tag:blogger.com,1999:blog-21214902375174627362024-03-13T12:27:46.237-07:00Futronomics: contrarian analysis of global macro trends, commodities, currencies, equitiesTopics typically covered include: intermediate and long-term prices of major asset classes, political policy implications for the macroeconomy, socionomic and demographic influences on markets, deflationary vs. hyperinflationary influences, wealth preservation techniques, and more. Analysis is typically done with Austrian Economic Principles in mind... Site is run by Matt Stiles.Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.comBlogger264125tag:blogger.com,1999:blog-2121490237517462736.post-26398199927869578772010-03-05T10:39:00.000-08:002010-03-05T12:47:22.557-08:00Blog UpdateAfter quite the party throughout the Olympics here in Vancouver, capped off by a brilliant victory in men's hockey (take that!), I have had some time to evaluate how I am using my time to maximize the return on my existing skills and to simultaneously build skills that can be used in the future. Long-time readers of this blog know that this blog itself has generated no income, nor was it ever intended to do so. Income has been generated by my own speculative activities and some writing assignments for local financial firms. <br /><br />Five years ago I made a decision to pursue an education on my own terms. A practical education filled with real-world experiences and a "learn by doing" mentality. My other option was "what everyone else was doing." Going to university, racking up $100,000 plus of debts and coming away with a piece of paper declaring my competence. This piece of paper, I was told, would increase my earnings potential by about 20% for the first 10 years of my working life, at which point it would become more or less irrelevant. The math didn't make any sense. With the interest on the debt, even a high starting salary wouldn't pay it off in ten years. And to top it off, I was surrounded by people who already had degrees but couldn't find work in their trained fields. They went back to coaching tennis or doing security. It really was an easy decision. <br /><br />Over the past five years I have done proprietary trading for a small financial institution, managed my own account, operated this blog, attained a number of professional certifications in the financial services industry, and spent countless hours reading and researching economic theory, business cycle theory, economic history, the financial markets, capital flows and anything in between that interested me at the time. I have had the luxury of doing all this while living for extended periods of time in Europe and South America, gaining important cultural insights. I'm 27. I have no debt and a little stash of savings. <br /><br />Far from suggesting that I can't learn anything else (the more I learn, the more I learn how little I know), I have indeed reached a point where this sort of self-directed process has met the law of diminishing returns. It has come time for me to apply what I have learned in another fashion. <br /><br />I again had two options. The financial services industry was where my training naturally directed me toward. But being under 30 with my qualifications only gave me access to a few entry level positions. Positions abound for "investment advisors" at all the major institutions in Canada. They could just as accurately title the position "Shameless Mutual Fund Salesperson", because that is what they do: siphon their customers into a "balanced" portfolio of instruments that garner the highest sales fees possible. I couldn't, in good conscience, resign myself to this pitiful existence. Alternatively, I could be an "Investor Relations Representative" for a small junior mining company. Being paid primarily in stock options, whose value is dependent on some geologist finding a hot hand? Thanks, but no thanks.<br /><br />So the option remaining is to use my financial background by pursuing small business development. And as it turns out, there is a family business in need of a new manager. It has a stable earnings flow and significant potential for expansion. Starting now, the majority of my time will be spent improving this business. <br /><br />What this means for my readers, unfortunately, is that regular updates to this blog will no longer be a priority. I will continue to read a good amount of financial news, and thus, should have no problem keeping the "recommended reading" links updated regularly. Surely, I will at some point get antsy and feel like I should write something (or rant about something). Gone will be watching the markets tick-by-tick as I have for these past 5 years. Perhaps eliminating this short term oriented habit will help me gain a different perspective of the markets. <br /><br />I'd like to thank my long-time readers for their support, encouragement and advice. I have, indeed, gleaned as much insight from your feedback as I have provided to others. And that was my entire motive of this little project.<br /><br />Thank You!<br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com104tag:blogger.com,1999:blog-2121490237517462736.post-59464675302249814362010-02-15T16:19:00.000-08:002010-02-15T18:50:32.748-08:00Market Update 06.10A week of choppy trading saw the major indices gain about 1 percentage point. There were violent swings in both directions as rumours swirled in Europe of the Greek fiasco. If you've been reading my links on a daily basis, you've probably got a pretty good handle on the issues. I'll summarize the most important points here: <br /><br />1) The ECB is constitutionally forbidden from acting unilaterally to assist any one nation or group of nations<br />2) The IMF has a US veto over use of funds and the issue is too large for them to handle<br />3) Germany and Holland and Scandinavia cannot assist Greece because<br />i) politics - Germany underwent austerity to facilitate the EU's formation - telling them now to bailout profligate nations is politically impossible<br />ii) bailing out Greece will immediately lead to eyes laid on Portugal. Then Spain, Ireland, Italy, UK, France, etc.<br />iii) moral hazard is obvious<br />iv) adding the debt burdens of Club Med will put Germany's implied debt burden in just as poor shape as Club Med itself. Interest rates on Northern debt would rise<br />4) Letting Greece fail would cause a cascade of sovereign failures<br />5) Bank exposure to Greek debts in Germany, France, Switzerland is huge and enough to paralyze their credit markets<br />6) Nobody can devalue in a monetary union<br />7) Austerity in Greece, Portugal and Spain is apparently not an option. Workers refuse to accept lower wages. Politicians are resorting to pointing fingers, citing fear mongering and rumour spreading<br /><br />All routes lead to collapse of the monetary union. Germany bails out one, they must bail out all of them. This will incite political and financial collapse in Germany. Let one fail, the rest will fail by way of precedent and private banks all go down with them. Austerity is politically impossible (unemployment is already sky-high for example). Austerity in socialistically-minded economies will lead to complete depression. <br /><br />Yet most market analysts continue to believe that "something will get worked out." It is only their optimistic mindset that supports this view, not any kind of sound logic. And the buoyancy of markets is reflective of this. The second leg down in the <span style="font-style:italic;">Great Credit Crisis</span> will be led by the unwind of this baseless optimism toward solutions that don't exist. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S3nuaS_aZoI/AAAAAAAAA7Q/6iN6JRLBtGw/s1600-h/spx15.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S3nuaS_aZoI/AAAAAAAAA7Q/6iN6JRLBtGw/s400/spx15.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5438640160568403586" /></a><br /><br />See above the multiple 10-15 point swings last week on their way to nowhere. As I often repeat, "oversold conditions can work their way off by either time, price, or both." This week's choppy rise has successfully rooted out many of the oversold readings, and it has done so without inflicting much technical damage to the downtrend. <br /><br />Also notice the evident complacency among traders, who, despite violent swings in both directions last week put a much lower price on options. Implied option volatilities are worth 23.3% less on the 1075 close friday than they were at about 2:30pm the previous Friday with the S&P at 1044. If that sounds excessive, it's because it is. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S3oDtdZtQCI/AAAAAAAAA7Y/s4qHF0Jrt7Q/s1600-h/vix.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S3oDtdZtQCI/AAAAAAAAA7Y/s4qHF0Jrt7Q/s400/vix.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5438663579524743202" /></a><br /><br />We'll see if the greater downtrend prevails this week. Another week of gains would likely put it in jeopardy. <br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com8tag:blogger.com,1999:blog-2121490237517462736.post-58197408623449781732010-02-13T17:02:00.000-08:002010-02-13T17:14:42.247-08:00Note To ReadersPosting will be light over the next few weeks. The Olympics have rolled through my neck of the woods. I took a part-time gig just to be a part of the action, which has naturally turned into full-time with more responsibility than planned. I'd also like to spend some time mingling with the foreigners, etc. Oh, and I'm battling chronic tonsillitis. Nice! <br /><br />I'll at least keep the links updated and some charts on the weekend, but suffice to say I'll only have one eye on things. I'm sure you'll all be totally lost without me. <br /><br />I kid. <br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com10tag:blogger.com,1999:blog-2121490237517462736.post-19927938632158019272010-02-08T19:52:00.000-08:002010-02-08T21:21:04.835-08:00Market Update 05.10I'm a little late this week, but with the benefit of Monday's session, I think we have some added evidence for the beginning of a multi-month decline. The character of this latest selloff has a different feel than either the July or October selloffs. I would venture to guess that if I asked people a month ago that we'd have an unemployment rate of 9.7% and GDP growth of 5.7% (annualized), the stock market would be squeezing shorts into oblivion and trudging yet higher toward the heavens. <br /><br />Not so. Apparently, good news only mattes when, well, when it matters. If the stock market goes down, then the good news doesn't matter and something else does. Got it? Right. Perhaps it is best to pay greater attention to the bigger fundamental picture and what the market <span style="font-style:italic;">does</span>, rather than the monthly or weekly data. People decide what stocks are worth based on their emotions. And their emotions appear to be directed by something other than the monthly data. The best explanation I have found for this phenomenon is that people merely take their emotive cues from each other - oscillating between optimism and pessimism.<br /><br />Right now, everyone feels panicky about the situation in Greece, Portugal and Spain. But these problems are not new. They've been problems for a good 5 years now. The difference is that people are now paying attention to them. But I am sensing a great deal of complacency about the nature of this decline. Most sound completely certain that it is only a minor correction. And this gives me greater reason to believe that a far larger decline is upon us. See the chart below where a survey of 140 newsletter writers shows quite a decline in bullish sentiment, yet a far smaller increase in bearish sentiment. Notice how the two typically inversely correlate perfectly. But this time, we see a very strong resistance to the idea of becoming outright bearish. <br /><br />(Data as of last Tues) <br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S3Dnj3D7oJI/AAAAAAAAA6o/sHE3BFfRFGU/s1600-h/ii4.gif"><img style="cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S3Dnj3D7oJI/AAAAAAAAA6o/sHE3BFfRFGU/s400/ii4.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5436099353498067090" /></a><br /><br />Elliott Wave patterns have been extremely compelling on the way down. This is in contrast with the October selloff, where one had to stretch to count 5 waves down and when it rallied, it rallied very compellingly. The bounces on this selloff have been weak and overlapping. The implication is that a 3rd of a 3rd wave down is just beginning. Support resides in the 940-980 range. <a href="http://2.bp.blogspot.com/_TwUS3GyHKsQ/S3B-i-pwBuI/AAAAAAAAD4M/4-8jClauTTk/s1600-h/indu.png">This count</a> from <a href="http://danericselliottwaves.blogspot.com/2010/02/elliott-wave-update-8-february.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+DanericsElliottWaves+%28Daneric%27s+Elliott+Waves%29&utm_content=Google+Reader">Daneric's Elliott Wave Blog</a> looks like the most probable from my perspective. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S3DrjXrH60I/AAAAAAAAA6w/fi1b2VGQn6E/s1600-h/spx5.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S3DrjXrH60I/AAAAAAAAA6w/fi1b2VGQn6E/s400/spx5.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5436103743119027010" /></a><br /><br />The Euro/Yen cross has been a reliable indicator for risk aversion over the past few years. While I feel that trend will break at some point, it still bears watching. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S3Dr4wUrHxI/AAAAAAAAA64/O9AlLNG4Wl0/s1600-h/xeuxjy.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S3Dr4wUrHxI/AAAAAAAAA64/O9AlLNG4Wl0/s400/xeuxjy.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5436104110513004306" /></a><br /><br />Gold needs to hold the 200 day EMA to avoid significant technical damage. I think a test of the April lows at $865 is a best case scenario. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S3Dt9W1DyVI/AAAAAAAAA7A/ox5fUhpH3No/s1600-h/gold.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S3Dt9W1DyVI/AAAAAAAAA7A/ox5fUhpH3No/s400/gold.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5436106388592118098" /></a><br /><br />The weekly chart of oil is not looking pretty. I've pointed out the bunched up moving averages before, and they usually portend a major move in one direction or another. I still think we see new lows for oil as speculators unwind their positions. A sustained break of $70 would be very bearish. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S3DuwI2GzNI/AAAAAAAAA7I/2RVtNV8CQ64/s1600-h/sc.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S3DuwI2GzNI/AAAAAAAAA7I/2RVtNV8CQ64/s400/sc.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5436107261011741906" /></a><br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com3tag:blogger.com,1999:blog-2121490237517462736.post-16174181039643458562010-02-06T17:33:00.000-08:002010-02-06T20:48:54.801-08:00Themes For 2010 - 6 - Final ThoughtsLast month, I ran a series of pieces detailing my outlook for credit markets, the economy, asset markets, and government interventions in them. <br /><br />The overarching theme was that a secular shift had occurred in 2007 toward the reduction of debt and leverage within our economies. 2008 was the point of recognition. In 2009, we experienced a barrage of "fix-its." Most of these programs were designed to either conceal the actual problem, transfer the obligations to others, and to otherwise re-instill confidence in asset price valuations. The natural tendency for market participants to fluctuate between pessimism and optimism resulted in the perception that these programs had worked and that "normalcy" had returned. <br /><br />But our concept of "normal" had been skewed by the previous secular shift, which was anything but normal. Its duration of over 3 decades was sufficient to eliminate the memories of how a normal economy actually functions. Indebtedness had replaced the role of savings; speculation the role of investment; consumption the role of production. <br /><br />A number of factors enabled this shift: the fall of Soviet Russia, globalization, productivity enhancing technological advancements, booming demographics, and most importantly, the implicit and explicit government guarantees doled out to the financial services industry. <br /><br />A number of those factors have reached their points of maximum impact. Others are already reversing. The first baby boomers began retiring in 2007. The impact of this will increasingly show its effects on markets as they liquidate their assets to pay for their retirements. Globalization grew to the point that the social ramifications of its imbalances will force a retrenchment. The cyclical nature of international trade is well documented. And technological progress, while it will always continue, has not experienced the type of long-term investment necessary to garner returns seen in the 90's and 00's. <br /><br />The only constant is change. But while most are afraid of change, I prefer to embrace it. Every decade sees enormous secular shifts in our markets, yet most analysts, pundits and economists spend a majority of their time trying to figure out how we can avoid, or blunt the effects of such shifts. It is an exercise in futility. I don't expect to be able to alter people's irrational fear of change. I can only point to it in hopes that some can capitalize on it early. <br /><br />I will reprint the conclusions from the previous installments in this series. <br /><br /><a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-2-credit-markets.html">Part 2 - Credit Markets</a><br /><br /><blockquote>On the whole, credit markets have not recovered. In fact, in many areas credit quality has continued to deteriorate unabated. A pending supply of low grade mortgage recasts, along with an overhanging inventory of underwater mortgages will likely force a continuing deterioration in loan performance and further house price declines. Despite accounting shenanigans that allow banks to value their assets at whatever they like, banks' lending ability remains constrained, while the ability and willingness to borrow is also under pressure. The overall amount of debt outstanding is also constraining the economy's ability to lend its way out of the recession. Even with historically low rates, the high level of debt gives us a servicing ratio that constrains our ability to invest in productive capacity. </blockquote><br /><a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-3-economy.html">Part 3 - The Economy</a><br /><br /><blockquote>We are most likely (as of June '09) in the midst of a technical recovery as defined by GDP. But this masks the rot underneath the surface. Consumer credit and income growth are contracting. As such, personal consumption expenditures will likely remain depressed for some time. Short term gimmicks like "cash for clunkers" and homebuyer tax credits may provide incentives for consumers to delay their deleveraging, but the cost of the programs add to the overall debt burden, which needs to be paid with interest. High debt servicing burdens hinder our ability to invest. In the long run, these programs are detrimental to GDP - even though they may provide relief in the near term. <br /><br />Structurally high unemployment will likely persist, as those who have recently fallen out of the workforce will join it again upon improving job market fundamentals. This will serve as a drag to economic robustness, but should keep wage pressures low for a considerable amount of time. Declining wages will increase productivity and likely bring about a revival in the US goods-producing industries that have shed jobs for 3 decades. <br /><br />The picture I have painted above is very deflationary. Combined with contracting credit markets, valuations of financial assets should decline to reflect their weak earnings potential. I will discuss the implications of a rebalancing economy and contracting credit on asset markets later this week. </blockquote><br /><a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-4-government.html">Part 4 - Government </a><br /><br /><blockquote>A vast majority of the $23.6 Trillion in bailouts, swaps and guarantees has been directed toward supporting home prices. For the most part, they have failed. The natural course is quite obviously for home prices to continue declining toward levels commensurate with incomes and revenue generation ability. The expiration of many temporary "kick the can down the road" schemes, along with a flood of Option-ARM and Alt-A recasts, will significantly hamper bank balance sheets and eventually force further credit writedowns. Populist anger toward big bank favouritism will also limit the government and the Fed's ability to enact further legislation favourable to banks. </blockquote><br /><a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-5-asset-markets.html">Part 5 - Asset Markets</a><br /><br /><blockquote>Credit contraction and asset price deflation are two peas in the same pod. As I believe credit contraction is unavoidable over the long-term, I also see lower asset prices ruling the roost. In many cases, a return to historical valuation levels would imply drastic reductions in prices. This should be viewed in a positive light. Lower asset prices enable lower wages, which restore competitiveness and lays the foundation for a robust economic recovery. Whether this happens in 2010 is to be determined. But I feel that the probabilities are strongly in favour of such a scenario.</blockquote><br />With all that in mind, I'll proceed to my "Themes for 2010." The normal qualifications are required. Some of these themes will be correct, others will be laughably false. Such is the nature of prediction in a dynamic system. Many of these themes are very long-term in their nature. While pressures may build, many may not necessarily "peak" in their effects until many years down the road. For example, this will be the third year that I have highlighted the stresses in state and municipal governments. I have not necessarily been wrong in the past two years, as the problems have continually grown in both their size and realization in the mainstream. Indeed, it will likely take many more years for a long-term solution to be found. Such is the case with much of the below. <br /><br />- a resumption in the trend toward deleveraging and falling prices for most liquid assets (stocks, commodities and corporate bonds)<br />- a consequent rise in the US Dollar Index, perhaps very substantially so as credit contracts<br />- decreasing global trade and a continuation in protectionist measures, primarily directed toward China<br />- outright collapse of China's bubble-economy as foreign capital flees. Chinese officials blame everyone but themselves<br />- movement toward surplus for America's trade deficit<br />- sovereign debt concerns roil Europe, the Middle East and perhaps even Japan<br />- state and municipal debt concerns accelerate, pitting unions and pensioners vs. everyone else<br />- another leg down in North American real estate prices - especially Canada's largest markets<br />- growing dissent within the Obama Administration as populist anger disables government's favourable treatment of the FIRE industry ahead of midterm elections<br />- falling salaries for sports stars and actors/entertainers as discretionary spending wanes on event tickets<br />- relative bright spots will include South America (specifically Brazil, Chile, Colombia and Peru) and personal wireless devices. <br />- the US manufacturing industry begins a revitalization <br /><br />Regardless of what happens, I wish my readers a prosperous 2010! <br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com7tag:blogger.com,1999:blog-2121490237517462736.post-44473228427733653072010-02-04T12:20:00.001-08:002010-02-04T13:49:48.221-08:00Must Read Articles 05.10If you're wondering what all the hubbub is about Greece, Portugal and Spain, I've grouped together a set of articles that explain the situation lucidly. Like most of the world's economic problems, it can be summed up by the simple phrase "there's too much debt." But in Europe, individual governments are restrained from printing money to temporarily relieve the stress. The only other cited cure is for public and union workers to take massive pay cuts in order to regain competitiveness. Socialist-leaning governments in these countries are not treating that like a legitimate option and appear to be losing control. They've now resorted to blaming their problems on "speculators." Euro-skeptics have always said this would eventually prove to be the undoing of the Euro. Right now they're being proven correct in spades. <br /><br />While most of the focus lies on government debt, please remember that private banks in this region are even more susceptible. Credit default swaps (CDS) on Portuguese banks, for example, are up 30% today. That's no small potatoes. And Europe's banking system is just as systemically intertwined as is America's. If Club Med banks start going down, the big northern banks will likely follow. <br /><br />The only actual solution to this problem is the only one everybody seems to agree is "not a solution." Debt repudiation. <br /><br /><a href="http://blogs.reuters.com/rolfe-winkler/2010/01/29/spanish-canary-in-the-european-coal-mine/">Spanish Canary in the European Coal Mine</a> (Rolfe Winkler) <br /><br /><a href="http://www.creditwritedowns.com/2010/02/if-piigs-could-fly.html">If PIIGS Could Fly</a> (Neils Jensen, Absolute Return Partners via Credit Writedowns and John Mauldin) <br /><br /><a href="http://www.telegraph.co.uk/finance/comment/7119986/Should-Germany-bail-out-Club-Med-or-leave-the-euro-altogether.html">Should Germany Bail Out Club Med or Leave the euro Altogether?</a> (Ambrose Evans-Pritchard) <br /><br /><a href="http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7095818/Funds-flee-Greece-as-Germany-warns-of-fatal-eurozone-crisis.html">Funds Flee Greece As Germany Warns of "Fatal" Eurozone Crisis</a> (Ambrose Evans-Pritchard)<br /><br />And now for some other issues: <br /><br /><a href="http://globaleconomicanalysis.blogspot.com/2010/02/demand-for-loans-weakens-again-in-fed_01.html">Demand For Loans Weakens Again in Fed Senior Loan Survey</a> (Mish) <br /><br />It is easy to blame banks for not lending money to people who "need" it. President Obama does it all the time. But the problem is not that banks won't lend, it's that there's nobody willing to borrow that is remotely credit-worthy. <br /><br /><a href="http://mannfm11.blogspot.com/2010/02/saving-asset-price-inflation-and-debt.html">Saving, Asset Price Inflation and Debt Induced Deflation</a> (Michael Hudson, via mannfm11) <br /><br />Hudson follows a similar train of thought as Steve Keen. Neither are Austrians. They both maintain that Keynes was misinterpreted and combined with destructive "equilibrium based" theories. This is the most compelling of non-Classical Liberal theories I have come across. <br /><br /><a href="http://www.creditwritedowns.com/2010/02/on-depreciation-malinvestment-and-gdp-as-a-gross-number.html">On Depreciation, Malinvestment and GDP as a Gross Number</a> (Ed Harrison) <br /><br />All things I like to talk about. GDP is calculated based on aggregate spending data. Not all of that spending is worthwhile and beneficial. In fact, some of it is downright harmful. Eventually, that must be realized. The process of realization is otherwise known as "recession." <br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com4tag:blogger.com,1999:blog-2121490237517462736.post-56905121264436801892010-01-30T07:53:00.000-08:002010-01-30T09:13:21.453-08:00Market Update 04.10<a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/S2RZmDUdNNI/AAAAAAAAA6A/n81YKxfu2qM/s1600-h/spx5.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/S2RZmDUdNNI/AAAAAAAAA6A/n81YKxfu2qM/s400/spx5.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5432565560776668370" /></a><br /><br />Continuation to the downside in equity, commodity and foreign currency markets as the total decline now exceeds the late October selloff in both duration and degree. Market character was very bearish all week, as large cap indices trended down, making a series of lower highs and lower lows. The Nasdaq, Semiconductors, Transports and Small Caps all underperformed the broader market. <br /><br />The fall has occurred in conjunction with the start of earnings season. So one would be led to believe that earnings have been very poor. They would be wrong. From CNBC: <br /><blockquote>Of the 220 (~44%) S&P 500 companies who have reported Q4 results, 78% beat estimates, 8% were in-line, and 14% were below estimates.</blockquote><br />Even optimistic earnings expectations have been surpassed, yet the market has "sold the news" apparently. Or perhaps it was just going to fall anyway and people have thus ignored earnings and focused on other perceived "catalysts." This has most noticeably been the case in the large-cap tech sector with GOOG, AAPL, QCOM among others beating expectations, but being sold in the aftermarket and experiencing a continuation of that selling in subsequent days. This is the "change in market character" that I have been awaiting for numerous months now. <br /><br />Two quarters ago, I mentioned that the boost in earnings was, <span style="font-style:italic;">in many cases</span>, merely a reflection of cost cutting, inventory restocking and increased productivity from employers terrified of losing their jobs. I argued that without a recovery in consumer balance sheets, employment, capacity utilization and private fixed investment, the recovery in corporate profits would prove temporary. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S2Rex6uPTRI/AAAAAAAAA6I/6MLmcwzFJSM/s1600-h/investment.gif"><img style="cursor:pointer; cursor:hand;width: 400px; height: 213px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S2Rex6uPTRI/AAAAAAAAA6I/6MLmcwzFJSM/s400/investment.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5432571262185458962" /></a><br /><br />The above chart includes preliminary estimates for private fixed investment in Q4. Nothing too spectacular. So I am wondering if analysts are starting to look out a few quarters, knowing that the temporary boosts will have worn off, and seeing that recovering to trend growth is going to be a very difficult task...? <br /><br />The moment said analysts look away from their mathematical models, which naturally forecast a recovery to trend growth as a given, is the moment they start to rethink the assumptions they have made. And when they do that, present equity valuations simply do not make sense - especially at the point of the business cycle they believe we are in (trough). <br /><br />Looking at this socionomically (ie. a Prechterian PoV), it all makes a lot of sense. We have people switching from interpreting every piece of information as a positive to now questioning those interpretations, while increasing public anger toward public officials and bankers is growing rapidly. (See the continuous revelations of the AIG-NY Fed-Goldman dealings). At the same time, we are seeing strongly impulsive moves down in the stock market, while corrections are occurring in sharp, overlapping waves, and often peaking in the futures market overnight before selling-off toward the open. If a "P3" move down is going to happen as Elliott Wave Theory seems to strongly suggest, then this is precisely the type of environment one would expect. <br /><br />Staying on the Elliott Wave theme, I should note that it is not always the best tool to use. I find that if the pattern cannot be immediately identified as obvious, then other TA methods should be used instead. But if I look at a pattern and see the waves immediately, I lend a much larger weight to their validity. Take for example a multi-year chart of the USD Index. The dollar completed a very evident 5 waves up during in '08, followed by a 3 wave decline in '09, and has now turned up quite violently. If a 3rd wave up is what's coming, it should be sharper and longer than the previous up wave. And this is precisely how one would expect it to begin. I've been calling for par with the Euro for a couple of years now. The chart below suggests that is what we'll see. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S2RitWwDSlI/AAAAAAAAA6Q/ueAaxSM53p4/s1600-h/usd.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S2RitWwDSlI/AAAAAAAAA6Q/ueAaxSM53p4/s400/usd.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5432575581856418386" /></a><br /><br />Let us not forget the carry trade that was a popular idea a few months ago, but seems to be forgotten right now. Those that are losing money on the stock market selloff are in many cases also losing on the currency side. With emerging markets selling off over 10% and the US Dollar higher by 7%, the pain is being felt more than a 6.7% S&P correction would otherwise indicate. <br /><br />The Volatility index moved sharply higher last week, but sold off without a corresponding recovery in stock prices. This demonstrates complacency among options traders and could require them to panic and cover their bets should the divergence persist much longer. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/S2Rn90X-cJI/AAAAAAAAA6Y/CQGge7YjOVY/s1600-h/vix.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/S2Rn90X-cJI/AAAAAAAAA6Y/CQGge7YjOVY/s400/vix.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5432581362244546706" /></a><br /><br />Lastly, this is a chart of the percentage of stocks above their 200 day moving average. Notice that this is the type of indicator that moves in long waves, oscillating between many above and then many below. Further correction should be forthcoming. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S2RolrjM4iI/AAAAAAAAA6g/J7zGXXlMM-s/s1600-h/nya200r.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S2RolrjM4iI/AAAAAAAAA6g/J7zGXXlMM-s/s400/nya200r.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5432582047070478882" /></a><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com5tag:blogger.com,1999:blog-2121490237517462736.post-15067950889693948682010-01-28T11:00:00.000-08:002010-01-28T11:56:49.103-08:00Must Read Articles 04.10<span style="font-style:italic;">Note: I'll hopefully get my final "Themes" piece out this weekend or early next week. Sorry for the delay. I've been inundated. </span>
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<br /><span style="font-weight:bold;">This week's must read articles</span>
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<br /><a href="http://www.nakedcapitalism.com/2010/01/taibbi-assaults-criticizing-wall-street-populism-meme.html">Taibbi assaults criticizing wall street populism meme</a> (Yves, Naked Capitalism)
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<br />Indeed, this is getting to me too. Somehow the tables got turned on common sense. Now, anyone who criticizes Wall Street is simply labeled a "populist" thereby inferring a depart from rationality. Not all populism is wrong-headed.
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<br /><a href="http://www.comstockfunds.com/default.aspx?act=newsletter.aspx&category=SpecialReport&newsletterid=1504">The total debt relative to GDP trumps everything else </a> (Comstock Funds)
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<br />Comstock picks up on many of my themes, primarily private sector debt deleveraging. They see a reduction in the amount of private debt from $40 Trillion to 20 or 30. I agree.
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<br /><a href="http://www.debtdeflation.com/blogs/2010/01/24/debtwatch-no-42-the-economic-case-against-bernanke">The economic case against Bernanke/</a> (Steve Keen)
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<br />Keen dismantles Bernanke's adherence to faulty interpretations of the causes behind the Great Depression. Irving Fisher lost nearly his entire net worth betting against the possibility of depression in the 30s. His reasoning was the same as Bernanke's is now. After some reflection, Fisher concluded that debt <span style="font-style:italic;">does</span> matter, and that its growth led to an unnatural perception of stability. A stability that was later revealed to be a bubble, followed by a bust. Bernanke appears desperate to re-learn Fisher's lesson.
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<br /><a href="http://www.calculatedriskblog.com/2010/01/update-on-residential-investment.html">Update on residential investment</a> (Calculated Risk)
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<br />Being one of the leading indicators for economic recovery, residential investment is obviously an area to keep an eye on. But even more important is the ramifications for major banks with trillions in mortgage assets on their books (and off). They are hoping for a recovery in home prices to make these bad loans whole again. The data does not support such a scenario. In fact, prices are again falling and subsidy infused activity is now drying up.
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<br /><a href="http://econblogreview.blogspot.com/2010/01/debt-monster-may-threaten-governments.html">The debt monster may threaten governments more than corporations</a> (Econblog Review)
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<br />EBR notes that the cost of insuring against default for many of our largest conglomerates has fallen below that of insuring against sovereign default.
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<br />With that, I would also note that sovereign CDS spreads for troubled countries in southern Europe are absolutely blowing out. Bond spreads are doing the same. Greece, Portugal and Spain are in the most trouble - in that order. This is a problem that doesn't appear to be going away. I doubt it comes to a head in the near term. They'll likely find a half-measure or two before the inevitable occurs.
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<br />Related to that are long-term issues with Japan. See the video below from Kyle Bass.
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<br />Ever wonder why there is never agreement on <span style="font-style:italic;">anything</span> when it comes to economics or finance? You'll be happy to know this is nothing new. In fact, the same arguments have been going on for more than a century. I doubt it will ever be resolved, as people have different value structures toward stability, freedom, wants/needs, etc. The video below explains it well and in a very entertaining format. Enjoy!
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<br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com0tag:blogger.com,1999:blog-2121490237517462736.post-7616962250243216592010-01-24T10:13:00.000-08:002010-01-24T15:50:45.044-08:00Market Update 04.10Whack! Just like that, nearly 3 months of slow, grinding gains were eliminated in three days of trading. The selling intensified into the close on Friday. It seem that every time three days of selling close out a week, analogies to 1987 get thrown around. While I don't expect anything like that to occur anytime soon, this is indeed the type of action one would expect to see if "the big one" still lied ahead. Long periods of perceived stability breed complacency. <br /><br />And the last few months of trading have certainly given the impression of complacency as most stocks have returned to their cyclical high valuations, despite earnings that remain in the dumps compared to their cyclical high earnings of '07. Many have also taken it for granted that banks are earning their way out of trouble, completely ignoring the multi-trillion dollar portfolios of toxic assets that are temporarily held off-balance sheet. While most have just assumed that FASB will never grow a pair big enough to enforce GAAP, they seem to forget that eventually these distressed debt instruments mature. So unless home prices start rising again soon, these losses will be realized eventually. Unfortunately for them, home prices have begun falling again (as of the most recent <a href="http://www.calculatedriskblog.com/2010/01/first-american-corelogic-house-prices.html">Core Logic numbers from November</a>). The overhang of inventory (ie. shadow inventory) has clearly started to matter again. <br /><br />Isn't it funny how things that seemingly "don't matter" all of a sudden become important? Like sovereign debt problems. Or funding crises at state and municipal pension funds. Or sour commercial real estate loans causing small regional banks to fail at an increasingly rapid rate. Or skyrocketing delinquency rates on credit cards, HELOCs, and FHA/Fannie/Freddie loans. It costs money to maintain these operations. One way or another, resources are being redirected from what they would otherwise be doing toward trying to plug these black holes. And this misallocation of resources is precisely what will keep the economy from recovering - just like Japan but without exports to fall back on. <br /><br />This week's selloff may not be in reaction to these cumulative imbalances finally exacting influence on the stock market. After all, as I'll show below, internals are in better shape while oscillators are more oversold than during their late October corrections. This could be just another correction. Until markets display a <span style="font-style:italic;">change in character</span>, it would be wrong to assume another leg lower has begun. Then again, after 10 months of gains, markets may have sufficiently done their job to turn even bears cautious. <br /><br />Now, some charts: <br /><br />S&P Daily. Selloff only takes this average back to the bottom of its trend channel. Notice how the RSI is lower than at any point since the rally began. Does this signify a buying opportunity? Or is it a signal of the higher intensity of the selloff and thus a change in market character? I suppose it depends on how one looks at it. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S1zWEEpMYNI/AAAAAAAAA5Q/eA4GNcMUA0M/s1600-h/spx.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S1zWEEpMYNI/AAAAAAAAA5Q/eA4GNcMUA0M/s400/spx.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5430450616156315858" /></a><br /><br />Similarly, Crude Oil has been trending in its own channel, but while stocks are a good 15% higher than their June highs, oil has not yet signaled any increasing industrial demand since the summer (when many contend the recession ended). There is a confluence of support between $70-72.50. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/S1zaS0DWVQI/AAAAAAAAA5Y/Gw3LAxyA7gI/s1600-h/wtic.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/S1zaS0DWVQI/AAAAAAAAA5Y/Gw3LAxyA7gI/s400/wtic.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5430455267447166210" /></a><br /><br />And internals. Most remain in stronger positions than at their July and early November cyclical lows. Again, this could be indicative of strength, or could simply mean they have further to fall before finding support. <br /><br />Advance/Decline Volume Ratio<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/S1zcLwEIwXI/AAAAAAAAA54/2EjgAwZ_A8s/s1600-h/nyud.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/S1zcLwEIwXI/AAAAAAAAA54/2EjgAwZ_A8s/s400/nyud.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5430457345140900210" /></a><br /><br />Advance/Decline Issues Ratio<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S1zcHag_tcI/AAAAAAAAA5w/w5eW3uKTIaU/s1600-h/nyad.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S1zcHag_tcI/AAAAAAAAA5w/w5eW3uKTIaU/s400/nyad.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5430457270636885442" /></a><br /><br />% of stocks above their 50 day moving average<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S1zbi0-NV2I/AAAAAAAAA5o/Y-ng2rq96ys/s1600-h/nya50r.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S1zbi0-NV2I/AAAAAAAAA5o/Y-ng2rq96ys/s400/nya50r.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5430456642083575650" /></a><br /><br />Put/Call Ratio<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/S1zbegjPBzI/AAAAAAAAA5g/KDLyB98MPg4/s1600-h/cpc.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/S1zbegjPBzI/AAAAAAAAA5g/KDLyB98MPg4/s400/cpc.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5430456567882254130" /></a><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com2tag:blogger.com,1999:blog-2121490237517462736.post-32893119686952195742010-01-20T09:40:00.000-08:002010-01-20T12:41:22.370-08:00Must Read Articles 03.10Starting this week, I'll begin posting a brief list of what I consider to be the last 7 days' most important reads. For those that have been utilizing my "Recommended Articles" widget on the right-hand side of the page, you'll notice that I sometimes add notes to the end of articles I find to be particularly noteworthy. As I do read a copious amount of information on a daily basis (my Google Reader account tells me I go through more than 100 blog posts, newspaper articles and reports daily), I try to share only 10% of that in the sidebar. For most people, I can understand even that is excessive and too cumbersome to delve through daily. And to be honest, for most people with a more long-term focus, I don't see how reading more than a few articles per week would be very beneficial. <br /><br />As such, I'll be pulling out just a few of the "Must Read" articles and posting a quick caption on their importance. I'll try to do this mid-week as it is warranted. <br /><br /><span style="font-weight:bold;">Must Read Articles of the past week:</span><br /><br /><a href="http://www.scribd.com/doc/25241418/Corriente-China">A Contrarian View of China - Corriente Advisors</a> (hat tip reader Roger) <br />Corriente gives an in-depth but easy to read presentation on the state of affairs in China. The consensus of China's situation (plenty of savings, solid growth, booming domestic market, etc) is incredibly one sided. And this report tears many of those misconceptions to shreds. As we know, the consensus is rarely right - especially on matters as opaque as China's debt and currency markets. I find their take compelling. <br /><br /><a href="http://www.mckinsey.com/mgi/reports/freepass_pdfs/debt_and_deleveraging/debt_and_deleveraging_full_report.pdf">Debt and Deleveraging - McKinsey</a> (ht Rolfe Winkler)<br />Lengthy and Exhaustive, a team of researchers has compiled a list of more than 40 historical examples of deleveraging across many countries since the Great Depression. As the title suggests, McKinsey believes our excessive debt levels will result in a prolonged period of deleveraging. But they go one step further and attempt to identify precisely which sectors within the various economies are most likely to undergo this process. They argue that among four primary ways to deleverage (austerity, inflation, default, and growth) we are most likely to take the most common among them - which is austerity. I think default is a higher probability than they're willing to admit. Well worth the read - if only for the intro (pp 9-17). <br /><br /><a href="http://www.annaly.com/blog/?p=851">A Measurement of the Economy - Annaly Capital Management</a><br />Annaly challenges the wisdom of relying on GDP for an accounting of the nation's health. They prefer to look at "what the nation earns, rather than what it spends." I agree with this, as it cannot be exogenously influenced as easily. With this metric, they look at tax receipts and conclude that a recovery is unlikely until people start producing, and thus earning, more. <br /><blockquote>To us, a rebound in GDP only reflects a rebound in consumption, and today’s consumption is fueled to a large extent by growth in government spending, incentives and, most significantly, borrowing. A rebound in tax receipts, sans tax increases that stymie economic activity, would reflect growth in our country’s earning power.</blockquote><br /><a href="http://www.calculatedriskblog.com/2010/01/option-arm-recast-update.html">Option-ARM Update - Calculated Risk</a><br />As the title suggests. A short recap of what's to come for recasting Option ARM mortgages - which in most instances were just as poorly underwritten as subprime mortgages. <br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com2tag:blogger.com,1999:blog-2121490237517462736.post-34504668269429303872010-01-19T06:52:00.000-08:002010-01-19T13:37:44.604-08:00Themes For 2010 - 5 - Asset MarketsIn the last three installments of this series I have covered the <a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-2-credit-markets.html">credit markets</a>, <a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-3-economy.html">the economy</a> and the <a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-4-government.html">government's influence on each</a>. <br /><br />The picture painted is one of a continuing deflation. This deflationary process should not be seen as "armageddon" or a "bottomless spiral" as some like to imply. It is a removal of excessive debt levels that will otherwise hamper the economy's ability to grow based on its typical catalysts: savings, investment, and production. <br /><br />Governments, working in conjunction with their central banks, have attempted to remedy the adverse symptoms of recession with conventional and unconventional measures. The unconventional measures (massive bailouts, asset swaps, accounting shenanigans) will not and cannot prevent the eventual realizations of losses outstanding on bad loans and their derivatives. This reality will hinder banks' ability to lend at low rates to risky borrowers, thus cutting off one engine of typical recoveries. Conventional measures (low interest rates, fiscal stimulus) serve as a disincentive to save, and thus hinder the economy's desire to spontaneously and creatively adapt to a new environment. <br /><br />Large investment houses, hedge funds, and analysts are assuming that the recession of 08-09 is a normal inventory retrenchment, rooted in overcapacity. Taken together with the conventional and unconventional measures noted above, they almost unanimously agree that a "V-shaped" recovery will ensue, as they have before. In 2007, they all unanimously agreed that there was no overcapacity, and therefore could be no recession. As they were proven wrong for ignoring the debt side of the equation then, so will they again. This was not a normal recession. It was brought on by a credit contraction for the first time since the Great Depression. <br /><br />The unanimity of opinion on this matter should not be understated. Nearly every investment/business professional (+/- 90%) has received their education from the same sources that suggest a) credit growth/contraction has no appreciable impact on the business cycle or the structure of production; b) aggregate debt levels are irrelevant because "we owe it to ourselves." They are wrong on both accounts. <br /><br />The mathematically based assumptions of these professionals not only influence their views on an imminent economic recovery to "equilibrium" or "potential output," but they influence their views on how asset markets in general will respond. Naturally, these mathematical models with all their flawed assumptions paint a very favourable picture for stocks, corporate bonds, commodities and foreign currencies. <br /><br />Because I operate from a different perspective, focusing on debt and the effects it has on growth patterns, my views on asset markets are also different. I see the present (and pre-bubble) valuations of these assets as being determined on the availability of credit and thus the ability for people to borrow money for speculative purposes. Comparative valuation analysis of the past 30 years (during which credit growth was excessive) with the previous 100 years of data is supportive of this claim. To date, I have found no other explanation for these discrepancies. <br /><br />The value of any asset is primarily owed to its ability to generate cashflow. The value of an apartment building is the amount of rents it can generate over the projected life of the building minus property taxes, maintenance costs, and depreciation. But over the past few decades a premium has been applied to this. Because interest rates have been held below the rate of credit growth, asset prices can reasonably be expected to increase. It is a simple calculation for speculators: if outstanding credit is expanding at 8% per year, then the price of an asset should rise to reflect the total amount of credit available to purchase it. But if interest rates are at only 5%, then owning the asset yields a greater return than a savings account. <br /><br />Neoclassical economists assume that people make decisions based on aggregate levels of inflation (like the CPI). They use that assumption to fix the cost of money (interest rates). Again, they are wrong. People make decisions based on real-life scenarios like that described above, not nebulous, aggregate statistics. The result is that a massive premium has been applied to the value of all assets based on future implied rates of credit growth. That credit growth has hit a wall and is now contracting - as illustrated in Part 2 of this series. In 2008 and early 2009, asset prices successfully eliminated that future implied rate of credit growth from their valuation. But the efforts of governments and central banks have reapplied it by promising to fight credit contraction with all means necessary. Those efforts are failing. It is my contention that markets will eventually realize that credit expansion is not coming back anytime soon and asset prices will again need to readjust to more conventional valuation metrics. <br /><br /><span style="font-weight:bold;">Equities</span><br /><br />To avoid being sensationalist, I will use the most conservative valuation metric available. The Shiller 10-year real P/E. It takes the last decade of operating earnings, and adjusts for inflation (CPI). Keep in mind that over the last decade, companies booked profits on many sorts of malinvestment like originating bad loans. That all gets counted under "normal operating revenues." But when the loans get written down, they are "one time charges" and therefore don't get counted. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S1YE0IkOl4I/AAAAAAAAA5A/MIQqilpt-tc/s1600-h/case+shiller+PE.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 270px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S1YE0IkOl4I/AAAAAAAAA5A/MIQqilpt-tc/s400/case+shiller+PE.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5428531694540855170" /></a><br /><br />Even using this valuation metric, it is apparent that stocks are at least 25% overvalued from their historical mean. If the economy is indeed in the early stages of a new business cycle as most suggest, then this overvaluation is unprecedented for that position. Valuations have always been much lower for the first few years of an economic expansion. The forward expectations for corporate profits to justify present valuations are out-of-this-world optimistic. David Rosenberg of Gluskin Sheff comments: <br /><br /><blockquote>We should add here that on a Shiller real 10-year “normalized” earnings basis, the S&P 500 is now trading at 20x, which is 25% above the historical average of 16x. This is the same level of overvaluation heading into October 1987, though at the bubble peak in October 2007, the overvaluation gap was 70%. At the average of prior market peaks, the extent of the overvaluation is 50%. We are not saying that equities as an asset class is in a bubble but they certainly have moved to an overvalued extreme.<br /><br />Moreover, as we have pointed out recently, what is “normal” is that every percentage point of nominal GDP growth translates into 2.5 percentage points of profits growth. Most economic forecasters see nominal GDP growth at 4% for this year. But strategists see, on average, 36% profit growth. But that 4% growth in nominal GDP is only enough to boost profits by 10%, if the normal relationship holds up. To see such low nominal growth and such strong profit growth is a 1-in-50 event. Maybe the economist and strategist at the Wall Street research houses should sit down with each other.</blockquote><br /><br />Analysts are expecting $75+ in earnings for 2010. Based on those estimates, and today's current S&P 500 level of 1148, stocks are trading at a P/E of 15.3. That is considered "fair value." Unfortunately, analysts are a fairly rosy-eyed lot. Even last year they expected to see around $77 in earnings. All they got, even with phantom profits at big banks from accounting breaks, was mid-50s. Again, the rate of profit growth needed to achieve this feat is unprecedented. Readers are free to take those projections at face value. But given the track record of these analysts, one would be wise not to. <br /><br />So my view is that equity markets will correct to valuation levels commensurate with a trough in economic growth. This is heavily dependent on the credit markets, which are the basis for these present overvaluations. If credit continues to contract, then the inflated earnings from previous credit expansions will prove even more elusive. I project trough "operating" earnings (in a period of contracting credit) somewhere between $38-48. If trough valuation levels are applied to this (6 or 7 in the chart above, but we'll use 10 to be conservative), one can expect the S&P to bottom somewhere between 400-500. How soon that occurs depends largely on the rate of credit contraction, and the amount of time it takes to deleverage the economy sufficiently so that growth can take root from more sustainable levels. <br /><br />I fully expect that certain sectors of equities and perhaps even certain markets (like South America) have very likely already put in major bottoms. But all assets worldwide are credit sensitive, so a prolonged contraction could still have very noticeable effects on even those areas that are recovering.<br /><br /><span style="font-weight:bold;">Real Estate</span><br /><br />Perhaps more than any other asset, residential and commercial real estate is dominated by credit availability. For centuries it has been a common rule of thumb that homebuyers are able to afford 3x their household incomes for the purchase of their primary residence. Banks would almost never lend more than this. But this all changed in the 80's. As quantitative finance and exotic mortgages became normal practice, justifications were found to lend up to 10x one's income for the purchase of a home. <br /><br />As mentioned above, an asset's value is its ability to generate cashflow. This means rent for real estate. And at present valuations, most areas are still selling at 20x yearly rents or higher. Like stocks, average valuations for real estate are around 12-15 depending on the type and location of the property. We will likely return or sink below those levels prior to a bottom in real estate prices. For bubble areas like Vancouver, this means <span style="font-style:italic;">drastic</span> price reductions or <span style="font-style:italic;">drastic</span> rent increases. Because people can't borrow to pay rent, rents are determined solely by wages. Thus, the only way for this imbalance to be rectified is by either enormous wage increases or price declines. I'll let you figure out which is most likely. <br /><br />One way or another, we will return to tried, tested and true mortgage practices. This means 3x average household incomes correlates with the average home price. It means mortgages are not issued without a 20% down payment. It means loans are only made if total debt servicing (including credit card, car loans, etc) accounts for less than 40% of one's income. And it means that owners of buildings buy them for their rental revenues - not price appreciation differential over the cost of borrowing. <br /><br />Most would consider my projections to be apocalyptic. They are merely reversions to long-term historical means. If asset prices were at such levels for hundreds of years before, I can assure you that were they to go back to said levels the sky will not fall, the seas will not boil. And no, the earth will not be covered in eternal darkness (although for investment bankers, living hell may be an appropriate analogy). <br /><br /><span style="font-weight:bold;">Commodities</span><br /><br />I am of the view that commodity prices are impacted by speculative credit flows. I also believe that a fair bit of "hoarding" has occurred in some markets, which has elevated commodity prices past levels that would likely prevail otherwise (read: China). <br /><br />So to be consistent, I do expect commodity prices in aggregate to decline over the coming years. This decline should take prices back below their March lows. The recovery in the CRB just looks choppy and corrective. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S1YcR9xLUhI/AAAAAAAAA5I/-OnqcD4miAY/s1600-h/crb.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S1YcR9xLUhI/AAAAAAAAA5I/-OnqcD4miAY/s400/crb.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5428557495805891090" /></a><br /><br />Within the commodity complex, I continue to believe that gold and agricultural commodities will hold up best. But they will be far from immune should credit contract the way I believe it will. Should gold rise past $1160, I see a non-trivial possibility of a blowoff leg higher toward $1800. As of now, I am expecting lower prices over the next year. <br /><br /><span style="font-weight:bold;">Bonds</span><br /><br />Corporate bonds are in the same boat as equities in my opinion. Excluding a couple dozen high-quality borrowers, most corporate issues are risk assets - largely dependent not on ability to repay principal, but on the ability to refinance at maturity. <br /><br />Government bonds, on the other hand, are a different story. I can understand cases for both extremes on long term interest rates. Should sovereign concerns spread in Europe and elsewhere, risk premiums could begin to be priced in to US, UK and Japanese debt. But I also see the possibility of another "flight to quality" like we saw in 2008. I have no edge on this scenario, so the best I can offer is to stay away from long-term bonds and instead stick to shorter maturities. <br /><br /><span style="font-weight:bold;">Conclusion</span><br /><br />Credit contraction and asset price deflation are two peas in the same pod. As I believe credit contraction is unavoidable over the long-term, I also see lower asset prices ruling the roost. In many cases, a return to historical valuation levels would imply drastic reductions in prices. This should be viewed in a positive light. Lower asset prices enable lower wages, which restore competitiveness and lays the foundation for a robust economic recovery. Whether this happens in 2010 is to be determined. But I feel that the probabilities are strongly in favour of such a scenario. <br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com6tag:blogger.com,1999:blog-2121490237517462736.post-13491750153980858592010-01-17T07:23:00.000-08:002010-01-17T08:20:13.098-08:00Market Update 03.10A late week selloff resulted in negative performances across most major indices. Particularly interesting is the recent underperformance of prior star sectors. The Nasdaq failed to make new highs on Thursday and was the worst performing major index on the week. The large contributor to this phenomenon was the sharp selloff in the semiconductor sector. After reporting earnings aftermarket on Thursday that the media characterized as "crushing estimates," Intel stock immediately skyrocketed higher (5%) in the aftermarket. But it quickly ran out of gas. It closed the afterhours session back where it began, opened Friday morning lower, and continued to fall all day, closing down more than 3% on its highest volume of the past two years. Textbook exhaustion reversal on good news. <br /><br />Intel has been one of the darlings of the technical recovery, nearly doubling since its bottom in March. Its earnings have kicked off "better than expected" earnings seasons in most quarters, setting the bar for everyone else. They have reported strong sales to nearly all groups - business, consumer and emerging markets - suggesting that technological investment may be higher than aggregate numbers suggest. As I wrote in my Themes for 2010, Part 3 article on the economy, I challenged the consensus that a recovery was going to be led by the consumer/credit growth and suggested instead that it would eventually come from investment. Thus, Intel (along with IBM, QCOM, CAT, and other makers of productive capital) are my bellweathers for a legitimate recovery. <br /><br />See below a comparison of the Semiconductors Index vs. the Dow Industrials. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/S1M1ehJesKI/AAAAAAAAA4w/g-dKIt81xDY/s1600-h/sox60.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/S1M1ehJesKI/AAAAAAAAA4w/g-dKIt81xDY/s400/sox60.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5427740774322057378" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S1M1ql4H3oI/AAAAAAAAA44/K62zSAtwl6s/s1600-h/indu.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S1M1ql4H3oI/AAAAAAAAA44/K62zSAtwl6s/s400/indu.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5427740981749866114" /></a><br /><br />Readers should also notice that two other important earnings releases (Alcoa and JP Morgan) also disappointed last week. Keep in mind that the year-over-year comparisons this quarter are totally wacky. Q4 of '08 was writedown central for most companies. So the actual performance will be more interpretive than usual, and thus more liable to the sway of human emotions. I suggest readers take the time this week to listen to some conference calls and try to glean some info based on tone and CFO confidence. <br /><br />That's all for now. <br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com1tag:blogger.com,1999:blog-2121490237517462736.post-58066707730723954642010-01-15T08:29:00.001-08:002010-01-15T16:12:30.225-08:00Themes For 2010 - 4 - The GovernmentI'm loathe to add this section to a series of articles typically directed to investors and speculators. But it is undeniable that the government and central bank actions of the past few years have had large impacts on everyone's portfolio. To a certain extent, I support the idea that over the long-term, market intervention proves irrelevant. No force is larger than the market. So even though various interventions appear to have great short-term impacts on our investments, I don't think it is instructive to look at what the government "wants" to achieve over a 5 or 10 year period and structure a portfolio thereupon. <br /><br />The government/central bank duo are herd followers by definition. Bureaucracies are inherently incapable of acting proactively. They are reactive. It is for this reason that centrally planned economies always fail. You may call the market interventions of the past few years (not forgetting those over decades prior that caused the crisis) whatever you like: socialism, corporatism, crony capitalism, kleptocracy. Whatever. The term used is not important (nor are many of the terms particularly useful after decades of redefinition). What is important is the immediate objective of nearly every intervention: <span style="font-weight:bold;">Price Fixing</span><br /><br /><blockquote>"I don't think it's a bad thing that the bad loans occurred. It was an effort to keep prices from falling too fast. That's a policy."</blockquote> -- Chair of the House Financial Services Committee Barney Frank - Oct 9, 2009<br /><br />Just to nip any allegations of conspiracy in the bud, the quote above illustrates the explicit nature of these price fixing objectives. Both monetarist and keynesian (aka. neoclassical) economists are literally terrified of falling prices. Therefore, they target positive rates of inflation on a year-to-year basis. Many classical economists suggest that it is precisely this price fixing that led to most of the excesses and imbalances precipitating the crisis in 2008. If prices were mandated to rise, why not borrow money to speculate on rising prices? That is the train of logic that I subscribe to, but I won't delve further into that debate, as considerable ink could be spilled. <br /><br />Thankfully, for those of us who prefer to see markets discover prices on their own, we can take solace in the fact that never in the history of price fixing has it ever achieved its objective. Not once. The reason this is so, is that in order to keep prices either above or below the level they can be sustained by incomes and revenues, a greater and greater amount of capital is required to be directed toward this goal. Eventually the cost or the political implications of doing so exceed the implied cost of allowing the market price to prevail. The price fixing scheme collapses and prices revert toward equilibrium (toward - but they <u>never</u> arrive). The same holds true for monopolies. <br /><br />In the meantime, however, prices can be influenced by these measures. Because it is widely acknowledged that it is real estate prices that led to the deterioration of bank balance sheets, and it is a collapse of the major financial institutions that politicians and central bankers are trying to prevent, most of the price fixing schemes are directed toward supporting home prices. Let's discuss some of the schemes being employed. <br /><br /><span style="font-weight:bold;">Asset purchases -</span> both the Fed and Treasury have involved themselves in the buying of trillions in mortgage backed securities. This has obscured the rate of interest (to the downside) making homeownership more affordable. <br /><br /><span style="font-weight:bold;">FHA balance sheet swelling -</span> When it became apparent that Fannie Mae and Freddie Mac were essentially toxic waste dumps for bad mortgages and were put into gov't receivership, a new source of funds "needed" to be found - lest demand for mortgage securities fall and interest rates rise. Enter: The Federal Housing Administration. Their balance sheet skyrocketed and they became the buyer of a vast majority of MBS that were previously bought by Fannie and Freddie. Because Fannie and Freddie worked out so poorly, the obvious course of action was to do the same thing again - only this time, making the taxpayer the <span style="font-style:italic;">explicit</span> buyer. <br /><br /><span style="font-weight:bold;">Foreclosure moratoria -</span> numerous state governments and financial institutions have declared moratoria on foreclosures. By not allowing these foreclosures, people who are no longer paying their mortgages are being allowed to stay in their homes at no cost. The "logic" behind this is that foreclosures result in bank auctions which decimate property values, thus affecting bank balance sheets. <br /><br /><span style="font-weight:bold;">Modifications -</span> numerous attempts to modify the existing delinquent or risky mortgages have all failed. They are trying to extend the mortgages even longer in duration, lower rates for the first few years, etc. Basically, they're trying to turn prime mortgages that never should have been issued into subprime or Option-ARM mortgages. Anything to avoid forgiving principal outstanding - because that requires balance sheet writedowns for the banks. Typically (and unsurprisingly), these modifications end up re-defaulting in ridiculous numbers (<a href="http://www.calculatedriskblog.com/2010/01/hamp-66465-permanent-mods.html">40-70%</a>) after only 6 months or a year. But the purpose they do serve is to kick the can down the road. And they've been doing enough kicking to put any Detroit Lions punter to shame. Their hope is obviously that home prices will start rising again, bringing these homeowners back above water. They're dreaming. <br /><br /><span style="font-weight:bold;">Accounting shenanigans -</span> Perhaps the most egregious example of market intervention has been the suspension of Generally Accepted Accounting Principles (GAAP). Admittedly, this is the one intervention I never expected in 2009. I should have known better. What has typically separated America from the rest of the world is accounting and balance sheet transparency. They threw all that away in 2009 when the US Treasury strongarmed the FASB (Federal Accounting Standards Board) to suspend FASB 157 (mark-to-market accounting). This allowed banks to value their assets at whatever price they wanted. Originally, this was going to be until yearend. Then it was extended. Had it still been in effect, as much as $5 trillion in "off balance sheet" assets would need to be revalued at their true prices. This would have made the big banks insolvent (again). This also facilitated greater market liquidity, better capital ratios, lower leverage ratios and therefore lower interest rates. <br /><br />The above programs (and, to be sure, there are others) have only worked to a small extent. As of October, home prices have risen only modestly from their bottom. In year-over-year terms, they are still down approximately 6-7%. The stunning price declines of early 2008 were largely abated by the above programs. Indeed, the low interest rates encouraged many to buy their first home, move-up, or to change locations. Investors have also stepped in. I know of a number of folks here in Vancouver that have picked up vacation homes in Arizona and California. See below a number of different home price indices through October numbers. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/S1DW9fbU3iI/AAAAAAAAA4o/IAZTko7rhW8/s1600-h/HousePriceIndicesOct2009.jpg"><img style="cursor:pointer; cursor:hand;width: 400px; height: 278px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/S1DW9fbU3iI/AAAAAAAAA4o/IAZTko7rhW8/s400/HousePriceIndicesOct2009.jpg" border="0" alt=""id="BLOGGER_PHOTO_ID_5427073902877924898" /></a><br /><br />Not exactly breathtaking, considering the many trillions of dollars that have poured into supporting prices. Surely, much of this will prove to be malinvestment, throwing good money after bad, averaging a losing trade, or whatever you want to call it. <br /><br />So what of the future? If prices start falling, can't they just increase the size of the programs? Well, no. They can't. <br /><br />The available pool of would-be buyers has largely already been exhausted. If someone hasn't accepted a near zero interest rate on a distressed property already, they're not likely to do so anytime soon. Additionally, the modification/moratorium games can only go on so long. After the banks offer remods, delay for months on paperwork and start to see 8 or 12 months of arrears build up, they will realize that not a penny more will be squeezed out of the mortgage. Foreclosure then becomes their best option. <br /><br />But the real factor here is social mood. Populist anger toward the big banks is growing rapidly. It seems that every day we learn of one or more nefarious activities that went on between government, the Fed and the big banks. Backroom deals, non-disclosure agreements, acting with insider information, conflicts of interest, political favouritism, silencing dissidents, etc. Myself and a number of other bloggers were screaming from proverbial mountaintops that all of this was illegal and fraudulent. Nobody seemed to care at the time. They were scared. They had bought into the argument that "it had to be done... for the greater good." <br /><br />But now, with the benefit of hindsight, the average person is starting to see what really occurred during those frantic days: a massive transfer of wealth from taxpayers to the financial industry. Yet the promised benefits - the unemployed getting their jobs back, investors getting their money back, etc - have not happened. In fact, as I pointed out in Part 3 of this series, the employment market continues to deteriorate. And now, gosh golly, the same financial firms are making money hand over fist and paying out bonuses like nothing happened! Taxpayers were duped. And they're pissed. President Obama's approval rating has plummeted faster than any president in the last 50 years. He makes speeches about "getting the money back from the banks" and literally nobody believes him. <br /><br />An anecdote to illustrate the above: On occasion I post short rants on the CBC.ca comments forum below their articles. They have a feature that allows one to vote thumbs up or down on the comment. Usually I just post to get a feel for "the common man's" opinion. Being a libertarian in Canada doesn't often put me in good books of many, as Obama is likened to the second coming up here. But I posted in reaction to the recent plans for the Obama Administration to recover the TARP funds. I was harshly critical. I asked, "why such a focus on $800 billion, while the other $22.8 trillion in guarantees/swaps never gets mentioned?" My comment was met with unanimous approval. 88-0 last I checked. People aren't falling for this charade any more. And the Democrats are going to learn very quickly that if they don't start clamping down on the big banks, voters will clamp down on them next fall (yes, elections are only 10 months away). <br /><br />The feasibility of introducing any more bailouts under these circumstances is nil. There will be violent rebellion before that happens again. Not only that, but the Obama Administration will face growing pressure to reverse as many of the bailouts as possible. They won't. At least not a significant amount. But the trend of social mood has sufficiently handicapped government's interventionist abilities. Likewise, it seems that a large portion of Americans have woken up to at least some of the Fed's activities. I see it likely that the Obama Administration will be held accountable for their actions as well. <br /><br /><span style="font-weight:bold;">Conclusion</span><br /><br />A vast majority of the $23.6 Trillion in bailouts, swaps and guarantees has been directed toward supporting home prices. For the most part, they have failed. The natural course is quite obviously for home prices to continue declining toward levels commensurate with incomes and revenue generation ability. The expiration of many temporary "kick the can down the road" schemes, along with a flood of Option-ARM and Alt-A recasts, will significantly hamper bank balance sheets and eventually force further credit writedowns. Populist anger toward big bank favouritism will also limit the government and the Fed's ability to enact further legislation favourable to banks. <br /><br /><br /><br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com3tag:blogger.com,1999:blog-2121490237517462736.post-65782149516244742662010-01-11T14:22:00.000-08:002010-01-12T19:16:42.791-08:00Themes For 2010 - 3 - The EconomyFor last week's discussion of the credit markets <a href="http://futronomics.blogspot.com/2010/01/themes-for-2010-2-credit-markets.html">click here</a>. In it we discussed the state of the existing credit base as well as the supply/demand equation for new credit and refinancings. In both cases, we found that credit was contracting significantly - even while government encouragement of accounting shenanigans has been allowing financial institutions to value their assets at [essentially] whatever they want. <br /><br />Today, we turn our attention to how this above state of affairs is going affect the US and Global economy as a whole. <br /><br />To calculate the GDP of a nation, most feel a fairly simple equation can be made: GDP = C + I + G + (E -M). Private Consumption, Gross Investment, Government Spending and Exports less Imports. <br /><br />I'm not a particular fan of this metric. First, because essentially any activity, no matter how wasteful, counts as a net positive toward "economic activity." As a result, we are encouraged by government to undertake all sorts of wastefulness in order to keep up the appearance of prosperity. Second, economic activity which has been financed by debt counts just as much as does that financed by savings. All sorts of malinvestments result from crazy debt ponzi schemes. Should this really be considered "growth"? Third, GDP is too aggregative for my liking. It does not tell me enough about which part of the structure of production economic activity is being directed toward. Is money being spent on raw materials for the use of a factory owner who wants higher quality/more durable products? Or is it being spent by the military for the construction of bombs? The use of each have directly opposite impacts on our overall wealth, once the materials are used. GDP does not distinguish. <br /><br />Return on our investments and the overall wealth of our society is what most readers here are concerned with, not some nebulous GDP number. So for our purposes, we will try to delve deeper into the various components of GDP for clues as to whether our overall prosperity will be on the rise, or will contract further. <br /><br />It should also be noted that there is a wide theoretical disagreement on the cause of the current recession. Most of economic orthodoxy believes that an economy is always at equilibrium. There is no such thing as "growing imbalances" to worry about. This way, they can turn the entire economy into a mathematical model and determine the correct inputs and functions to predict the future. When the crisis erupted in 2008, plunging asset prices completely discredited this mathematical approach to economics. But the neoclassical economists have useful little terms like "rogue waves" and "tail risk" to explain crises. According to them, this completely random wave is what hit the economy in 2008. Nobody could have predicted it. It also necessarily follows that because this was just some irrational <span style="font-style:italic;">exogenous</span> shock, now that it is over we should experience a rebound back to "trend growth" <br /><br />While this is the orthodoxy subscribed to by many, there are literally thousands of economists who think it is total lunacy. Many of these economists instead choose to pay attention to debt levels and their effects on the economy, or the <span style="font-style:italic;">endogenous</span> nature of recurrent financial crises in all economies. They focus on demographics, international trade and changing social preferences. The predictive record of these economists has been orders of magnitude better than the neoclassical economists and their mathematical models. Other than cognitive dissonance, it behooves me why one would continue to ignore the former in favour of the latter. <br /><br />Before I bore you to tears, let me get started. <br /><br /><span style="font-weight:bold;">The Consumer</span><br /><br />It is no secret that the consumer's large impact on the direction of the economy has, in part, been influenced by the easy availability of credit as well as a social incentive to go into debt for the purchase of material goods. Last week, we saw consumer credit numbers for November. Total credit outstanding continues to contract at increasing rates. It should be clear that this is a secular trend, after hardly dropping much below zero in the postwar period. Consumer attitudes toward debt have clearly changed. And we should be careful to assume that discretionary consumer spending will lead the economy out of recession as it typically has. This is not a typical recession, where producers overproduce, causing supply gluts, affecting employment, prices, etc. The cause is credit based. Too much of it. So while the cause was different than most recessions, the cure will also be different. Below is a chart of consumer credit outstanding. It contracted a further $17.5 billion in November - a new record rate of decline. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0vZBtA_RhI/AAAAAAAAA3o/tePJ4Oyx2b8/s1600-h/ConsumerCreditDec.jpg"><img style="cursor:pointer; cursor:hand;width: 400px; height: 252px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0vZBtA_RhI/AAAAAAAAA3o/tePJ4Oyx2b8/s400/ConsumerCreditDec.jpg" border="0" alt=""id="BLOGGER_PHOTO_ID_5425668799384733202" /></a><br /><br />Of course, not all of America's consumption growth has been based on credit growth. Much of it has been based on genuine income growth. But that income growth has been falling of late as well. See below, the decreasing income and sales taxes collected. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0vgIuaDdxI/AAAAAAAAA3w/q8II9FKWEiw/s1600-h/income+tax.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 289px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0vgIuaDdxI/AAAAAAAAA3w/q8II9FKWEiw/s400/income+tax.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5425676616598779666" /></a><br /><br />Both real incomes and consumer credit have been deflating. This bodes ill for future consumption. Most would consider this a bad thing. But, as we can see in the chart below, the US (and much of the West) have been consuming more than they produce for a long time. So long, that we have gotten used to it. Over time, consumption must equal production. And it appears that truism is finally playing out. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/S00Mo4TtwII/AAAAAAAAA34/IZf3m2_TLfM/s1600-h/purchases+.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 300px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/S00Mo4TtwII/AAAAAAAAA34/IZf3m2_TLfM/s400/purchases+.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5426007022500692098" /></a><br /><br />(chart from Jake at <a href="http://econompicdata.blogspot.com/2010/01/more-on-gross-purchases-and-china.html">EconomPic Data</a>) <br /><br />He explains,<br /><br /><blockquote>The difference between GDP (what the U.S. produces) and Gross Domestic Purchases (what the U.S. purchases) is net exports. Thus, the charting is easy, but the result of the chart is rather astounding. The net level of purchases over production peaked at more than $2500 per person (that is literally $2500+ in a single year for every man, woman, and child within the U.S.) in September '06. This has "collapsed" to "only" $1150 a head, but that $1350 less that each person in the U.S. has been able to purchase (without producing) is a real decline.<br /><br />So where does that leave us? It leaves us with entire generations (starting with the baby boomers) that believe it is the norm to purchase more than one produces<br /></blockquote><br />Instead of lamenting this, I suggest we embrace it. As we do so, jobs will be lost in service industries and gained in manufacturing. This is a transition that could occur fairly quickly if wages were permitted to become more flexible. Americans have lost a large portion of their competitive advantage. As such, they must be willing to accept lower wages. Over time, this competitive advantage may be regained and wages will rise with it. <br /><br /><span style="font-weight:bold;">Employment</span><br /><br />The breathtaking rates of job losses we saw throughout 2008 largely abated in the spring of '09. But contrary to the spin, the employment market has not been improving. It simply stopped getting progressively worse. (ie. the second derivative was improving while the overall picture was still deteriorating). <br /><br />Last Friday, we received the nonfarm payroll data for December. The headline establishment survey number showed an additional 85,000 job losses. But the more revealing number comes from the household survey. There, we learn that 843,000 stopped looking for work and fell out of the workforce. That makes for a yearly total of 3.5 Million that decided to stop looking for work. Some of these are discouraged; some are back in school; others might be boomers retiring. But a large majority of them will be back looking for work as soon as there is demand for their services and this will keep a lid on wages for many years to come. Add that to a gradually growing population and we are painted a very bleak picture. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S00Ys3l0OOI/AAAAAAAAA4A/maFevq-NbPc/s1600-h/employment-pop.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S00Ys3l0OOI/AAAAAAAAA4A/maFevq-NbPc/s400/employment-pop.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5426020285167188194" /></a><br /><br />Companies may have stopped firing workers <span style="font-style:italic;">en masse</span>, but they are nowhere near ready to begin hiring. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/S001rVe10bI/AAAAAAAAA4g/Nw02I7YUUDM/s1600-h/workers_per_opening.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 300px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/S001rVe10bI/AAAAAAAAA4g/Nw02I7YUUDM/s400/workers_per_opening.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5426052144668463538" /></a><br /><br />This structurally high level of unemployment does not portend well for the "V-shaped recovery" thesis. <br /><br />The silver lining in this may be that as hours worked and labour costs have been falling, output has fallen less. This means that productivity has been increasing. People are having to work harder in order to keep their jobs. Businesses have likely also tried to eliminate wasteful spending. This is always a good thing. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/S00lvUtV0gI/AAAAAAAAA4Q/HXD6BLQkqtU/s1600-h/ouput.gif"><img style="cursor:pointer; cursor:hand;width: 400px; height: 245px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/S00lvUtV0gI/AAAAAAAAA4Q/HXD6BLQkqtU/s400/ouput.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5426034620994277890" /></a><br /><br /><span style="font-weight:bold;">Investment</span><br /><br />We become wealthier by learning how to produce more with fewer resources. We also "accumulate" capital goods that are able to produce more of what we want. As people die, others inherit these capital goods and knowledge at no cost to themselves. As a result, every subsequent generation is wealthier than the previous. The only way to reverse this trend is by destroying capital goods. This is typically achieved through war, but can also occur by not sustaining equipment and allowing it to fall into disrepair. <br /><br />In much of the postwar period until the early 80's, nonresidential investment was a leading indicator for the economy. But then consumers began to leverage themselves and consumption growth was the main driver for the economy out of recessions. I believe that we will be experiencing a return to the previous order, as consumer credit remains constrained for the first time in decades and the trade balance comes back into line. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/S00mvNC6f1I/AAAAAAAAA4Y/xSMz9TVBj0I/s1600-h/nonresinv.gif"><img style="cursor:pointer; cursor:hand;width: 400px; height: 245px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/S00mvNC6f1I/AAAAAAAAA4Y/xSMz9TVBj0I/s400/nonresinv.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5426035718448906066" /></a><br /><br />Unfortunately, investment has been taking the brunt of corporate retrenching. But as wages remain low, and productivity rises, large investment projects may become more feasible in coming years. This may not be the key to a recovering GDP, but it is a key to an improving economy. Investment has a positive multiplier effect on future rates of growth. Debt fueled consumption and government spending typically have a negative multiplier effect. <br /><br /><span style="font-weight:bold;">Conclusion</span><br /><br />We are most likely (as of June '09) in the midst of a technical recovery as defined by GDP. But this masks the rot underneath the surface. Consumer credit and income growth are contracting. As such, personal consumption expenditures will likely remain depressed for some time. Short term gimmicks like "cash for clunkers" and homebuyer tax credits may provide incentives for consumers to delay their deleveraging, but the cost of the programs add to the overall debt burden, which needs to be paid with interest. High debt servicing burdens hinder our ability to invest. In the long run, these programs are detrimental to GDP - even though they may provide relief in the near term. <br /><br />Structurally high unemployment will likely persist, as those who have recently fallen out of the workforce will join it again upon improving job market fundamentals. This will serve as a drag to economic robustness, but should keep wage pressures low for a considerable amount of time. Declining wages will increase productivity and likely bring about a revival in the US goods-producing industries that have shed jobs for 3 decades. <br /><br />The picture I have painted above is <span style="font-style:italic;">very</span> deflationary. Combined with contracting credit markets, valuations of financial assets should decline to reflect their weak earnings potential. I will discuss the implications of a rebalancing economy and contracting credit on asset markets later this week. <br /><br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com3tag:blogger.com,1999:blog-2121490237517462736.post-68933161967433505322010-01-10T19:53:00.000-08:002010-01-10T21:05:00.535-08:00Market Update 02.10Another week of gains for major market averages to start the year. Volatility is low. Fear is non-existent. An array of 12 analysts polled by Bloomberg all expect gains for stocks in 2010. The most "bearish" of all these analysts expect gains of 10% on the year. Have these people learned nothing of the perils groupthink and recency bias can bring? <br /><br />I can only equate today's long grind higher - behind the veil of steadily weakening fundamentals and unacknowledged credit market deterioration - as analogous to that of what we experienced toward the end of the bull market in '07. See the charts below for a visual on that analogy. <br /><br />First, here is today's market. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S0qqlwdp3cI/AAAAAAAAA3Q/FQJ5G_B63pE/s1600-h/spx_today.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S0qqlwdp3cI/AAAAAAAAA3Q/FQJ5G_B63pE/s400/spx_today.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5425336266762345922" /></a><br /><br />Next, here is the '06-'07 advance. Following this grind, while very few even conceived of anything other than perpetually higher prices, a few subprime mortgage lenders "all of a sudden" went bankrupt. Following a fairly substantial two day shock, the markets continued higher. But they were never the same. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0qq5KDmJHI/AAAAAAAAA3Y/3G4IaXJHd2o/s1600-h/spx07.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0qq5KDmJHI/AAAAAAAAA3Y/3G4IaXJHd2o/s400/spx07.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5425336600049886322" /></a><br /><br />Just a short blurb today. I'll have something more cohesive later this week. <br /><br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com2tag:blogger.com,1999:blog-2121490237517462736.post-76576615077961824382010-01-07T07:56:00.000-08:002010-01-08T11:46:00.939-08:00Themes For 2010 - 2 - Credit Markets<span style="font-style:italic;">The Great Credit Crisis of June '08-March '09</span> was triggered two years earlier by debt ratios that had exceeded the economy's ability to service them. Quite naturally, this was first felt in areas of the credit markets that were serviced by the weakest incomes, ie. subprime. As homebuilding activity reacted to oversupply and contracted, rising unemployment in this and related industries put these marginal borrowers into default. The ensuing foreclosures pressured home prices, putting large numbers of "homeowners" underwater on their mortgages. This led to more foreclosures and the cycle became self-perpetuating. <br /><br />Stresses on the balance sheets of major banks started to become apparent in late 2007. Interest rates were slashed. The pyramid nature of credit derivatives was exposed shortly thereafter. Ultra-leveraged hedge funds blew up, forcing liquidations. Panic set in. Losses had exceeded 10% on (and off) global bank balance sheets. With leverage of 10:1 or greater this meant one thing: bankruptcy. For the entire financial system. <br /><br />This is not the version of events described by policy makers and the banks themselves. They prefer to pin blame on certain people involved: typically regulators, politicians, borrowers, mortgage brokers, fund managers, irrational investors or anyone else that deflects attention from the simple mathematics of what happened. Deflecting attention is so easy, because by blaming people rather than a faceless structure, partisan politics can evoke human emotions. This is how it becomes possible to create a media hoopla over hundreds of millions in banker bonuses, while trillions in guarantees are simultaneously shoveled into the pockets of agencies like Fannie and Freddie with nary a peep. One problem evokes ideological debate, while the other (10,000 times larger) has received bipartisan support for decades. <br /><br />I trust that my readers are intelligent enough to see through this charade. Once this bickering is completely ignored, the simple facts of what happened and what our present situation entails for the future become totally transparent. Our job here is not to pin blame on Democrats or Republicans for the current state of affairs or past events. Our job is to simply acknowledge that credit flows have been the primary determinant of the business cycle and of major asset markets for decades. By following some indicators of these credit flows, we should then be able to determine which part of the business cycle we are in and what that should mean for asset prices going forward. <br /><br /><span style="font-weight:bold;">Credit Markets</span><br /><br />The existing debt stock in the US, inclusive of government, consumer, financial and corporate debt is estimated to be $53 Trillion. This excludes unfunded liabilities and credit derivatives. Total US GDP was $14.2 Trillion in 2008. This gives total debt 370% greater than GDP, illustrated below. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S0YlfgcKH2I/AAAAAAAAA2o/_lf7AH1oXKU/s1600-h/debtgdp.gif"><img style="cursor:pointer; cursor:hand;width: 400px; height: 242px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S0YlfgcKH2I/AAAAAAAAA2o/_lf7AH1oXKU/s400/debtgdp.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5424064024428552034" /></a><br /><br />A larger portion of our incomes are required to finance this debt as the ratio increases. This has been ameliorated by falling interest rates. As rates have fallen and debt has accumulated, the overall servicing burden on the economy has remained somewhat constant. 10-20% of our incomes go toward debt servicing. When interest rates started falling in 2007, the servicing burden eased toward the lower band of 10%. Incomes were freed to be spent or saved elsewhere. This has created a temporary resurgence in economic activity. The reason I suggest this is temporary, is because interest rates are primarily a market price for money. As economic activity accelerates and people start to believe it will continue, the cost of funds rises. Because of interest rate convexity (changes in rates have greater impact the lower they are), even a slight increase in rates will have disastrous consequences. At a current rate of 4% for all debt outstanding (derived from the Lehman Agg Bond Index), we are back to using 15% of our incomes for debt servicing. Should rates rise to 6%, we'll need 22.3%. I highly doubt an economy can grow with debt servicing ratios above 15%. It crimps our ability to invest in productive capacity and to replace old and obsolete capacity. It is like a tapeworm, sucking the life out of the patient. <br /><br />There are a number of ways out of the above conundrum. Historically, when interest rates have fallen, the nominal debt level has been much lower (relative to output), resulting in a debt servicing burden far below 10%. This has encouraged huge amounts of investment, and the economy has grown into its debt burden. But our starting point is far more problematic this time around. Government spending and consumer spending without increased tax revenues or incomes respectively, do nothing but increase the overall debt burden. It is investment in productive capacity that is required. As I'll show, this is not yet happening. <br /><br />The other way around the situation is for debt to be retired, ie. paid back at an increasing rate or defaulted on. This appears to be the market's preference, but the various legislative and executive actions taken since the onset of the crisis have been direct attempts to prevent this from occurring. This has had the effect of masking the market values of some credit instruments. Like morphine, this does not eliminate the disease. It only buys time for the economy to grow into its debt burden. <br /><br />If loan losses had ceased and money was being poured into investment, I could see the argument being made that the recession was over. Considering the credit crisis was caused by these very problems (bad loans piling up on bank balance sheets), and with aftereffects like the falling stock market and rising unemployment being mere symptoms, logic would suggest that the disease would at least slow down before we claimed victory. But loan delinquencies in nearly every category continue to deteriorate at or near the same rate. See the Fed's delinquency report <a href="http://www.federalreserve.gov/releases/chargeoff/delallsa.htm">here</a>. Notice that real estate loans, both residential and commercial are falling delinquent at an accelerating rate all the way through Q3 - almost 1% of loans per quarter. C&I, Agricultural and Lease delinquencies are rising as well. Only the consumer loan category has shown any signs of abating. It has merely stabilized at all-time highs. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/S0dN5qqN72I/AAAAAAAAA24/qmJJWKt8EJ8/s1600-h/total+nonperforming+loans.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/S0dN5qqN72I/AAAAAAAAA24/qmJJWKt8EJ8/s400/total+nonperforming+loans.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5424389929290297186" /></a><br /><br />The increasing stresses on residential mortgages should come as no surprise to anyone. 1/4 of all mortgages are underwater, ie. the price of the residence is worth less than the mortgage. Half of that group are 20% or more underwater. (source: First American CoreLogic). <br /><br />So why aren't the banks announcing writedowns on these bad loans? First, they're not foreclosing on them. Various foreclosure moratoria have prevented banks from foreclosing. And the modification efforts have stalled hundreds of thousands more. Second, banks have been given free reign to value their assets at whatever they like in the accounting process. But the losses still exist, and they will need to be taken. This is one reason why we hear of "banks not lending money." Their balance sheets are so impaired that they can't. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0dQZ_HaglI/AAAAAAAAA3A/mxzwNKkbOtk/s1600-h/alll.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0dQZ_HaglI/AAAAAAAAA3A/mxzwNKkbOtk/s400/alll.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5424392683560534610" /></a><br /><br />The above is a chart of Allowances for Loan and Lease Losses (ALLL). With the enormous inventory of delinquent loans, this metric should be rising in anticipation of the writedowns. But making provisions is not free. Capital needs to be freed from elsewhere. This crimps the banks' profits and therefore their ability to make huge bonus payouts. <br /><br />Regulators and policymakers have been telling us that the banks' health is improving. This is a lie. Not only are ALLL at all-time lows in the face of all-time highs in loan delinquencies, but the too-big-to-fail banks that caused so much systemic risk in 2008 are even bigger today. If I were a cynic, I would think that they are merely keeping up appearances to justify enormous end-of-year bonuses. <br /><br />One argument to the above weakness I have heard suggests that it is all rear-view thinking. The banks are being recapitalized with favourable lending spreads and their leverage ratios are falling. This is true, but in the face of what? See below. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0dhog6n25I/AAAAAAAAA3I/ZZ6NBUr_cxk/s1600-h/IMFresets.jpg"><img style="cursor:pointer; cursor:hand;width: 320px; height: 294px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0dhog6n25I/AAAAAAAAA3I/ZZ6NBUr_cxk/s400/IMFresets.jpg" border="0" alt=""id="BLOGGER_PHOTO_ID_5424411624849529746" /></a><br /><br />Notice the lull in resets during 2009 as subprime mortgages became less of an issue and Option-ARM resets hadn't quite got going yet. There will be no such reprieve in 2010. A wave of recasting mortgages will hit banks this year. And with such high numbers of these borrowers significantly underwater, a large percentage will end in foreclosure. In most cases, the quality of these loans were just as bad as their subprime counterparts. Negative amortization loans, teaser rates, and various "pick-a-pay" loans are all included in this category. <br /><br />A few things to note from the chart above. First, it is two years old. So the number of recasting Option-ARMs may be slightly overstated as some have been already walked away from, foreclosed, or renegotiated. However, one should also note the vintages. Option-ARM mortgages typically recast every 5 years. So the influx of such recasts in 2010 suggests that their vintage is primarily 2005 - right near the peak of the housing bubble. <br /><br />Another important indicator for the overall health of the credit markets can be found in refinancing activity and new credit creation. By all accounts, these metrics are declining rapidly. <br /><br />The Mortgage Bankers Association provides weekly data on purchase applications and refinance activity. (Chart courtesy <a href="http://calculatedriskblog.com">Calculated Risk</a>)<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0ZNUaUJ1AI/AAAAAAAAA2w/jOoACNMucHA/s1600-h/MBAPurchaseIndexJan12010.jpg"><img style="cursor:pointer; cursor:hand;width: 320px; height: 223px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0ZNUaUJ1AI/AAAAAAAAA2w/jOoACNMucHA/s400/MBAPurchaseIndexJan12010.jpg" border="0" alt=""id="BLOGGER_PHOTO_ID_5424107814270915586" /></a><br /><br />There was a brief blip in activity earlier in the year, but starting in October, mortgage applications began falling off a cliff. Indeed, there are many buyers who have simply paid cash for distressed properties and these will not show up here. But their overall impact is still fairly benign. Keep in mind that this index is moving lower <span style="font-style:italic;">despite</span> a large tax credit for homebuyers and massive efforts to refinance existing mortgages (HAMP). <br /><br />Evidence of weak credit expansion can also be found in the latest <a href="http://www.federalreserve.gov/boarddocs/SnLoanSurvey/200911/fullreport.pdf">Fed Senior Loan Officer Survey</a>. While demand for loans and willingness to lend appears to have risen appreciably since the spring, a majority of respondents still suggest that demand is weakening while lending standards continue to tighten. <br /><br />Some entities, however, have had an easier time finding access to credit over the past year. Many large multinational corporations have managed to take advantage of the Fed's asset purchase/swap programs by refinancing their obligations and restructuring the duration of their debts. Real Estate Investment Trusts (REITs like SPG and KIM) are perfect examples of this. Saddled with debts owed to major investment banks, mall owners and the like were bordering on bankruptcy. But by stashing these debts on the Fed's balance sheet through the TALF program, the REITs have managed to rollover their near-term obligations while the IBs have been book-runners for numerous equity offerings, reaping major profits in the process. <br /><br />Although this could be considered positive to those hoping their stocks don't become worthless (like that of GGP, for example), I see it as more malinvestment which needs to be liquidated at some later date. It kicks the can down the road. Business prospects for these companies are bleak. Even as their current status quo was rescued, their ability to service these future debts was rapidly weakening. Retail vacancies rose from 12.9% in 2008 to 18.6% in 2009. Meanwhile, asking rents have fallen 8% over the past year. This is the primary revenue generator for mall operators. When the malls were purchased during the leveraged buyout (LBO) craze of the '04-'07 years, the prospectuses for the new debt issues projected steadily appreciating rents and constant-level demand for square footage. This has now proven to be wildly optimistic, yet the Investment Banks feel it prudent to continue extending them credit at low rates. <br /><br />If the above sounds like moral hazard in action, you would be correct. The Investment banks feel like they will always be able to throw their losses upon either the Fed or taxpayers. So there is no risk to them in extending high-risk credit at low-risk rates. This may buoy the stock prices of banks, but it is a net negative for the economy and the credit markets as a whole. Obviously bad loans being extended is not a recipe for recovery. It is a recipe for disaster. One would think we should know that by now. <br /><br /><span style="font-weight:bold;">Conclusion</span><br /><br />On the whole, credit markets have not recovered. In fact, in many areas credit quality has continued to deteriorate unabated. A pending supply of low grade mortgage recasts, along with an overhanging inventory of underwater mortgages will likely force a continuing deterioration in loan performance and further house price declines. Despite accounting shenanigans that allow banks to value their assets at whatever they like, banks' lending ability remains constrained, while the ability and willingness to borrow is also under pressure. The overall amount of debt outstanding is also constraining the economy's ability to lend its way out of the recession. Even with historically low rates, the high level of debt gives us a servicing ratio that constrains our ability to invest in productive capacity. <br /><br />I will detail what the implications of this are for the economy in Part 3. <br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com0tag:blogger.com,1999:blog-2121490237517462736.post-30599387886743213862010-01-05T10:21:00.000-08:002010-01-05T12:53:43.099-08:00Themes For 2010 - 1 - Review of '09For much of 2009 I was proven to be too bearish on asset markets. I have learned a lot from this experience. That is the entire purpose of this blog. For me to learn. That is how it began in late '06 when I simply wanted to organize my thoughts and decided to publish them online. I have left all my previous learning experiences online, in part hoping that others can learn from them. But mostly because I want my past failures to remain inescapable. I am cognizant of the various forms of psychological bias (recency bias, confirmation bias, cognitive dissonance, etc). And I'm determined to mitigate them while expanding my knowledge in an industry typified by those with a heightened sense of self-importance. Modesty is either willfully accepted or forcibly applied. <br /><br />This is the fourth year in which I offer my thoughts. Previous year's themes can be seen here: <a href="http://futronomics.blogspot.com/2009/01/themes-for-2009-part-6-final-thoughts.html">2009</a>, <a href="http://futronomics.blogspot.com/2007/12/outlook-for-2008.html">2008</a>, and <a href="http://futronomics.blogspot.com/2007/01/themes-for-2007.html">2007</a>. <br /><br />I am typically as critical of my own performance as I am of others'. But that aside, my overarching theme of debt deflation/deleveraging and its adverse consequences for asset markets has been proven correct in spades, even while that sentiment was deeply unpopular in the beginning and widely thought to be "impossible" in many academic circles. <br /><br />Lastly, some context to last year's themes. At the end of 2008 we had just endured two massive plunges, bailouts and confidence campaigns by governments everywhere. Markets had rallied 25% from their November lows. Most concluded that the bottom was in and would not be revisited. In the first two months of '09, most of my themes were playing out according to plan. Markets plunged 30%, making new lows. The recession was deepening. People were getting scared. Riots and protests broke out in much of Europe. I had forecasted a "false recovery" of sorts. But I thought it would be brief. August was as long as I thought it could last. <br /><br />I had fallen victim to my own success. Self-attribution bias. So it was a tale of two seasons for me. January to March vs the rest of the year. Shockingly accurate and then wrong. <br /><br />In last year's themes for 2009 post I had derided the popular bullish projections given by most analysts. 1200, 1300 by year-end. Pft! By the end of the year, they were far closer than my bearish calls. But with the early year plunge, most had retracted their projections. So if one listened to the bulls a year ago, would they have held on the whole way? Hard to say. <br /><br />Here are my Themes for 2009: (this year's thoughts in bold)<br /><br /><blockquote>- Government attempts to "get credit moving again" will fail. The credit contraction (deflation) will continue even as governments and central banks do everything within the law (and even some outside) to encourage hyperinflation <span style="font-weight:bold;">-- Half point. In some areas credit came back. In others, it has continued to deteriorate. And others still, it has been manipulated. I was right about the lawlessness bit. </span><br /><br />- Crumbling corporate earnings as consumer psychology moves away from the "gotta have it now" mentality to "it can wait until next year" <span style="font-weight:bold;">-- Airball. Consumers have changed, but only slightly (when don't they?). But corporate earnings benefited from cost-cutting, strong exports and low interest rates. Huge miss</span>. <br /><br />- Municipal and State bankruptcies requiring federal bailouts in the US <span style="font-weight:bold;">-- This is the second year I've made this one of my themes. It continues to play out, although slower than I expect. Half point again. </span><br /><br />- Skyrocketing unemployment. Official figures to reach 9% or higher in the US.<span style="font-weight:bold;"> -- Swoosh. That one seems almost too easy, but was far from consensus a year ago. </span><br /><br />- Worldwide social unrest or even war as currency collapses, unemployment and falling asset prices shake people's faith in their governments and scapegoats are made of traditional enemies <span style="font-weight:bold;">-- riots in Europe, Thailand, Iran were not what I had in mind. Miss.</span> <br /><br />- Plummeting stock markets worldwide with losses of 50% or more in major indices as hype over President Obama wanes <span style="font-weight:bold;">-- Obama went from 70% approval ratings to 48%. The market did not follow as I expected. Miss</span>. <br /><br />- A wave of bankruptcies in retail, restaurants, airlines and financial services. Nationalization of the politically well-connected -<span style="font-weight:bold;">-- Small business bankruptcies <a href="http://www.latimes.com/business/la-fi-smallbiz-bankruptcy22-2009dec22,0,3305684.story?track=rss">rose 44%</a> for the year. Restaurant activity <a href="http://www.calculatedriskblog.com/2009/12/restaurant-index-shows-contraction-in.html">contracted all year</a>. We know what happened to the banks. I'll take a point here.</span><br /><br />- A continued strength in the US Dollar vs most other major currencies as European infighting escalates <span style="font-weight:bold;">-- Finished down 3%. Euro tensions indeed growing. Miss.</span> <br /><br />- Declines in the price of gold but continued relative outperformance to other assets and most currencies <span style="font-weight:bold;">-- Half point. Price up and outperformed. </span><br /><br />- Large declines for Canadian real estate, notably in bubble areas of the west and prairies<span style="font-weight:bold;"> -- Again, worked well early. Fell apart thereafter. Miss.</span> <br /><br />- Social "witch hunts" for those responsible for the common plight. Multiple scandals uncovered. Persecution and enormous tax increases on the extremely wealthy <span style="font-weight:bold;">-- Not as fierce as I expected, but I'll take it. Tea Parties, windfall bonus taxes, populist anger growing toward bankers. Insider trading rings, hedge fund ponzi schemes, tax haven busting.</span> <br /><br />- An increased focus on the family, on close friends and "time" in general <span style="font-weight:bold;">-- Too interpretive to take credit either way. I see it slowly evolving. </span></blockquote><br /><br />As I always disclaim, <span style="font-style:italic;">"some of these will be proven correct, others will prove laughably false."</span> While I give few absolute targets, and thus many are interpretive, I lean toward the critical side. I'd rather learn something from going too far or not far enough, than simply pat myself of the back. <br /><br />In some areas, I have become even more bearish than I was at this time last year. In others, the unfolding events have me convinced that some legitimate progress is being made. I will surely expand on these thoughts, sparing no ink over the next week or so. I will cover the current state of the credit markets, the economy in general, followed by the impact this will have on asset markets. Stay tuned! <br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com5tag:blogger.com,1999:blog-2121490237517462736.post-47340580284771095862010-01-03T12:01:00.000-08:002010-01-03T13:23:28.105-08:00Market Update 01.10Note: I have changed the name of my weekly update to "market update" from "technical update." As this will be my primary communique, it will have less of a technical analysis theme to it most weeks. This way, I won't feel obligated to post charts if nothing much has happened. And I'll be more able to branch out into other themes if attention warrants (silly really, it's my blog, I can always post whatever I want). So if you're not a TA type and have ignored my weekly columns hitherto, perhaps it will be of more interest this year. <br /><br />Ironically, however, today I <span style="font-style:italic;">will</span> just post a few charts. I'll have more big picture stuff later this week. <br /><br />The last 30 minutes of trading in 2009 saw some heavy volume selling that essentially wiped out the previous 2 weeks' low volume gains. The markets still look overextended and tired. But as long as market participants are willing to ignore the creaking fundamentals underpinning these prices, they can remain where they are. I see social mood rolling over slowly as it has for months now, but it seems to be taking various groups of people with it separately. Those in the financial industry still seem to be euphoric in their expectations, while the masses are downright apocalyptic. This is the source of the sentiment dichotomy many are hearing about. Every couple of days a sentiment report will be released giving complete opposite readings. Either extremely bullish or extremely bearish. It's funny to watch. <br /><br />So whether the end of year selloff meant anything or not largely depends on who is going to win this battle. Populist anger is growing toward the ineptitude of "reform" efforts. I continue to be shocked and amazed at how blatantly the efforts are designed to preserve the status quo - and in many cases even to encourage the same excesses that caused the crisis (eg. raising the cap limits for Fannie and Freddie, authorizing $4 Trillion dollars for future bailouts). I don't even know how to respond to something so idiotic. Should I be angry? Should I laugh? Should I bother to explain why it's a bad idea? Seriously, am I even going to write an article saying that increasing the cap limits for Fannie Mae is potentially disastrous? Would I spill ink explaining that drinking ammonia could be harmful to your health? The paralyzed reaction I've had toward this is something that I've seen in a lot of people. But I've noticed that a number of dissenting high-level officials have started coming forward. The backlash is growing. And it will win eventually. The banks always lose in the end. Banking has been around for millennia, yet few banks have survived a century. It is their nature to fail when populist anger toward their activities rises. Now some charts. <br /><br />The S&P sold off to the upper band of its previous trading range. This could be supportive ahead of an early year push. More support resides around the 1085 level. Anything below 1060 looks like it would severely damage the integrity of the longer term charts. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0EHwqN9PoI/AAAAAAAAA2Q/rCzlCow6txA/s1600-h/spx.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0EHwqN9PoI/AAAAAAAAA2Q/rCzlCow6txA/s400/spx.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5422623958878731906" /></a><br /><br />The US dollar was halted at its 200 day EMA. There is big time support surrounding 76.50-77. If it can close a fair bit above its recent highs, I think it is lights out for the dollar bears. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/S0EJJv3MPmI/AAAAAAAAA2Y/ELit1xrob3c/s1600-h/usd.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/S0EJJv3MPmI/AAAAAAAAA2Y/ELit1xrob3c/s400/usd.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5422625489402216034" /></a><br /><br />Internals are mixed. But the Put/Call ratio hit a new low for the rally and appears to be putting in a reversal. Lower readings reflect more call buying and thus more optimism. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/S0EKds09C8I/AAAAAAAAA2g/hqF-pLlhNPg/s1600-h/cpc.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/S0EKds09C8I/AAAAAAAAA2g/hqF-pLlhNPg/s400/cpc.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5422626931696536514" /></a><br /><br />Good luck in 2010!<br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com2tag:blogger.com,1999:blog-2121490237517462736.post-82391126205547768632009-12-30T15:58:00.000-08:002009-12-30T16:10:59.497-08:00Tick TockNot much to post of late. I'm summoning my energies for a series of articles reviewing the past and looking toward the future. I always look forward to these articles. They allow me opportunity to clear away the poor analysis and build upon the good. <br /><br />In the meantime, let me entertain you with a poem, courtesy of the Financial Times' deputy editor Martin Dickson. If nothing else, the appearance of this now, after such massive recoveries in asset markets confirms the Socionomic/Elliott Wave thesis of a secular bear market in social mood. A secular bull market - like that during the S&L crisis or LTCM - is typically quick to forgive bankers for losses they have incurred to all. A year after the carnage and it seems that antagonism toward the finance industrial complex grows more rabid by the day. As it should. Pass this on to your friends. <br /><br /><a href="http://www.ft.com/cms/s/0/d3977b0e-f3eb-11de-ac55-00144feab49a.html">The Bankers Who Wouldn't Say Sorry; A Cautionary Tale</a><br /><br /><blockquote>(With apologies to Hilaire Belloc)<br /><br />There was a time when naughty boys<br />Would have to forfeit all their toys,<br />And go to bed without their food<br />To force a new, repentant mood<br />Upon the wretched little toads,<br />Who flouted our great social codes.<br /><br />Nor was blind arrogance a trait<br />That parents liked to inculcate.<br />They had regard for social graces: <br />Not for their offsprings’ haughty faces.<br />A beastly child engaged in folly<br />Would surely have to say: “I’m sorry!”<br /><br />But now we live in debased times,<br />Sans punishment to fit our crimes<br />Our moral compass has got lost,<br />Or on the rubbish heap been tossed.<br />As in this cautionary tale of bankers,<br />Who came to look like social cankers.<br /><br />You will all know the basic story,<br />In all its venal details, gory.<br />Of how a bunch of peerless clowns<br />Despite degrees – from Yale to Brown –<br />Behaved like schoolboys in the lab,<br />When teacher’s gone to smoke a fag.<br /><br />Exuberant beyond all reason<br />(For this or any other season)<br />Fired up by dreams of starter castles,<br />Sardinian yachts and vineyard parcels,<br />They built themselves a strange device –<br />A ticking bomb, to be precise.<br /><br />The trouble was they did not know,<br />It was a bomb ’twas ticking so.<br />They thought it merely marked the beat<br />That called them to stay on their feet<br />And dance away – to really bop –<br />To music that would never stop.<br /><br />At last the bomb it ticked no more.<br />Instead it gave a mighty roar<br />Like some avenging finance demon,<br />And destroyed RBS and Lehman.<br />That made the bankers wail and yelp,<br />And rush to teacher for some help.<br /><br />Faced with the imminent demise<br />Of all world banks of any size,<br />And thus of global finance too,<br />The state bailed out this sorry crew.<br />But were they grateful? Not a jot,<br />This arrogant and greedy lot.<br /><br />“It wasn’t us,” was their refrain.<br />The regulators are to blame.<br />They failed to prick our growing bubble.<br />They are the cause of all this trouble!<br />And China too, and central bankers,<br />Who failed to give us decent anchors.<br /><br />“And while we’re at it, let’s include<br />Those nasty hedge funds, brash and crude,<br />We may have lent them stock to play,<br />But not to short poor banks at bay.<br />We’re sad events turned out this way<br />But not to blame; nothing to pay.”<br /><br />Their minds so tainted by success,<br />They could not see their gross excess<br />Had played a very major role<br />In this colossal world own-goal.<br />Amnesia can be a sickness,<br />But this denoted arrant thickness.<br /><br />Their attitudes were so repulsive<br />The public backlash grew convulsive,<br />And dimly seeing that their wages<br />Just might be threatened by these rages,<br />Self-interest prompted some to say<br />“We’re sorry” – in a muted way.<br /><br />But actions more than words do speak<br />And their repentance was skin-deep,<br />Just like the artful crocodile<br />Shedding fake tears beside the Nile.<br />(And while we’re thinking of the zoo,<br />A vampire squid swims into view.)<br /><br />“It’s plain,” they said, “we do not need<br />Tough regulation. Do not heed<br />The cries of all those sad dimwits <br />Who want to break us into bits.<br />Our little hiccup now has passed.<br />Back to the gravy train – and fast!<br /><br />“To moral hazard give no thought!<br />We see no need to get distraught.<br />Please rest assured God’s work we’re doing<br />(It’s merely taxpayers we’re screwing.)<br />The Lord to us has sent a sign:<br />Monopoly profits are just fine.”<br /><br />How could these people fail to see,<br />Their debt to all society?<br />The short answer must surely be<br />A banker’s mind is conscience-free. <br />They grab the profits of risk-taking,<br />Leave us the losses that they’re making.<br /><br />The politicians fumed and fussed,<br />But they were well and truly stuffed:<br />The banking system had to work<br />Or jobless men might go berserk,<br />Victims of a growth disjunction<br />Piled upon finance malfunction.<br /><br />In short, the banks – still big and burly –<br />Had got them by the short and curlies.<br />So their response was rather vapid,<br />And not decisive, hardly rapid. <br />Bankers returned to their old ways,<br />Assured a life of Christmas days.<br /><br />Too big to fail, too hard to tame,<br />They returned to their former game:<br />Taking risks of insane folly,<br />To stuff their pockets full of lolly,<br />Untroubled, with the certainty<br />Of a taxpayers’ guarantee.<br /><br />It would be good to end this story<br />In a nice blaze of moral glory,<br />Like Hilaire Belloc’s clever tales<br />Where evil-doing always fails.<br />Alas, the only moral here<br />Is bankers just themselves hold dear.<br /><br />But there’s a price we all will pay<br />If politicians won’t display<br />A little courage and crack down<br />Upon these unsafe, grasping clowns:<br />Another bomb is being built,<br />By bankers with no sense of guilt.<br /><br />It’s ticking now, will louder tick<br />Unless we stop it, fast and quick.<br />For mark my words, believe this rhyme,<br />It will go off in five years’ time. <br />You’ll hear no end of sturm and drang.<br />When it explodes with a loud BANG!</blockquote><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com1tag:blogger.com,1999:blog-2121490237517462736.post-83285625528378731492009-12-24T08:53:00.000-08:002009-12-24T08:56:09.017-08:00Happy HolidaysI'm taking a much needed few days off over the holidays. Thus, there will be no weekend commentary this week. <br /><br />I'll be doing some in depth posting over the next few weeks, so stay tuned! <br /><br />Let me wish my readers a happy and safe holiday season. <br /><br />Best, <br /><br />Matt<br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com5tag:blogger.com,1999:blog-2121490237517462736.post-24450246506096865622009-12-20T11:50:00.000-08:002009-12-20T15:39:00.797-08:00Technical Update 49.09/European WoesAnother week of gains for the US dollar was met with general indifference from equities around the world. Commodities also turned their cheeks to the currency market action, reminding us that correlations long-adhered to can break. Last week we were expecting a bit of a retrace in the dollar index and commodities which would allow for equities to put in new highs. That is still my working assumption. Yet with option expiry hangover, combined with 2 weeks of very low volume upcoming, I suppose anything is possible. <br /><br />The weakness in the Euro is being blamed on sovereign concerns around the periphery of the EMU (European Monetary Union). Specifically, Greece, Ireland, Spain, Portugal, and Italy are the focus of most observers. But bear in mind that these issues are not somehow "unforeseen" as most imply with their surprise. Greece did not accumulate a 12.4% budget deficit overnight. Nor did Italy find itself with a total debt 1.14x its GDP. These have been very long-term problems. I, as well as many others, have been pounding the table with the untenability of this situation for a long time. And I ruminated back in the spring that the next round of this crisis would originate in Europe. <br /><br />Social mood may have turned with the recent attention to these long-standing problems. And we know the kind of contagion that will result should this escalate. Let us not forget the issues facing Ukraine, Hungary, Romania and the Baltics. All major european financial institutions have exposure to these toxic emerging markets in addition to their hidden exposure to US subprime CDOs. <br /><br />Below is a table from STRATFOR that details each Eurozone country and their debt burdens. Remember that the Maastricht Treaty forbids any country from surpassing a deficit of 3% of their GDP. Nearly every nation has completely ignored this. Germany's supposed new "conservative" coalition threw in the towel this week, suggesting they would escalate their deficit spending. If nothing else, this proves the uselessness of international regulations. When push comes to shove, any nation will look after their own asses first. It is this mentality that will, in my opinion, eventually lead to the breakup of the EU and the dissolution of the EMU. This process may have begun already. Or it may be dragged on for a decade or more longer. But the endgame is already written. A Euro will eventually be worth less than the "lowly" US dollar. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/Sy6Q6yyqVPI/AAAAAAAAA1Y/gU9JhUbmBK8/s1600-h/europe+debt.png"><img style="cursor:pointer; cursor:hand;width: 353px; height: 400px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/Sy6Q6yyqVPI/AAAAAAAAA1Y/gU9JhUbmBK8/s400/europe+debt.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5417426741514360050" /></a><br /><br />I recommend readers monitor CDS spreads closely as an indicator of the seriousness of these problems. Over a week ago, when stories started breaking about Greece's problems after a Fitch downgrade, their CDS premiums shot up to 232. Since then, Greek officials have said there is "no possibility" of EMU withdrawal or sovereign default. Yet, the assurances have not seemed to gain traction. Greek CDS now stand at 279. Intraday top movers in CDS premiums can be found at <a href="http://www.cmavision.com/market-data">CMA Market Data</a>. <br /><br />Below is a chart of the Euro's performance. This makes 3 weeks straight of declines and essentially wipes out any of its gains from the previous 3 months. What's done can be undone in short order. Equity speculators should take note. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/Sy6jZ7HU3mI/AAAAAAAAA1g/eIAgUaHf2Js/s1600-h/xeu.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/Sy6jZ7HU3mI/AAAAAAAAA1g/eIAgUaHf2Js/s400/xeu.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5417447067533762146" /></a><br /><br />I am also including a number of charts from eastern European currencies relative to the Euro. Last winter, some of these currencies began blowing out. But assurances from the IMF managed to ease the fears - for a time. At issue are loans made in these countries (Latvia, Poland, Czech Republic, Hungary, Bulgaria, Romania, Ukraine, Russia) but denominated in other currencies (primarily the Euro, Swiss Franc and US Dollar). The availability of loans at very low interest rates; prospects of continuance in the decade long appreciation of local currencies; and eventual induction into the EMU were the primary forces driving asset bubbles in these countries. When the bubbles popped along with asset bubbles all over the world in 2008, their central banks began printing money to "stimulate" their economies. This had the effect of depreciating the local currencies and thus increasing the debt burdens of those who borrowed in foreign currencies. Default prospects increased, jeopardizing the solvency of their western lenders. This is where the IMF stepped in and gave some very vague guarantees with some very unknown preconditions. Most likely they instructed the eastern central banks to stop printing and told their finance ministries to instead introduce austerity measures. I wonder how long populist oppositions will stand for the rising unemployment that goes along with this? At what point will they simply say, "to hell with the western bank's losses, we default." Or, "to hell with the EU and the Euro, we're inflating our way out!" Either way, losses will eventually be realized on these malinvestments. <br /><br />Hungarian Forint/Euro:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/Sy6wHin100I/AAAAAAAAA1w/BFrGJHJjGWg/s1600-h/eurhuf.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/Sy6wHin100I/AAAAAAAAA1w/BFrGJHJjGWg/s400/eurhuf.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5417461045372769090" /></a><br />Polish Zloty/Euro:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/Sy6whOAbdKI/AAAAAAAAA14/QmyIZg8MBaw/s1600-h/eurpln.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/Sy6whOAbdKI/AAAAAAAAA14/QmyIZg8MBaw/s400/eurpln.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5417461486515352738" /></a><br />Russian Ruble/Euro:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/Sy6wuRqIj3I/AAAAAAAAA2A/YRngLDIcaJ0/s1600-h/EURRUB.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/Sy6wuRqIj3I/AAAAAAAAA2A/YRngLDIcaJ0/s400/EURRUB.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5417461710833880946" /></a><br />Ukrainian Hryvnia/Euro:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/Sy6wz0IvARI/AAAAAAAAA2I/4-PFy4O2QWM/s1600-h/euruah.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/Sy6wz0IvARI/AAAAAAAAA2I/4-PFy4O2QWM/s400/euruah.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5417461805988380946" /></a><br />There are also potential issues in Bulgaria and Latvia, where currencies are pegged to the Euro. They were both scheduled to enter the EMU by 2012, but that now seems unlikely. If they decide to forego entrance, their pegs break and any loans made are essentially wiped out. <br /><br />Ambrose Evans-Pritchard has <a href="http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6851932/Euro-Diktats-risk-terrorist-response-across-Southern-Europe.html">another Euro-skeptic piece</a> detailing the unsustainable nature of these austerity measures in southern Europe. Enduring deflation is the natural way out of things for the US, UK, Canada and essentially any country whose debts are largely domestically originated. But when this path is dictated by foreigners who got you into the problem in the first place, I can see how the political impossibility would lead to its failure. <br /><br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com10tag:blogger.com,1999:blog-2121490237517462736.post-5431579465631948122009-12-14T09:17:00.000-08:002009-12-14T09:43:34.018-08:00Response to Robert MurphyRobert Murphy of the Mises Institute had a good article out this morning titled, "<a href="http://mises.org/daily/3933">A Case For The Inflation Camp</a>." He talks about why he expects consumer prices to continue to rise. I recommend my readers have a glance over this. <br /><br />As my readers know, I have a different take on matters. Below is the brief response I left in the comments section of Murphy's post. Feel free to weigh in with your own take. <br /><br /><blockquote>The primary arguments in favour of deflation look less at consumer prices and more at asset prices, bank lending, debt/income or debt servicing ratios, demographics and social revulsion of excesses.<br /><br />Many things can contribute to consumer price changes. This year we had a very large drop in inventories and capacity utilization which eased downward pricing pressures significantly in spite of falling consumer demand and reduced credit availability. We also had commodity prices rising from leveraged speculative bets by hedge funds.<br /><br />The first two are like bullets in a six shooter. They can only be used once. I suppose the commodity speculation could be considered the very early beginnings of a "crack-up-boom," but other than gold, there seems to be little panic buying in the more "emotional" of these commodities (grains, energy). And it is precisely this fear (OMG, I might not be able to feed my family, "I'll take 10 sacks of rice!") that characterizes the CuB.<br /><br />Until I see that kind of fear and still no willingness to quash it from central bankers, speculation of runaway inflation is premature.<br /><br />One thing we can likely all agree on is that deflation "should" happen. We have too much debt and asset prices are too high to be supported by our incomes. And the easiest solution to this problem for those without access to a printing press (small businesses and consumers) is deleveraging. Considering they compose the largest sectors of the economy, their actions will determine the overall outcome.</blockquote><br /><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com4tag:blogger.com,1999:blog-2121490237517462736.post-84157304091949382592009-12-13T11:53:00.000-08:002009-12-13T15:36:42.554-08:00Technical Update 48.09Most major stock indices were flat around the world last week, even as the US dollar continued its push higher and commodities sold off significantly. The followthrough on the US dollar was something we were looking for last week as a key to the topping process we have been tracking for months. It has traced out a very nice looking 5 waves up (the Euro has done the inverse) and should now retrace that move in 3 waves down. <br /><br />The blue chip stock indices have been the most resilient over the past few months as the FIRE sector (Financials, Insurance, Real Estate) has lagged behind considerably. It was a credit based bubble that popped in 2008 and it has been a credit based recovery. To me, this suggests that the overall structure of the economy has not changed. Therefore, weakness in these areas, much like during the 2007 rally, should be considered a leading indicator for the overall market. I am expecting the major indices to make marginal new highs next week, as the US dollar retraces but fails to make a new low. This should be the final non-confirmation prior to embarking on a monumental decline. This likely sounds like a broken record by now. We've been monitoring this process for months. Bears are now, to be sure, tired of waiting. I know I am. But to keep things in context: after a 53% rally in 6 months, the S&P 500 has rallied only 8% in the 4 months from August to the present. <br /><br />The past few weeks have seen painstakingly quiet markets, reminiscent of John Kenneth Galbraith's account of the 1930 rally which he described, "as placid as a produce market." Despite the historical context of nearly all major bear markets retesting their lows to some degree, I have been able to find few market analysts/pundits willing to entertain that possibility. The idea of going back to where we came from is as preposterous to most now than dropping below Dow 10,000 was to most in 2007. Sure, many are expecting a correction, but little more than 10-20%. This is an incredible amount of confidence considering we have rallied more than 65% in just 10 months. I'd wager a guess that this is unprecedented confidence. Below is the Bull/Bear ratio, as determined by the <span style="font-style:italic;">Investors Intelligence</span> survey. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://3.bp.blogspot.com/_P7en4o3WN38/SyVrJjjJGMI/AAAAAAAAA04/9Ud4yMO7vpY/s1600-h/bullbea.gif"><img style="cursor:pointer; cursor:hand;width: 400px; height: 163px;" src="http://3.bp.blogspot.com/_P7en4o3WN38/SyVrJjjJGMI/AAAAAAAAA04/9Ud4yMO7vpY/s400/bullbea.gif" border="0" alt=""id="BLOGGER_PHOTO_ID_5414851938888521922" /></a><br /><br />The S&P 500 has traded within a 3.5% range over the past 5 weeks. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/SyVsGj-z1hI/AAAAAAAAA1A/hq6XYxfd-5Y/s1600-h/spx60.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/SyVsGj-z1hI/AAAAAAAAA1A/hq6XYxfd-5Y/s400/spx60.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5414852986976589330" /></a><br /><br />Crude oil has an opportunity to extend to the downside. Any continuation below Thursday's low substantially damages this chart. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/SyV3tWXn4SI/AAAAAAAAA1I/ci0PCN6qEXs/s1600-h/wtic.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/SyV3tWXn4SI/AAAAAAAAA1I/ci0PCN6qEXs/s400/wtic.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5414865747965370658" /></a><br /><br />As previously mentioned, the Euro has put in its most significant decline since June. A fairly swift retrace back up to 148-149 should occur prior to a resumption of the downward trend. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/SyV6XdqJq2I/AAAAAAAAA1Q/CAhu0WgzTdA/s1600-h/xeu.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/SyV6XdqJq2I/AAAAAAAAA1Q/CAhu0WgzTdA/s400/xeu.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5414868670499892066" /></a><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com5tag:blogger.com,1999:blog-2121490237517462736.post-36652128658581658112009-12-09T11:35:00.000-08:002009-12-09T11:51:06.014-08:00Sovereign Default Risk Puts Floor Under US Dollar<span style="font-style:italic;"><span style="font-weight:bold;">Note to readers: </span>The following post originally appeared at Examiner.com. I have recently taken a position as their Canadian Economy writer. I will still be contributing to Futronomics, but some of the articles will be cross-posted. You will notice a difference in the style of writing in such articles, but I pledge to stay true to the spirit of my work to date. Naturally, the work will be a little more "Canada centric," but most will still have relevance for my American readers. Feel free to visit <a href="http://www.examiner.com/x-31999-Canada-Economy-Examiner">my Examiner page</a> often and subscribe to my posts if you wish. I am paid minimally based on article views, subscribers and comments. However, this is more of a resume boosting endeavor, so we will see how it goes... </span><br /><br />When Dubai World, the state backed infrastructure company, warned of its inability to meet obligations without assistance two weeks ago, some analysts noted that it had the potential to spark fears of other susceptible nations to do the same. <br /><br />This week, markets have been tentative after rating agencies confirmed those fears with downgrades in Europe. <br /><br />Greece, widely known to be the weakest among major EU economies, was the first to be given a downgrade by Fitch. Its rating was slashed to BBB+ and reiterated that further cuts may be in the offing. Standard and Poor's also expressed heightened caution a day earlier, stating that they have a "negative" outlook on the future direction of ratings. Ratings were also lowered on Greek commercial bank debt.<br /><br />Ratings downgrades are considered significant events because certain investment institutions (such as pension funds) are only allowed to invest in debt that is considered investment grade. A downgrade could force selling of government bonds, pushing interest rates up and exacerbating the problems. <br /><br />Fitch noted that the historical record of fiscal management in Greece had been poor and that they are, "not convinced that the substantive pension reform and other measures necessary to contain public spending pressures and broaden the tax base will be sufficiently strong to materially reduce debt."<br /><br />Credit default swap contracts (the cost to insure against default) on Greek sovereign debt has risen substantially over the past two days to 232 basis points. <br /><br />Spanish sovereign debt risk also rose, as Standard and Poor's put the nation on "watch negative." <br /><br />Fears of greater contagion have put higher risk premiums on almost every European nation. As a result, the euro has fallen by 3% against the US dollar in the last week. Over the past few years, the US dollar has strengthened when risk aversion increases. The reaction could prove detrimental to other currencies like the Canadian and Australian dollars, which have also benefited from risk seeking investors borrowing money in the US and taking it abroad. <br /><br />Willem Buiter, professor at the London School of Economics, and incoming economist with Citigroup, suggested that a bailout by the European Union may be a last-resort option at some point for Greece. But certain German officials have warned against this, asserting that it could set precedents for other EU members such as Ireland, Italy, Spain, and Portugal to expect the same. <br /><br />Watch a Bloomberg interview with Buiter below. Interested parties can follow daily CDS movements here.<br /><br /><object classid="clsid:D27CDB6E-AE6D-11cf-96B8-444553540000" id="cs_player" width="425" height="330"><param name="movie" value="http://eplayer.clipsyndicate.com/cs_api/get_swf/3/&pl_id=8178&page_count=5&windows=1&va_id=1208936&show_title=0&auto_start=0&auto_next=0"></param><param name="allowfullscreen" value="true"></param><param name="allowscriptaccess" value="always"></param><embed src="http://eplayer.clipsyndicate.com/cs_api/get_swf/3/&pl_id=8178&page_count=5&windows=1&va_id=1208936&show_title=0&auto_start=0&auto_next=0" type="application/x-shockwave-flash" allowscriptaccess="always" allowfullscreen="true" width="425" height="330"></embed></object><br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com3tag:blogger.com,1999:blog-2121490237517462736.post-85628184335191779252009-12-05T10:12:00.000-08:002009-12-06T13:23:37.392-08:00Technical Update 47.09Most indices posted large gains on the week, with previously underperforming groups (Semis, Small Caps, Transports, Utilities, Asia) taking the baton from the previous outperformers (like the Dow). Sector rotation is a signal of market strength and should not be ignored by market bears. Many of the negative divergences we have been tracking for months disappeared this week, showing a lack of ability for bears to capitalize on weakness. <br /><br />There were, however, a few signals on Friday that may prove to be important for the bearish case. Nonfam payroll data was released, which beat expectations by a large margin. But after a short spike higher on the open, markets sold off for much of the rest of the day. This again proves my oft cited opinion that it is not the news that matters, but rather the reaction to it that we must give heed to. <br /><br />The US Dollar was the big story on Friday, however. It posted its biggest gain in many months as the Euro and the Japanese Yen especially put in major reversals. It is my belief that the direction of the dollar holds more sway on equity markets than anything equity specific (carry trade), so it is not necessarily "cognitive dissonance in action" to ignore the many positive price movements in equities in favour of the evidence being displayed in the currency markets. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/Sxv-2sUgdJI/AAAAAAAAA0Q/fWB1oePkCnE/s1600-h/usd.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/Sxv-2sUgdJI/AAAAAAAAA0Q/fWB1oePkCnE/s400/usd.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5412199592779347090" /></a><br /><br />There's a lot to like in the chart above. It has decisively broken its down sloping trendline from March after briefly poking through 3 times in November. The RSI has, as pointed out over the past few weeks, displayed improving readings as the dollar has slowly drifted lower. It now pushes past the 50 barrier convincingly, which has proven to be the high water mark of the latest decline. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/SxwUO63LwDI/AAAAAAAAA0Y/T3_bkkUuORY/s1600-h/usdw.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/SxwUO63LwDI/AAAAAAAAA0Y/T3_bkkUuORY/s400/usdw.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5412223098743930930" /></a><br /><br />The weekly also displays some interesting signals. The MACD has crossed into positive territory along with the histogram. And stochastics are also looking bullish. The decline has been an 81% retrace of the previous advance, which, from an Elliott wave perspective, is not uncommon for a "wave 2" correction. This would imply sharply higher prices in a 3rd wave higher, which would greatly surpass the previous levels. Elliott waves are not always a useful tool, but when their patterns are as compelling as they are right now for the currency markets, extra attention is definitely warranted. Also of importance to the bullish outlook on the dollar is the current extreme sentiment against it, despite the fact that it is above where it was 18 months ago. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://1.bp.blogspot.com/_P7en4o3WN38/SxwXsJV6pcI/AAAAAAAAA0g/TcyBVgdbbGE/s1600-h/usdm.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://1.bp.blogspot.com/_P7en4o3WN38/SxwXsJV6pcI/AAAAAAAAA0g/TcyBVgdbbGE/s400/usdm.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5412226899382019522" /></a><br /><br />In fact, looking at the monthly chart, the extreme bearishness against the dollar looks even more unwarranted. It only sits a few percentage points below where it was in the early 90's. I'm fairly certain that if a survey of laymen were done and asked, "where is the USD relative to 17 years ago," the answers would be far lower, based on the steady barrage of "dollar doom" media coverage. I was recently forwarded <a href="http://www.stockhouse.com/Community-News/2009/Nov/27/Precious-metals-bull-market-just-underway">an article</a> where an interviewee responded with this intellectual gem:<br /><blockquote>As far as the "short dollar trade being too crowded," I'd dismiss it as nothing more than <span style="font-weight:bold;">Nazi-style propaganda</span> with no basis at all, only an underlying motive of trying to scare people out of their gold and silver positions so that the "bad guys" can take it from them.</blockquote><br />I nearly hit the floor in hysterics. <br /><br />As the near inverse of the dollar index, the euro also posted a large reversal day. The 50 day EMA remains as a barrier to lower prices, holding on all previous declines since the spring. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://4.bp.blogspot.com/_P7en4o3WN38/Sxwb32-awcI/AAAAAAAAA0o/ZyXTW139h_w/s1600-h/xeu.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://4.bp.blogspot.com/_P7en4o3WN38/Sxwb32-awcI/AAAAAAAAA0o/ZyXTW139h_w/s400/xeu.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5412231498656563650" /></a><br /><br />The Japanese Yen also had a sizable loss on Friday, giving up most of its previous gains of the past few months. Something looks like it went KABOOM here, and it would not surprise me at all to hear of hedge funds caught offside, betting against continuing correlations. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://2.bp.blogspot.com/_P7en4o3WN38/Sxwcn95gpvI/AAAAAAAAA0w/hHqnbKvviRg/s1600-h/xjy.png"><img style="cursor:pointer; cursor:hand;width: 400px; height: 314px;" src="http://2.bp.blogspot.com/_P7en4o3WN38/Sxwcn95gpvI/AAAAAAAAA0w/hHqnbKvviRg/s400/xjy.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5412232325148747506" /></a><br /><br />As always, followthrough will be the key to the importance of Friday's reversal. Over the past few months, we have documented dozens of opportunities like this for currencies, commodities and equities to change course. And in an almost comical ineptness, they have failed every time. We will know early this week, whether this is just another head-fake or the early stages of a resumption in trends that began 18 months ago. <br /><br />Have a great week!<br /><br /><i>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.</i>Matt Stileshttp://www.blogger.com/profile/17977694389453612864noreply@blogger.com3