Technical Update 30.09

Apologies for not getting anything out sooner. I was away for the weekend and didn't feel like I had much to add.

There were some negative divergences showing themselves last week as the S&P managed to make marginal new highs, but the Nasdaq failed to confirm the move. Volatility is also failing to budge and the advance/decline line is putting in lower highs as the market marches higher, signaling growing skepticism about the rally's sustainability. This could be seen as bullish or bearish depending on how one looks at it. On the one hand, it could be said that there is more "capitulation" to come by squeezing shorts. But on the other, the weakening leadership is typically a sign of looming tops.

As usual, I think the currency markets are acting as the real driver for the equities. And Friday's action spoke volumes to me about what is possibly around the corner. First, we saw the Yen get smacked along with the other currencies in the Dollar Index - not typically something one sees, and perhaps a "shot over the bow" of some imbalances being unwound somewhere. But what is really compelling about the dollar index's strength on Friday was that it marked a near perfect elliot wave ending pattern of a corrective A-B-C from the highs last fall. Strong reversals are characteristic of these ending patterns, especially when there is decent follow-through - something we're seeing in today's (Monday's) session.

As a corollary to further US Dollar strength, I think that the precious metals are setting themselves up for a fairly low risk short opportunity, despite seasonal strength that is on the horizon. I've been bearish on the precious metals from a technical standpoint since about July of '08, while maintaining that they do represent one of the fundamentally "safer" investments available. I still think the '08 lows will be exceeded to the downside at some point, but believe that will prove to be a long term buying opportunity of the non-speculative variety. We shall see.

I'll have some deeper insights later on this week for those interested. I will also be working on some site improvements going into the fall. Stay tuned.


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.

Midweek Thoughts

Markets appear to be range bound going into Friday's payroll data. I can see a number of outcomes as plausible. The July data could turn out to be better than expected. However, this month's report also happens to be the one where birth/death model numbers are revised for the previous 6 months. That could force the total unemployment rate past the 10% mark. Again, it won't be the data that is so important, but rather which data gets reported as being more important. And the direction of the market will determine that.

I've got a long weekend coming up, so don't have much time to wax intellectual. I'll simply point out a few of the more interesting things I've come across in my reading this week.

UBS economist Paul Donovan has touched upon something that I've often wondered about. Namely: How can a government inflate away its debt, if a vast portion of that debt matures within short time periods? His answer: They can't. And this is a damning blow to the case for a looming inflationary spiral.

Tracy Alloway of the Financial Times reports:

The debt-inflation myth, debunked by UBS
Posted by Tracy Alloway on Aug 04 09:23.
Here’s an interesting counterpoint to the theory that governments are attempting to inflate their way out of their financial crisis-related debt dilemmas.

It comes courtesy of UBS economist Paul Donovan, who argues:

While most investors today acknowledge that deflation is likely to be a feature for the OECD economies during the second half of 2009, inflation pessimists cling resolutely to the belief that inflation will inevitably return. “Fiscal deficits are rising dramatically” goes the argument. “Governments will have to create inflation to reduce debt:GDP ratios, as they have done in the past.”

The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. Market mythology has created the idea that inflation will help reduce government debt ratios. The facts do not support the myth. OECD government debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future.

To wit — this chart, which purportedly shows year-on-year levels of inflation on the x-axis and change in government debt (as a per cent of GDP) over one year on the y-axis. The two axes cross each other at the 5 per cent inflation level because that’s deemed, by UBS, to constitute a genuine inflation shock.



The point then, is that there aren’t many instances in the lower right-hand quadrant, which would coincide with relatively high levels of inflation and a decline in government debt as a proportion of GDP. The picture is much the same, according to UBS, over a two-year period too.

But why? Here’s Donovan again:

The fundamental obstacle to governments eroding their debt through inflation is the duration of the government debt portfolio. If all outstanding debt had ten years before it matured, then governments could inflate their way out of the debt burden. Inflation would ravage bond holders, and governments (with no need to roll over existing debt for a decade) could create inflation with impunity, secure in the knowledge that existing bond holders could do nothing to punish them. In the real world, of course, governments roll over their debt on a very frequent basis. As a result, governments are vulnerable to higher debt service costs if market interest rates change. If markets move to price in the consequence of higher inflation by raising nominal interest rates, then the debt service cost will rise and increase the debt. Thus a period of high inflation will tend to raise both the numerator and the denominator of the debt:GDP ratio.

As an example, the US can expect to roll over almost 45 per cent of its debt in the next 12 months and some 55 per cent over the course of the next two years. So according to UBS, if there is an inflation surge in the next 12 months, the US government would expect that to be reflected in higher borrowing costs — thus negating any ’sympathetic’ inflation-impact on its national debt. There’s also the issue of TIPS, or index-linked (inflation-linked) securities.

Add to that the notion that real yields tend to also rise in times of uncertain inflation — by as much as 100 to 150bp, according to UBS’s analysis, as investors demand a premium for the uncertainty — which further adds to government borrowing costs.

Thus, according to UBS, the problem governments face is that high inflation is likely to generate higher nominal and higher real interest rates. This means the rate of increase in debt servicing costs will probably exceed the rate of increase in nominal GDP, as a result of the higher inflation, and voila — you have very little government benefit associated with stronger inflation, according to the bank.

Donovan’s conclusion:

The idea that governments can readily inflate their way out of their debt problems is a misnomer — arising, perhaps, from confusion between the fate of the individual bondholder and the response of the collective market. An individual holder of a long duration bond will lose out as a result of inflation. However, modern governments can not rely on markets to remain collectively indifferent to inflation. Inflation will raise the nominal cost of borrowing (of course) but through the inflation uncertainty risk premium it will also add to the real cost of borrowing.

The higher debt service cost becomes a problem for a government that is pursuing an inflation strategy because government debt does have to be rolled over. Unless a government is willing to pursue hyper-inflation as a strategy, raising inflation will not reduce the government debt burden. Indeed, history indicates that the reverse result will be achieved.

So caveat hyperinflation. Not sure that will appease the uber-inflation hawks, really.

I heard Ron Paul on a radio show the other day suggest that if the US was going to try and reduce their debt load, they'd simply devalue the money by 50%. Ron and I will have to respectfully disagree on this and see what happens. I still see outright default, selectively at first, and then total, as a far more likely and feasible outcome than attempting to inflate. Donovan's point about roll-over is another confirmation to this hypothesis.

Annaly Capital (NLY) was out with a good report last week. Interested readers can read it in Scribd format below. (Note: If you're having trouble reading this embeded on my website, you can click either the "Scribd" box at the top left, or the "fullscreen" box at the top right).

Annaly Capital


And according to CNBC, ever the bastion of journalistic integrity, we learn that stocks and commodities can "only go in one direction." Up. I'd like to thank GE's subsidiary for that pearl of wisdom/shameless propaganda. And Zero Hedge for ensuring that everyone knows about it.






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.

Geithner Throws Hissy-Fit Over Power Struggle

Treasury Secretary Tim Geithner gathered the major financial regulators last Friday to discuss how Obama's regulatory overhaul of the financial system was going to play out. The meeting, which included SEC Chairwoman Mary Schapiro, FDIC Chairwoman Sheila Bair and Fed Chairman Ben Bernanke, became nothing other than Geithner throwing a hissy-fit about the lack of consensus to give the Federal Reserve all the power immediately.

It should have been clear from the outset that Geithner, previously the head of the New York Federal Reserve Bank, accepted his position as Treasury Secretary for the explicit purpose of consolidating the Fed's reach. I cannot see any reason for someone holding such a powerful position to accept such a demotion unless they have ulterior motives. And I think after seeing the skyrocketing deficits in the first 6 months, we can rule out any notions of altruism in "fixing the nation's finances."

But it has become apparent that both Bair and Schapiro are not prepared to budge on their authority.

The interesting undertones to this are that Geithner effectively holds a guillotine above the head of the FDIC. They are, for all intents and purposes, out of cash. There are three large banks (Colonial, Guaranty, and Corus) that require resolution, but the FDIC has only a pittance remaining to fund such action and requires tapping into their $500 Billion line of credit with the Treasury to do so.

Geithner's cavalier attitude in demanding more power for the Fed is likely not a coincidence in my mind.

From the Wall Street Journal:

Treasury Secretary Timothy Geithner blasted top U.S. financial regulators in an expletive-laced critique last Friday as frustration grows over the Obama administration's faltering plan to overhaul U.S. financial regulation....

Mr. Geithner told the regulators Friday that "enough is enough," said one person familiar with the meeting. Mr. Geithner said regulators had been given a chance to air their concerns, but that it was time to stop, this person said.

Among those gathered in the Treasury conference room were Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chairman Mary Schapiro and Federal Deposit Insurance Corp. Chairman Sheila Bair.

Friday's roughly hourlong meeting was described as unusual, not only because of Mr. Geithner's repeated use of obscenities, but because of the aggressive posture he took with officials from federal agencies generally considered independent of the White House. Mr. Geithner reminded attendees that the administration and Congress set policy, not the regulatory agencies.

Mr. Geithner, without singling out officials, raised concerns about regulators who questioned the wisdom of giving the Federal Reserve more power to oversee the financial system. Ms. Schapiro and Ms. Bair, among others, have argued that more authority should be shared among a council of regulators..

The government's proposal would empower the government to take over and break up large financial companies, merge two bank regulators, and toughen oversight of mortgages, among other things.

Administration officials say they aren't worried about the overhaul's prospects, adding that there is consensus on key aspects, including the regulating of over-the-counter derivatives. Treasury officials say they expected a big debate over the complex legislation. The first piece, which addresses executive pay, passed the House Friday.

"The industry is already back to their pre-meltdown bonuses," said White House Chief of Staff Rahm Emanuel. "We need to make sure we don't slip back to risky behavior where the institutions have all the upside and the taxpayers have all the downside, which is why we need regulatory reform."

Neal Wolin, Treasury's deputy secretary, said Mr. Geithner told regulators "they have the prerogative to express their views, but he wanted to make sure that, since everyone had agreed on the importance of achieving reform this year, everyone stayed focused on that goal."...

The administration has pushed for Congress to complete the overhaul by the end of the year. House Financial Services Committee Chairman Barney Frank (D., Mass.) and Senate Banking Committee Chairman Christopher Dodd (D., Conn.) have both said that remains the goal.

Both men, however, have suggested the overhaul could change from Treasury's proposal. Sen. Dodd favors giving extra powers to an oversight council rather than the Fed. Mr. Frank said Monday lawmakers were still working on a way to "make sure you have a sufficient broad base of participation and input" and "to make sure you have effective authority."

He said the flap several months ago over the Federal Reserve's role in allowing American International Group Inc. to pay large bonuses to employees "damaged the Federal Reserve politically."

The top Republicans on these committees, Sen. Richard Shelby (R., Ala.) and Rep. Spencer Bachus (R., Ala.), have also expressed skepticism over ceding too much power to the Fed.

"A rush to judgment where they basically throw these things together without any consensus is going to be a disaster," Rep. Bachus said.

With various agencies and interests fighting for their own survival, who wants to bet that one or more of them aren't willing to hold the economy or the financial system hostage to prove that they're not bluffing.

For more on this matter, one may wish to investigate Karl Denninger's Market Ticker, "Is The FDIC Broke And Covering It Up?"

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.