Saturday, February 28, 2009

Technical Update 7.09

I covered my outlook on equities already this week in Equities. Buy 'em or Run for the Hills? Friday's action only served to reinforce the divergences I pointed out. Stocks made lower lows on heavy volume, but volatility and option activity failed to produce any signal of fear or panic that would provide a lower-risk entry for longs. I did find it interesting that the close of the day, week and month was so decisive. Typically, monthly bars that close at their highs or lows have a high probability of follow-through in the next bar (although there is often a reversal during that bar). Take a look back at this monthly chart and you can see that quite clearly:

I have a suspicion that we see a wash-out low in the first half of this month. This would coincide quite well with a few of my sources that have been whispering for quite some time now to "beware the ides of March" based on the various time-span indicators they follow.

Elsewhere, I see the US Dollar flirting with it's November highs. Ultimately, I see the Greenback heading much higher. But I would like to see it consolidate a little from here. A multi-week correction back to it's 20 week EMA (blue line) would be ideal. This would allow for the other MAs to "catch-up" and provide a launching pad for a major move higher (major MAs in tight proximity commonly precede big moves).

Copper is paying no mind to the rapidly declining economy. It is still sitting 24% above it's December lows. Is "Dr. Copper" forecasting a little improvement?

Gold and Silver both appear to have finally made their tops and have begun falling. Both experienced overly optimistic treatment from speculators during this recent upleg. reported over 90% bulls for a multi-week period. Similar readings were had at every other major top in the PMs. Gold got unprecedented coverage in the media, even appearing during a SuperBowl ad. I fully believe the long-term gold bull is alive and well, but it needs to take a rest. My target remains between $550-650 at which point I suspect the bull market will be declared "dead." Only then will I buy.

I also expect the gold:silver ratio to continue its trend of expansion. That is, I expect silver to underperform. The ratio could top 100, in my opinion. For disclosure's sake, I am short silver.

I also wanted to remind readers about the dangers involved in the leveraged ETFs. They are trading vehicles only. Those with a longer time-frame should use more conventional, less exotic instruments. The leveraged funds do not necessarily achieve their stated missions over longer periods of time (ie. more than a few weeks). The same thing could be said about err, nevermind...

That's all for now.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Thursday, February 26, 2009

Equities. Buy 'em or Run for the Hills?

This has been one of the more interesting weeks I can remember in watching the markets. Why? Because I have a host of indicators telling me completely opposite things.

On the one hand, sentiment is skewed negative and the press is bombarding us with bad news on a daily basis. On the other, stocks look extremely expensive, and complacency is everywhere. I'll present both sides as best I can today.

For the record and to share my process, I'm getting out of the way. I had a host of puts spread out across the board in Canadian Financials, Consumer Discretionary and Staples, and index puts in general. The value of those puts more than doubled over the last two weeks and I reduced my exposure by more than that, leaving me with some limited short side exposure. They have summer expiries. Other than that, I took a position in the double short silver ETF (ZSL) on Tuesday morning.

The Bull Case

Many sentiment indicators are at negative extremes. For example, the Daily Sentiment Index from reads 3% stock bulls as of last Friday. This is commensurate with both October and November lows. Compiled in a completely different manner are the Investors Intelligence (oxymoron, I know) data. The percentage of bulls suffered a huge weekly decline this week. Again, usually a signal of an imminent low.

The mysteriously accurate Tom Demark Sequential buy/sell indicator (which, I admittedly don't understand very well) is suggesting a monthly and weekly buy setup is at hand.

Even the "perma bear" Bob Prechter was suggesting that now is a good time to cover shorts in preparation for what he calls a "wave 2 rally." Prechter, the undisputed authority on the Elliot Wave Theory believes that the end of Wave 1 is nearing. Ultimately, he believes we are in a "Grand Supercycle" correction greater than the Great Depression and by the time all 5 waves down are complete, the Dow will be well below 1000.

Some of my other indicators have taken a turn for the worse as well. For example, the daily breadth indicator that I cite often:

Additionally, the argument can be made on a number of fronts that relative strength in various markets and sectors is suggestive of a rally. The October decline saw all markets and all sectors making new 52-week lows with almost zero exceptions. So if this was a true "break of the lows" we should see everything participating anew. Here is a partial list of those that have broken their October lows, and those that have held them:

Holding: S&P 500, Russell 2000, Nasdaq Composite and 100, Discretionary Sector, Healthcare Sector, Materials Sector, Emerging Markets, Nikkei (Japan), FTSE (UK), ASX (Holland)

Broken: Dow Industrials, Dow Transports, Financials Sector, Staples Sector, DAX (Germany), CAC (France), MBI (Italy), SMI (Swiss), IBEX (Spain), Eastern Europe and Russian markets

AORD (Australia) and TSX (Canada) are both debatable.

The Bear Case

While sentiment as measured by a number of services indicates excessive pessimism, I really wonder how accurate those measures are. And here's why: Every once in a while I punish myself and listen to the financial news-media for days at a time. I do it in order to get a feel for the overall tone of the market. Normally, I just have it on to listen to something specific, but occasionally I immerse myself in it. My vehicle of choice is Canada's BNN. It is bad, but not nearly as bad as CNBC or Bloomberg. That is, they at least make an attempt at balanced reporting.

Listening to BNN this week and last, I get the opposite feel as from the published numbers; the majority of analysts, pundits, traders, fund managers and anchors are bullish. How can this be? How can analysts be bearish and bullish at the same time? I've come up with a theory to explain this. Quite simply, these folks are saying one thing and doing another.

I see it day after day, and now it all makes sense. Nearly every one of these people are "advising caution" and believe lower prices are "very possible" because the credit market issues have "not yet been resolved." But as the interviews go on, it becomes apparent that these people are not simply sitting on the sidelines and waiting. They're fully invested or nearly so and tout their cash positions of 20%. They all seem to believe that "their" stocks won't be the ones making new lows.

Because BNN is based in Canada, and because Canadian stocks are heavily weighted to the Materials sector, there is a lot of coverage of the major stocks in that sector. During the lunchtime trading hours, BNN has a show called "Market Call" where an analyst or manager comes in to tout his favourite picks, and take calls on listeners questions. Without fail, throughout the course of this program, distressed Canadian investors call in about companies like Suncor, Encana, Enbridge, or many of the energy trusts, all of which have been decimated, and ask "what should I do?"

Over the course of the last two weeks, I've yet to come across one of these guys who advises nearly everyone to sell what they have and wait to buy anything else. They all suggest that everyone should have "a little of this" and "a little of that" in their portfolios.

So if these guys (and some gals) consider themselves bearish, why do they insist on hawking the same stocks that people have been getting destroyed on? Why not tell them to take the losses and wait a few years? The answer to that is simple. It's not their job. They are paid to sell stocks. And the news station has them there to do so. Neither gain any short-term benefit by telling people to go away and come back later. Additionally, they don't know how to do anything other than pick a portfolio of stocks. That's all they've done for their entire careers. Sitting in cash is not something they're comfortable with.

How prevalent is this? How many investors are bearish, yet find themselves fully invested in their "favourites?"

An indication of this potential complacency can be found in the Volatility Index. It has not broken out of its recent consolidation despite the overall markets making new lows or at least re-visiting their autumn lows. In fact, the index (sometimes referred to as the "fear index") is about half the level it was back in October when stocks were at the same price. This suggests that either the fears back in October were way overblown, or we are way too complacent now. See it below:

Another very disturbing piece of evidence I have come across the last few days has been the plummeting corporate earnings (now referred to as "corporate losses"). 93% of companies in the S&P 500 have now reported their 4th Quarter numbers. And they have been an absolute disaster. The total losses amount to nearly $12 per share for the quarter, bringing the full year 2008 reported earnings for the index to $26.16. (Q1 - +15.54, Q2 +12.86, Q3 +9.73, Q4 -11.97). Divided by the price on my screen right now (775), we get a 1 year trailing earnings multiple of P/E 29.62. We are now approaching the absurd multiples reached during the bubble.

To be fair, these are only 1 year multiples. If this were the only way to determine value, we would have to conclude that after 4 quarters of negative earnings, the S&P should be priced at 0. That is obviously not true. However, the value of a basket of money losing enterprises would not be very much.

Others will argue that these are only "reported" earnings, and if one were to use "operating" earnings we would have a P/E multiple of 14.19. My response to that is: "if if's and but's were candy and nuts..." Operating earnings don't include things like goodwill reductions, plant and property writedowns, and any other losses from businesses that are "non-core". For example, General Electric would only report their performance in selling dishwashers and airplane engines, but leave out losses they've incurred by lending money to people so they can buy those goods. In other words, operating earnings are in la-la land, and reported earnings reflect reality.

To be sure, losses of $12 per share will not occur indefinitely. And companies will at some point write down the value of their assets so far that they have to mark them up again. But that is a long time away.

Indeed, a lot of technical indicators are reading oversold. The danger, of course, in reading into oversold indicators, is that "oversold" can turn into "more oversold." Those that were buying in early October after the indicators were reflecting extremes like those in March or January ('08) got absolutely punished.

Other indicators, like the put/call ratio, are telling us that we have lots of room left to the downside.

All in all, a convincing argument can be made either way. Therefore, I elect to stay out of the way. At least for now.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Tuesday, February 24, 2009

On Journalistic Integrity

Today's Globe and Mail was dressed with a total abomination of journalism.

Heather Scoffield asks, Will Invoking the Great Depression Bring It On?

To be fair, poor journalism is nothing new. In fact, it is the rule rather than the exception. But this particular article did such a marvelous job of repeating nearly every economic fallacy going around and while doing so attempted to shift the blame from the culpable to the prudent.

OTTAWA — Farms turned to dust, livestock starved to death and migrant workers toiled for pennies a day, sleeping in barns at night and eating mush. Children went without shoes in winter.

“I never took a backward step in my life until that Depression whipped me, took away my wife, my home, a section of good land back in Saskatchewan,” 78-year-old Henry Jacobson told Canadian writer Barry Broadfoot in his chronicle of the Depression in Canada.

“Left me with nothing.”

Scoffield starts out with a classic misrepresentation of the depression. I'm not saying it wasn't bad, but to proclaim that "Children went without shoes in winter," as a statement of absolute fact should strike anyone as sensationalist. Surely, some children went without shoes in winter in the Depression. Surely some went without shoes last year, and the year before.

And the workers "toiling for pennies a day," does not mention that adjusted for inflation those pennies were enough to feed themselves and survive. But again, it is a blanket statement. "Workers." Not some workers. She makes it sound as if it was a condition that plagued all of society. In fact, even at the worst estimates of 25% unemployment, there is the little noticed fact that 3 in 4 people still had their jobs. And while their wages may have been falling, they were not reduced to sleeping in barns.

Scoffield goes to great lengths to sensationalize the worst parts of the Depression. She's not alone. I distinctly remember learning about the Depression in high school (it was one of the classes I didn't skip, evidently). What sticks out in my memory? Pictures like these of course:

What my teachers and Ms. Scoffield failed to point out was that you could traverse across any country at any time (boom or bust) and find people in this condition of poverty. Examples like that of Mr. Jacobson (who lost his farm, home and wife - I'm pretty sure that is the correct order) could be from any period of modern history.

The truth of "the Great Depression affected everyone" has been skewed to make us believe, "the Great Depression had everyone sleeping in barns." This sensationalism is not limited to this article. It is prevalent in every reference to the GD.

Back to the article:

The era was so punishing that it has become ingrained in Canada's psyche as something that must never be repeated. The D word is a painful one, used sparingly and with dramatic effect.

Now, however, as the U.S. economy craters, the global economy falters and Canada is clearly in recession, talk of depression has become commonplace. The 1930s are no longer a distant memory. The decade has become a poignant reference point, with policy makers drawing lessons and making comparisons, and some economists now warning that the world is at the precipice.

Dominique Strauss-Kahn, who heads the International Monetary Fund, has suggested that the world's major economies are “already in depression.” Economist bad-boy Nouriel Roubini warns that the United States is in a “near depression.”

Such seemingly casual use of the D word has many analysts balking, warning of the effect such a mindset can have in an already fragile economy plagued by a lack of consumer and business confidence.

And why do you think "many analysts" are balking at the use of the word? Could it be because its comeuppance would be of no benefit to them? Because their heavily leveraged portfolios are getting margin calls and they need some optimism to sell to a greater fool? Nevermind the conflict of interest. That's a whole other topic.

I want to touch on this issue of "confidence," and whether the lack of it is the cause for our current predicament. Of course, we know the answer is "no." But I always find it amusing that journalists, analysts and most economists never refer to the years of excessive confidence, only pointing it out on the way down. It is always assumed with shocking agreement that rising confidence is rational, yet falling confidence is irrational. You'll often hear guys like Bernanke talking about a "deficiency in aggregate demand." As if by it's very nature, demand is lower than it "should" be. How does he know what it should be? He doesn't, of course.

So can "the news" cause confidence to fall? Think about it. Does one fear losing his job because the newspaper said 120,000 Canadians lost their jobs last month? Or does one fear losing their job because their co-workers or neighbours lost their job last month? What is the reason for the person fearing for their job? Is it job losses or the reporting of job losses? If you guessed the latter, then may I suggest a career with Pravda.

Seriously, the insanity has to stop somewhere. If fallacious arguments like this become acceptable logic in our mainstream media, then the entire institution of a free press is in jeopardy. If we are to vilify people such as myself for making correct analysis of the economy, where do we stop? Do we vilify the person who reports the damage of a natural disaster? How about the journalist that uncovers political fraud? Why not just outlaw any news that could be perceived as negative? Do you see where these arguments are rooted? Do you think it is accidental? If so, you are thinking with a dangerous naivety.

But as confidence in the banking system continues to falter, jittery investors drive down stock markets and inflation hovers close to zero, more economists are grappling with the possibility that the deepening recession could turn into something worse and more intractable – a slump that may earn the D-word moniker, even if it doesn't replicate the misery of the 1930s. “It's a worry,” says Angela Redish, an economics historian at the University of British Columbia.


The chances of Canada, or even the U.S., facing a repeat of the 1930s is slim to none, most analysts say, because the North American economy is much different than it was 70 years ago. Employment insurance and social programs are beefier now, especially in Canada, and the population in general is much further away from the poverty line.

There is nothing correct in this last paragraph. Nothing. The North American economy is very similar to 70 years ago. It is lopsided toward consumption. Previously, it was lopsided toward production. Either way, it is lopsided. The insinuation is that we have a more balanced economy now. Nothing could be further from the truth. The services sector accounts for an enormous portion of our economy. And with less consumption to "serve," many of these jobs will become obsolete.

The second assertion is that social programs are "beefier" now. I suppose that would be why more than a dozen US states are already at the bottom of their employment insurance funds? Despite the facts, people continue to praise the social security model as if it is functioning. In reality, pension funds are being decimated, and employment insurance funds are grossly inadequate to cope with anything close to what we face. The jobless elderly are going to find that neither of their promised insurance schemes will be able to pay. And the reason is simple: they were never designed to pay. They were designed as ponzi schemes, where incoming money would be used to pay current obligations. When the incoming money declines, due to economic reasons or demographic, the scheme implodes - just like Madoff's. Citing this as a "strength" is grossly misleading. Rather, the false sense of security our populations have been lulled into is more of a weakness. (I do realize some pension programs are in better shape than others. But if you set the bar low enough...)

The third false assertion is that our general populations are further away from the poverty line than before. In order to make this determination, we need to replace "savings" with "home equity." The former is non-existent, and the latter is dropping like a stone. I can't remember the exact numbers, but something like 80% of Canadians live paycheque to paycheque. I don't care how many flatscreen TVs one has. Without a paycheque, a person without a job, no savings and a house that can't be sold is impoverished.

Below is a chart of consumer and mortgage debt as a percentage of GDP in Canada and the US. If you've fallen for the punchline that Canadians are more responsible with their finances than Americans, you've been fooled. This is not healthy:

More from the article:

For Luc Vallée, former chief economist at the Caisse de dépôt et placement du Québec, the U.S. has already reached that point. The hugely expensive fiscal measures that Washington is throwing at the crisis, accompanied by interest rates near zero and ever-creative moves by the Federal Reserve to fix the financial system, mean that the economic trouble is extraordinary, not just a recession, he argues.

“It looks like maybe the big D has arrived. It may not be the Great Depression, because we have these stabilizers which prevent us from collapsing totally. But it looks like we're stuck in a place where it can't start on its own, because the financial intermediation is not functioning properly, and that's a big part of a market economy.”(emphasis mine)

By Mr. Vallée's logic we can also conclude that: Levitation is a big part of gravity. Killing something is a big part of keeping it alive. Turning out the lights will help us see at night.

Sadly, Mr. Vallée's verbal defecation was only about half-way through this article. We continue boldly:

Deflation is one of the key differentiators between recession and depression, explains economist Robert Fairholm, director of the Toronto-area Centre for Spatial Economics.

If prices are rising, and some sort of inflation persists, it means consumers and investors are still somewhat active, and the economy should be able to start growing again. But if consumers and investors fear widespread falling prices, then a dangerous deflationary spiral – one that drives up the value of debt and prompts consumers to delay purchases – could take hold. And that would drive the economy into a long, deep depression.

So far, Canada's inflation numbers are in positive territory, and look poised to stay there – save for a few months of some negatives due to lower energy prices. In the U.S., however, the spectre of deflation is looming large, with officials from the Federal Reserve talking openly about it.

Spacial economics is an accurate description of this person's views. Better would be "outer spacial." Let's get a show of hands among my readers. Who would prefer to pay less for nearly everything they buy? Everyone? Well that's strange. According to the institute of outer space economics, we should want to pay more. We should be afraid of paying less. Running for the hills at the very sight of "price reduced" signs.

This clown, like all the other neoclassical economists, equates inflation with growth. "If prices are rising and some sort of inflation persists, it means consumers and investors are still somewhat active..." This is an absurd statement. How active are consumers and investors in Zimbabwe? How is their economy doing? Rising prices can be due to any number of things. Chiefly, rising prices are a result of consumer time preferences that are effected by social trends, demographics, and monetary policy. It is not a sign of strength or weakness.

Additionally, "economists" like Mr. Fairholm are completely lost to explain the near 30 year period after the civil war in America. Prices were falling an average of 2% every year (compound that), yet America was in the midst of the Second Industrial Revolution. They also cannot explain why recent progress has been centered around sectors where prices have been falling rapidly - namely technology.

Entire schools of economics have been crafted to promote this confiscatory inflationist mantra. Inflationism that we know benefits only those with first access to credit (namely the already rich). So now that we are mired in this rapid deflation, the minions of this inflationist tyranny are sent out to spread their propaganda.

Central banks now have far more flexibility to fend off deflation than in the 1930s, UBC's Ms. Redish stresses. Back then, the gold standard that backed up most currencies constricted central bankers' ability to expand the money supply. Not so now.

“When you have the Fed able to print money and the Bank of Canada able to print money, you're not going to get those deflations,” she said.

I discussed the Fed's ability to "print" money in "It Ain't Gonna Work."

The Fed's "money printing" charade amounts to increasing reserves. This puts the reserve cart before the lending horse. Unless they increase the physical supply of dollar bills by 25x, they cannot start to have an effect on the overall supply of money and credit. But still, that money requires velocity in order to have the same inflationary impact that newly minted credit had back in the boom time. There is no engine for that velocity.

All in all, this article is one of the worst pieces of rubbish I've ever read.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Saturday, February 21, 2009

"Grandpa, Don't Blame Us!"

Paul Volcker, former Chairman of the US Federal Reserve, gave a speech Friday. The media picked up on it because he showed a little leg in comparing today's crisis as such:

"I don't remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world"

View the video below.

I'm not interested in the quotes about the depression. We already know this is just as bad or worse. What I was interested in was the story he gave at the end. About his grandson, a financial engineer.

More specifically, the response his grandson gave him after hearing about some less than nice things said by Volcker about financial engineers.

"Grandpa, don't blame it on us. We were just following the orders of those guys up above, getting those big salaries that told us to design all this stuff."

I'm interested is this because it is shockingly in-line with Generational Theory. An entire generation (Gen-X) of these types were ushered into the financial world at around the same time Boomers were taking over for their Silent generation elders in corner offices everywhere in the western world. This was happening around the early/mid-90's when the internet and computers were becoming the new thing.

For the most part, boomers had very little understanding of the "new-age" technologies. But their underlings did. They had been schooled on MS-DOS and could come up with an answer in seconds to any question using a combination of their quantitative analysis learned at Harvard and computer skills.

All over the western world, there were 20-something mathematical geniuses reshaping our financial world. They thought their superiors were too careful to allow anything bad to happen and the superiors thought the kids were too smart to allow anything bad to happen. "Just keep doing what you're doing, kid. You're making us all rich."

This is the root of our crisis today. It has very little to do with subprime mortgages or fiscal deficits. Those were symptoms of the above reckless abandon our financial system allowed to grow out of control. It happened at precisely the same time all of those who had experienced the Great Depression began retiring. Those that took over thought they were too smart to allow anything like it to happen again. Government regulators and ratings agencies went along for the ride (as they always do). And so their collective actions made the Depression's recurrence an inevitability.

Pointing fingers doesn't usually get us anywhere. But expect a lot of it over the next few years. Boomers will blame Gen-Xers for promising them that failure was "basically impossible." Gen-Xers will blame Boomers for never second guessing them. The few remaining Silent Generation will shake their heads in disbelief at the stupidity of both. Government will plead the 5th. And the younger generations will become increasingly angrier as their career opportunities wither and it becomes apparent that all the finger pointing is getting in the way of allowing a recovery to take root.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Technical Update 6.09

The "imminent move lower" I have been expecting for a few weeks has begun, although unevenly. I favour an extension of this selloff, but a bounce may be required to work off some measures that are displaying excessive pessimism.

Increasing talk of "nationalization" has been hammering the financials, as common and preferred share holders fear getting a goose-egg on their speculations. Readers of this blog know that a goose-egg on many of these stocks is inevitable. The only questions are when and how.

In the middle of the carnage on Friday we were told that more details were forthcoming on Timmy Geithner's "plan." I'm not so sure that's a good thing, but we'll find out Monday.

As you can see, the SPX has managed to stay above it's November lows. The same can be said about the Nasdaq and the Russell. The Dow Industrials and all of the indices I mentioned last week (Transports, Canadian Financials, and Staples) have not been so lucky. All made new lows this week. The Industrials are looking the ugliest. You have to go back to early 1997 when the index closed the week at such a level. So much for buy and hold. What else happened in early 1997? OJ Simpson was aquitted, Dolly the sheep was cloned, Packers beat the Patriots in the Superbowl. I got my braces removed and was battling acne.

Another problem area on my radar is the utilities sector. Think this is a relatively stable sector with secure dividend payments? Think again. Many of them are saddled with enormous debt/equity ratios and much of that debt is coming due over the next two years. Their situation is similar to that of the REIT complex (with different problems obviously). Fear of not being able to refinance is hammering their share prices. Lower share prices increase the debt/equity ratio and increase fears of not being able to refi. Previously, when a utility would get over its head, another one would simply take it over. They'd do a public offering or go to the debt markets at more favourable terms and consolidate the debt. That is not economic now. Even the strongest are trying to reduce debt levels. Yet one more manifestation of peak-credit. I don't think the socialists in government around the world would think twice about nationalizing this sector, as they are about the banks. I can just see President Obama giving a heartwarming speech about having to keep the lights on so a student can study at night and become a doctor. "It is government's res-pon-si-bility to maintain essential services for everyday Americans."

Preferred shares. Getting hammered as a function of nationalization talks. (note: Financial preferreds make up 81% of this index)

But as I mentioned earlier. A continued swift move lower is guaranteed to no one. I covered some of my GE and Canadian Financial short exposure into the morning abyss on Friday. Some of my indicators, and a few being followed via others are already at extremes. Take for example the 10 day MA of the Advance/Decline ratio. I'm not sure if the increased volatility is responsible for the recent swings out of the 2 year range, but I suspect so. In that case, there's still plenty of room on the downside.

A weekly look at the same indicator supports that view, as the extremes on both sides have been expanding for at least 20 years. Try to ignore the red lines on this chart. Does it mean anything? Maybe not. To me, it is supportive of the gambler's mentality that was prevalent over this period.

My put/call indicator is suggestive of further downside.

Although a look at the same indicator on the weekly chart is unconvincing.

For practical purposes, these are both likely better used on shorter timeframes. But I was fooling around with the inputs and thought I'd share them.

That's all for now.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Friday, February 20, 2009

Scandals Multiply Like Cockroaches

Back in December we started learning about one of the biggest frauds ever perpetrated by one person. In my article, "Madoff Scandal a Microcosm of Social Mood," I stated:

These kinds of events feed off each other. From personal experience, I know that when you see a cockroach, you have cockroaches. There will be many more Bernie Madoffs. It was not his incredible arrogance or greed that allowed this to go on for so long. Rather it was the social atmosphere of neglect that led nobody to question it. Until now. Now people are starting to ask questions. Is my mutual fund invested in what they say it is? Are they invested in the real asset, or in a derivative of that asset? How else did they manage such great returns?

Like clockwork, we have learned of two additional scandals as social mood darkens, suspicions circle anything that smells bad and the lust for scapegoats to the financial crisis intensifies. Please consider:

Sir Allen Stanford served with legal papers

FBI agents tracked down billionaire R. Allen Stanford at the Virginia home of an acquaintance Thursday and served him with legal papers in a civil case accusing him of orchestrating an $8-billion investment scam.


The SEC announced its action against Stanford on Tuesday, alleging that the flamboyant billionaire and his two colleagues perpetrated "a fraud of shocking magnitude that has spread its tentacles throughout the world."

In Latin America and the Caribbean, where much of Stanford's operations are based, depositors have since besieged Stanford bank branches, demanding return of their money only to be turned away.

The Venezuelan government on Thursday seized a failed bank controlled by Stanford after a run on deposits.

Stanford's offshore financial services operations were subject to the regulatory authority of Antigua & Barbuda, the tiny two-island Caribbean nation that the 58-year-old Texan adopted as his second home and lavished with millions in sports promotions.

This latest scumbag was one of the many billionaires operating hedge funds out of the Caribbean tax havens. He attracted investors from all over the world, with significant contributions from Mexicans, Venezuelans, and Antiguans. Note that he was knighted. Antiguans didn't care if he was a fraudster years ago. All they knew was that he was rich. And thus, he was deserving of a title of nobility. Also note that he was a significant donor to the Obama presidential campaign.

Speaking of tax havens, another one has come under scrutiny. Switzerland.

UBS Agrees On Tax Fraud Settlement in US

Switzerland's largest bank, UBS, has agreed to pay $780 million (SFr915.8 million) and name some United States clients to resolve criminal fraud charges against it.

The deal is to settle the claim that UBS helped wealthy American clients evade taxes. It could expose some UBS customers to US Internal Revenue Service scrutiny and law enforcement action

Is this news to anyone? No. It has been widely understood for decades that the wealthy have used Switzerland as an offshore banking haven. Why the scrutiny now? We need look no further than the darkening social mood and general disdain toward the wealthy and the banking industry specifically.

People are angry. They are distrustful. That anger and distrust leads them to scrutinize aspects of society that they had previously ignored. This leads them to uncover frauds like the Madoff and Stanford schemes. This outrages people even further. It is a vicious cycle.

Anyone who became wealthy in the previous period of social nihilism will be persecuted. First it will be the big fish. Then the little guy who thought he could get away with some accounting shenanigans. Then anyone wealthy will be perceived as a criminal - guilty or not.

It will get to the point that people will go out of their way to appear worse off than they really are. No more yachts and garages full of toys to impress the neighbours. The neighbour lost his job. The culture of frugality will engulf all.

And so deflates our culture of consumerism. Good riddance.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Tuesday, February 17, 2009

Is Nationalization the Answer?

The growing consensus among financial experts and economists who still have some credibility left is that stimulus packages and bailouts are only having limited effect in the near-term, and are destined to fail in the intermediate-term.

While this is no surprise to anyone in possession of their own thoughts, those operating from corrupted textbooks are now finally starting to understand that the only other legitimate option is for these failed institutions to go bankrupt.

Nouriel Roubini was the latest to take to the idea. Bloggers Yves Smith of Naked Capitalism and Calculated Risk both support it in one form or another. Many others are on board.

Of course, "bankruptcy" is a dirty word. It implies that something new would have to be constructed to replace the old. This is dangerous territory for closed minds. They'd rather see certain parts of our financial system salvaged, thus enabling the same crooked system to return and perpetrate the same problems all over again. So they have come up with another term: "Nationalization."

I suppose they're on the right track. Even if they're going in the wrong direction. Still, that's a giant step forward from their "of another solar system" ideas most have given us previously. For that, I give them my applause.

For most, the term "nationalization" has connotations of military dictators confiscating foreign interests in a misguided attempt to return it "to the people." Fret not, the proposals going forward are nothing of the sort. No sane person would want the big banks. Not even power hungry government. I doubt even Barney Frank or Nancy Pelosi would be foolish enough to take ownership of the banks in an attempt to do the lending themselves. But maybe I'm giving them too much credit.

In effect, "nationalization" as it is being proposed is merely a synonym for "bankruptcy." To that end, I welcome it with open arms. The proposed plan would:

- be done unilaterally and without warning
- wipe out common share holders
- wipe out preferred share holders
- guarantee depositors (likely only to a certain limit)
- leave bondholders with the scraps (which in most cases would be nothing)
- cleaned up banks would then be re-privatized

To be sure, it's not just a matter of taking a pill and expecting things to be better right away. It's more like an enema. Uncomfortable. Unpleasant. Even painful for some...or so I'm told. There will be some big time consequences and an enormous amount of deleveraging would immediately result. Pension funds would be forced to accept the reality that their lopsided bets on juicy dividend paying financials would receive a goose-egg. Hedge funds would be stuck with derivatives that have experienced "credit events" but will find that there is no counterparty to pay up. Most of them would go under too.

Surely doing something like this would likely see a sizable crash in world stock markets, a further flight out of real estate assets, and a dizzying spike in unemployment.

But that is going to happen anyway.

So I like this plan for a few reasons:

1. It comes close to addressing the fact that these assets are not worth nearly what we're told
2. It punishes those that took risks and rewards those that did not with lower prices
3. It gets the bulk of deleveraging out of the way sooner, rather than dragging the process out over decades (ie. Japan 90's and US 30's)
4. It accelerates the uncovering of another enormous bubble yet to pop - pension funds

Unfortunately, I highly doubt any of this is a politically acceptable possibility. It wreaks of "short-term pain for long-term gain." That is not a language spoken in political capitals anywhere, let alone Washington where they're already looking forward to the next election (mid-terms 2010).

Frankly, this is the same sort of process that needs to take place in the auto makers, airlines, newspapers, and many other dead or dying industries. More needs to be done, of course. Repealing legal tender laws, for example. But liquidation is a start.

If the prices are low enough, competent people will take over the assets and rebuild the companies. Some of them may not come back (like the late, great US piano industry - a very good read, btw), but at least resources will be freed up to positively invest in something useful, thus creating employment).

It all reminds me of battles I used to have with my old late 90's PC. It would get so overloaded and so slow, that simply loading one page would take over a minute. No matter what I did, that stupid hourglass would pop up. Each action I took would take longer, and longer, and longer. And then... crash. Any unsaved information was lost forever. On a few occasions, after being forced to go nuclear and press the power button, the worst would happen: the blue screen of death.

If only I had been a little more proactive. Restarting the computer every once in a while. Making backups of information and reinstalling Windows. So much wasted time swearing and cursing could have been saved. I probably could have got another 2 years use out of that machine, had I only done the proper maintenance.

Let's be proactive.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Sunday, February 15, 2009

Anecdotes of Deflation

Earlier this week, Mike Shedlock pointed out some very relevant articles in Have Your Cake and Lend it Too. Among them were:

Banks: Feds Telling Us to Keep Cash and Lend it

NEW YORK -- Banks that are being scolded by the government for not lending are blaming a new obstacle: The government itself.

Fearing more bank failures, federal regulators are forcing institutions to hold more money in reserve and scrutinizing loans. But bank executives complain that the extra oversight thwarts their ability to quickly pump billions of bailout dollars into the ailing economy.

Banks say they are caught in a frustrating Catch-22: How can they make more loans when creditworthy borrowers are scarce, their balance sheets are saddled with bad debt and regulators are hounding them to horde cash?

"We want to lend, but the regulators are flat-out telling us, 'Get your capital up.' Then there's Congress telling you to lend it all out," said Greg Melvin, a board member at FNB Corp., a Hermitage, Penn.-based bank that got $100 million in bailout money.

"Two arms of the government are saying exactly the opposite thing - it's ridiculous," added Melvin, who is also chief investment officer at investment firm C.S. McKee.


Four government regulators oversee the country's roughly 8,500 federally insured banks and thrifts: the FDIC, the Office of Thrift Supervision, the Federal Reserve Board, and the Office of the Comptroller of the Currency.

Regulators shut down 25 banks last year and closed three so far this year because their capital levels fell too low. Meanwhile, regulators have ordered several banks to stop lending until they get more capital.

But the credit crisis has made it harder for banks to raise private capital. And the government doesn't want to give bailout money to banks that might later fail.

The fact that there are four separate regulators in charge of ensuring sound banking principles, yet this crisis occurred anyway may strike some as odd. Especially considering the oft trumpeted cause of the crisis is "lax regulation." How many more regulatory bodies would have prevented the crisis? 5? 20? That answer is never given. They always just claim "more." That way when regulation fails again, they can still claim, "it wasn't enough." Not a bad little deal they have going for themselves.

That is to say nothing of the explicit role many of those regulators played in perpetuating the crisis in the first place via moral hazard, implicit guarantees of reckless activity, or wink-wink, nudge-nudge agreements with fraudsters like Bernie Madoff.

But I digress...

"I'm skeptical," Democratic Rep. Barney Frank of Massachusettes, chairman of the House Financial Services Committee, told The Associated Press in an interview. "If you're a bank that has TARP money, then you have more capital and you should be able to lend."

Frank said the Obama administration would push for more lending by banks that get bailout money. But others fear such efforts could backfire by forcing banks to lower lending standards.

Barney Frank is a idiot. After months of sitting on the financial services committee and pushing for bailout after bailout, he still can't figure out why troubled banks are asking for money. On a daily basis more and more of banks' assets become impaired requiring higher loan/loss reserves. When those impaired assets eventually default, the banks take the loss, drawing down their reserves. Complicating matters are trillions of "assets" being held off the balance sheet.

Any spare cash donated by generous taxpayers goes directly into the black hole that are these many trillions of impaired assets. So no, Mr Frank, if you are a bank and you have TARP money, you are no more able to lend than anyone else. You're immediately right back where you started minus a tiny fraction of your total impaired assets - soon to be replaced by further falling asset prices.

Ok, so the problem is that the bailouts just aren't big enough. Let's just shower the banks with trillions. Buy up every single stinking piece of garbage on and off their balance sheets - regardless of the cost. Then they won't have any choice but to lend the money. Right? Think again.

The following article reminds us that a loan is a two-way agreement. Somebody needs to be willing to take on the debt at interest on the other side.

MidSouth Loses Would-Be Borrowers as TARP Fails With Louisianans

Feb. 12 (Bloomberg) -- C.R. “Rusty” Cloutier of MidSouth Bank wants to heed President Barack Obama’s call to lend money. It’s his customers who aren’t paying attention.

Cloutier, chief executive officer of MidSouth Bancorp Inc. in Lafayette, Louisiana, received a $20 million cash infusion from the U.S. government on Jan. 9 and instructed loan officers to line up borrowers. Then he went on the road to make personal appeals at 14 town hall meetings.

“What we want to do is make people aware we have $250 million to lend,” Cloutier said Jan. 28 at the branch in downtown Lafayette. The 20 or so in the audience were outnumbered by bank employees handing out cookies and bottled water. Nobody asked for an application.

Try to picture that in your imagination. In mine "Rusty" is dressed up as a clown, juggling Mortgage Backed Securities on a unicycle to a background of circus music. The audience is unimpressed. Looking at each other. Shaking their heads. They don't even want the cookies, let alone another mortgage.

Outstanding loans and credits at commercial banks fell to $7.057 trillion in the week ending Jan. 28 from $7.266 trillion in October, according to the Federal Reserve.

“If people thought the government would give banks money and they would turn around and leverage that and lend it, that’s not the way it works,” said Robert E. Litan, a senior fellow in economic studies at the Brookings Institution in Washington.

Ding, ding, ding. We have a winner! Indeed, that is not how it works. In a credit-based economy it works the other way. Banks make loans based on a multitude of factors, the loan is recorded as both an asset and a liability on their balance sheet. Later on, they go searching for deposits to satisfy capital ratios. Orthodox economists like Bernanke or Krugman and political hacks like Barney Frank see that A (bank lending) typically corresponds with B (total reserves). Therefore, by increasing B, A will naturally follow. This is wrong. Correlation does not imply causation. B simply piles up, because it's utility was a function of A, now absent.

Before I get too far out of my mathematical comfort zone, I'll again refer readers to Steve Keen's far more eloquent explanation of this phenomenon. If you haven't already, take a week off work and read it.

Complicating matters further, FDIC Shutters Four Banks in One Day

Loup City, Neb.-based Sherman County Bank, Cape Coral, Fla.-based Riverside Bank of the Gulf Coast, Pittsfield, Ill.-based Corn Belt Bank and Trust Company, and Beaverton, Ore.-based Pinnacle Bank were closed by regulators Friday, bringing the number of U.S. bank failures for 2009 to 13 and 38 total since the start of the credit crisis, the Federal Deposit Insurance Corp. said.

Total cost to the FDIC of these failures is $340 million. A relatively small number in comparison to the figures being thrown around lately. But the bigger issue is the precedent it sets for the other 8,500 banks.

Lost in all of this is the gross inconsistency of policy by the FDIC. If any of the large banks were to be somewhat truthful of their holdings, they would also be shuttered by the FDIC. However, because they have 1000s of lobbyists working for them and are well-connected, they qualify for a special status of "too big to fail." Those concerned about corporate oligopolies need look no further to find that the main (and only) enabler of such arrangements are governments themselves. Without government assistance, their size was never otherwise attainable.


- Banks are being told to lend and not to lend at the same time
- Banks cannot lend because their balance sheets are black holes of impaired assets
- Consumers and Businesses don't want to borrow - and can't even be enticed with free cookies
- Regulation does not prevent financial crises - it causes them
- Giving banks money and expecting them to lend it is a backward understanding of our financial system
- Monopoly is only possible with government favoritism of large firms

That's quite the list of accomplishments for a Sunday. I think I deserve a Weißbier.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Saturday, February 14, 2009

Eastern European Crises Spread West

I don't often just repost entire articles of others. However, after reading primarily North American news, I understand how limited good information about the rest of the world is to come by. Ambrose Evans-Pritchard of the UK Daily Telegraph has consistently been providing front-line info from the Eurozone. Although he is hindered by his orthodox economic education in trying to suggest solutions, that has not stopped him from rejecting the common maxim of "kumbaya" in Europe and pointing out the obvious storm that is brewing. Much of the information contained in the following article was not new to me, but I had only read of it in newspaper footnotes while doing my daily "German reading comprehension" exercises - not exactly reliable. Some of this is completely new to me. But what this article does is compress much of the most important info into a small space. I'll spare you of my interjections. But you might want to get comfortable before reading this.

Failure to Save Eastern Europe Will Lead to Worldwide Meltdown

By Ambrose Evans-Pritchard
Last Updated: 9:23PM GMT 14 Feb 2009

If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the
ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East.

Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Stephen Jen, currency chief at Morgan Stanley, said Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.
"This is the largest run on a currency in history," said Mr Jen.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

Under a "Taylor Rule" analysis, the European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

But I digress. It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, told me the region may need €400bn in help to cover loans and prop up the credit system.

Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights.

Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

"This is much worse than the East Asia crisis in the 1990s," said Lars Christensen, at Danske Bank.

"There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU."

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter.

If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.

The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

So we watch and wait as the lethal brush fires move closer.

If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?

Pritchard suggests throughout that if somebody were to do something, this could all be averted. There is more debt in the system than there is capital. Default is the only possible solution. No amount of firemen can put out an avalanche.

Lastly, I'm not so sure when this will all culminate. Suggesting that chaos will occur in days or weeks, like Pritchard does, is mere speculation. But it will happen. There will be failed states and political turmoil.

To me, this is far more interesting than 600 idiots quibbling over a few billion in a stimulus package.

But that's just me.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Friday, February 13, 2009

Technical Update 5.09

The market continues to hold support like a champion.

A number of key averages were testing their last line in the sand going into the final hour of trading Thursday, when the Obama Administration "pushed the button" with some sort of mortgage gimmick. We know that the impact of these interventions are only very short term in nature. Ultimately, markets will go where they want to go.

In the long term, mid-market policy announcements will only serve to increase uncertainty. With increased uncertainty comes decreased liquidity. And with decreased liquidity comes increased volatility.

But for now, we have another rally to deal with. I don't know why, but I can't shake the idea that the "path of greatest frustration" would be for this rally to continue a little bit higher than the last few before turning around again. But maybe I'm overthinking matters.

Thursday marked a "peek-a-boo" break of the lower boundary of the triangle. As the market saw goes, "the second bird gets the worm." In order for a test of the upper boundary of the triangle to transpire, there is the minor issue of resistance all along the way at numerous levels before it gets there. For the record, I'm doing more watching than trading while this unfolds.

Some other indices were revisiting their November lows yesterday. Among them were the "strongest in the world" Canadian Financial Services sector:

The Dow Transports are also playing with fire. I consider the trannies a leading indicator.

And even though consumer staples are supposed to be "recession resistant," we can see them struggling as well. There are no safe havens in a depression. The staples sector is currently trading at a 1 year trailing multiple of 13.7 and dividend yields of 3%. At the bottom of a bear market we should see this sector trade for less than half that and for dividends yielding more than double.

This is not the underpinnings of a strong and robust market. That's not to say there are no bright spots. Select tech sectors appear to be very healthy. Some of the stronger companies (like Cisco) have been raising money without problems and intend to use that to grow their businesses. But as of now, the total market capitalization of the Nasdaq is 1/4 the size of the NYSE. I expect that to change in the future (a subject I intend to explore further), but it will be a slow process. Until then, the dog wags the tail.

Gold continues to push higher. The advance "makes sense" in that it is a store of value in uncertain times, but I still think holders of the metal (mostly via the ETF GLD, rather than taking possession of physical coins or bars) are more speculating on skyrocketing prices than attempting to simply preserve their wealth. I'm waiting for a washout of these speculators before the next leg of the bull market takes hold. I don't dislike gold, but I do think it is still widely misunderstood.

That's all for now.

Wednesday, February 11, 2009

European Disintegration Continues

As tweedle-dee and tweedle-dum capture the imaginations of only a select remaining few with their "something left to be desired" speeches, the rest of the world continues to unravel at an accelerating pace.

Over in Europe, the major leaders are doing their best to destroy what is left of the Union. I had thought that this would be a slow progression. But at the rate the rhetoric is picking up, I doubt the EU or the EMU make it through the summer. Consider the following:

Europe Ambushes Germany on Debt Bail-Out

EU finance ministers are to discuss proposals over breakfast in Brussels today for some form of "debt-agency" or mechanism for the EU to raise bonds, a move seen by diplomats as a ploy to ambush Germany into accepting shared responsibility for EU debts – anathema to Berlin.

Concern is mounting over the dramatic deterioration of public finances across the EU. Ireland's deficit is heading for 12pc of GDP, and there are doubts over whether Italy and Greece can roll over some €250bn (£218bn) in state debt between them this year.

EU company debt is a worry too, now 95pc of GDP compared to 50pc in the US. "The amount of debt to roll over in the eurozone is huge, at a time when banks are tightening credit standards," said Gilles Moec, from Bank of America. "Spanish businesses are in a dire situation."

The amount of vital information packed into these three paragraphs is about equivalent to what you would read in an entire issue of the Wall Street Journal. Indeed, Germans are becoming increasingly annoyed with calls, rather demands, for Germany to shoulder the burden of Southern Europe's debt binge of the last 10 years.

Germany is not immune to feeling the squeeze of the global depression. Industrial production fell 4.6% in December compared to a year earlier. Announcements of layoffs and reduced work hours are daily occurrences here as well. Volkswagen recently cut work hours for 86,000 employees. German workers who are losing their jobs or having their wages cut are not taking kindly to requests from Spain or Ireland to fork over billions.

It was never supposed to happen this way. The strong nations were always assumed to be able to help the weak. The entire blueprint of the EU was drawn up with the same principles as models for the US economy. It was assumed to be at equilibrium before making assumptions as to what would occur in the event of isolated problems. A complete collapse of all markets simultaneously was never incorporated into the model. Now that it is happening, is it any wonder that the individual nations revert to finger-pointing and protectionism?

A very apt blog post by Bruno Waterfield at the Daily Telegraph highlights this accelerating devolution. From the post:

Intensive, even frantic, talks are going on behind the scenes to keep the lid on the political fall out from the economic meltdown.

The European Commission and Czech EU presidency, they took it over from France on Jan 1 (it hasn't been easy, see here and here), have announced an emergency summit for the end of February.

The emergency? Nicolas Sarkozy.

The French president's threat (made in Munich, where there are bad memories for the Czechs) to call a crisis meeting of the eurozone countries in Paris has set the cat amongst the pigeons.

It is not his job for starters.

But he has made little secret of his desire to run the show and has treated the Czech EU presidency, who are supposed to be in charge, with true old Europe patrician contempt for "parvenu" East European members of the club.

Sarkozy is rapidly turing into a thorn in the side of anything non-francophone. His rhetoric is angering not only the Czechs, but everyone. Recent comments will ring a familiar tone to Canadians worried about provocative statements from the new Obama administration about a "Buy American" push.

To recap, Mr Sarkozy last week pointedly referred to a Peugeot-Citroen plant in the Czech Republic to say that planned French government aid to automakers would be on the condition that all cars would be "Made in France".

This is what he said: "If you build a Renault plant in India to sell Renaults to Indians, that's justified, but if you build a factory, without saying the company's name, in the Czech Republic to sell cars in France, that's not justified".

Like it or not, that is what the EU's single market is all about. Is Mr Sarkozy now against it? Question that and then what is left for the EU?


Prague is furious.

Mirek Topolanek, the usually unflappable Czech PM, has lashed out by warning Mr Sarkozy that the Lisbon Treaty, much beloved in Paris and Berlin, might be a casualty.

"If someone wanted to really jeopardise the ratification of the Lisbon Treaty, he could not have chosen a better way and a better time," he snarled on Monday.

A Czech statement: "As the Prime Minister of the Czech Republic I do not understand the argument that it is unjustifiable to manufacture cars for the French market in the Czech Republic. The attempts to use the financial crisis to introduce such forms of protectionism and protective measures may slow down and threaten the revival of the European economy".

All bets appear to be off. Europe is disintegrating into the same protectionist tendencies that accompanied every other economic slump.

How people actually believed that Europe was going to keep on chugging along while the US and the Dollar gradually waned to irrelevance is beyond me. The talk of the Euro overtaking the US Dollar as reserve currency of the world never made any sense. Yet that didn't stop a number of well-known analysts to tout Europe's "relative safety" as grounds for buying stocks or the Euro itself. Now the truth has been revealed. The problems in Europe are every bit as dire as those in the US. And that cannot be stressed any better than yet one more article from the Telegraph:

European Banks May Need 16.3 Trillion Pound ($24 Trillion USD) Bailout, EC Document Warns

No that is not a typo. That is Trillion with a capital "T".

A secret 17-page paper discussed by finance ministers, including the Chancellor Alistair Darling on Tuesday, also warned that government attempts to buy up or underwrite such assets could plunge the European Union into a deeper crisis.

National leaders and EU officials share fears that a second bank bail-out in Europe will raise government borrowing at a time when investors - particularly those who lend money to European governments - have growing doubts over the ability of countries such as Spain, Greece, Portugal, Ireland, Italy and Britain to pay it back.

“Estimates of total expected asset write-downs suggest that the budgetary costs – actual and contingent - of asset relief could be very large both in absolute terms and relative to GDP in member states,” the EC document, seen by The Daily Telegraph, cautioned. “

"It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems.”

Sadly, these are the types of numbers that are somewhat reflective of reality in both Europe and the US - although the only way for people to be exposed to an inkling of the truth is via "leaked documents." However, these numbers are only reflective of the current state of affairs. They do not take into account any further deterioration in asset prices - something that is sure to happen as job losses accumulate and rising inventories of nearly everything forces further liquidation. Back to the article:

European Commission officials have estimated that “impaired assets” may amount to 44pc of EU bank balance sheets. The Commission estimates that so-called financial instruments in the ‘trading book’ total £12.3 trillion (13.7 trillion euros), equivalent to about 33pc of EU bank balance sheets.

In addition, so-called 'available for sale instruments' worth £4trillion (4.5 trillion euros), or 11pc of balance sheets, are also added by the Commission to arrive at the headline figure of £16.3 trillion.

Banks account for their assets in different ways. Assets put into the “trading book” have to be marked to current market values, while those in the “banking book” are loans and other assets which the institution believes it can hold to maturity. Other assets are classified as “available for sale”, which are also marked to market values.

Again, this isn't just the reality in Europe. A similar amount of bank assets are impaired in the US. Japan and the rest of the world could probably claim the same amount or more. Yet an admission to that has not been forthcoming. Banks continue to proclaim that they can hold their debts to maturity and retain 100% of their value. But debtors are defaulting on these assets at a rapidly increasing pace. There is no credibility to the claims.

The Commission figure is significant because of the role EU officials will play in devising rules to evaluate “toxic” bank assets later this month. New moves to bail out banks will be discussed at an emergency EU summit at the end of February. The EU is deeply worried at widening spreads on bonds sold by different European countries.

In line with the risk, and the weak performance of some EU economies compared to others, investors are demanding increasingly higher interest to lend to countries such as Italy instead of Germany. Ministers and officials fear that the process could lead to vicious spiral that threatens to tear both the euro and the EU apart.

“Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance,” the EC paper warned.

We're getting closer to another "point of recognition." The deflationary impact of this realization should make it clear to most that a reinflation attempt by central banks or governments ain't gonna work.

(Update: The above article claiming those numbers has been censored by the Telegraph. The three excerpts above were the original article in it's entirety) -- Matt

Monday, February 9, 2009

It Ain't Gonna Work

Allow me to put away my tinfoil hat and replace it with one I'm more comfortable with: Railing against idiotic economic central planning. And there's been plenty of news on that front over the last week. Please consider:

US Delays Finance Plan as Officials Debate Debt

Treasury Secretary Timothy Geithner delayed the announcement of the Obama administration’s financial-recovery plan as officials debated proposals aimed at addressing the toxic debt clogging banks’ balance sheets.

Some aspects of the plan, to be announced by Geithner tomorrow in Washington, have been settled. They include a new round of injections of taxpayer funds into banks, targeted at firms identified by regulators as most in need of new capital, people briefed on the matter said. A Federal Reserve program designed to spur consumer and small-business loans will be expanded, possibly to include real-estate assets, they said.

This is so far removed from the actual problem at hand that I'm almost left speechless. Almost. Months of preparations, meetings with bank officials, lawyers, and accountants have not proved to be enough for this band of geniuses to come up with a solution. But just one more day will be enough to come to some hard and fast conclusions? No. I'm sorry. No sane person could believe that. These people have absolutely no clue what is going on or how to fix it. It's like a veterinarian being asked to do heart surgery on a human. Their models are so distanced from reality that they provide no use whatsoever. An extra day?

Still outstanding is the issue Geithner’s predecessor failed to address: the illiquid assets that have caused the credit freeze. Officials continue to consider a so-called bad bank to buy them, perhaps in cooperation with private investors, such as hedge funds and private equity. It’s unclear how big a role there’ll be for federal guarantees of securities that remain on banks’ balance sheets.

Banks are “looking for clarity, we’re looking for this to be the complete package,” said Wayne Abernathy, an executive vice president at the American Bankers Association in Washington. “If they don’t have the details spelled out they will just freeze the market.”

"The complete package." It sounds like they're hocking entertainment systems. They have completely given up trying to say anything meaningful and all efforts are now focused on providing an image of being "in control." This idea of a bad bank doesn't make any sense. And attempts to get private capital to buy the assets should not have to be "attempted" if the securities were being offered at market prices. Why would private capital buy something for more than it is worth?

Anyone can see that such an idea does not make sense in theory or in practice. It is complete lunacy. They floated the same idea last year under a different name. Remember the "Super SIV?" The idea failed then for the same reasons it will fail now: It doesn't make any sense.

Over the last year I've seen numerous attempts by sane economists (stop laughing, there are a few) to try and explain how the current approach to fixing this crisis will not work. Every time such a plan has been put forward, it has been correctly predicted that it would fail by these same people. And the reason is simple: those trying to do the fixing are operating with a set of assumptions about the economy that are false. You cannot fix a solvency problem with liquidity. And that is what all of these solutions amount to.

People scream about a coming hyperinflation due to all of these bailouts and liquidity injections, yet they are operating from a false understanding of our economy.

Last week, Steve Keen, an Australian economist had a fantastic (and long winded) discussion about why all of this "stimulus" essentially amounts to a potato gun in a bazooka fight. I don't agree with everything Keen proposes, but his analysis of "what's wrong" is spot on. I highly recommend my readers take a look at this paper in entirety. The article is called, "The Roving Cavaliers of Credit," which is, yes, a reference to Marx. But don't let that dissuade you from reading it.

In the article, Keen attacks the popular belief of what money is and how it is created. We would like to think that the people making these trillion dollar bailouts and stimulus packages would at least have a decent handle on a subject so basic. But they don't. Bernanke, Geithner, Krugman and the rest of them cling to the fallacy that we live in a fiat money world. This is not true. Fiat money only makes up for about 2% of the entire supply of money, being printed and supplied by the Federal Reserve and by other central banks. The other 98% percent is lent into existence by private banks - not as a multiple of their reserves, but at a whim, knowing that they can create deposits for nearly every dollar lent out and search for reserves to back them up later.

Bernanke and the other neoclassical economists believe that the Fed controls the supply of money (via interest rates and other measures - now predominantly by "talking"). Yet Keen outlines quite clearly that is is blatantly false. That private banks create credit and the Fed follows with a lag by providing reserves. As such, the Fed creating reserves will not have the desired effect of expanding the money supply because it essentially puts the cart before the horse. From the article:

...from the point of view of the empirical record, and the rival theory of endogenous money, this will fail on at least four fronts:

1. Banks won’t create more credit money as a result of the injections of Base Money. Instead, inactive reserves will rise;

2. Creating more credit money requires a matching increase in debt—even if the money multiplier model were correct, what would the odds be of the private sector taking on an additional US$7 trillion in debt in addition to the current US$42 trillion it already owes?;

3. Deflation will continue because the motive force behind it will still be there—distress selling by retailers and wholesalers who are desperately trying to avoid going bankrupt; and

4. The macroeconomic process of deleveraging will reduce real demand no matter what is done, as Microsoft CEO Steve Ballmer recently noted: “We’re certainly in the midst of a once-in-a-lifetime set of economic conditions. The perspective I would bring is not one of recession. Rather, the economy is resetting to lower level of business and consumer spending based largely on the reduced leverage in economy”.

A prerequisite for a credit based monetary system is that the total credit supply needs to continually expand. Any contraction in credit (or even a slow-down in the rate of acceleration) would self-perpetuate itself through falling asset prices that further lower the demand for credit. This is happening now and has been for some time. Although Bernanke and other government officials talk of it as some future event that must be prevented. They don't want the psychology to ingrain itself in the minds of consumers. But it has already happened.

I've been talking about this for quite a while and wrote that "deflation is on the way" as long ago as late 2006. This was very easy to see by treating credit as an equal to money in our credit-based monetary system. People would simply send me charts of John Williams M3 charts like the one below along with a note saying something like, "M3 is expanding at 15%. You're wrong, hyperinflation is gold."

Unfortunately, charts like the one above are not as all encompassing as they purport. When home prices began to fall in 2006, and subprime mortgage lending began to be cut off, that was all the information required to know that the jig was up for the credit binge of the previous 10-25 years (depending on where you define your starting point '82 or '95). Certain credit instruments continued to expand (derivatives) but none of this had nearly the effect on the economy as did the falling asset prices around the world.

For example, we know that as of May 2008, total world equity markets were valued at approximately 60 Trillion dollars. They're now worth closer to 30 Trillion. According to, US real estate owners have lost 6.1 Trillion since the peak in mid 2006. I would assume a similar amount or more has been lost elsewhere in the world. And now commercial real estate values are plunging worldwide also.

These many trillions in wealth being destroyed have a far greater impact on the average person than does unused bank reserves piling up at the Fed or its member banks. And the numbers are orders of magnitude greater than the figures being thrown around by Obama and his new buddies Geithner and Bernanke.

Now I know the solution most will come up with in order to get banks lending again will be to nationalize them and have the government do the lending. Unfortunately, this won't work either because consumers and businesses no longer have the same motivations to borrow - asset prices are falling, so they would rather wait to expand business or buy a new home. Inventories of nearly everything are enormous and growing and the generation of people (mine) are buying from a more numerous pool of sellers, thus adding even more natural supply as the years go on.

The reasons are many and those understanding them are few, but it is apparent that none of the solutions being put forth will have anything close to the advertised effect. And by extension, there is no conceivable chance that the actions could have more than the desired effect and thereby send us on a Zimbabwe/Weimar style hyperinflation that would destroy the value of the dollar.

Quite simply, it ain't gonna work. Deflation. Full steam ahead.

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