Recession Generation Turns into Rental Generation

Wednesday, August 8th, 2012

by Mark Hanna, Market Montage

No surprise that we are seeing a big change in attitudes towards housing ownership among the younger generation.  There are a lot of things stacked against them – global wage arbitrage has pushed down wages for many, new college grads who enter the job market tend to have lower wages then those who do not [May 9, 2009: The Curse of the Class of 2009 - Lower Wages for Up to a Decade], and they are graduating with far more debt then their parents [Oct 19, 2011: Student Loan Debt Continues to Hit New Records].  Not to mention many see what happened to their parents in the “can’t lose” housing market during the past half decade.  That said, it appears renting is going far beyond just housing (furniture, clothing) as lower wages conspire with the American need/desire to consume.

Bloomberg takes a closer look:

• Anselmo and many of his peers are wary about making large purchases after entering adulthood in the deepest recession and weakest recovery since World War II. Confronting a jobless rate above 8 percent since 2009 and student-loan debt hitting about $1 trillion, 20-to-34-year-olds are renting apartments, cars and even clothing to save money and stay flexible.
• As the Great Depression shaped the attitudes of a generation from 1929 until the early years of World War II, so have the financial crisis and its aftermath affected the outlook of young consumers like Anselmo, said Cliff Zukin, a professor of public policy and political science at the Edward J. Bloustein School of Planning and Public Policy at Rutgers.  “This is a generation that is scared of commitment, wants to be light on their feet and needs to adjust to whatever happens,” said Zukin, who’s researched the effects of the recession on recent college graduates. “What once was seen as a solid investment, like a house or a car, is now seen as a ball and chain with a lot of risk to it.”
• Enterprise Holdings Inc. and Hertz Global Holdings Inc. (HTZ) are expanding in …the $1.8 billion hourly car- rental business, a segment dominated by younger drivers and made popular by Zipcar Inc. (ZIP).  The by-the-hour segment accounts for about 6 percent of the $30.5 billion U.S. car-rental market, a share that is forecast to rise to about 10 percent in five years, according to IBISWorld.   Those 34 and younger make up 84 percent of Hertz’s by-the-hour customer base.
• Startups such as Rent the Runway Inc. are supplying high-fashion apparel to satisfy those who want to wear, not own. CORT, a unit of Berkshire Hathaway Inc. (BRK/A), is increasing its furniture-rental marketing efforts to college students and fledgling households, said Mark Koepsell, CORT’s senior vice president.
• “Renting makes a lot of sense,” said David Blanchflower, professor of economics at Dartmouth College in New Hampshire and a Bloomberg Television contributing editor. “They have no money and they are not buying fridges and they are not buying the things they normally buy when they set up homes. Their incomes are a lot lower.”
• College graduates earned less coming out of the recession, according to a May study by the John J. Heldrich Center for Workforce Development at Rutgers. Those graduating during 2009 to 2011 earned a median salary in their starting job $3,000 less than the $30,000 seen in 2007.
• The majority of students owed $20,000 to pay off their education, and 40 percent of the 444 college graduates surveyed said their loan debt is causing them to delay major purchases such as a house or a car. The U.S. Consumer Financial Protection Bureau said in March it appeared student loans had reached $1 trillion “several months” earlier.
• The shifting attitudes also pose a threat to retail sales, said Candace Corlett, president of New York-based retail- strategy firm WSL Strategic Retail. Younger consumers are already comfortable buying used items and borrowing from friends. Renting will only reinforce their tendency not to buy new.

Tags: Adulthood, Arbitrage, Bloustein School, Class Of 2009, Cliff Zukin, Closer Look, College Grads, Great Depression, Hertz, Housing Market, Jobless Rate, Mark Hanna, Political Science, Recent College Graduates, Recession, Renting Apartments, Solid Investment, Student Loan Debt, World War Ii, Younger Generation
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Rosenberg On The Pending Trade Shock and Q4′s GDP Growth Outlook

Wednesday, August 8th, 2012

It would appear that the dilemma of the world exporting more than it imports (that we initially pointed out here) is starting to come to a head in reality with a negative export trade shock. As Gluskin Sheff’s David Rosenberg notes, since the recovery began three years ago, over 70% of the real GDP growth we have seen was concentrated in export volumes and inventory investment; and recent data from the ISM (here and here) points to a dramatic slowdown in both. Compounding this weakness is the fact that the remaining growth was from Capex – which is now likely to slow given the weakening trend in corporate profits – and will more than offset any nascent turnaround in the housing sector – if that is to be believed. The consumer has all but stalled and adding up all these effects and there is a high probability of a 0% GDP growth print as early as Q4.

Macro Risks Squarely To The Downside

I think that there may be a time, before too long, when we will walk into the office to find that the US prints a negative GDP reading on the back of a negative export trade shock that does not appear to be in any forecast – let alone consensus.

Look at the pattern of ISM export orders:

• April: 59.0
• May: 53.5
• June: 47.5
• July: 46.5

That is called a pattern. And this is a level that coincided with the prior two recession. As the chart below vividly illustrates, there is a significant 81% correlation between annual growth in total US exports and the ISM new orders index (with a four month lag). So either the market has already priced this in or it is going to end up coming as a very big surprise. We are already seeing the lagged effects of the spreading and deepening European recession hit Asian trade-flows: Korean exports sagged 4.1% in July after a 3.7% slide in June and are down 9% on a YoY basis. Industrial production there edged lower by 0.4% as well last month – I like to look at Korea since it is a real global ‘play’ on the economic cycle.

There is likely going to be another surprise, which is inventory destocking. How do I know that? Because the share of ISM industries polled in July reported that customer inventories were excessively high soared to 33% in July from 11% a year ago (because this metric is not seasonally adjusted it can only be assessed year-on-year), the highest ever for any July in the historical database.

Add to that what is happening to order books – the share of the manufacturers reporting expanded orders sank to 17% in July from 50% a year ago and again – the worst July showing on record.

The food price situation is another major wild card, especially since whatever relief we enjoyed from lower gasoline prices is now behind us. At a 14% share of the consumer spending pie, only shelter is more important than food. And when you go back to the last food cost surge, in the first quarter of 2011 when the grocery bill soared at a punishing 10% annual rate, real GDP growth slowed to a 0.0% annual rate that quarter, which arguably was the big surprise of the year (up until the dent downgrade, that is).

In the final analysis, since the ‘recovery’ began three years ago, over 70% of real GDP growth we have seen was concentrated in these two areas: export volumes and inventory investment. The rest was in capex which is now likely to slow along with the weakening trend in corporate profits, more than offsetting the nascent turnaround in the housing sector. Also keep in mind that the consumer has stalled.

Tally all these effects up and you are looking at the prospects of 0% growth as early as Q4.

Tags: Asian Trade, Capex, Corporate Profits, Correlation, Dalio, David Rosenberg, Downside, Dramatic Slowdown, Export Orders, Export Trade, Export Volumes, GDP, GDP Growth, Gluskin Sheff, Growth Outlook, Inventory Investment, Ism, Korean Exports, Real Gdp, Recession, S David
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“Did Somebody Repeal The Laws Of Mathematics?”

Sunday, August 5th, 2012

From Grant Williams’ latest Things That Make you Go Hmmm

Remember late-2010? When Spain wasn’t a problem, but merely a potential problem? I do:

(FT, November 17, 2010): For some of the world’s biggest hedge funds, typically regarded as the savviest traders in the market, there is now one big question facing the eurozone: what is going to happen to Spain?

While Europe’s politicians are grappling with the crisis unravelling in Ireland, hedge fund managers are already turning their attention to the issue of how – and if – a peripheral crisis in Ireland could leap via Portugal and Spain to become a systemic crisis for the eurozone as a whole.

“The Irish problem will be contained,” says Guillaume Fonkenell, chief investment officer at Pharo, one of Europe’s biggest and most successful macro funds, which specialises in trading on macroeconomic events and trends. “For us contagion is the issue … If the market loses confidence in Spain, then all bets are off. Spain is too big to bail.”…

Back then, the general opinion was that if the contagion spread to Spain the game was over because there wasn’t enough money with which to bail out an economy the size of The Kingdom of Spain. I’m not sure exactly what happened— maybe I wasn’t paying attention—but suddenly, almost two years on and in an environment where even the rich nations of Europe are seeing an undeniable slide towards recession, there is no talk about Spain being ‘too-big-to-bail’ anymore.

Did somebody repeal the laws of mathematics?

Presumably, if the contagion reaches Italy that would be OK too now, I guess.

As it first hit the headlines as a potential problem, Spain made a presentation to potential investors that highlighted how strong the country actually was despite the conjecture amongst market participants. The presentation is highly educational and can be found in full HERE, but as a taster, here’s one particular slide that caught my eye:

Oh, to hell with it… here’s another:

Some opportunity.

* * *

Full letter:

Hmmm 05 Aug 2012a

Grant Williams
Portfolio & Strategy Advisor at Vulpes Investment Management Private Ltd
2 Battery Road #26-01, Maybank Tower Singapore 049907
http://www.vulpesinvest.com/

Tags: Bets, Chief Investment Officer, Conjecture, Contagion, Enough Money, Eurozone, Grant Williams, Guillaume, Hedge Fund Managers, Hedge Funds, Kingdom Of Spain, Macroeconomic Events, Market Participants, Mathematics, Paying Attention, Pharo, Politicians, Recession, Systemic Crisis, Taster
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The Death of Equities Redux

Monday, July 30th, 2012

by Patrick Rudden, AllianceBernstein

A famous Business Week article, “The Death of Equities,” concluded, “Today, the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared.” Sound familiar? The article was published in August 1979.

The Business Week article discusses how, with “stocks averaging a return of less than 3% throughout the decade,” investors were fleeing equities in favor of cash and real assets such as property, gold and silver. “Further,” it states, “this ‘death of equity’ can no longer be seen as something a stock market rally—however strong—will check. It has persisted for more than 10 years through market rallies, business cycles, recession, recoveries and booms….For better or worse, then, the US economy probably has to regard the death of equities as near-permanent condition.”

The primary economic problem back then was high inflation, which had devastated returns for  stocks and bonds but had greatly buoyed the value of real assets such as gold. Of course, Paul Volcker, then Chairman of the Federal Reserve, was soon to unleash his war on inflation, which set the stage for a prolonged period of strong equity and bond market returns.

But the article says other factors contributed to the death of equities: “The institutionalization of inflation—along with structural changes in communications and psychology—has killed the U.S. equity market for millions of investors. We are all thinking shorter term than our fathers and our grandfathers.”

Inflation (at least of the consumer-price variety) has not been the problem it was in the 1970s, but I would argue that structural changes in communications and psychology have been, if anything, more severe. We are all subject sooner and sooner to more and more information. And, as a consequence, we are thinking shorter term than our fathers and grandfathers and, I should add, mothers and grandmothers.

Equities are no more likely to be dead now than they were in August 1979. Indeed, the expected return advantage of stocks versus government bonds is unusually high at present, in our opinion. However, shorter-time horizons may require us to revisit our investment portfolios. In addition to longer-horizon strategies like value and growth, investors may need to consider shorter-horizon strategies, such as equity income or low-volatility stocks.

Finally, for those investors worried about the return of the inflation bogeyman, holding some exposure to real assets is a good insurance policy.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Patrick Rudden is Head of Blend Strategies at AllianceBernstein.

Copyright © AllianceBernstein

Tags: Bond Market, Booms, Business Cycles, Business Week Article, Chairman Of The Federal Reserve, Economic Problem, Federal Reserve, Gold And Silver, Grandfathers, Grandmothers, inflation, Institutionalization, Market Rally, Paul Volcker, Prolonged Period, Real Assets, Recession, Rudden, Stock Market, Stocks And Bonds
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Stephen Roach: “QE3 Is Not Going To Work”

Wednesday, July 25th, 2012

Is it any wonder that Stephen Roach is now ex-Morgan Stanley? Today’s brilliant truthiness in his interview on Bloomberg TV is an absolute must-watch as the veteran market practitioner notes that the Fed is forced to act next week and while consumers are telling you that they want to pay down debt – which all the monetray stimulus in the world is not going to change – that QE is nothing but crack to a ridiculously addicted market. With 70% of the US economy in a balance sheet recession, the Fed knows this (which he notes is now run by WSJ’s Jon Hilsenrath since what he prints must be adhered to by Ben for fear of market disappointment) and is “dangling QE in front of the markets like raw meat – but it has not worked and it will not work!” But critically, he believes, the euphoric response of markets will be tempered since they have become “used to the fact that all of this unconventional monetary easing by the central bank is just not what it is supposed to be.”

Roach on whether more Fed stimulus is a good idea:

“The Fed is flailing and has been flailing for the better part of the last three years. We had QE1, which worked, and that’s it. We’ve had QE2, Twist 1, Twist 2 and now maybe QE3. The economy is in the doldrums. The biggest piece of the economy is the American consumer. 70% is in a balance sheet recession…The Fed knows this, but they are dangling this raw meat in front of the markets and the markets are salivating as they always do in that frenetic way that they try to believe in the Fed. But it has not worked and it will not work. “

On how likely it is that the Fed will issue more stimulus:

“Absolutely. They have no choice. They have gone about their usual pre-FOMC leak frenzy where they talk to this reporter and that reporter. Jon Hilsenrath is actually the chairman of the Fed. When he writes something in the Wall Street Journal, Bernanke has no choice but to deliver on what he wrote.”

On whether the Fed will move on stimulus next week:

“Absolutely. They will not disappoint the markets. The markets are now setting themselves up and discounting the next QE2. The Fed has just woken up to ‘oh my gosh, the economy is weak again.’ Well hello! The economy has been weak for the consumer for 18 quarters. The growth rate of consumption over the last four and a half years has averaged below 1%. 70% of the economy growing below 1% and the Fed is just figuring this out? Come on.”

“The point is, when they plant a story in the Wall Street Journal, and this story has been planted. Jon Hilsenrath is the weed that grows…the guy has a perfect track record…They’ll do some type of QE3. Twist 2 was a huge disappointment. It was a feeble flailing at the windmill and the economy is a lot weaker than when they reached the Twist 2 decision. They’ll have to do another round of quantitative easing. I don’t know exactly what securities will be involved. You could speculate it could be mortgage-backeds to try to help the housing market. There is some criticism they have been too focused on Treasuries. We’ll have to wait and see, but I think it will definitely be another round of quantitative easing as opposed to the twisting again like we did last summer.”

On whether QE3 will work:

“No, it’s crack! That’s what it is. It’s not going to work. QE1 worked because it was in the midst of wrenching crisis. QE2 failed, despite what the Fed’s research shows. Twist 1 has failed. Twist 2 is failing. When 70% of the economy is in a balance sheet recession and the growth rate for 18 quarters in row has been at less than 1% at an average annual rate, consumers are telling you something. They want to pay down debt and rebuild saving and all of the monetary stimulus in the world is not going to change what is a perfectly rational response. So the idea that the Fed is going to step in and save the day, it has not worked in the past except during the depths of the crisis and i give them credit for that. And it will not work in the future. Don’t believe the Fed PR that they put out while we have research that shows that it worked. Of course they do.”

On whether he expects futures to be higher than they are right now:

“The markets have responded positively to the leaks that came out late yesterday afternoon, but the response is small. I think the markets have gotten used to the fact that all of this unconventional monetary easing by the central bank is just not what it is supposed to be. In terms of delivering an actionable vigorous response in the real economy.”

Tags: Balance Sheet, Bernanke, Chairman Of The Fed, Consumers, Crack, Disappointment, Doldrums, Frenzy, Morgan Stanley, Qe, Qe1, Qe3, Raw Meat, Recession, Stephen Roach, Stimulus, Truthiness, Wall Street, Wall Street Journal, Wsj
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The T Report: China & LIBOR: Spain, Messy & Messi

Wednesday, July 25th, 2012

by Peter Tchir, TF Market Advisors

PMI

Chinese PMI was better than feared, but if I had to bet on what number is less manipulated, Chinese data or LIBOR, I would have to bet on LIBOR. Since we don’t have much else to work with, I guess we are stuck looking at it, and it shows that the slowdown is slowing, but I can’t get very excited about that.

European manufacturing PMI came in at 44.1, worse than the already low expectations of 45.2. The situation in Europe is deteriorating and all the summits aren’t helping. The banks need to be recapitalized and “uncertainty” needs to be removed or else business will continue to grind to a halt.

Most interesting, I thought, was that German Manufacturing PMI came in at only 43.3 and even German service remained under 50. Germany is not immune to the woes in the rest of Europe or to the global economy. French manufacturing PMI was an equally dreadful 43.6. Maybe the growing weakness in the core will light a fire. It isn’t enough to have firewalls. They either have to spend that money and finally take serious default and currency risk off the table, or the economies will continue to slide deeper into recession or depression.

Pesetas and Real Madrid

Spain had a reasonable t-bill auction today. The yields were high compared to any of the core with 6 month t-bills coming in a 3.69%. In a normal world, that isn’t bad, but in a world where Germany and others get paid to issue money for 6 months, it doesn’t look great.

In any case, talk of redenomination continues. Many people argue that the only way out for Spain and others is to exit the Euro and create their own currency that they can devalue at will.

I continue to see several problems with that. Devaluation will be controlled by the markets and not the politicians making it uncertain where the exchange rate will settle in. If the bets are “too high”, “too low” or “just right”, I would certainly bet against “just right”.

The uncertainty created by a new currency will be immense. The confusion for banks and businesses will overwhelm any possible business. Who will want to do business in a country with a highly volatile currency where the end result remains highly uncertain? Who will do business in similar looking countries? Trade will grind to a halt and demand for non-essential goods will dry up as people wait to see the results.

Finally, in a country where much of the “daily essentials”, particularly energy have to be imported, it is far more difficult to see how the people or the country, prosper. In successful devaluations, the country has often been natural resource rich and been able to “harness” those resources for their domestic economy during the devaluation process.

But those arguments are confusing, so let’s look at Barcelona and Real Madrid. Will Barcelona be able to afford Messi? How much of the revenue of these clubs from domestic markets? The higher the percentage of domestic revenue, the more expensive players will be. And it wouldn’t just be foreign players. Spanish players would also be tempted to leave. The clubs would have to pay their players in Euros. That could become a huge burden for Spanish clubs. As the peseta plummets, how will they afford these top players? Will clubs in other countries be able to pay them?

What if the situation in Spain erodes where daily protests become a way of life? What if the devaluation causes domestic problems? If political tensions grow and civil unrest increases will players want to stay in Spain when they could demand the same money elsewhere, without the additional risk?

Maybe Germany is hoping to transform the Bundesliga into the best league through currency devaluation? Yes, this is largely tongue in cheek, but it may be worth thinking about what Liga BBVA would look like after devaluation. People may not be passionate or understanding of the economy, but they are passionate and informed about their football clubs. In a world where much of the talent is imported and the local talent is free to leave, the analysis may not be as fanciful as it sounds. M

any Canadians saw it happen to their teams when a combination of a weak Northern Peso (this was pre loonie) and high taxes made it hard for Canadian franchises to compete (the BlueJays have never recovered). It wasn’t just sports. There were big issues of “brain drain” as many top people and companies looked to move to the U.S.

A weak currency may not be as helpful as people think and in fact may cause far more problems than it fixes, especially since this wouldn’t merely be devaluing, it would be creating a new currency and leaving a union, adding to the confusion and complexity of the task. Any real “progress” towards a near term redenomination would cause me great concern for all risk.

Risk “Meh”

Markets really don’t seem to know what to do. The greed is saying sell-off because Europe is a mess, yet the fear is that enough government money and liquidity comes into the market that we ignite another rally.

Domestic credit continues to do okay. Spreads have widened in the past few days, but very calmly and with relatively little enthusiasm for any move wider. You can pick up some high yield bonds marginally cheaper, but that’s probably only until you engage an offer and find out they aren’t really selling.

My concern that Europe will mess this up is growing. They seemed to have been implementing small steps that could work, but they seemed to have slowed down, and the level of dangerous (and poorly thought out) rhetoric is growing. I will continue to keep a close watch on the situation and am continuing to lighten up risk, though will add when drops seem overdone.

The price action in Spanish bonds is chilling, but volumes are incredibly low.

Tags: Bets, chinese data, Currency Risk, Devaluation, Exchange Rate, German Service, Global Economy, Libor, Low Expectations, Madrid Spain, Politicians, Real Madrid, Recession, Redenomination, Slowdown, Summits, T Bills, Tf, Uncertainty, Woes
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Biderman: “The Most Damage Is Caused By Those Who Are Not As Smart As They Think They Are”

Wednesday, July 25th, 2012

 
It is not often we double-dip in the Sausalitan’s soliloquies but tonight’s glorious truthiness from Charles Biderman, CEO of TrimTabs, is worth the price of admission. After explaining that the only way he could be any more bearish is to be double-levered – and that he believes that besides “believing in miracles” this market will see the March 2009 lows once the market-rigging is fully exposed, he makes probably the most clarifying statement we have heard regarding our central-planners-in-chief. With regards to Messrs. Bernanke, Geithner, and Obama: “The most damage is caused by those who are not as smart as they think they are.” They continue to believe they are smart enough to fix all our financial problems (and Europe’s – if they would just listen to Timmay) by building a bridge over the recession – thanks to asset-buying and ZIRP. “The only problem is we are running out of bridge and are nowhere near recovery” is how he sees it and reflecting on the massive gains that have been made on short-dated Treasuries as the Fed (who is the one buying them) extends the ZIRP horizon – it is clear that this is nothing but a huge Ponzi scheme.

Tags: Bernanke, Building A Bridge, Central Planners, Ceo, Europe, Geithner, Horizon, Lows, Market Rigging, Massive Gains, Messrs, Miracles, Obama, Ponzi Scheme, Price Of Admission, Recession, Soliloquies, Treasuries, Trimtabs, Truthiness
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The Deleveraging Trap

Thursday, July 12th, 2012

Submitted by John Aziz of Azizonomics

The Deleveraging Trap

Hayekians and Minskians agree on one key thing: an increase in debt beyond the underlying productive economy is unsustainable.

In my view, the key figures in defining this are total debt as a percentage of GDP, and its relationship with industrial production. Debt as a percentage of GDP tracks how much debt there is relative to one measure of economic activity, GDP. Yet GDP is a very limited tool of measurement; all GDP really tracks is the circulation of money. To get a clearer sense of the true relationship with underlying productivity, it is useful to compare the ratio of debt-to-GDP with the level of industrial production.

Up ’til the ’70s, debt-to-GDP grew more slowly than industrial production. That is healthy and sustainable. While the total market debt may grow in tandem with GDP, and with industrial production — indeed, this can be the case even under a gold exchange standard (as the gold supply increases) — there is no sensible reason for the ratio of debt-to-GDP to grow faster than industrial production. Indeed, this is symptomatic of just one thing — consumption without income, enjoyment without effort, living beyond the means of productivity. This is just an unsustainable bubble.

As the ’90s turned to the ’00s and the United States gains in industrial production ceased to accumulate, while GDP and most concerningly (and hilariously) while the debt-to-GDP ratio continued to increase. This was classical bubble behaviour, and the end came very poetically; the recession and the industrial production collapse hit just as growth in the debt to GDP ratio (as indexed against 1953 levels) finally surpassed growth in industrial production. Indeed, I hypothesise that a very strong indicator of a Minsky moment — when excessive indebtedness forces systemic deleveraging, leading to price falls, leading to widespread economic contraction — is the point when long-term growth in the debt-to-GDP ratio exceeds long-term growth in industrial output.

The debt-to-GDP ratio is gradually falling, yet it is still at a far higher level than the historical average, and it is still proportionately higher than industrial output. And at the same time, consumers are re-leveraging, and government debt is soaring. And industrial production is barely above where it it was a decade ago, and far below its pre-2000 trend line. We have barely started, and already this has been a slow and grinding deleveraging; rather than the quick and brutal liquidation like that seen in 1907 where the banking system was effectively forced into bailing itself out, the stimulationist policies of low rates, quantitative easing and fiscal stimulus have kept in business zombie companies and institutions carrying absurd debt loads. Like Japan who experienced a similar debt-driven bubble in the late ’80s and early ’90s, we in the West appear to have embarked on a low-growth, high-unemployment period of deleveraging; and like Japan, we appear to be simply transferring the bulk of the debt load from the private sector to the public, without making any real impact in the total debt level, or any serious reduction in the debt-to-GDP ratio. 

Cutting spending — for both the private sector and public sector — is problematic. My spending is your income; as spending falls, income falls, which leads to more consumers, producers and governments attempting to deleverage. This leads to more monetary easing, simply to keep the zombie system stable, and keep the zombie debt serviceable. More consumers and producers can take on debt, at least for a time, but the high residual debt level makes any great expansion of productivity or growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load. It is a vicious cycle.

Quantitative easing does not even tackle the main challenge: reducing the debt load. In fact, it is targeted at precisely the opposite — increasing the debt load, by encouraging lending. But lending into a society that is already heavily indebted leads to no great uptick in productivity, because consumers and producers are already over-indebted to begin with, so few can afford new debt. And banks — flush with cash — have no real incentive to lend; the less they lend, the more deflationary conditions are prone to become, increasing the purchasing power of their excess reserves (on which the central bank already pays interest). The outcome is greater economic stagnation, ’til the next round of monetary easing which leads to a brief uptick, and then further stagnation.

To break out of the deleveraging trap, the debt load needs to be drastically reduced. In my mind there are three potential pathways there, each with various drawbacks and advantages:

1. Liquidation; when a debt-driven crash happens, the central bank stands back and lets it happen, as happened in 1907. Prices will drastically fall, many companies and banks and debt will be liquidated, until the point at which prices have fallen to a sustainable level. But we may have missed the boat — the crash already happened, the system has already been bailed out, and the financial system today has already become zombified. And under a system where the central bank determines the availability of money and the level of interest rates this approach has in the past led to excessive central-bank-enforced liquidation, from which the economy may struggle to recover, as happened after 1929.
2. (Hyper)inflation; the central bank prints money and injects it into the economy via the banking system. Prices rise, wages rise, and the nominal debt remains the same, thus reducing the debt burden. While most economists who advocate such an approach advocate a slightly elevated level of inflation, the higher the rate of inflation, the more the residual debt load will be devalued; under a Weimar-style regime, mortgages could be repaid in a week. Unfortunately inflation is nonuniform; whoever gets the money first (i.e. banks) can buy up assets on the cheap, and pass the cost of the inflation down the chain of transactions. As Keynes himself noted: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Inflation discourages savings and capital formation, which are necessary for new growth. And most significantly — as the Fed’s experiment with QE shows — inflation unless it is very severe will not even necessarily have much bearing on reducing the debt-to-GDP load. The results of a severe (hyper)inflation could be very chaotic and dangerous.
3. Debt Jubilee; the central bank prints money, and injects it into the economy via the citizens, with the explicit condition that they use it to clear their debts. This will have the desirable effect of directly reducing debt levels, and lifting over-indebted consumers and producers out of the deleveraging trap. Additionally, the inflation would be uniform and so not to the advantage of the banks or the financial elite. However introducing a large quantity of money to the system — even directly as a medium for debt-cancellation — does itself carry a high inflationary potential.

Certainly, the current status quo of high unemployment, low growth, sustained over-indebtedness and zombie banks and corporations surviving on government handouts is not sustainable in the long run. We shall see which route out of the deleveraging trap we take. Liquidationism seems unlikely, as central banks are afraid of the concept. Inflation (or its unintentional corollary, currency collapse) seems risky and dangerous. A debt jubilee would at least address the real problem of excessive debt, although it is in modern times uncharted territory, and would surely face much political opposition.

Copyright © Azizonomics

Tags: Circulation, Collapse, Consumption, Economic Activity, Economic Contraction, GDP, Gdp Ratio, Gold Exchange Standard, Gold Supply, Indebtedness, Measurement, Minsky Moment, Money, Productive Economy, Productivity, Recession, Sensible Reason, Tandem, True Relationship, United States
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Is a U.S. Recession Looming?

Wednesday, July 11th, 2012

by Scott Colyer, Advisors Asset Management

In the third quarter of 2011 the Economic Cycle Research Institute (ECRI) called for a 100% chance of a U.S. recession. They have a stellar track record of calling U.S. economic cycles. We noted this in our communication to clients at the end of 2011 and again in the first quarter of 2012. We gave the call credence because of who was making the call. What we also noted is that the ECRI estimated the severity of any slowdown to be shallow and fairly short-lived. Most recessions in the U.S. are over even before they are positively identified. Other very reliable indicators did not flash a U.S. recession and did not support the ECRI assertion which included a very positively sloped U.S. yield curve (still 100-110 basis points between the 30’s and 10’s).

The ECRI is very well thought of as Morgan Stanley reversed their bullish call on the U.S. equity markets back in August of 2011 based on the same data. Months and months have gone by since these calls were made. It now appears that we have a slowing economy based on the trajectory change in job creation and other monitors. Europe woes are the blame of the day. Is this the 2011 recession coming in 2012? I am not sure but I doubt it makes much difference to us.

Normally, a slowing U.S. economy would prompt Central Banks to ease monetary policy. However, right now, not only the U.S. Federal Reserve (Fed) has the monetary policy pedal already to the metal. Likewise, the global economies are easing at record pace. The point here is the Fed, if faced with a recession, will certainly move to implement QE3. We believe this would be supportive of higher U.S. equity prices and lower bond yields. The bottom-line here is that whether we are seeing a recession or just a soft patch in the economy, our investment thesis remains the same. With monetary policy GLOBALLY being the easiest in history, we would expect future returns in the equity markets to be greater than high grade debt. Additional QE measures should goose hard asset prices and tend to weaken the dollar. Income assets will be what investors will seek as traditional assets have little yield. This situation will be supportive of the prices of income producing assets.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.

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Tags: Basis Points, Bond Yields, Central Banks, Colyer, Credence, Economic Cycle Research Institute, Economic Cycles, Ecri, Future Returns, Global Economies, Investment Thesis, Job Creation, Monetary Policy, Morgan Stanley, Recession, Recessions, Record Pace, Slowdown, Trajectory Change, Yield Curve
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Swimming with Black Swans: The Volatile Decade Ahead

Tuesday, July 10th, 2012

by Russ Koesterich, Chief Investment Strategist, iShares

Investors, prepare for a rocky decade ahead.

I have already warned on this blog that heightened market volatility is likely to continue for the remainder of the year. The truth is that markets have become more volatile in recent years, and they’re likely to remain that way throughout this decade.

Looking at weekly data, between 1982 and 2007, a period often referred to as the “Great Moderation”, the annualized volatility of the S&P 500 was approximately 15%. Since 2008, however, the annualized volatility has risen to nearly 25%.

While no single explanation fully captures why volatility has risen, in my view the rise in equity market volatility can primarily be attributed to a rise in economic volatility. Work done by my colleague Daniel Morillo demonstrates that the volatility of financial assets is closely correlated with the volatility of the underlying economy. In less stable economic environments in which recessions are more frequent and economic measures more volatile, financial assets tend to be more volatile as well.

And since the most recent recession began in 2008, the economies of most developed countries have simply been less stable then they used to be, as reflected in the seemingly out-of-the-ordinary “Black Swan”-type economic events that have occurred in recent years. In fact, over the last few years, developed market economic volatility has increased by almost any measure. In the United States, inflation is more volatile, industrial production is more volatile and overall consumption is less stable. In Europe the situation is even worse. For example, since 2008, European-wide industrial production is approximately 80% more volatile than it was between 1990 and 2007.

What’s behind this newfound economic volatility? I would attribute most of it to the lingering impact of the financial bubble and accompanying deleveraging. Most developed countries are attempting to reduce their debt levels, European countries through fiscal austerity and the United States through the household and financial sectors. This deleveraging is creating significant economic headwinds, leading to less stable economies and more volatile markets.

Unfortunately, the deleveraging in the developed world is still in its early stages. Credit growth has been on an upward trajectory for roughly four decades, but deleveraging has been occurring for barely four years. European sovereigns and US households still have much more deleveraging to do. Worse, the biggest offenders – the United States and Japanese governments – have not even begun to reduce their debt burdens.

To the extent that the deleveraging cycle is likely to last throughout this decade, investors should get accustomed to more economic instability (think more Black Swans) and more market volatility.

They may also want to consider taking a defensive portfolio positioning through dividend-paying stock funds such as the iShares High Dividend Equity Fund (NYSEARCA: HDV) and minimum volatility funds such as the iShares MSCI All Country World Minimum Volatility Index Fund (NYSEARCA: ACWV).

Source: Bloomberg

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

The author is long HDV

There is no guarantee that dividend funds will pay dividends.
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. The Minimum Volatility funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.

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Tags: Black Swan, Black Swans, Chief Investment Strategist, Colleague, Cou, Economic Environments, Economic Events, Economic Measures, Economic Volatility, Financial Assets, Financial Bubble, Ishares, Market Volatility, Moderation, Morillo, Most Developed Countries, Recession, Recessions, Russ, Swans
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