U.S. Equity Market Radar (August 6, 2012)

Sunday, August 5th, 2012

U.S. Equity Market Radar (August 6, 2012)

The S&P 500 Index rose 0.36 percent this week as the equity market shrugged off initially disappointing news from both the Federal Reserve and European Central Bank (ECB). The market rallied strongly on Friday to erase losses from earlier in the week. It appears the market also negatively reacted to the news that Knight Capital lost $440 million in a mini “flash crash” for the firm caused by a software glitch. By Friday, the company was able to secure short-term financing to continue trading and this appeared to be a relief to the market.

Strengths

• The technology sector was the best performer this week rising 1.52 percent driven by a stealth rally in Apple which rose by more than 4 percent this week, along with healthy performances from Teradata, Microchip Technologies and Cisco.
• The financial sector was once again near the top of the performance charts with solid performances from the insurance companies as Metlife, Lincoln National, Prudential and Allstate all reported earnings this week that were well received by the market.
• Frontier Communications was the best performer in the S&P 500 this week, rising by 18 percent on better than expected second quarter results and an improving outlook.

Weaknesses

• The healthcare sector lagged as managed care companies and healthcare distributors sold off sharply on disappointing quarterly results. Within the managed care industry group, Humana dropped more than 11 percent and in the distribution space, Cardinal Health fell by more than 7 percent.
• Utilities also underperformed this week, bucking a recent positive trend for the sector.
• Abercrombie & Fitch was the worst performer in the S&P 500 this week. The stock hit a three-year low as the company slashed its full-year earnings outlook by almost a third.

Opportunity

• The market shifted its focus from earnings to central bank policy last week and that shift will likely dominate the price action for the next several weeks.

Threats

• While policy makers in Europe have made strides to stabilize the economic situation, many risks remain and the situation remains very fluid.
• The head of the ECB, Mario Draghi, stated that the ECB will do whatever it takes to save the euro. However, it appears all is not under his control and policy makers in Germany may not allow for the policies the central bank believes the economy needs.

Tags: Allstate, Cardinal Health, Distribution Space, Financial Sector, Frontier Communications, Healthcare Distributors, Healthcare Sector, Industry Group, Insurance Companies, Lincoln National, Market Radar, Market Strengths, Metlife, Microchip Technologies, Performance Charts, Quarter Results, Quarterly Results, Short Term Financing, Software Glitch, Technology Sector
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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
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U.S. Equity Market Radar (July 30, 2012)

Sunday, July 29th, 2012

U.S. Equity Market Radar (July 30, 2012)

The S&P 500 Index rose 1.71 percent this week as the equity market shrugged off weak earnings reports and focused on potential monetary policy easing from both the Federal Reserve and European Central Bank (ECB), which could come as early as next week. The telecom services sector led the way, followed by financials and industrials. The materials sector was the only sector in negative territory for the week.

Strengths

• The telecommunication services sector was the best performer this week rising 4 percent, driven by much-better-than-expected earnings reports from MetroPCS Communications and Sprint Nextel. MetroPCS was the best performer in the S&P 500, rising by more than 40 percent.
• The financial sector was predominately led higher by the investment banks and brokerage stocks, which were among the worst performers last week. JPMorgan Chase, Goldman Sachs, Morgan Stanley and Citigroup all rose by more than six percent.
• The industrial sector also performed well as key stocks outperformed, including Caterpillar and General Electric.

Weaknesses

• The materials sector lagged as Dow Chemical disappointed along with Vulcan Materials. Cliffs Natural Resources was the worst performer in the group on continued weak iron ore prices.
• Other areas that were weak included education services, casino and gaming, construction materials, and coal.
• DeVry, the for-profit education company, was the worst performer, falling 29 percent as the company warned of higher costs and declining enrollment.

Opportunity

• The market shifted its focus from earnings to central bank policy late in the week and that should be the focus next week as we could see action from the Fed, the ECB or both.

Threat

• While policy-makers in Europe have made strides to stabilize the situation, many risks remain and the situation remains very fluid.
• China recently cut interest rates for the second time in a month, which likely indicates that conditions on the ground remain challenging.

Tags: Dow Chemical, Earnings Reports, ECB, Education Company, Education Services, Financial Sector, Goldman Sachs, Industrial Sector, Investment Banks, Iron Ore Prices, Market Radar, Materials Sector, Metropcs, Morgan Stanley, Negative Territory, Profit Education, Sprint Nextel, Telecom Services, Telecommunication Services, Vulcan Materials
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The Weaponization of Economic Theory

Saturday, July 21st, 2012

This is an excellent article by Michael Hudson. The very end is a powerful commentary on the neoliberal ideology, defined in Wiki as “based on the advocacy of economic liberalizations, free trade, and open markets. Neoliberalism supports privatization of state-owned enterprises, deregulation of markets, and promotion of the private sector‘s role in society. In the 1980s, much of neoliberal theory was incorporated into mainstream economics.”

This doctrine has been used to shift power, money and other resources to the members at the very top of our society, with great support from the non-top who have been successfully misled into thinking they are supporting an equitable system. It’s not, at the very foundations. If you read nothing else, read the final section in which Michael explains why neoliberalism is a weaponization of economic theory – a “doctrine of power and autocracy combined with deregulation and dismantling of democratic law” – aimed at replacing the government’s power to protect the people with an oligarchic power to oppress them. It is not about free markets and free trade, as the terms were traditionally used by economists. It is about central planning by financial centers, and it requires deregulation and a tax structure favoring banking and financial institutions, and their major customers, real estate interests and monopolies. We have that now.

Michael argues that “the result is a doctrine of financial war not only against labor but also against industry and government. Gaining the financial power to indebt economies at increasing speed, the banking and financial sector is siphoning resources away from the real economy. Its business plan is not based on employing labor to expand output, but simply to transfer as much of the existing flow of revenue as possible into its own hands, by capitalizing all such revenue into interest payments, on loans collateralized and pledged to creditors.” In his conclusion, Michael compares our state to the economic polarization characterizing ancient Rome before its ruin. ~ Ilene

The Weaponization of Economic Theory
Courtesy of Michael Hudson

Europe’s three needs: a debt write-down, a real central bank, and a more efficient tax system

Brussels Talk, Madariaga College, Governing Globalisation in a World Economy in Transition, June 27, 2012

What can Europe learn from the United States?

First, the United States – like Canada, England and China – have central banks that do what central banks outside of Europe were created to do: finance the budget deficit directly.

I have found that it is hard to explain to continental Europe just how different the English-speaking countries are in this respect. There is a prejudice here that central bank financing of a domestic spending deficit by government is inflationary. This is nonsense, as demonstrated by recent U.S. experience: the largest money creation in American history has gone hand in hand with debt deflation.

It is the commercial banks that have created the Bubble Economy’s inflation, from North America to Europe. They have recklessly lent mortgage credit and other credit far beyond the ability of domestic economies to pay. A real central bank can create credit on its electronic keyboards just as easily as commercial banks can do. But central banks do not create credit for speculative purposes. They do not make junk mortgages based on “liars’ loans” (the liars are the banks, not the borrowers), based on fictitious evaluations by crooked appraisers, and sold fraudulently to investment banks to package and sell to gullible Europeans, pension funds and other customers.

In short, there is no need for the present austerity. If Europe acted like the United States, it could bail out the banks.

But would this be a good thing? My second point is that there are good reasons not to fund a dysfunctional debt overhead, financial and tax system. It is preferable to change these systems.

In the United States, Paul Krugman has urged the Federal Reserve to simply lend banks an amount equal to their bad loans and negative equity (debts in excess of the market price of assets). He urges a “Keynesian” program of spending to re-inflate the economy back to bubble levels. This is the liberal answer: to throw money at the problem, without seeking structural reform.

The Bank for International Settlements (BIS) disagreed last week in its annual report. It said – and I believe that it is right – that monetary policy alone cannot solve an insolvency problem. And that is what Europe has now: not merely illiquidity for government bonds and corporate debt, but insolvency when it comes to the ability to pay.

In such circumstances, the BIS explains, it is necessary to write down the debt to the amount that can be paid – and to undertake structural reforms to prevent the Bubble Economy from recurring.

The Canadian postal workers union has an informal slogan: “A job that’s not worth doing is not worth doing well.” I might apply this to Europe by saying that a badly structured economy is not worth subsidizing or saving. It should be made well.

This entails, for starters, writing down the debt overhead. That is what created the German Economic Miracle of 1948: the Allied Monetary Reform that wiped out debts over and above minimum working balances, and wages debts owed by employers to employees. It was easy to write down debts that were owed to Nazis. It is much harder to do so when the debts are owed to powerful and entrenched institutions – especially to banks.

Take the case of a Greek debt writedown. This would hurt the Greek banks first and foremost, and also more innocent German insurance companies and banks.I have a modest suggestion as to how to handle this. First, let the Greek banks go under. They helped stymie the Greek government’s attempt to stop tax evasion and money laundering. They have been described as co-conspirators and corrupt. Of course their depositors should be made whole by a standardized, public bank insurance scheme. But bank bondholders and stockholders, and even non-insured depositors, are another matter.

As for the German institutions, if a Greek Clean Slate pushes them into insolvency, the German Government should do what the U.S. Federal Deposit Insurance Corp. (FDIC) is empowered to do: take them over, make all the depositors and policy holders whole, and operate these institutions as a public option – either temporarily or permanently.

The alternative is austerity and debt deflation that will leave European markets shrinking, living standards falling, and turn Europe into what U.S. Defense Secretary Rumsfeld has said so often: “Old Europe,” as if it is too late to be saved. Any discussion of the U.S. economy necessarily involves the global context. So it is necessary to discuss not only domestic U.S. developments, but also relations with Europe and the BRICS countries.

The most important dynamic is financial. A continued decline in real estate prices, coupled with local government debts, has led to debt deflation. As personal and corporate income are diverted to pay debt service, spending on new consumption and investment goods is cut back. Sales and employment opportunities are falling off, especially for new entrants into the labor force. Major categories of debt cannot be repaid in Europe and the United States, except by foreclosures transferring property to creditors. Short-term financial aims overshadow the long-term adjustments that ultimately will be needed: debt writedowns in the public and private sectors. The alternative to this “business as usual” scenario is for the U.S. and European economies to look increasingly like the Baltics – austerity aggravating economic shrinkage.

The U.S. Government as well as European governments have taken bad bank debts onto the public balance sheet. This is not a problem for the United States, whose Federal Reserve can simply create the credit to roll over its debt. But for Europe, public debts simply cannot be paid under current central bank constraints. Instead of changing the central bank rules, the European Union is willing to plunge the continent into depression and economic shrinkage.

U.S. Austerity and deeper Negative Equity

The U.S. economy is free of the monetary constraint that Europeans impose on themselves. The Federal Reserve does what central banks are supposed to do: monetize government deficit spending by buying public debt. However, the increase in new government debt creation has not been mainly to finance deficit spending to increase economic activity and employment, to invest in rebuilding the nation’s infrastructure or providing states and cities with the revenue sharing that in the past enabled them to balance their local budgets. Instead, the government has created debt in an attempt to re-inflate real estate markets back toward Bubble Economy levels. The idea was for the economy to “borrow its way out of debt.”

In practice, there was not much hope of success. The banks sent the $800 billion of Federal Reserve’s Quantitative Easing (QE2) in 2012 abroad, mainly to the BRICS economies in the form of interest rate and currency arbitrage. The banks’ idea was to earn their way out of their own negative equity, but not by lending to a real estate market whose prices continue to decline. This is forcing more properties into negative equity – and that leaves the banks themselves in a negative equity position. So there is little new lending for real estate, to consumers, or to business. Markets are being shrunk by debt deflation.

States and cities also face a shrinking tax base, and many are subject to constitutional requirements for balanced budgets. The path of least resistance has been to underfund their pension plans – which have fallen far behind, especially inasmuch as most plans assume an 8% annual rate of return. This rate – assuming a savings doubling time of just nine years – has become even more fictitious today than it was a decade ago. So some localities have taken risks and lost – with their loss being the counterpart to earnings by the largest banks on derivatives.

The bottom line here is that the U.S. economy is not in a position to “borrow its way out of debt.” The outlook thus is for a similar austerity to that of Europe.

Financial fraud has been effectively decriminalized in the United States. In a nutshell, people have lost trust in the banks – and the financial sector itself mistrusts its fellow institutions. So the non-bank money market funding has dried up for business, and individuals are afraid to invest in the stock market.

President Obama retains his progressive rhetoric, but actually is neoliberal. (His Senate mentor was Joe Lieberman who helped him go for the money and choose Rubinomics advisors.) Mitt Romney pretends to be a right-wing extremist, but seems reasonable on economic policy. However, he may feel under pressure to support right-wing Republican lobbyists in the Congressional leadership. Even if he does, there will not be much difference from the Obama administration. The U.S. situation thus is much like that of Britain under Labour party leadership in recent years: centrist or even left-wing rhetoric on social policies, but neoliberal financial policy favoring the banks.

BOTTOM LINE: Neither the U.S. nor European economies can “grow their way out of debt.” Their debt deflation will worsen, and their budget deficits will widen.

The U.S. Political Outlook

As in Europe, there is little alternative from the ostensible left – from the Democratic Party, the labor unions and allied interests. President Obama seems likely to win this November’s presidential elections, and he is a neoliberal – probably more so than the Republican candidate Mitt Romney.

The common backers of the Republican and Democratic Parties – mainly, Wall Street and real estate interests – realize that a Democratic President is in a better position than a Republican to neutralize Congressional or Senate opposition to scaling back and privatizing Social Security and Medicare. Democratic politicians are more likely to counter Republican proposals along these lines than proposals put forth by their party’s own president. The situation is much like Tony Blair out-Thatchering Britain’s Conservatives in trying to privatize British rail and tube infrastructure and promoting the Public-Private Partnership plan. This is essentially the Rubinomics position supported by the Democratic leadership.

Many voters simply will stay home, so Mr. Romney may have a chance to win, based on support in the South and the West – and even perhaps some Midwestern swing states. In either case, the 2013-16 administration looks like it will be a bipartisan neoliberal austerity.

From the U.S. vantage point, Europe is a dead zone. It looks to me like financial and fiscal self-destruction.

There would be some hope for progress if the financial crisis was used to clean up bureaucracy and shift the tax system off the cost of living and doing business to a land tax on economic rent. This would prevent a new real estate bubble from developing, by holding down the “free” site value that could be capitalized into bank loans. This would lower the cost of housing, and also free employment from taxation. And it could go hand in hand with reducing the size of the Greek bureaucracy, for instance.

But I don’t see this happening in Europe. So financial austerity is likely to aggravate the budget deficits rather than help them. European economies are likely to grow “surprisingly” less than forecasts suggest, and news media will report this as “unanticipated slowdown” “to everyone’s surprise” and so forth.

The likely political reaction in Europe is likely to be a nationalistic opposition to relinquishing government power. But this opposition is likely to come more from the right than from the left of the political spectrum. This is what is so striking about today’s political situation both in Europe and the United States: the failure of the left to provide an economic alternative, and of the right to reform the tax system and corruption.

BOTTOM LINE: The U.S. trade balance may improve as consumer budgets are squeezed, limiting imports, and as domestic shale gas cuts import demand. But capital inflows are unlikely to increase. And until interest rates begin to rise, capital outflows will continue (much as was the case in Japan after 1990). The U.S. is thus suffering a “Japan syndrome.”

Increasing global fracture into regional blocks

Instead of international “cooperation,” I see a regional rivalry among blocs polarizing between the U.S.-centered NATO bloc and the BRICS, expanding their influence. Europe looks pretty much left out, as its markets are not growing and it is not a prime investment area. The BRICS countries are likely to start erecting capital controls against easy-credit policies in the United States funding a takeover of their assets.

Financial flows and capital flight are putting upward currency pressure on the BRICS at the expense of the euro and the dollar. If the euro does not decline against the dollar, it is largely because both currencies are equally weak together and share similar problems. Both economies will shrink, leading to more insolvency for real estate and also for government budgets. This Euro-American shrinkage is likely to spur moves in China and other BRICS to rely more on growth of their internal market. China’s wage levels are likely to rise, prompting production to aim more to satisfy domestic consumer demand than foreign export demand.

The main problem for China is that one of the first expenditures of families with rising revenue is to buy autos. The government’s response is to invest more in public transportation, and is likely to impose an environmental tax. More dispersion of urban centers is likely in order to minimize transportation costs – and more infrastructure spending in general.

Capital controls are likely, and also a denomination of foreign trade and investment in BRICS currencies rather than the U.S. dollar or euro. This tendency will accelerate if U.S. and European military policy continues to expand into Asia and other regions. As matters look at present, U.S. military diplomacy will focus more on trying to recover influence in Latin America, including privatization of key infrastructure to buyers (on credit) who will engage in rent extraction, adding to the price level. The result of debt deflation is thus to raise the cost of living and doing business for much of the economy, squeezing labor and commerce alike.

These policies are likely to be characterized as “muddling through.” This means postponing what looks like the inevitable end game: a large write-down of government debt, a shift away from the dollar as global currency (quite possibly with a re-introduction of gold to settle balance-of-payments deficits). Diplomatically, these changes will constrain U.S. military spending, while pressuring Europe to re-orient its geographic focus if it is to resume economic growth and pull itself out of a feedback of debt deflation, unemployment and even emigration.

The neoliberal challenge

The term “neoliberalism” misrepresents and even inverts the classical liberal idea of free markets. It is a weaponization of economic theory, kidnapping the original liberal ethic that sought to defend against special privilege and unearned income. To classical economists, a free market meant one free of unearned income, defined as land rent, natural resource rent, monopoly rent and rent-extracting privilege. But to neoliberals a free market is one free from taxes or regulation of such rentier income, and indeed gives it tax favoritism over wages and profits.

Neoliberalism and neo-conservatism are complementary doctrines of power and autocracy combined with deregulation and dismantling of democratic law. The aim is to replace government power as used to protect the people with an oligarchic power to oppress the people.

Today, the neoliberal aim is to cripple government power, enabling a free-for-all for the financial sector. Protecting civil freedoms are also heavily signposted, but the high price of legal representation is a barrier for most. A doctrine primarily of the financial sector, the aim is to un-tax banks and financial institutions and their major customers: real estate and monopolies.

Neoliberalism is a doctrine of central planning, which is to be shifted from governments to the more highly centralized financial centers. This requires disabling public power to regulate and tax banking and finance. As a transition, ideological deregulators such as Alan Greenspan and Tim Geithner have been appointed to the key regulatory positions in the United States.

The result is a doctrine of financial war not only against labor but also against industry and government. Gaining the financial power to indebt economies at increasing speed, the banking and financial sector is siphoning resources away from the real economy. Its business plan is not based on employing labor to expand output, but simply to transfer as much of the existing flow of revenue as possible into its own hands, by capitalizing all such revenue into interest payments, on loans collateralized and pledged to creditors.

The effect is no more democratic than the Roman democracy, which arranged voting by “centuries” headed by the largest landowners – essentially an acre-per-vote, to make an analogy. In the U.S. case, votes are bought not by land as such, but by dollars – mainly from the financial sector. In the end, to be sure, most dollars come from rent extraction.

The result must be economic polarization, above all between creditors and debtors as in Rome. So the end stage of neoliberalism threatens a Dark Age of poverty/immiseration – most characteristically, one of debt peonage. And just as Rome’s creditor class and its predatory imperial expansion brought down the Roman Empire and reduced it to mere subsistence, so the combination of neoliberalism and neo-conservatism today seeks to globalize itself, spreading austerity even as it brings technological progress to sovereign debtors.

Tags: Autocracy, Business Plan, Creditors, Deregulation, Economic Theory, Economists, Equitable System, Estate Interests, Financial Institutions, Financial Sector, Free Markets, Interest Payments, Mainstream Economics, Michael Hudson, Monopolies, Neoliberal Ideology, Open Markets, Privatization, State Owned Enterprises, Tax Structure
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The Heart of the Matter (Hussman)

Sunday, June 10th, 2012

by John Hussman, Hussman Funds

Over the past 13 years, the S&P 500 has underperformed even the depressed return on risk-free Treasury bills. Real U.S. gross domestic investment has not grown at all since 1999, and even as a share of GDP, real investment remains weak.

The ongoing debate about the economy continues along largely partisan lines, with conservatives arguing that taxes just aren’t low enough, and the economy should be freed of regulations, while liberals argue that the economy needs larger government programs and grand stimulus initiatives.

Lost in this debate is any recognition of the problem that lies at the heart of the matter: a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad.

Specifically, over the past 15 years, the global financial system – encouraged by misguided policy and short-sighted monetary interventions – has lost its function of directing scarce capital toward projects that enhance the world’s standard of living. Instead, the financial system has been transformed into a self-serving, grotesque casino that misallocates scarce savings, begs for and encourages speculative bubbles, refuses to restructure bad debt, and demands that the most reckless stewards of capital should be rewarded through bailouts that transfer bad debt from private balance sheets to the public balance sheet.

What is central here is that the government policy environment has encouraged this result. This environment includes financial sector deregulation that was coupled with a government backstop, repeated monetary distortions, refusal to restructure bad debt, and a preference for policy cowardice that included bailouts and opaque accounting. Deregulation and lower taxes will not fix this problem, nor will larger “stimulus packages.” The right solutions are to encourage debt restructuring (and to impose it when necessary), to strengthen capital requirements and regulation of risk taken by traditional lending institutions that benefit from fiscal and monetary backstops, to remove fiscal and monetary backstops and ensure resolution authority over institutions engaging in more speculative financial activities, and to discontinue reckless monetary interventions that encourage financial speculation and transitory “wealth” effects without any meaningful link to lending or economic activity.

By our analysis, the U.S. economy is presently entering a recession. Not next year; not later this year; but now. We expect this to become increasingly evident in the coming months, but through a constant process of denial in which every deterioration is dismissed as transitory, and every positive outlier is celebrated as a resumption of growth. To a large extent, this downturn is a “boomerang” from the credit crisis we experienced several years ago. The chain of events is as follows:

Financial deregulation and monetary negligence -> Housing bubble -> Credit crisis marked by failure to restructure bad debt -> Global recession -> Government deficits in U.S. and globally -> Conflict between single currency and disparate fiscal policies in Europe -> Austerity -> European recession and credit strains -> Global recession.

In effect, we’re going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable.

Once we abandoned Glass-Steagall, removing the firewall between traditional banking and more speculative activities, and allowing those activities to have the effective protection of the U.S. government, it was only a matter of time until a credit crisis would unfold. My 2003 piece Freight Trains and Steep Curves detailed the problem: “So the real question is this: why is anybody willing to hold this low interest rate paper if the borrowers issuing it are so vulnerable to default risk? That’s the secret. The borrowers don’t actually issue it directly. Instead, much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government. These are held by investors precisely because they piggyback on the good faith and credit of Uncle Sam.”

The ability to use the Federal government as a backstop for risk-taking was the central element in creating the housing bubble. As long as a borrower was physically breathing, you could make a mortgage loan without really worrying about whether the loan could be paid back. By the time it was packaged up, tranched out, and securitized either by a bank or by Fannie and Freddie, all of which had the government backstop, the loan was somebody else’s problem. When the bubble crashed, our policy makers made their crucial mistake – first through the Bush Administration, and then continued by the Obama Administration – they failed to require bondholders to take losses on bad loans.

Every major bank is funded partially by depositors, but those deposits typically represent only about 60% of the funding. The rest is debt to the bank’s own bondholders, and equity of its stockholders. When a country like Spain goes in to save a failing bank like Bankia – and does so by buying stock in the bank – the government is putting its citizens in a “first loss” position that protects the bondholders at public expense. This has been called “nationalization” because Spain now owns most of the stock, but the rescue has no element of restructuring at all. All of the bank’s liabilities – even to its own bondholders – are protected at public expense. So in order to defend bank bondholders, Spain is increasing the public debt burden of its own citizens. This approach is madness, because Spain’s citizens will ultimately suffer the consequences by eventual budget austerity or risk of government debt default.

The way to restructure a bank is to take it into receivership, write down the bad assets, wipe out the stockholders and much of the subordinated debt, and then recapitalize the remaining entity by selling it back into the private market. Depositors don’t lose a dime. While the U.S. appropriately restructured General Motors – wiping out stock, renegotiating contracts, and subjecting bondholders to haircuts – the banking system was largely untouched.

The failure of our policy makers to restructure debt resulted in the worst of both worlds – an economy where banks were relieved of the need for transparency (thanks to accounting changes by the FASB), and yet homeowners strapped with bubble-sized mortgage obligations saw very little in terms of debt restructuring. The reason we never got any economic traction in this “recovery” is that these debt burdens remain in place. While we certainly don’t advocate “freebie” principal writedowns – which would almost surely result in a tsunami of strategic defaults, we’ve long proposed what we’ve called Property Appreciation Rights as a way to partially substitute mortgage premium for a marketable claim on future appreciation. Failing any meaningful debt restructuring, however, we’ve got a financial system that continues to operate with a confident government backstop for risk taking, while aggregate demand remains suppressed by a burden of existing debt.

Economists define a standard of living as the amount of goods and services that people in the economy can consume as a result of the work they do. They define productivity as the amount of goods and services that people in the economy can produce as the result of the work they do. In the long run, a rising standard of living requires rising productivity, which in turn requires the economy to accumulate a stock of productive investments – factories, machines, inventions, education, and so forth. In the short run, the benefits of productivity growth can be retained through profits in a way that prevents those benefits from being enjoyed by workers, but even then, redistributing wealth can only achieve limited improvements in living standards. Over time, an economy that squanders its scarce savings will predictably suffer for it.

Tragically, nobody seems to have learned a thing from the dot-com crash, or the tech crash, or the housing crash. Wall Street continues to beg for monetary interventions to reward speculative trading, even though these rewards have repeatedly proved to be short-lived. What investors don’t seem to appreciate is how much of our nation’s scarce savings have been burned to ashes as a result.

I really don’t mean to pick on Facebook. It’s a neat company, a neat platform, and I respect Mark Zuckerberg’s charitable initiatives. But the example is too instructive to miss, so let’s think about it as a recipient of investment capital. If you go on Amazon or Ebay, you want to stay in order to buy something. That’s a fine business model, and network effects work in your favor because there are a lot of sellers on the other side. If you go on Google, you want to find what you’re looking for and then leave, which is a situation where advertising is welcome, and also works as a business model. But consider Facebook. If you go on Facebook, your whole intention is to stay on Facebook for a while, but not to buy something. Here, network effects work against advertising because responding to the ad pulls you away from the network.

Tags: Backstop, Bad Debt, Cowardice, Debt Restructuring, Deregulation, Financial Sector, Global Financial System, Government Programs, Gross Domestic Investment, Heart Of The Matter, Hussman Funds, John Hussman, Lower Taxes, Partisan Lines, Policy Environment, Public Balance, Right Solutions, Scarce Capital, Speculative Bubbles, Treasury Bills
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The Pros and Cons of Preferreds (Koesterich)

Tuesday, May 22nd, 2012

Given the universal hunt for yield, many investors are asking me what I think of preferred stocks.

I believe that this asset class certainly has a place in yield oriented portfolios, but I wouldn’t overweight preferred equity funds at this time and would instead remain neutral. Why? While preferred funds are certainly providing a healthy, relatively high yield in a low yield environment, the extra yield comes with a lot of volatility.

Currently, preferred funds are offering a yield similar to that of a high yield bond fund, but preferred funds are also offering about 50% more volatility. For instance, the yield on the iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA: PFF) is now approximately 6.5%, roughly in line with the yield of the iShares iBoxx $ High Yield Corporate Bond Fund (NYSEARCA: HYG). But at the same time, PFF’s three-year trailing volatility is more than 15% compared with less than 10% for HYG.  Past performance is no guarantee of future results.  For standardized performance for PFF, please click here.

To be sure, preferred stocks are generally more volatile than bonds and this makes sense given their lower place in the capital structure. However, there is another reason for the heightened volatility of preferred funds today.

The S&P U.S. Preferred Stock Index is composed of mostly financial companies. In fact, today, more than 85% of the issuers in the index are financials. This heavy concentration in the financial sector is also contributing to preferred funds’ volatility — the financial sector is now the most volatile sector in the market.

As such, preferred funds modeled on the index are essentially acting as proxies for financial stock funds, but with equity-like risk and bond-like returns. For those with a positive view on financials, this may be an acceptable risk-reward tradeoff. But as I currently hold an underweight view of global financials, I’m advocating a neutral allocation to the preferred stock asset class for now.

Source: Bloomberg

Russ Koesterich is the iShares Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

The author is long PFF and HYG.

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com.

Index constituents are subject to change.

In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. Preferred stocks are not necessarily correlated with securities markets generally. Rising interest rates may cause the value of the Fund’s investments to decline significantly. Payment of dividends is not guaranteed. Removal of stocks from the index due to maturity, redemption, call features or conversion may cause a decrease in the yield of the index and the Fund.  Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.

Tags: Acceptable Risk, asset class, Capital Structure, Corporate Bond, Equity Funds, Financial Sector, Financial Stock, High Yield Bond, High Yield Bond Fund, Hyg, Ishares, Pff, Preferred Equity, Preferred Stock, Preferred Stocks, Preferreds, Risk Reward, Stock Funds, Stock Index Fund, Volatile Sector, Volatility
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U.S. Equity Market Radar (April 16, 2012)

Sunday, April 15th, 2012

U.S. Equity Market Radar (April 16, 2012)

The S&P 500 Index fell 1.99 percent this week, the biggest weekly drop this year as concerns mounted over a global economic slowdown and financial imbalances in southern Europe.

Strengths

• Supervalu was the best performer within the S&P 500, rising 25 percent. The company reported earnings that are more or less even with expectations, but the stock appears to have benefited from a significant short squeeze.
• Consumer discretion was the best performing sector, as the homebuilders bounced back from last week’s weakness to be the top industry group this week.
• Other strong performers for the week include Hewlett-Packard, Starbucks and Safeway.

Weaknesses

• The financial sector was the worst performer this week as European concerns resurfaced and initial earnings reports within the sector met expectations.
• The energy sector was also weak on concerns of global economic weakness.
• F5 Networks was the worst performer this week, falling by more than 10 percent as a sell side-analyst raised concerns that the company may have had to push really hard to close deals at the end of the quarter, potentially increasing the odds of an earnings miss.

Opportunity

• The market didn’t respond positively to early earnings reports and suffered its worst week of the year. This may set a precedent for next week as earnings releases are set to pick up.

Threat

• The S&P 500 is arguably still overbought in the short term and could be vulnerable to profit taking after the rally in the first quarter.

Tags: Amp, Discretion, Earnings Releases, Earnings Reports, Economic Weakness, energy sector, European Concerns, Financial Sector, First Quarter, Global Economic Slowdown, Hewlett Packard, Homebuilders, Industry Group, Market Radar, Miss Opportunity, Safeway, Short squeeze, Southern Europe, Starbucks, Supervalu
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U.S. Equity Market Radar (April 9, 2012)

Sunday, April 8th, 2012

U.S. Equity Market Radar (April 9, 2012)

The S&P 500 Index fell 0.74 percent this week driven in large part by cyclical sectors as concerns mounted over a global economic slowdown.

Strengths

• Within the S&P 500 Avon Products was the best performer, rising by more than 20 percent as Coty, Inc. is seeking to buy Avon for $10 billion.
• Bed Bath & Beyond was the second-best performer this week rising by more than 9 percent on a better-than-expected fourth quarter earnings report.
• The technology sector eked out a small gain as Apple, Priceline and Mastercard were among the best performers in the S&P 500 this week.

Weaknesses

• The energy sector was the worst performer this week as global macro concerns dominated, even though oil prices were roughly flat for the week.
• The financial sector was also weak as macro concerns surrounding Europe and European banks resurfaced.
• First Solar was the worst performer this week, falling by more than 16 percent as the solar industry faces many obstacles.

Opportunities

• The market continues to grind higher irrespective of recent news. The “trend is your friend” until this pattern changes.

Threats

• The S&P 500 is arguably overbought in the short term and could be vulnerable to profit-taking.

Tags: Amp, Apple, Avon Products, Bed Bath, Coty Inc, energy sector, European Banks, Financial Sector, Fourth Quarter Earnings, Global Economic Slowdown, Global Macro, Market Radar, Obstacles, Oil Prices, Pattern Changes, Priceline, Recent News, Sectors, Solar Industry, Technology Sector
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Europe’s Scariest Chart Just Got Scarier

Monday, March 12th, 2012

The last time we plotted European youth unemployment in what was dubbed “Europe’s scariest chart” we were surprised to discover that when it comes to “Arab Spring inspiring” youth unemployment, Spain was actually worse off than even (now officially broke) Greece, whose young adult unemployment at the time was only just better compared to that… of the United States. Luckily, following the latest economic (yes, we laughed too) update from Greece, it is safe to say that things are back to normal, as Greek youth unemployment is officially the second one in Europe after Spain to surpass 50%. In other words, Europe’s scariest chart just got even scarier.

And so while the Greek economy is in tatters, following another downward revision to its GDP as reported last week, this time dragging Q4 GDP from -7.0% to -7.5%, that’s only the beginning, and it now appears that a terminal collapse of not just the Greek financial sector, but its society as well, has commenced, as the number of people unemployed in the 11 million person country is now 41% greater than its was a year ago. From Athens News:

The average unemployment rate for 2011 jumped to 17.3 percent from 12.5 percent in the previous year, according to the figures, which are not adjusted for seasonal factors.

Youth were particularly hit. For the first time on record, more people between 15-24 years were without a job than with one. Unemployment in that age group rose to 51.1 percent, twice as high as three years ago.

Budget cuts imposed by the European Union and the International Monetary Fund as a condition for dealing with the country’s debt problems have caused a wave of corporate closures and bankruptcies.

Greece’s economy is estimated to have shrunk by a about a fifth since 2008, when it plunged into its deepest and longest post-war recession. About 600,000 jobs, more than one in ten, have been destroyed in the process.

Things will get worse before they get better, according to analysts. “Despite some emergency government measures to boost employment in early 2012, it is hard to see how the upward unemployment trend can be stabilised in the first half of the year,” said Nikos Magginas, an economist at National Bank of Greece.

A record 1,033,507 people were without work in December, 41 percent more than in the same month last year. The number of people in work dropped to a record low of 3,899,319, down 7.9 percent year-on-year.

When will the Greeks ask themselves if the complete and utter destruction of their society is worth it, just to pretend that life as a European colony is worth living. Especially now that pension funds have been vaporized?

Tags: 24 Years, Athens News, Average Unemployment Rate, Bankruptcies, Budget Cuts, Collapse, Debt Problems, Downward Revision, Financial Sector, Greece Economy, Greek Economy, Greek Youth, International Monetary Fund, Post War, Q4 Gdp, Recession, Seasonal Factors, Tatters, Young Adult, Youth Unemployment
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The Great Deleveraging Myth

Tuesday, January 17th, 2012

There’s been talk in the blogosphere lately about whether or not developed economies are deleveraging, i.e. winding down their debt.

Some recent posts, under headlines such as “The Age Of Consumer Deleveraging Is Over” and “Deleveraging is So 2011,” have argued that at least in the United States, consumer deleveraging appears to be a thing of the past.

My take, however, is that in many sectors of the US economy, deleveraging hasn’t happened at all. In fact, the notion that the United States is deleveraging is mostly a myth.

Now to be fair, deleveraging has occurred in at least one sector of the economy: The US financial sector, which has significantly reduced its debt. But once you move outside of the financial sector to the real economy — households, corporations and government — the great deleveraging idea evaporates.

The dirty little secret is that US non-financial debt rose by more than $5 trillion from the end of 2007 through the third-quarter of 2011. In the last year alone, the real economy has added roughly $1.4 trillion in debt to the overall US non-financial total.

It’s true that US household debt has contracted in recent years, but the contraction has been modest and is mostly due to bank write-offs. Since a debt peak in early 2008, US households have shed roughly $800 billion in debt. And as pointed out by the blog posts cited above, new US consumer credit numbers show increasing consumer debt.

At the same time, corporate debt has been rising as companies take advantage of record low yields. Since 2008, corporations have added approximately $500 billion in debt to their balance sheets.

This half-trillion increase, however, pales in comparison to the debt binge of the federal government. Publically traded or net federal debt has risen by more than $5 trillion since late 2007. As you can see in the chart below, this puts overall US non-financial debt at a bit under $38 trillion (for the purists, this arguably understates the total by $5 trillion as it ignores government debt held by the Social Security Trust Fund).

In short, it’s hard to argue that the US economy has deleveraged. Since 2009 the US debt burden has been relatively stable when compared to GDP. Essentially, nominal private sector debt has stabilized, while public sector debt has skyrocketed in an attempt to ease a collapse in consumption.

As I’ve mentioned before, this can continue for a while longer. In a world in which investors are short of safe investments, most are still willing to give the benefit of the doubt to the US government and lend long for the privilege of a safe place to park their money.

But for those who believe that debt levels are still unsustainably high — as I do — there does eventually need to be a reckoning. When this eventually happens, lending to the government for 2% may no longer seem like a safe haven.

Source: Bloomberg

Tags: Balance Sheets, Binge, Blogosphere, Consumer Credit, Consumer Debt, Contraction, Corporate Debt, Corporations, Credit Numbers, Dirty Little Secret, Federal Debt, Federal Government, Financial Debt, Financial Sector, Household Debt, Households, Myth, Notion, Purists, Tota, Trillion
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