use. In any case, growth has been built on an investment bubble creating "massive spare capacity". It says 2010 will be the year when it becomes clear that there is not enough demand in the world to absorb all their excess production. The yuan will devalue by 5%, defying near universal expectations of a sharp appreciation.
- As for Japan, Saxo advises clients to sell the overvalued currency as the yen carry trade comes back into vogue and the dollar rebound gains traction. The yen will weaken from 89 yen to 110 yen against the dollar.
- Saxo advises clients to dump 10-year Japanese bonds, doubting that current rates of 1.26% are remotely sustainable at time when the public debt is exploding towards 227% of GDP.
- "The yield is ridiculously low. The Japanese are no longer saving much, and they have hardly any economic growth," he said. However, Tokyo's TSE index of small stocks is a buy with a price to book ratio of 0.77, just about the cheapest stocks in the world.
- And lastly, if you jumped on the lucrative sugar bandwagon in 2009 as India's drought played havoc with supply, get off soon. Bad weather rarely persists. Sugar is about to crash by a third.
Saxo Bank offers its thoughts as "Black Swan" risks that could paddle up quietly and bite you, rather than absolute predictions. Take them in the right spirit.
Wednesday, December 23, 2009
The Chart Pattern I Trust Above All Others
The Chart Pattern I Trust Above All Others
By Jeff Clark | 23 December 2009
We've already covered how to read Bollinger Bands and VIX option prices to reduce your trading risk and maximize profits. Today, I'd like to turn to chart analysis… There are dozens, perhaps even hundreds, of technical chart patterns. Most of them don't make much sense.
The majority are nothing more than subjective lines drawn on a chart. Their track record at forecasting future price movements is no better than flipping a coin. There is, however, one chart pattern I place a great deal of faith in. It's a terrific signal for when a trend is about to come to an end and reverse. The pattern is called a "wedge," and it is my favorite technical formation.
A wedge forms when a stock makes an extended move higher or lower, and when the distance between the highs and lows gets compressed. Whenever a stock or an index breaks out of these patterns, the ensuing move is often quick and large. The psychology driving the wedge has something to do with the anxiety created as a trend gets extended.
Folks who were early to catch the trend are nervously trying to protect profits. Latecomers— who 'need' to jump on board or risk being left out of all the cocktail-party conversations— are worried about being the "greater fool". So, when the wedge breaks, and it looks like the trend has shifted, everyone rushes to get out. The recent action in the dollar is a perfect example.
This is an example of a falling-wedge pattern. The chart is in an extended decline. And you can see how the distance between the high and low points since May has continued to narrow. The wedge eventually comes to a point, and the chart has to break out of the pattern one way or another.
The best indicator to use to determine the direction of the break is the moving average convergence divergence (MACD) indicator— which is displayed on the bottom chart.
The MACD helps determine the strength of a trend. If a stock is falling and the MACD is falling as well, the downtrend is strong and likely to continue. In the above dollar index chart, however, the MACD is actually moving higher while the dollar is falling. This "positive divergence" suggests the momentum behind the downtrend is weakening and the chart is likely to break out to the upside. And that is exactly what happened…
Now, Let's Take A Look At A Recent Chart Of The S&P 500
This is an example of a rising-wedge pattern, where the chart is in an extended uptrend. Notice how the index is moving up while the MACD is declining. This "negative divergence" is a warning sign the momentum behind the trend is weakening and traders should be on the lookout for a reversal. There is still some room inside the wedge pattern for the S&P to continue higher. But the chart is nearing an apex. And if the negative divergence continues, the next big move will likely be to the downside.
Best regards and good trading,
Jeff Clark
By Jeff Clark | 23 December 2009
We've already covered how to read Bollinger Bands and VIX option prices to reduce your trading risk and maximize profits. Today, I'd like to turn to chart analysis… There are dozens, perhaps even hundreds, of technical chart patterns. Most of them don't make much sense.
The majority are nothing more than subjective lines drawn on a chart. Their track record at forecasting future price movements is no better than flipping a coin. There is, however, one chart pattern I place a great deal of faith in. It's a terrific signal for when a trend is about to come to an end and reverse. The pattern is called a "wedge," and it is my favorite technical formation.
A wedge forms when a stock makes an extended move higher or lower, and when the distance between the highs and lows gets compressed. Whenever a stock or an index breaks out of these patterns, the ensuing move is often quick and large. The psychology driving the wedge has something to do with the anxiety created as a trend gets extended.
Folks who were early to catch the trend are nervously trying to protect profits. Latecomers— who 'need' to jump on board or risk being left out of all the cocktail-party conversations— are worried about being the "greater fool". So, when the wedge breaks, and it looks like the trend has shifted, everyone rushes to get out. The recent action in the dollar is a perfect example.
This is an example of a falling-wedge pattern. The chart is in an extended decline. And you can see how the distance between the high and low points since May has continued to narrow. The wedge eventually comes to a point, and the chart has to break out of the pattern one way or another.
The best indicator to use to determine the direction of the break is the moving average convergence divergence (MACD) indicator— which is displayed on the bottom chart.
The MACD helps determine the strength of a trend. If a stock is falling and the MACD is falling as well, the downtrend is strong and likely to continue. In the above dollar index chart, however, the MACD is actually moving higher while the dollar is falling. This "positive divergence" suggests the momentum behind the downtrend is weakening and the chart is likely to break out to the upside. And that is exactly what happened…
Now, Let's Take A Look At A Recent Chart Of The S&P 500
This is an example of a rising-wedge pattern, where the chart is in an extended uptrend. Notice how the index is moving up while the MACD is declining. This "negative divergence" is a warning sign the momentum behind the trend is weakening and traders should be on the lookout for a reversal. There is still some room inside the wedge pattern for the S&P to continue higher. But the chart is nearing an apex. And if the negative divergence continues, the next big move will likely be to the downside.
Best regards and good trading,
Jeff Clark
V Is For Vicious Cycle
V Is For Vicious Cycle
By A. Gary Shilling, Forbes | 30 November 2009
If you want to know where the economy and our markets are headed over the next decade, focus on the consumer. The picture I see is rather depressing. Most people don't share my view, which is why we have had a bull run in stocks since March. The bull market presumes a 'V' recovery with consumers quickly returning to their profligate ways. [[FWIW, even assuming that's true of consumers' propensity to spend, where's the cash/credit to come from? The banks aren't lending (and most of the 'non-bank' lenders— except for pawnshops and the neighborhood loan shark— have long since gone bye-bye)— and if history is any guide, may not for another generation or so. Most banks are at least technically insolvent; moreover, they are looking forward to the 'second wave' of home mortgage defaults*— prime and alt-A ARMs will reset during 2010 (peaking in mid-January) and most 'homeowners' cannot afford the new payments (shades of sub-prime) and cannot refinance (their home prices are far 'underwater'). The trend in the CC default rate is still rising (and will probably continue to do so until at least the unemployment picture stabilizes). Then, the banks have yet to be really hit with that bad commercial RE tsunami (if money is borrowed to build a mall in **** and no one buys any homes in the housing developments nearby, guess whether that loan is likely to be repaid?) At the moment, the only one lending is Uncle Sam— and there has to be a limit to that! : normxxx]] I'm not expecting any such rebound. If consumer spending doesn't improve, 2010 earnings won't support current stock prices. Third-quarter GDP rose at a 3.5% annualized rate [[since adjusted down to 2.2%: normxxx]], but don't kid yourself that our economic malaise is over.
From the early 1980s through 2007 consumers were on a borrowing-and-spending binge fueled by rising asset prices [[net wages, after inflation, were disappointingly flat: normxxx]]: stocks in the 1980s and 1990s, houses in this decade. Their saving rate dropped from 12% to 1% of income. Home mortgage and consumer debt jumped from 60% to 135% of aftertax annual income. Consumer spending in relation to GDP went from 62% to 70%. And. for every 1% increase in consumer spending, U.S. imports climbed 2.8%. That propelled foreign economies, as the American trade balance dropped from zero to an $800 billion annual deficit.
But now consumers have no choice but to begin a decade long saving spree. The nosedive in house prices has left a third of those with mortgages underwater. Their average home equity has dropped from 48% in the early 1980s to 23% now. Despite the recent stock rally, equity prices remain well below their 2000 and 2007 peaks.
In relation to aftertax income, household net worth is lower than in the 1950s. Also, the postwar babies hoping to maintain their standard of living in retirement desperately need to save. The good news is that they can. Many are in their 50s, their peak earning years [[assuming that they are still employed or have not suffered a 'job turnover' benefits/wage cut: normxxx]], and their tuition payments are done. If their kids are as old as mine, they no longer have to replace smashed-up cars.
People will save because it's scary out there. Unemployment is high and rising. Moreover, the layoff and unemployment numbers understate the problem because they do not include involuntary furloughs and wage cuts, which have surfaced for the first time since the 1930s. It's scary for employers, too; with a pickup in orders, they just work remaining employees harder. In the recession so far the average number of weeks between jobs has gone from 17 to more than 26.
No wonder that consumer confidence remains depressed. Households saved virtually all of last spring's tax cuts and extra Social Security payments. Families are paying down debts. Homeownership rates are declining as foreclosures leap. Those forced out are doubling up with family and friends, leaving apartments vacant. The government's cash-for-clunkers deal and other stimulus subsidies have provided temporary growth that won't last.
Spending this holiday season will follow Scrooge's inclinations. Stocks will fall through March lows as investors begin to worry about disappointing 2010 earnings. [[I'm not sure I agree with either of the two preceding points. I think holiday sales (though disappointing) will beat expectations, and stock prices may fall, but will hit a great buying point— possibly good for a one or two year move— sometime next summer or fall. : normxxx]] Stockholders should abandon their dreams of a V-shaped recovery and instead worry about how we are going to break out of the vicious cycle of consumer weakness, depressed output and underemployment. We might see another round of fiscal stimuli, this time aimed at job creation. It might end the recession by mid-2010, in time to save some incumbents from being unelected. [[But in November look for the Republicans to retake the House, or very nearly so, and for them to reduce the Dems 60 votes in the Senate. Then it's all gridlock from then on out.: normxxx]]
But [any] 'recovery' will likely be so weak as to be nearly invisible. This kind of recovery won't put consumers back in a consumption mood and won't absorb the excess inventory of housing [[nor cause banks to open their coffers: normxxx]]. Within a decade the saving rate will probably return to double digits. Until recently, consumer spending was rising a half-percent per year faster than aftertax income; now it will be rising 1% slower. That shift will knock 1.5 percentage points off annual real GDP growth in the next decade to a low 2% compared to 3.7% in the 1982-2000 salad days.
Those seeking to preserve wealth or even make a profit in this environment should avoid producers of big-ticket consumer discretionary products like autos, appliances, airlines, ocean cruises and boats. They'll suffer twice as consumers cut the nonessentials in order to save and as 'deflationary expectations' convince them to wait for still lower prices. Companies with slow revenue and big debts are vulnerable in a deflationary economy. Sell them.
Stick with stocks that pay meaningful and rising dividends. Consumer staples are relatively immune to slow growth and deflation, although trading down from national brands will persist. Treasury bonds will continue to rally as deflation settles in. [[But beware of the hit that bond prices take when interest rates rise, as they ineviably must.: normxxx]]Brace yourself. The U.S. consumer will rule the world economy for years, but I expect he will be a miserly king.
A. Gary Shilling is president of A. Gary Shilling & Co., economic consultants and investment advisers. Visit his homepage at www.forbes.com/shilling.
By A. Gary Shilling, Forbes | 30 November 2009
|
If you want to know where the economy and our markets are headed over the next decade, focus on the consumer. The picture I see is rather depressing. Most people don't share my view, which is why we have had a bull run in stocks since March. The bull market presumes a 'V' recovery with consumers quickly returning to their profligate ways. [[FWIW, even assuming that's true of consumers' propensity to spend, where's the cash/credit to come from? The banks aren't lending (and most of the 'non-bank' lenders— except for pawnshops and the neighborhood loan shark— have long since gone bye-bye)— and if history is any guide, may not for another generation or so. Most banks are at least technically insolvent; moreover, they are looking forward to the 'second wave' of home mortgage defaults*— prime and alt-A ARMs will reset during 2010 (peaking in mid-January) and most 'homeowners' cannot afford the new payments (shades of sub-prime) and cannot refinance (their home prices are far 'underwater'). The trend in the CC default rate is still rising (and will probably continue to do so until at least the unemployment picture stabilizes). Then, the banks have yet to be really hit with that bad commercial RE tsunami (if money is borrowed to build a mall in **** and no one buys any homes in the housing developments nearby, guess whether that loan is likely to be repaid?) At the moment, the only one lending is Uncle Sam— and there has to be a limit to that! : normxxx]] I'm not expecting any such rebound. If consumer spending doesn't improve, 2010 earnings won't support current stock prices. Third-quarter GDP rose at a 3.5% annualized rate [[since adjusted down to 2.2%: normxxx]], but don't kid yourself that our economic malaise is over.
|
From the early 1980s through 2007 consumers were on a borrowing-and-spending binge fueled by rising asset prices [[net wages, after inflation, were disappointingly flat: normxxx]]: stocks in the 1980s and 1990s, houses in this decade. Their saving rate dropped from 12% to 1% of income. Home mortgage and consumer debt jumped from 60% to 135% of aftertax annual income. Consumer spending in relation to GDP went from 62% to 70%. And. for every 1% increase in consumer spending, U.S. imports climbed 2.8%. That propelled foreign economies, as the American trade balance dropped from zero to an $800 billion annual deficit.
But now consumers have no choice but to begin a decade long saving spree. The nosedive in house prices has left a third of those with mortgages underwater. Their average home equity has dropped from 48% in the early 1980s to 23% now. Despite the recent stock rally, equity prices remain well below their 2000 and 2007 peaks.
In relation to aftertax income, household net worth is lower than in the 1950s. Also, the postwar babies hoping to maintain their standard of living in retirement desperately need to save. The good news is that they can. Many are in their 50s, their peak earning years [[assuming that they are still employed or have not suffered a 'job turnover' benefits/wage cut: normxxx]], and their tuition payments are done. If their kids are as old as mine, they no longer have to replace smashed-up cars.
People will save because it's scary out there. Unemployment is high and rising. Moreover, the layoff and unemployment numbers understate the problem because they do not include involuntary furloughs and wage cuts, which have surfaced for the first time since the 1930s. It's scary for employers, too; with a pickup in orders, they just work remaining employees harder. In the recession so far the average number of weeks between jobs has gone from 17 to more than 26.
No wonder that consumer confidence remains depressed. Households saved virtually all of last spring's tax cuts and extra Social Security payments. Families are paying down debts. Homeownership rates are declining as foreclosures leap. Those forced out are doubling up with family and friends, leaving apartments vacant. The government's cash-for-clunkers deal and other stimulus subsidies have provided temporary growth that won't last.
Spending this holiday season will follow Scrooge's inclinations. Stocks will fall through March lows as investors begin to worry about disappointing 2010 earnings. [[I'm not sure I agree with either of the two preceding points. I think holiday sales (though disappointing) will beat expectations, and stock prices may fall, but will hit a great buying point— possibly good for a one or two year move— sometime next summer or fall. : normxxx]] Stockholders should abandon their dreams of a V-shaped recovery and instead worry about how we are going to break out of the vicious cycle of consumer weakness, depressed output and underemployment. We might see another round of fiscal stimuli, this time aimed at job creation. It might end the recession by mid-2010, in time to save some incumbents from being unelected. [[But in November look for the Republicans to retake the House, or very nearly so, and for them to reduce the Dems 60 votes in the Senate. Then it's all gridlock from then on out.: normxxx]]
But [any] 'recovery' will likely be so weak as to be nearly invisible. This kind of recovery won't put consumers back in a consumption mood and won't absorb the excess inventory of housing [[nor cause banks to open their coffers: normxxx]]. Within a decade the saving rate will probably return to double digits. Until recently, consumer spending was rising a half-percent per year faster than aftertax income; now it will be rising 1% slower. That shift will knock 1.5 percentage points off annual real GDP growth in the next decade to a low 2% compared to 3.7% in the 1982-2000 salad days.
Those seeking to preserve wealth or even make a profit in this environment should avoid producers of big-ticket consumer discretionary products like autos, appliances, airlines, ocean cruises and boats. They'll suffer twice as consumers cut the nonessentials in order to save and as 'deflationary expectations' convince them to wait for still lower prices. Companies with slow revenue and big debts are vulnerable in a deflationary economy. Sell them.
Stick with stocks that pay meaningful and rising dividends. Consumer staples are relatively immune to slow growth and deflation, although trading down from national brands will persist. Treasury bonds will continue to rally as deflation settles in. [[But beware of the hit that bond prices take when interest rates rise, as they ineviably must.: normxxx]]Brace yourself. The U.S. consumer will rule the world economy for years, but I expect he will be a miserly king.
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A. Gary Shilling is president of A. Gary Shilling & Co., economic consultants and investment advisers. Visit his homepage at www.forbes.com/shilling.
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