Treading Water (Sonders)

Monday, July 30th, 2012

July 27, 2012

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
and Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research,
and Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key Points

• Volume has been low and stocks have managed to drift higher, despite some volatile days; but conviction appears to be lacking. We seem to be biding time until the action heats back up as summer winds down, but market-moving events can happen at any time.
• The US economy continues to slow and Fed Chairman Bernanke had a relatively dour outlook before Congress. But it appears things would have to get worse before another round of easing is initiated; the effectiveness of which we continue to question.
• Yields in Spain and Italy indicate action may be needed sooner rather than later, but we did get positive remarks by the ECB, which led to market rallies and a big drop in yields, providing a measure of hope. Meanwhile, Chinese growth has been hit by the global economic slowdown but their lack of transparency means getting a good read is difficult.

In contrast to the athletes in the Olympics that are laser-focused on moving forward and achieving their objectives, markets seem to be caught in a sort of summer malaise. Volume has been depressed and sentiment surveys show retail investor skepticism at high levels-despite stock market performance being relatively decent this year, with the S&P 500′s 8.5% gain through July 20 the best showing to this point in the year since 2000 (thanks to Wolfe Trahan & Co. Portfolio Strategy). But with policymakers lacking the discipline and focus of Olympic athletes (the understatement of the year), and continuing publicity hits to the financial sector, we can’t blame investors for their doubts; and determining what direction the next major move will likely be more difficult than usual. Whenever you get politicians and the courts involved in the financial picture, predictions become even more difficult than usual, and that’s saying something!

In this frustrating, unpredictable environment, we find it helpful to take a step back. Asset allocation continues to be important and investors need to pay attention to their distribution of money relative to their time horizon and risk tolerance. In this environment, investors ignore their portfolios at their peril as things can and likely will change quickly. We are unlikely to see any resolution to the fiscal cliff before the election and the eurozone crisis remains on tenuous footing; notwithstanding Mario Draghi’s encouraging comments (discussed below). But if you look out the five years that we suggest is an appropriate time horizon for equities, it’s difficult to imagine that we’ll still be dealing with these same issues. And US equities remain quite cheap based on historical measures and recently hit a cyclical high in terms of relative performance to most other global equity markets. Our view that the US market will be the best relative performer through at least the balance of 2012 has not changed.

Economy keeping its head above water—barely

The US economic picture continues pointing toward still (barely) positive but slowing growth. Somewhat concerning, however, was the third-consecutive negative reading on retail sales, the Philly Fed Index remaining in negative territory, and the Index of Leading Economic Indicators declining by 0.3% last month.

LEI paints a disappointing portrait

Source: FactSet, U.S. Conference Board. As of July 24, 2012.

However, there continue to be positive offsets that did not exist in either of the past two years when we also dealt with growth scares—dominant among them is the recovery in housing. We’ve seen steady improvement over the course of the year; but housing is now less than 3% of US gross domestic product (GDP) after hitting a high of over 6% at the peak in the bubble. The National Association of Home Builders (NAHB) Index rose 6 points to 35, still below the 50 mark that would denote a growing housing market, but the best reading since March 2007. Additionally, housing starts rose 6.9% to the highest level since October 2008.

Housing now contributing positively?

Source: FactSet, U.S. Census Bureau. As of July 24, 2012.

And although existing home sales posted a decline of 5.4%, the National Association of Realtors noted that the fall was attributable to inventory tightness, something that we haven’t heard in a while. In fact, there is now just a 6.6 month supply of existing homes for sale, versus 9.1 months a year ago. We’re not trumpeting the all-clear signal yet, but it appears to us that housing is now a help and not a hindrance to economic growth.

Additional support for our “muddle through” view comes from various other areas such as the Empire Manufacturing Index getting a modest bump to 7.4, industrial production expanding by 0.4%, and jobless claims remaining comfortably below 400,000. We are also through the bulk of earnings season and bottom-line results, while not spectacular, were largely better than reduced expectations. However, top-line growth was somewhat disappointing but consistent with the low level of nominal GDP growth.

Policy frustration grows

Unfortunately, much of the frustration expressed during earnings season was directed toward Washington. Politics has thrust itself into the middle of both the markets and the economy and cannot be ignored. Corporate executives are increasingly pointing toward the uncertainty surrounding regulation and tax policy as reasons that they were unwilling to take the risk of expanding their business or hiring new workers. And while companies often take shots at Washington, the difference this time around is the unanimity in the desires of executives. While each would likely have their own view on what the ultimate outcome would look like, the bottom line for the vast majority of them is that they need a bottom line. Businesses can adjust to a variety of circumstances—that’s one thing that has made America what it is—but they need to know the rules of the game. Unfortunately, Washington’s dysfunction and the typical antics in an election year suggest limited resolutions to what presently ails confidence and hiring.

Last week’s outrage was to hear a sitting Senator tell the Chairman of the Federal Reserve—after hearing again that the best thing for economic growth would be responsibly addressing the fiscal cliff—that the Fed better “get to work” because Congress was hopelessly deadlocked. And while Bernanke said the Fed is prepared to act again if necessary, our belief is that there is little they can do at this point to have a real impact on the economy.

Europe’s cliff draws nearer

Europe has leaned more toward collectivist fiscal policies than the US, which has helped to contribute to the ongoing debt crisis as governments have spent and promised beyond their means. At some point, bills have to be paid, and without strong incentives to take risks and expand business, payers start to dwindle while payees increase.

Currently, policymakers are again treading water but summer doldrums are noticeable in the peripheral sovereign bond auctions in Europe, where the few buyers that are showing up are demanding higher rates, particularly for Spanish and Italian government debt.

The risks for Spain remain high, with regional government debt and deficits the new concern du jour. Despite the 17 regional governments being major contributors to the 2011 deficit slip, the Spanish central government has been unable to control their spending due to strong cultural and historical adherence to regional autonomy. Regional government spending is significant, as they control education, health and social services, accounting for 50% of total government spending. The buyers’ strike for Spanish debt is intensified for regional governments, where the 10-year debt yield for the region of Catalonia exceeded 14% in June and the region of Valencia had to pay a punitive 6.8% six-month yield to roll over 500 million euros of debt in May.

As a result, yet another bailout fund has been created; this time for Spain’s regional governments, which Spain insists will not increase its borrowing burden. When adding to bank capital needs that were revised higher and deficit targets which were adjusted larger, investors are skeptical. This lack of confidence has resulted in Spanish government short-term yields spiking nearly as high as long-term rates, a sign of market stress, although we did see a marked pullback following the Draghi comments.

Spain’s stress gauge volatile

Source: FactSet, Tullett Prebon. As of July 26, 2012.

With Spain’s average maturity of 6.4 years resulting in a 4.1% average interest rate, rates may need to stay elevated longer before a bailout is necessary, but more forceful action is needed to contain the situation. The reason is that the size of Spain’s economy and government bond market is around double the combined size of those of Greece, Portugal and Ireland, and Spain’s problems have increasingly ensnared Italy.

Meanwhile, eurozone bailout funds are still impotent, with the temporary European Financial Stability Facility (EFSF) lacking sufficient funds, the permanent European Stability Mechanism (ESM) on hold for a ruling by the German Constitutional Court in September, and the European Central Bank (ECB) is not yet using monetary measures to solve what they view a fiscal problem. Despite recent comments by ECB President Mario Draghi indicating they would do “whatever it takes to preserve the euro,” actions are still lacking and their ability to implement substantial plans is likely severely constrained by their mandate and the continuing disagreements among member nations. While the market rallied on the comments and reminds us that sharp rallies are possible on potential positive movement, words have become less meaningful and more decisive action is needed.

We’ve said in the past that the situation is rife for outbreaks of market volatility, as we continue to see. Moody’s Investor Service apparently concurs, downgrading the outlooks for the AAA-rated nations of Germany, the Netherlands and Luxembourg. It was due in part to the rising risk of future liabilities, because policymaker’s “continued reactive and gradualist” response will “very likely be associated with a series of shocks, which are likely to rise in magnitude the longer the crisis persists.”

We’ve believed it would take severe market instability, nearing the edge of the precipice, before more forceful actions would be taken. The flattening of the Spanish yield curve indicates more forceful actions are drawing closer, with the ECB the institution able to respond most quickly. Granting the ESM a banking license could create large firepower, but Draghi said in July that this could risk the ECB’s credibility by behaving outside its mandate—seemingly conflicting with the above statement of unconditional support. Other “non-standard” measures such as restarting the Securities Market Program (SMP) for sovereign bond purchases were not discussed at the ECB’s July policy meeting, but traders are on the lookout for a change in the ECB’s stance.

Germany remains resistant to endlessly fund peripheral country problems, as it is responsible for the largest share of potential future liabilities. With Greece’s problems remaining, a Greek exit from the euro is not out of question. Conversely, there have been increasingly vocal suggestions that Germany leave the euro. While this is easier said than done and any action would have attendant costs, the ultimate decision is political, and therefore difficult to forecast.

All of the wrangling does have an outcome we can foresee—likely continued economic suppression in the eurozone; as uncertainty halts investment and spending, and a hobbled banking sector hampers lending. Additionally, the rollercoaster of investor sentiment is likely to remain, and we continue to believe European stocks will underperform most other global markets.

Chinese economic data manipulated?

China’s lack of transparency breeds speculation about where the economy is headed. Attention has focused on a significant slowdown in electricity production and consumption, which have fallen to single-digit rates in recent months, while gross domestic product (GDP) has slowed more modestly.

China’s electricity deviation historically “normal”

Source: FactSet, National Bureau of Statistics of China. As of July 24, 2012.

Electricity production has deviated from GDP in the past, not only in China, but also in other major economies, including the United States. This statistic is volatile and it is important to note that one of China’s major long-term initiatives has been to lower its energy usage per unit of GDP, and that energy-intensive industrial sectors have slowed more than the overall economy.

Positively, HBSC’s initial manufacturing purchasing manager index (PMI) for July rose to a five-month high of 49.5, driven by gains in production and export order components. We are skeptical China’s economy has yet to significantly accelerate, believing growth in China will slow further in the third quarter, but remain above a hard landing. Conversely, the Street is still grappling with the slowdown, forecasting a turn higher in third quarter growth 8.2% from 7.6% in the second quarter. A pick-up in fiscal and monetary stimulus is likely needed for China’s economy to reaccelerate, and the government thus far has been disappointingly slow and measured on this front.

With the desire to keep social unrest at bay, employment trends are likely closely monitored by Chinese officials. While not yet at a crisis level, the faster rate of contraction in employment indicated in the HSBC report, and comments from consumer-goods maker Jarden about a “halt” in wage inflation momentum, may indicate stepped up stimulus measures could be on the immediate horizon.

Spiking corn prices have ignited concern about food prices, in particular for emerging markets where the food component in consumer price inflation (CPI) indexes is two-to-five times larger than in developed markets, which could limit growth and continued easing by emerging market central banks. We are monitoring the situation, but aren’t yet ready to declare a lasting and broad increase in overall food prices, with prices of the important staple of rice still subdued. Read more international research at www.schwab.com/oninternational.

So what?

With such a conglomeration of concerns, investors can be tempted to throw up their hands in frustration and seek the perceived safety of a nice, comfortable mattress. However, as we saw with the Draghi comments, sharp equity rallies are possible and we believe at some time in the not-too-distant future resolutions to the two major issues—the eurozone crisis and the fiscal cliff—will emerge, setting the stage for a renewed sustainable move. Waiting until it occurs carries risks just as staying invested does, so we urge investors to maintain a diversified portfolio with a bit more exposure to the US side of the ledger at the expense of some European exposure. Valuations are attractive and sentiment is very pessimistic—a contrarian indicator. For tactical investors we would suggest adding to equities during pullbacks and trimming outsized positions during any fierce rallies.

This commentary originally appeared at Schwab.com

Important Disclosures

The MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States and Canada. As of May 27, 2010, the MSCI EAFE Index consisted of the following 22 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The MSCI Emerging Markets Index^SM is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of May 27, 2010, the MSCI Emerging Markets Index consisted of the following 21 emerging-market country indexes: Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey.

The S&P 500® index is an index of widely traded stocks.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.

Past performance is no guarantee of future results.

Investing in sectors may involve a greater degree of risk than investments with broader diversification.

International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation or a recommendation that any particular investor should purchase or sell any particular security. Schwab does not assess the suitability or the potential value of any particular investment. All expressions of opinions are subject to change without notice.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Tags: BRICs, Charles Schwab, Chief Investment Strategist, Chinese Growth, ECB, Fed Chairman Bernanke, Financial Sector, Getting A Good Read, Global Economic Slowdown, Liz Ann, Olympic Athletes, Portfolio Strategy, Research Key, Retail Investor, Sector Analysis, Senior Vice President, Stock Market Performance, Summer Winds, Trahan, Treading Water, Understatement Of The Year
Posted in Markets | Comments Off

“Fed Between a Rock and Hard Place,” says Goldman’s Jan Hatzius

Thursday, June 23rd, 2011

Goldman Sachs’ economist Jan Hatzius appeared on CNBC late yesterday to explain his theory.  In a nutshell, the Fed has nowhere to go – if it stands down, the U.S. economy faces slow growth; if it continues easing (QE) it faces threatening levels of inflation.

Video

Here are Hatzius’ main news conference points:

MAIN POINTS:

1.    Fed Chairman Bernanke’s press conference included many details but few major surprises. On activity, he expressed relatively low conviction, saying “We don’t have a precise read on why this slower pace of growth is persisting” (note that quotes come from the real-time transcript, which may be revised slightly). However, consistent with the FOMC’s forecasts (see below), he emphasized that he thought that some factors restraining growth were temporary.

2.    On inflation, Chairman Bernanke also cited temporary factors, particularly a pickup in auto prices related to supply chain disruptions in that sector.

3.    Guidance on the near-term policy outlook was relatively clear: more quantitative easing is unlikely due to reduced deflation risks. He gave two lengthy responses on this issue, and made clear why conditions last year differed from today. Most importantly: “at that time inflation was low and falling, [and] many objective indicators suggested that deflation was a non trivial risk”. He also noted the pickup in payroll employment over the last few quarters.

4.    At the same time, his remarks hinted that the FOMC has in fact discussed easing options. Specifically, he said options could include: 1) securities purchases, which could be structured in various ways; 2) a cut in the interest rate on excess reserves; 3) guidance on how long the Fed will wait to sell securities; and 4) or “a fixed date to define extended period”. With regard to the extended period language, he revised his remarks from the last press conference, in which he said the extended period language meant “there would be a couple of meetings probably before action”. Today he said: “I think the thrust of extended period is that we believe we’re at least two or three meetings away from taking any further action, and I emphasize ‘at least.’”

5.    The Fed revised down its central tendency forecasts for GDP growth in 2011 to 2.7-2.9% to from 3.1-3.3%. It also reduced its 2012 GDP forecasts. For 2011, the cut was slightly smaller than we had expected, but for 2012 it was a bit larger. The committee also revised up its forecast for core inflation by 1-2 tenths, a bit more than we had anticipated.

Hatzius’ conference notes courtesy of ZeroHedge.com.

Video: CNBC

Tags: Auto Prices, Cnbc, Conviction, Disruptions, Economist, Excess Reserves, Fed Chairman Bernanke, Fomc, Goldman Sachs, inflation, Interest Rate, Main News, News Conference, Nutshell, Objective Indicators, Payroll Employment, Policy Outlook, Qe, Quantitative Easing, Sector 3
Posted in ETFs, Markets | Comments Off

Positive Forces Should Win Out, But It Will Take Some Time (Doll)

Wednesday, June 1st, 2011

Bob Doll, Chief Equity Strategist, Fundamental Equities, BlackRock

Economic data has continued to come in on the weak side, which caused stock prices to slide yet again last week. For the week, the Dow Jones Industrial Average dropped 0.6% to 12,442, the S&P 500 Index fell 0.2% to 1,331 and the Nasdaq Composite declined 0.2% to 2,797. In our opinion, some of the recent weakness in economic data can be attributed to temporary factors such as the spike in oil prices, the natural disasters in Japan and flooding in the Southern United States. In any case, however, the soft patch in the economy has dented the pace of economic acceleration and we expect to see some continued signs of weakness in the weeks ahead, including perhaps in this Friday’s labor market report for May.

In some ways, the current period of economic weakness is similar to what occurred in the second quarter of 2010, when the global economy experienced a slowdown in the face of rising sovereign debt issues in Europe, concerns over policy tightening in China and slower levels of consumption in the United States. One key difference, however, is that in the current slowdown the reductions in the forecasts for growth levels are centered around the United States, the United Kingdom and Japan. Weakness in Japan can be largely attributed to the earthquake and resulting nuclear issues and the US and UK slowdowns can be explained in part by greater-than-expected levels of consumer deleveraging. Forecasts for the rest of the world are holding up reasonably well.

One potential downside risk for the economy and the markets that has many concerned is the coming end of the Federal Reserve’s QE2 program. It is not surprising that investors are focusing on the end-of-June timeframe with concern. When Fed Chairman Bernanke first indicated that the QE2 program would be launched last August, it defined the start of a sharp uptrend in risk asset prices, so some are concerned that the end of the program will reverse this trend. We do not expect this to be the case. QE2 has been a tailwind for stocks, but only one of many, and the end of the program should not have an oversize impact on the markets. It is possible that we will see a modest rise in bond yields when the program ends, but yields have moved lower in recent weeks anyway in the face of some weaker economic data. In any case, the end of QE2 has been well telegraphed and has already been priced into the financial markets.

An additional issue that has some investors concerned is the ongoing debate over potentially raising the debt ceiling and what it will mean for spending levels. At this point, a consensus of sorts seems to be emerging that Congress will cut spending by somewhere around one trillion dollars over the next 10 years as part of a package to raise the debt ceiling. There is also a growing consensus that spending cuts in the neighborhood of over four trillion is needed to stabilize the country’s debt-to-GDP ratio, but changes of that magnitude are unlikely to occur before next year’s election.

Despite the recent tone in the markets, not all of the news has been bad. Corporate earnings in particular have remained an important source of strength. Nearly all companies have reported first-quarter earnings and, on average, results beat expectations by over 6%. Compared to last year, earnings grew by more than 20%, with particular strength emanating from the healthcare, technology and materials sectors. From this vantage point, it looks like second-quarter earnings should also be healthy. In addition to the corporate earnings backdrop, industrial production levels should be rising as inventories fall, which should help economic growth and we are also expecting to see some clarity around support mechanisms for the ongoing European debt issues.

Taking a broader view of the markets, we can see that the current market rough patch has emerged in part because of a softening in economic data and also due to the increasing number of downside risks, including geopolitical tensions, a lack of clarity over how to deal with the debt problems in Europe, the earlier spike in oil and other commodities and pending changes in monetary and fiscal policies.

It is important to note, however, that stocks have only dropped by a few percentage points over the last month. We would attribute this result to the fact that a number of positive factors remain as important tailwinds, including still-easy monetary and fiscal policies, high levels of liquidity, strong profit growth and reasonable valuations. The recent easing of oil prices is also a positive factor. On balance, we expect these positive forces to win out, but that may take some time, meaning that continued patience is warranted.

Tags: Asset Prices, Bob Doll, Debt Issues, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Downside Risk, Economic Data, Economic Weakness, Fed Chairman Bernanke, Global Economy, Nasdaq Composite, Natural Disasters In Japan, Nuclear Issues, Oil Prices, Slowdown, Sovereign Debt, Stock Prices, Uptrend, Will Take Some Time
Posted in Markets | Comments Off

William Black on Wall Street Fraud

Thursday, May 26th, 2011

Former banking regulator William Black speaks about rackets and fraud in the financial sector. He says Wall Street’s fraudulent CEOs looted with impunity, were left in power, and were granted their fondest wish when Congress, at the behest of the Chamber of Commerce, Fed Chairman Bernanke, and the bankers’ trade associations, successfully extorted the professional Financial Accounting Standards Board (FASB) to turn the accounting rules into a farce.

Source: YouTube, May 23, 2011 (hat tip: Global Investor Blog).

Tags: Accounting Standards Board, Behest, Ceos, Chamber Of Commerce, Congress, Farce, Fed Chairman Bernanke, Financial Accounting Standards, Financial Accounting Standards Board, Financial Accounting Standards Board Fasb, Financial Sector, Fraud, Global Investor, Hat Tip, Impunity, Trade Associations, Wall Street
Posted in Markets | Comments Off

U.S. Consumers Have Big Banks To Blame For High Gasoline Prices

Sunday, April 3rd, 2011

U.S. Consumers Have Big Banks To Blame For High Gasoline Prices

By Dian L. Chu, EconMatters

There is a bit of irony here in that the very same banks that taxpayers bailed out, and saved from going completely belly up, are now making you pay once again in the form of higher Oil prices, and the resultant higher gasoline prices at the pump (Fig. 1). Don`t be fooled by the rhetoric generated in the media by the Big Banks regarding the Middle East.

It All Started With Jackson Hole….

This run-up in oil prices started with Fed Chairman Bernanke`s Jackson Hole speech where the big banks realized they were going to get a bunch more juice in the form of POMO operations by the Federal Reserve to play around in markets with.

And what did the large financial institutions do with this newly created juice? Instead of allocating the almost zero percent money they are all borrowing to productive activities such as lending loans to small businesses which will create jobs and stimulate the economy, the big banks have decided that since the fed is electronically printing money and providing extra liquidity/juice for financial markets that this is inflationary and devalues the dollar.

All Fed Juice Leads to Commodities

And just to make things worse, the big banks have decided to take their cheap capital they borrow at basically zero percent , and invest into commodities, i.e., agricultural futures like Wheat, Corn, and Soybeans, energy futures like Oil and Gasoline (Fig. 2), and industrial and precious metals like Copper, Gold and Silver.

The unique aspect is that loose monetary policy isn`t problematic at face value when you are trying to stimulate growth, it is what the Big Banks are utilizing this cheap capital for that becomes problematic from an inflation standpoint. The very problem that the Banks are worried about in regards to inflation, they are in fact responsible for creating through self-fulfilling investment practices with regard to this cheap capital at their disposal.

Long Commodities, Short Dollar – Adding Inflation

But it gets worse because at the same time they also short the US Dollar, and going long the commodity currencies like the Canadian and Australian Dollar, which further exacerbates the slide in the US Dollar (Fig. 3), reinforcing the entire trade that they need to buy more commodities as an inflation hedge, further juicing up commodities like oil and gasoline.

Inflation Up, Purchasing Power Down

The consumer is hurt in two ways. First is that higher prices eat into their monthly budget with a higher percentage of their disposable income needed for purchasing items like milk, eggs, bread, and gasoline. Secondly, because the Dollar is losing its store of value, the consumer is losing their purchasing power, i.e., what a dollar is worth in relative terms around the world, and what it can buy. In other words, it is like getting a pay cut at work from your company, the amount hasn`t changed, but what goods that amount will be able to buy is less.

Consumers Getting Double Stiffed

The Big Banks like JPMorgan Chase, Goldman Sachs, Morgan Stanley, HSBC, UBS, and BOA-Merrill Lynch are some of the largest energy traders in the world. They all derive considerable trading revenue from the markets each quarter. So when you hear that Goldman Sachs, or BOA didn`t have a single losing trading day for a given quarter, these banks are taking a lot of money out of the market, and much of their hefty trading profits are generated from commodities like food and energy.

And guess who is footing the bill for these trading profits? Yes, the US consumer, the very same US consumer who bailed them out during the financial crisis. Talk about getting short shrifted twice. (I cleaned up the last sentence, but you get the gist.)

2008 Oil Bubble Redux

Currently, there are no supply shortages in the oil market, but what you have is a bunch of speculators going wild pushing up energy prices hyping the Middle East, Peak Oil, The Nigeria Card (remember in 2008 where every little Nigerian pipeline was under attack every day during that run-up, and all the sudden Nigerian pipeline attacks were inconsequential for two years—that`s the Nigerian Card-bring it out when traders are in Trend Trading Nirvana.)

What we have here is a 2008 redux. The Brent contract on the ICE exchange is being used to engineer prices up, as it is an unregulated exchange with no real transparency on position limits by the Big Banks. The Big Banks are also piling a bunch of money into commodity related ETF`s and mutual funds, which in turn have to buy exposure to the futures market in all these commodities. Add in the hedge funds, pension funds, money managers, and retail traders, and voila! you have these bubbles created which have no relation to the underlying fundamentals.

Trend Trading Hyper Leverage

It all comes down to fund flows, capital going into the commodity trade because it is going up, further adding fuel to fire that this is the place to be– Welcome to the self-reinforcing cycle of Trend Trading.

However, it gets even worse, because we have one-sided markets with no substantial pullbacks which normal healthy markets have. The Big Banks are able to add to their original positions with the profits they have locked in with stops that are already hugely profitable. The Big Banks are then buying additional futures contracts, pushing these same commodities up further, until eventually the bubble bursts like 2008, when everyone runs for the exits at the same time.

The effect is that by adding to original positions via locked in profits, the Big Banks have added even more liquidity/juice to the market – a form of hyper leverage without real risk. This results in the consumer paying more at the pump, not because there is less supply of oil in the market, but largely because of a trading technique that artificially inflates prices by adding more juice to the equation.

Crude Oil – An ‘Engineered’ Market

I know we had a recession, but Crude Oil went from $143 dollars a barrel to $33 in six months. Now, you don`t think demand dropped off that much, do you? It didn`t, even when a consumer lost their job , which at most we went from a 5% unemployment level to slightly above 10%–did this 5% completely stop consuming fuel? I know this is an oversimplification; however you can follow where I am going with this line of reasoning– Crude Oil should never have been $143 a barrel in the first place!

It was stage-managed to those levels the last time by the Big Banks like Goldman Sachs. Remember the infamous “$200 Oil Call” by the Goldman analyst – do you truly believe that happened by accident? It most likely served a purpose for Goldman Sachs at the time, to help ‘market’ the price of Crude Oil.

Banks Long Oil…Gee, You Think?

You now have Nomura Securities with their $220 Oil Call, and J.P. Morgan pumping out weekly analysts forecasts regarding Crude Oil targets of $130 for the second quarter. Why make these price forecasts available to the media and the public if they aren`t used for a purpose? Wouldn`t they want to keep these reserved for their paying, private clients? Gee, I wonder if they are positioned long in the Oil Market?

You guessed it. The same Banks that won`t give you a loan, or a credit card because your credit score isn`t perfect is making your financial condition even worse by pushing up the price of Oil, Food and Gasoline when there are no real supply shortages in the market.

The overall trend of a decline in new consumer credit line approval has also been noted by the industry monitoring service at credit-land, whereas in early 2008 a FICO score of 625 was still acceptable for approval, today you would need a score of 725 or more to qualify for the same offers.

So, what is taking place in the market are traders hitting revenue goals by trading commodities, using the QE2 liquidity, in order to maximize their bonuses.

Fed, The Enabler

This is not all the Big Banks fault, as just like in 2005-2007, regulations were eased to let them all lever up over 40 times base capital. Well, Chairman Bernanke and the Fed`s extremely loose monetary policies have enabled the banks to profit enormously from trading behavior and investment choices which inevitably have lead to the creation of another inflationary bubble. We still have a long way to go in recovering from the last Fed fueled bubble regarding the Housing Industry from the Alan Greenspan era of overly loose monetary policy.

Higher Margin Requirements – Not The Solution

In addition, the CFTC was supposed to come up with position limits for the Big Banks over 3 months ago, but even the limits they were considering were not going to do any good. The CME has raised margin requirements on all the commodities, but this actually makes things worse because it squeezes out more of the smaller speculators. It concentrates more of the contract from a percentage standpoint with the Big Banks who have access to all the capital they could ever need at zero percent interest.

If you raise margins for the Big Banks, they just go borrow more money to cover the raised requirements, but they never have to reduce positions like the smaller players. This makes for less of a diverse market. Therefore, raising margins isn`t the answer either. In other word, don`t expect any relief from the CFTC or the exchanges–they really are powerless to reduce this type of speculative fervor.

Two Ways To Tame Big Bank Cats

There really are only two options:

1) Bernanke has to immediately change his tone, and become much more hawkish regarding inflation, and he needs to do this immediately, as in, Monday morning. He needs to say something to the effect: “Due to rapidly building food and energy cost pressures, the fed needs to seriously discuss the idea of cutting short QE2 at our next monetary policy meeting on the 27th of April”.

That`s literally all Bernanke would have to say, not that they are going to cut QE2 short, just discuss the idea, and that you are worried about rising inflationary pressures in the economy exemplified by the unprecedented spike in gasoline prices. This would send the right message to the speculators, and curb much of the speculative fervor. All commodities would instantly sell off. For example, Oil would drop by $3.50 in an hour, and the RBOB contract would drop 18 cents.

This is how you can even maintain all the benefits of a relatively loose monetary policy without all of the acute negative consequences of unchecked speculation, which we are experiencing right now in commodities. It’s a one sided trade, that is crowded, unnatural, and bad for markets and consumers alike.

2) The second option is more micro managing an individual commodity. Let`s take Oil for example. President Obama could make a statement on Monday morning stating the following: “I have decided to open up the Strategic Petroleum Reserves to the market, not because there are any supply shortages in Crude Oil, far from it, actually, but we want to target the excessive speculation that we believe is occurring right now in the Oil market”.

Again that`s all it would take and Crude Oil would be down $3.50 and gasoline would drop as well. You do not even need to sell any Oil from the reserves, it actually isn`t needed, but the important part is the message that you are sending to markets, “this is not a riskless, one way trade.”

Fed’s Punchbowl Ends Here & Now

Speculation isn`t always bad, in fact, it often serves many valid purposes within markets. But excessive speculation to the point where markets diverge considerably from the underlying fundamentals is never a good thing. And it is important for those in positions of authority to manage such markets appropriately through legislative regulation, monetary policy, or simply managing market participants’ expectations by sending the right types of messages to markets.

However, our policy makers so far have mismanaged the message being sent to Wall Street. It is something along the lines of “Get drunk at the Fed inspired liquidity punchbowl, and don`t worry about the mess you make”. The message the Federal Reserve should be sending is, “Make sure you don`t drink too much at the liquidity punchbowl, or we will take it away”.

The reasoning here is that it is always much easier to prevent the mess in the first place, than to try and clean it up afterwards. We have reached the point where the Fed needs to take the punchbowl away!

Tags: Agricultural Futures, Canadian, Commodities, Copper Gold, Dian, Energy Futures, ETF, Face Value, Fed Chairman Bernanke, Financial Institutions, Financial Markets, Gasoline Prices, Gasoline Pump, Gold, Gold And Silver, Investment Practices, Jackson Hole, liquidity, oil, Oil Prices, precious metals, Printing Money, Productive Activities, Soybeans, Zero Percent
Posted in Canadian Market, Commodities, Credit Markets, Energy & Natural Resources, ETFs, Gold, Markets, Oil and Gas, Silver | Comments Off

An Uneven Global Recovery – Lingering Effects of the Credit Crisis

Wednesday, March 16th, 2011

An Uneven Global Recovery – Lingering Effects of the Credit Crisis

by Bill Hester, CFA, Hussman Funds

March 2011

What is the state of the almost two-year old global economic recovery? Do the characteristics of this recovery so far match the characteristics of the typical post-war recovery? Or are they more comparable to the periods that followed prior credit crises? How large a role are the economic backdrops of individual country’s playing in stock market valuations?

There aren’t short, simple answers to any of these questions. But they capture some of the issues that investors are currently confronting in their attempt to appropriately price global stock markets. A closer look at recent global economic performance can hopefully provide some data for the discussion.

The next few weeks may turn out to be a crossroads for global economies and stock markets. Over the past two years policy makers around the world mostly agreed on the medicine the global economy needed: add more liquidity in response to any sign of faltering stock prices or credit stress. Soon, economic prescriptions will begin to vary. The ECB will likely begin to boost short-term rates in early April as Euro-area inflation rates have climbed above the bank’s goal of about 2 percent. The Bank of England will likely respond in similar fashion later this year, although it finds itself in a tighter spot with higher levels of inflation than the Euro region, but also with output growing more slowly.

Meanwhile Fed Chairman Bernanke has made it clear that he will not be swayed by the trends in the volatile segments of inflation, like food and energy. He has suggested that the Fed will wait until the core rate of inflation pushes higher or inflation expectations rise to a greater extent before becoming concerned.

Continuing negotiations by Euro area leaders about the size and reach of the European Financial Stability Facility (EFSF) – the rescue fund created last year to help backstop sovereign debt – also provide fertile ground for disagreement. The market is sending signals that the current fixes in place may not be sufficient. Three-year government notes in Greece are now yielding 18 percent, up from less than 13 percent in January. Portugal borrowed money this week at 5.99 percent, up from a yield of 4.08 percent on bonds with the same maturity sold in September.

This recent market action forced European leaders into an emergency summit on Friday. From that meeting came important changes to the rescue fund. The EFSF will now be able to loan the full amount allotted to the fund, it will be allowed to buy sovereign bonds on the primary market, and the interest rate on loans to Greece was cut by a percentage point while the maturities of the loans were extended.

But the summit also highlighted the continuing divergences in opinions on fiscal strategies in the area, including ways to increase competitiveness, equalize retirement ages for pensioners, and appropriate tax policies. Ireland’s request for lower loan rates was denied by the group because the Irish refused to consider an increase in corporate income tax rates.

These growing disagreements in monetary and fiscal policies will likely create further divergences in economic recoveries. The health of the global economic recovery depends on which country you view it from. Some countries are performing much better than is typical for a period following a global credit crisis. Some are performing in line – or worse – than is typical for these periods.

To help gauge the recovery on a country by country level, we’ll lean on the body of work by Carmen Reinhart. In a paper published last year titled After the Fall , Carmen and Vincent Reinhart updated the research on the economic characteristics that follow credit crises. Where the book she co-authored with Ken Rogoff, This Time Is Different, looked at the immediate effects of global recessions that followed credit binges, last year’s paper extends the window of the analysis to include economic performance during the subsequent decade. Their conclusion was that economies tend to grow more slowly following credit crises, have higher levels of unemployment, and emerge with higher debt loads in relation to GDP. This period of below-average growth will often last as long as the credit surge that preceded it.

The Reinhart’s paper looked at the 21-year periods surrounding credit crises, comparing the decade following each credit crisis with the 10-year period that preceded it. To capture this style of analysis, the tables below attempt to provide a mid-recovery check-up. The tables compare the most recent data for each country to the average of that data during the decade that preceded the peak. The first table highlights changes in real GDP. For reference, the Reinhart’s found that the median growth rate of GDP following prior credit crises was about 1 percent less than the decade that preceded it.

In the table above, the average recent growth rate is about 1 percent below each country’s output growth prior to the peak. Of course, a large part of that average subpar GDP growth is due to the contraction in output in Greece. Without Greece, the average difference in growth rates is -.35%. But it’s also clear that a majority of economies are still growing at rates below levels attained prior to the peak. This is sobering considering the tremendous amounts of liquidity introduced into global economies during the past 18 months. Of the countries in the table, two-thirds of them currently have growth rates below longer-term averages, despite economic slack that would normally allow them to grow at much higher than average rates.

The Reinhart’s also found that high unemployment rates were sticky in developed countries following credit-related recessions. The median unemployment rate in developed countries was about 5 percentage points higher following these periods. The table below lists recent unemployment rates versus prior averages. The average difference among the countries is about 2 percentage points. As with GDP growth, there are large divergences. Peripheral Europe is enduring high rates of unemployment, with Ireland, Spain, Portugal, and Greece having unemployment rates that are averaging 6 percentage points above pre-crisis levels. More than 75 percent of the countries still have unemployment rates higher than the pre-crisis average.

Germany is an example of a healthy economic recovery. Germany’s unemployment rate is currently at nearly a two-decade low. These first two tables highlight the large extent to which the Euro area is relying on Germany’s recovery.

Looking at the labor data in this context also highlights how weak employment growth has been in the US. The US unemployment rate sits 4 percentage points above the pre-crisis level. In this light, the US job recovery’s best comparison is with peripheral Europe.

The data on changes in the rate of inflation that followed credit crises showed less agreement in the Reinhart’s work than did output growth and unemployment trends. Highlighting the two credit crises that were global in scale – 1929 and 1973 – deflation followed the former and very high rates of inflation followed the latter. Currently, divergences in global inflation rates are rising. Greece and the UK are experiencing high rates of inflation, versus generally accepted target levels. Ireland is experiencing low rates of inflation, as real estate prices continue to founder.

The table also highlights why the monetary policy trends among the major central banks will likely continue to diverge this year. While the UK confronts inflation rates at twice their longer-term average, the US inflation rate is still about one percent below its average prior to the crisis.

Real Interest Rates

Forward looking measures of growth are suggesting that sub-par economic growth will likely continue. As John Hussman recently noted , high real interest rates can signal opportunities for productive investment and future economic growth. During the technology boom of the 1990′s, real rates in the U.S. stayed persistently high, and were followed by strong GDP growth. These same trends can be seen globally. The graph below plots real rates (the 10-year yield minus consumer inflation) in Britain, along with GDP growth a year later.

Current global real interest rates are uninspiring. The table below compares the recent real rate for each country in our sample to the pre-crisis average. It’s important to highlight the countries with high real rates: Ireland, Greece, Portugal, Spain, and Italy. That’s also a list of countries where investors are unsure they’ll be paid back par on their bonds, so the high rates reflect significant default premiums. Outside of that group, all of the other countries currently have lower real rates relative to their pre-crisis average rate, either because of low interest rates or rising levels of inflation, suggesting potentially sluggish global growth going forward.

Debt and Economic Recovery

The tables above show that there’s been variation in how developed countries have recovered from the depths of the global recession. Why has this variation occurred? One reason is different levels of public debt. Countries that entered into the crisis with near-balanced budgets and didn’t need to issue debt to prop up their banking systems now have more flexibility and are generally experiencing healthier recoveries. In these countries output is growing more quickly, unemployment rates are falling, and inflation levels are staying low.

The graph below compares the growth in output for each country in our sample from June 2009 through the end of last year (where fourth-quarter data is available). That recent growth is compared to each country’s public debt to GDP ratio.

The graph below compares the changes in unemployment rates since June 2009 relative to debt to GDP ratios. Again, generally less indebted countries have seen their unemployment rates fall, or rise modestly, while more highly indebted countries has experienced rising jobless rates.

Finally, the graph below compares the changes in the level of inflation since June 2009 to each country’s debt to GDP ratios. Higher indebted countries have seen inflation rates rise more quickly relative to countries with healthier balance sheets.

Something to keep in mind when looking at these charts is that many of these countries will move outward on the horizontal axis as their debt loads in relation to GDP grow, especially when age-related liabilities are included in the analysis. Recent research from the BIS suggests that debt to GDP ratios will rise significantly over the next decade, growing to 300% in Japan, 200% in Britain, and 150% in Belgium, France, Ireland, Greece, Italy, and the United States. These increases would represent ratios of debt-to-GDP that are 60% higher than current levels, on average. (Japan was left out of our analysis only because its debt to GDP ratio is already so high that it visually distorts the trends of other developed countries.)

That means that a greater share of countries may take on the qualities of those economies currently saddled with high debt loads: slower economic growth, stubborn unemployment, and inflation rates above standard comfort levels. And these macro-economic risks correlate directly to stock market risk. The graph below displays the change in stock-market multiples (using MSCI price indexes and fundamental data) since June 2009 and the ratio of debt to GDP. The graph shows that investors continue to be sensitive to economic and default risks, containing the stock market multiples of the highly indebted countries, versus those with lower debt loads.

The health of the global recovery depends on which country it is viewed from. When compared to the decade ending in 2007, a majority of developed countries are currently growing more slowly, have higher rates of unemployment, and have higher levels of inflation. Some – like the countries of peripheral Europe – are deeply mired in standard post-credit crises characteristics. There are exceptions. Notably, Germany is growing at twice its long-term average, with very low relative levels of unemployment. Stock market investors are showing growing sensitivity to differences in macro-economic risks. These differences may soon be further aggravated by monetary policies from the major central banks that are about to diverge noticeably.

Copyright (c) Hussmsan Funds

Tags: Backdrops, Bank Of England, Core Rate Of Inflation, Credit Crisis, ECB, Economic Performance, Economic Recovery, Fed Chairman Bernanke, Financial Stability, Global Economies, Global Economy, Global Recovery, Global Stock Markets, Hester, Hussman Funds, Inflation Expectations, Inflation Rates, Rate Of Inflation, Stock Market Valuations, Stock Prices
Posted in Credit Markets, Markets | Comments Off

Big (U.S.) Banks Are Stifling Economic Growth & Taxing Consumers

Monday, December 6th, 2010

By Dian L. Chu, EconForecast

Have you noticed the price of oil lately? It’s $90 a barrel in a dismal economy with unemployment hovering around 10%. The problem with Fed chairman Bernanke`s latest QE 2 initiative is that he has just given more access of cheap money to the big banks.

Non-Productive Use of QE Money

And what are they doing with all this cheap money? Nothing productive from an economic standpoint. Instead of lending the money to entrepreneurs, business projects, and venture capital initiatives which actually create jobs and foster much needed economic growth, the big banks are just taking this cheap money and pouring it into commodities like crude oil, copper and grains.

Taxing Consumers by Bidding Up Commodities

So not only are the big banks doing nothing productive with the latest QE2 capital, but they are in essence dragging down economic growth with a counterproductive tax on consumers when they can least afford it. The last thing the economy needs with 10% unemployment is to be paying a hefty tax on food and energy products, especially given the fact that these markets are well supplied, and are necessity items for consumers.

Actually, Mr. Bernanke would have been better served by taking liquidity out of the system, as commodities would be much cheaper with higher rates, and the economy would be much more inclined to spur economic growth and job creation with lower food and energy prices.

Deflaton Fear – Theory vs. Reality

The entire notion that we have to worry about a Japan-style deflation is completely overblown, and the manifestation of over the top theoretical academic postulating. Sure, the US is just coming out of a recession, and we are growing slowly, but the differences between Japan and the United States in terms of resources, demographics, economic diversity, monetary policy, and how the US handled losses in the banking sector makes any comparison between the two countries a wild stretch by any standard.

This is the problem with having too many academics in the Fed, and absolutely no one with any market experience who understands how markets actually function. Mr. Bernanke even admitted in open proceedings in front of Congress that he didn`t understand the dynamics of the Gold market–a pretty telling inadequacy as the head of our monetary policy.

Exporting Inflation via Commodity Plays

But there is more to the story of how big banks are actually hurting global growth if we analyze the emerging markets and their burgeoning inflation problem. The emerging market economies like China, for example, have gone into tightening mode in order to fight what is starting to appear as a runaway inflation problem with a CPI reading of 4.4%, and talk of a 5% reading on the next CPI report.

Meanwhile, crude oil is up $10 and gasoline prices are up 25 cents per gallon since Bernanke’s QE2 announcement, and this doesn`t even factor in the run-up in commodity prices since QE2 was up for debate starting in August.

China Tightening Bad For All

How is this going to slow global growth? Well, because China needs to fight inflation, and the big banks are exporting inflation even further by pumping more money into commodities, artificially raising prices beyond any fundamental basis for these commodities, China has a more severe inflation fight on their hands, which means even more severe tightening measures and monetary policy controls.

So, what do these severe monetary measures do for growth in China? It starts putting downward pressure on the economy, i.e., results in slower growth. In essence, not only does big banks’ propensity to take government cheap capital and ineffectively invest it stifle growth in the US, but also is exported in the form of higher input costs and increased inflation dynamics for the emerging economies, which had previously been the one bright spot keeping the global economy afloat.

CFTC – No Action

The CFTC as part of the financial reform bill are supposed to come out with some new position limits for the big banks which might be helpful in reducing some of the speculative inflows into these commodities. But they keep dragging their feet on the issue, and since the big banks have historically obfuscated these rules in the past, I wouldn’t hold my breath on that one.

Take Physical Delivery or Else

However, it would be interesting to see this rule passed for the crude oil market–All market participants have to take physical delivery. Then, literally overnight, you would see the price of oil drop to $40-$50 a barrel as very few market participants actually take physical delivery.

Commodity generally has an inverse relationship with equity. But crude oil these days trades more in line with the S&P 500 as an asset class (see Chart) rather than as a commodity subject to supply and demand dynamics where producers and users like airlines actually hedge their interests.

Actually if the big banks like Goldman Sachs, Morgan Stanley, J.P. Morgan, HSBC and Bank of America got out of the business of pumping of commodity prices like oil, there would be a lesser need to hedge in the first place by actual producers and users.

Price Distortion = Lower Producer Profit

It’s the price distortion practices of the big banks that provide for so much volatility and instability in the market which needs to be curtailed so that the underlying fundamentals of supply and demand dynamics that embodies free markets can actually occur.

Producers are even hurt by this volatility and market price distortions as many have both upstream and downstream exposure, and with 10% unemployment and a sluggish economy, you can only pass so much of the gasoline price onto consumers and businesses, so the price of crude rises higher than the price of the products, which really hurts their refining margins.

QEs Should Be Conditional

The QE2 initiative is not the end of the world, but if you are going to go down this road, you need to have some kind of disincentive and/or penalty for the big banks to just take this extra cheap liquidity, and go and pile this capital into commodities like food and energy futures, and provide some sort of incentive for actually get this capital to directly support job creating business activity. After all, isn`t the business of lending supposed to be their primary business in the first place?

Even the I-Banks like Goldman Sachs and Morgan Stanley could better serve the Fed`s purpose of fostering economic growth and job creation if they used this cheap money for fueling venture capital initiatives and underwriting business expansion activities for corporations as opposed to taxing consumers through their investment in commodities like food and energy.

The Fed can also put some kind of ground rules for the big banks in what they can invest this essentially zero percent capital into so that the productive utilization of this capital occurs thereby stimulating job creation and economic growth, versus the counterproductive use of this cheap capital which actually stifles the economy and hinders job creation through higher input costs, and an effective tax on consumption in higher commodity prices.

Tags: Banking Sector, Business Projects, Cheap Money, Commodities, Crude Oil, Deflation, Dian, Dismal Economy, Economic Diversity, Economic Growth, Economic Standpoint, Energy Prices, Energy Products, Fed Chairman Bernanke, Japan And The United States, Japan Style, Job Creation, Price Of Oil, Qe 2, Qe2, Venture Capital Initiatives
Posted in Commodities, Energy & Natural Resources, Gold, Markets, Oil and Gas | Comments Off

Quantitative Easing Measures Likely to Help Economy

Monday, November 1st, 2010

Markets were generally flat last week, with the Dow Jones Industrial Average down fractionally to 11,118 and the S&P 500 Index unchanged at 1,183. The Nasdaq Composite did manage to make some gains, rising 1.1% to 2,507. The upcoming week is unusually packed with market-related events, including the US midterm elections tomorrow, the Federal Reserve’s scheduled policy meeting on Wednesday and the monthly labor market report on Friday, so investors have much to pay attention to over the next few days.

In economic news, the preliminary third-quarter gross domestic product (GDP) report showed that the economy grew at an annualized rate of 2.0%, which was in line with expectations. The numbers show that the economy continues to slowly improve, but is hardly growing at a rapid pace. Looking ahead, we expect that the fourth quarter should see growth levels in a similar range of 2.0% to 2.5%. Beyond that point, easier financial conditions and what seems to be a sustained easing of bank lending standards could help provide a further boost in 2011. As has been the case for some time, the key variable remains the labor market, which has been slow to add a meaningful number of new jobs. On that front, initial jobless claims fell again last week and are now at their lowest level since August 2008, which may auger well for the future.

Despite the mixed economic backdrop, corporate earnings have remained surprisingly strong. At present, over 85% of companies that have reported third-quarter earnings have posted better-than-expected results.

Investors are eagerly awaiting this week’s Fed meeting, where it is expected that the central bank will roll out the long-anticipated next round of quantitative easing (known informally as “QE2”). From an equity markets perspective, we would point out that markets have already climbed significantly since Fed Chairman Bernanke’s August speech that kicked off the series of hints that QE2 was in the pipeline. This probably means that many of the potential benefits of QE2 may already have been discounted by the markets, and investors should not expect to see a major move higher in stock prices as a result of the new easing efforts. In any case, we do believe QE2 should be supportive of modestly improved economic growth by lowering interest rates, furthering the weakness of the US dollar, easing credit conditions and improving confidence levels.

Of all of these likely results of QE2, one that bears especially close watching is the currency issue. Many countries (the United States included) are eager to lower the value of their currencies to boost export levels. As we have discussed in prior weeks, such a scenario poses the risk of escalating into a currency and trade war as individual countries begin to adopt more protectionist measures. We are hopeful that cooler heads will prevail and that such a trade war does not come to pass, but such an outcome is clearly on the risk list.

Tags: Corporate Earnings, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Economic Backdrop, Economic News, Fed Chairman Bernanke, Fed Meeting, Federal Reserve, Fourth Quarter, GDP, Gdp Report, Gross Domestic Product, Initial Jobless Claims, Nasdaq Composite, New Jobs, Qe2, Quarter Earnings, Rapid Pace, Related Events
Posted in Markets | Comments Off

The Economy and Bond Market Diary (October 18, 2010)

Saturday, October 16th, 2010

The Economy and Bond Market Diary (October 18, 2010)

Treasury bonds sold off this week, sending yields on the 30-year Treasury sharply higher. The 30-year bond auction on Thursday was poorly received, possibly indicating investor reluctance to push yields lower.

Strengths

• Fed Chairman Bernanke indicated in a speech on Friday that “further action” (meaning monetary stimulus) would be warranted due to low inflation and high unemployment.
• Retail sales for September were better-than-expected, rising 0.6 percent. Additionally, the strength was spread throughout the sector.
• In a Reuters poll of economists, strength in emerging markets has driven expectations for world GDP growth for 2010 upward to 4.6 percent from 4.2 percent.

Weaknesses

• The bond sell off this week may mark an inflection point for the market as quantitative easing may be fully priced into the market.
• The University of Michigan Consumer Confidence Index fell slightly in its preliminary October reporting, showing no signs of improvement.
• A foreclosure crisis may be upon us, which may prolong the housing recovery.

Opportunities

• Inflation is unlikely to be a problem for some time and this gives central bankers and other policymakers around the world room for expansive policies.

Threats

• Europe is looking better than expected and possibly presents an upside risk to the global economy. This means central bankers may need to change course quicker than expected.

Tags: 30 Year Treasury, Bond Auction, Bond Market, Consumer Confidence Index, Emerging Markets, Fed Chairman Bernanke, Global Economy, Inflection Point, Market Diary, Michigan Consumer Confidence, Policymakers, Recovery Opportunities, Reluctance, Retail Sales, Reuters Poll, Stimulus, Treasury Bonds, University Of Michigan Consumer Confidence, University Of Michigan Consumer Confidence Index, World Gdp Growth
Posted in Markets | Comments Off

The Economy and Bond Market Diary (July 26, 2010)

Sunday, July 25th, 2010

The Economy and Bond Market Diary (July 26, 2010)

Treasury bonds sold off modestly this week as sentiment toward global growth prospects improved and the stress tests of European banks turned out benign.

Economic data was generally disappointing this week but the market appears to now be leaning toward the current economic weakness as just a “soft patch” and is becoming more optimistic that growth will reaccelerate. The chart below illustrates the current market quandary: Leading economic indicators have decelerated three months in a row but still remain at a high level. The market is now struggling with whether the odds of a double dip were overestimated and whether those expectations are reversing.

Strengths

• The stress tests of European banks were released on Friday and the results were taken by the market as benign. After the data was released, stocks rallied and bonds sold off.
• The National Association for Business Economics conducted a poll which indicated increased hiring even in the face of slower growth expectations.
• Fed Chairman Bernanke implied the Fed would provide additional support for the economy if needed.

Weaknesses

• Housing data disappointed again with housing starts falling to an 8-month low and existing home sales falling 5.1 percent in June.
• The Bank of Canada raised interest rates, citing strong economic growth and increasing employment.
• Fed Chairman Bernanke, while offering support if needed, also highlighted the “unusually uncertain” environment with downside risk to both employment and economic growth.

Opportunities

• Inflation is unlikely to be a problem for some time. This gives central bankers and other policy makers around the world room for expansive policies.

Threats

• The risk of austerity measures going too far and significantly diminishing economic growth is a real risk.

Tags: Austerity Measures, Bank Of Canada, Bond Market, Business Economics, Double Dip, Downside Risk, Economic Growth Opportunities, Economic Weakness, European Banks, Existing Home Sales, Fed Chairman Bernanke, Global Growth, Growth Expectations, Growth Prospects, Leading Economic Indicators, Market Diary, Quandary, Stocks Bonds, Stress Tests, Treasury Bonds
Posted in Bonds, Canadian Market, Markets | Comments Off