economic news has turned decidedly negative globally and a sense of
‘quiet before the storm’ permeates the financial headlines. Arcane
subjects such as a Hindenburg Omen now make mainline news. The retail
investor continues to flee the equity markets and in concert with the
institutional players relentlessly pile into the perceived safety of
yield instruments, though they are outrageously expensive by any
proven measure. Like trying to buy a pump during a storm flood, people
are apparently willing to pay any price. As a sailor it feels
like the ominous period where the crew is fastening down the hatches
and preparing for the squall that is clearly on the horizon. Few crew
mates are talking as everyone is checking preparations for any
eventuality. Are you prepared?
What if this is not a squall but a tropical storm, or even a hurricane?
Unlike sailors the financial markets do not have the forecasting
technology to protect it from such a possibility. Good sailors before
today’s technology advancements avoided this possibility through the use
of almanacs, shrewd observation of the climate and common sense. It
appears to this old salt that all three are missing in today’s financial
Looking through the misty haze though, I can see the following clearly
looming on the horizon.
Since President Nixon took the US off the Gold standard in 1971 the
increase in global fiat currency has been nothing short of breath taking.
It has grown unchecked and inevitably became unhinged from world
industrial production and the historical creators of real tangible wealth.
Do you believe trees grow to the sky?
Or, is it you believe you are smart enough to get out before this graph
What made America great was her unsurpassed ability to innovate.
Equally important was also her ability to rapidly adapt to the change that
this innovation fostered. For decades the combination has been a self
reinforcing growth dynamic with innovation offering a continuously
improving standard of living and higher corporate productivity levels,
which the US quickly embraced and adapted to.
This in turn financed further innovation. No country in the world could
match the American culture that flourished on technology advancements in
all areas of human endeavor. However, something serious and major has
changed across America. Daily, more and more are becoming acutely
aware of this, but few grasp exactly what it is. It is called Creative
It turns out that what made America great is now killing her!
Our political leaders are presently addressing what they perceive as an
intractable cyclical recovery problem when in fact it is a structural
problem that is secular in nature. Like generals fighting the last war
with outdated perceptions, we face a new and daunting challenge. A
challenge that needs to be addressed with the urgency and scope of a
Marshall plan that saved Europe from the ravages of a different type of
destruction. We need a modern US centric Marshall plan focused on growth,
but orders of magnitude larger than the one in the 1940’s. A plan even
more brash than Kennedy’s plan in the 60’s to put a man of the moon by the
end of the decade. America needs to again think and act boldly. First
however, we need to see the enemy. As the great philosopher Pogo said:
“I saw the enemy and it was I”.
The IMF cautioned that governments need to avoid
complacency when their debt is close to its maximum
sustainable level because there may be little warning from
markets ahead of a very sharp spike in borrowing costs
While the financial problems of
Europe's periphery 'PIIGS' economies (Portugal, Italy,
Ireland, Greece, and Spain), has receded substantially
from business headlines, this doesn't mean that their
crisis is over, or even getting better.
In fact, the
creditworthiness of nations such as Greece,
Portugal, and Spain is looking worse than ever, as
represented by % spread between the yield demanded by
bondholder for ten-year PIIGS government bonds and the
ten-year bonds of Germany (Germany is Europe's version
of a 'risk-free' yield to compare things against). For
all of the PIIGS, it is worse off than before the
European Unions's one-trillion-dollar affirmations of
support for the PIIGS, or before the much bally-hooed
bank stress tests.
The frenzy surrounding the Eurozone
crisis may have ebbed, but it'll be back...
Morgan Stanley has some thoughts, though no
As shown in Exhibit 1, a relationship
emerged between the performance of EUR/USD and European
sovereign risk – proxied here by the Spanish 5Y CDS spread –
in early 2010. In June the EUR bottomed and the spread peaked
as the European governments agreed to provide multi-lateral
support to sovereign credits. But after the initial positive
response, concerns about long-term risks continued to overhang
the market and spreads started widening out again starting in
mid-July. The EUR initially tracked the spreads but over the
past two weeks it appears that the link is breaking with the
EUR holding firm as the spread widens back toward the June
It remains moot
whether this break is significant or, as was the case in
January when an apparent break proved to be temporary. But we
suspect it is not coincidental that the break emerged in the
wake of the August 13 release of much better- than-expected
German Q2 GDP growth, and we suspect that the EUR is now
principally driven by expectations on global economic activity
rather than the CDS spread.
But wait, there's more:
Further evidence that global growth rather
than CDS spreads is becoming a more dominant driver of the EUR
is apparent in the EUR correlation vs non-European currencies.
As shown in Exhibit 2, during the six month period prior to
August when sovereign concerns were dominating the EUR,
correlation with other currencies plunged. Over the past
month, as the EUR link to the CDS spread has faded,
cross-currency correlations have rebounded – with the
exception of the MXN. While the swing was more modest, the
pattern also holds for the correlation between the EUR and
The implication, of course, is that the dollar will lose its
appeal as a "risk off" asset (it already has) and sell off on
bad economic news, if the economy continues to weaken.
Anyone who believed that home prices never fall has learned a
The Case-Shiller price indexes released on Tuesday suggest
that since their national peak in 2006, home prices have fallen by
29 percent. Some areas of course look better than others. Las
Vegas is down 57 percent from its peak and Phoenix is down 51
percent. On the other hand, Boston is down just 13.5 percent and
Dallas only 4.2 percent.
The effect on household wealth has been huge. Data maintained
by the Federal Reserve show that the value of residential real
estate directly held by households fell to $16.5 trillion in the
first quarter of 2010, down from $22.9 trillion in 2006. It has
yet to be determined who will end up bearing those losses. The
decline in wealth has substantially reduced consumption, stifling
Four years ago, the monthly payment on a $300,000 house with 20
percent down and a mortgage rate of about 6.6 percent was $1,533.
Today that $300,000 house would sell for $213,000 and a 30-year
fixed-rate mortgage with 20 percent down would carry a rate of
about 4.2 percent and a monthly payment of $833. In addition, the
down payment would be $42,600 instead of $60,000.
Challenger said layoffs in August were down. ADP says
hiring was down, too. Today's initial claims report was okay,
Gallup is saying underemployment jumped in August.
...Wednesday's ADP report suggests
private-sector employment declined last month. Similarly,
Gallup's underemployment measure and its unemployment rate
show the job situation worsening. Gallup modeling suggests
it is likely that the U.S. unemployment rate will increase
to between 9.6% and 9.8% when the government reports the
August numbers on Friday.
Worse yet, Gallup's job data show that
28% of Americans aged 18 to 29, 24% of those with no
college education, and 22% of women were underemployed
in August. This is not good news for retailers hoping that
Christmas holiday sales will be better than those of
back-to-school, or for politicians hoping to be re-elected
In July alone, 381,000 adults chose to quit looking for work
altogether and that trend will continue in Obama's land of dashed
dreams and squandered opportunities. Economists expect the private
sector added about 100,000 jobs in August, but that is an abysmal
performance 14 months into a recovery from a deep recession. The
economy must add 13 million private sector jobs by the end of 2013
to bring unemployment down to 6%. Obama's policies are not
creating conditions for businesses to hire those 320,000 workers
each month, net of layoffs.
Net of inventory adjustments,
the economy's demand for goods and services is growing at only
about 1% a year. The real potential is about 5%, but with economic
policies so ill-conceived and with a president so ambivalent about
private enterprises - other than those run by Wall Street barons,
Hollywood producers and union bosses - that simply is not
In the second quarter,
spending, investment in new structures,
equipment and software, and government purchases added 4.4% to
demand - but as imports grew much more rapidly than exports, the
trade deficit tapped off 3.4%. The difference, 1% , is annual
growth in demand for US-made goods and services. That has been the
pace since the recovery began in July 2009. Businesses can
accommodate up to 2% growth in demand just by improving
productivity and not adding workers. Unless the rapid growth in
imports can be curbed, the US economy is headed for very slow
growth and rising unemployment.
The massive permanent
expansion in federal spending and regulatory oversight built into
Obama's budget is discouraging private hiring by raising fears of
even higher taxes and yet more intrusive regulation.
to the 2008 crisis, president George W Bush spent 19.6% of gross
domestic product (GDP) and the deficit was $161 billion; two years
into the economic recovery in 2011, Obama's budget projects
outlays at 25.1% of GDP and a $1.3 trillion deficit in 2011. The
latter figures are like to be closer to 27% and close to $2
trillion if the president does not accomplish the 4% growth his
budgets assume in stark contrast to the real world the rest of us
Too much spending will require new taxes, and
not just pushing rates marginally above 50% on families earning
$250,000. Higher rates for those families will raise taxes on half
the income earned by proprietorships - those small and
medium-sized businesses the president is urging to create jobs.
Much of the stimulus money was squandered on political
hobby-horses that create few jobs. For example, grants to build
green buildings displace other, more cost-effective private
construction and don't increase the amount of commercial space
rented or built over the next several years. By delaying projects,
those grants have slowed construction spending and killed jobs.
The biggest banks received more than $2 trillion in
Troubled Asset Relief Program funds and Federal Reserve assistance
to clean up their balance sheets and recapitalize securities
trading, while the 8,000 regional banks got
little assistance and remain burdened by toxic real-estate
loans. Consequently, nearly 250 regional banks
have failed, and small and medium-sized businesses cannot get
credit to expand.
In addition to credit, businesses need
more customers to create jobs, and the trade deficit - in
particular, imports of oil and the imbalance with China - cut a
huge hole in demand for US goods and services. Without addressing
oil and China, other efforts to create jobs are futile.
The best way to visualize this is with the
following image. The macro economy tends to be the
leading factor in corporate decisions. This is why we
will often see the business cycle peak at the point of rampant
exuberance and mass layoffs at the trough in the cycle.
Corporations are not always out in front of the business cycle
and in fact are usually reactive to the macro environment.
When times are good they spend. When times are really
good they spend excessively. The opposite goes for the
Analysts are the ultimate lagging factor in the equation.
A close study of analyst’s expectations will reveal very
close ties to what corporations actually tell them. This
generally comes via the form of press releases (when Apple
says they’ll earn $1 next quarter 75% of the analyst
estimates are near $1 even though Apple ALWAYS beats), but
can also come via the form of direct communication with
analysts. Corporations understand that the estimates
matter a great deal to their stock price performance so
they keep communications tight. A growing economy is the
perfect environment for wise executives who literally toy
with the analysts by continually under promising and
Intel and Cisco’s warnings a few weeks ago were likely
previews of what will become a trend in the coming two
months. If the macro picture continues to deteriorate
(which I think there is a fairly high probability of)
we will slowly see a deterioration in corporate
earnings and a lagging effect at the analyst level.
But with a slowly deteriorating macro picture this
won’t unravel overnight. While most investors like to
wish that this process would occur immediately (the
equity markets suffer from a nasty case of A.D.D.)
that just isn’t the case.
The global economy is like a battleship moving
through rough sees. Right now, I think we’re at a
critical juncture where the ship is turning south
through rough seas. Deterioration at the macro
level is clear, though we are likely to see it
play itself out over the course of several
quarters. If the macro environment deteriorates
more than I presume the earnings picture will have
a snowball effect. And of course, the same can be
said of a positive macro surprise (with markets
reacting positively). While we’re beginning to
see cracks in the earnings foundation we are not
seeing a full blown collapse as we saw in 2008.
The market has been volatile, but it has remained
resilient because we just aren’t seeing the
weakness in corporate earnings. Persistent macro
weakness and a few more earnings seasons will
likely change that as corporations move to adjust
expectations heading into a more difficult
environment and the analysts subsequently play
know the price of everything but the value of nothing.
Author Unknown In therapy, you have to accept a mistake to move on.
At times, this realization will be painful but in the end
it is better for you. Right now Wall Street is in
complete denial and trying to pretend all is well.
Their profits are up but all that is happening is a wealth
transfer from taxpayers to this unproductive group.
Gordon T Long is not a registered advisor and
does not give investment advice. His comments are an expression of opinion
only and should not be construed in any manner whatsoever as
recommendations to buy or sell a stock, option, future, bond, commodity or
any other financial instrument at any time. While he believes his
statements to be true, they always depend on the reliability of his own
credible sources. Of course, he recommends that you consult with a
qualified investment advisor, one licensed by appropriate regulatory
agencies in your legal jurisdiction, before making any investment
decisions, and barring that, we encourage you confirm the facts on your
own before making important investment commitments.ont>
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Gordon T Long
is not a registered advisor and does not give investment advice. His comments
are an expression of opinion only and should not be construed in any manner
whatsoever as recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. While he believes his
statements to be true, they always depend on the reliability of his own
credible sources. Of course, we recommend that you consult with a qualified
investment advisor, one licensed by appropriate regulatory agencies in your
legal jurisdiction, before making any investment decisions, and barring that,
we encourage you confirm the facts on your own before making important