The Global Markets have reached the point of what can be best labeled as "Elevated Risk". Analytics measurements including Fundamenal Analysis, Techncial Analysis and Risk Anlysis all are independently signalling this along with warnings. This months report lays out the Risk Assessment, Risk Levels as determined by our proprietary aggregated Global Financial Risk Index, changes in Tipping Points and the Macro Risk-On, Risk-Off Drivers. - The "Peek Inside" shows the detailed coverage available this month.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY
The European Central Bank's (ECB) unprecedented use of a three year, low cost LTRO (Long Term Repurchase Agreement) policy initiative may have removed some of the short term pressures from the EU Banking crisis, but like the Greenspan PUT, the unintended consequences are not yet fully understood. One is the moral hazard which is fostering financial "games" to be played with reckless abandon. Some of the mischievous and cunning games are frankly questionably as being even legal! But then, nothing is illegal if the regulators and those organizations charged with surveillance are not bothering to investigate. Extend > Pretend > Bend is the new approach. MORE>>
The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern. - The "Peek Inside" shows the detailed coverage available this month.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & EXECUTIVE BRIEF
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
The significant rise in global systemic risk that occurred in 2008 remained until mid 2010 when it began to subside a little as Jackson Hole and QE2 seemed to allay fears somewhat. However, in the last year or so, BofA's market fragility index has soared higher alarmingly signaling higher systemic risks than in the peak pre-Lehman era. This confirms the massively elevated signal for global systemic risk that credit markets are also sending.
Systemic Risk inferred from equity market variance decomposition...
and Global Systemic Risk from the credit market...
But it appears we have become Pavlovian in our learned response to any systemic risk as the chart below shows. The Fed has acted each time 5Y5Y forward inflation expectations drop below 2%. We were well on our way to this just a week or two ago (red arrow) only to have our own reflexive expectations of a Fed-Save drive inflation expectations back up (green arrow) and thus removing the possibility of QE in the short-term.
It would appear that while systemic risks are at peak levels, the Fed needs the 'public' to believe it is not always there to save the day in order that when it does save the day, its effect is more than transitory.
Finally, for those curious just how it is possible that even with trillions in implicit backstops the market is now less stable than with AIG, Lehman, Merrill and all the soon to be failed banks, the answer is simple: back then the market was in the hands of the, well, market. Now it is solely controlled by a few politicians and a even fewer academics. In other words, whatever can go wrong, will.
While the ever-present analogs to the last few years of crisis-response-improvement-complacency (CRIC), as Morgan Stanley so clearly described, have provided a clear picture of what to expect, the treja vu is now starting to fade in one very important market indicator. As BofA notes, the forward expectations of Fed Funds rates have finally started to shift from an endless string of 'hope' for growth and reflation just around the corner and rate hikes any quarter now (despite the Fed's 'exceptional' chatter) to a much less sanguine pit of despair that rates will indeed stay low for 'ever' reflecting a stagnating deleveraging economic reality. At some point they will be right as the Japanization of rates around the fiat world becomes the new normal and 'smart/fast-money' traders appear hope-less.
8- Bond Bubble
MONETARY POLICY - Actually Tightening on Short Dated Roll-Overs
The ever outspoken Grant notes that the Fed's balance sheet has been contracting (unlike Maria's mainstream perspective); for the past three months the Fed's balance sheet has contracted at an annualized rate of 10% - even as Fed-head after Fed-head talk up QE and so on. So unless they continue buying securities - since the short-dated positions will continue to roll off - the Fed's balance sheet will continue to contract and therefore the stimulative effect will fall.
If the Fed does nothing then there is an implicit 5-10bps of rate-hike tightening per quarter implicit in the balance sheet roll-down (50bps in next 3 years)
EARNINGS - We Have A Secular PE Contraction Under Way
What’s the difference between a correction and a bear market? The conventional definition is that the former is a drop in stock prices that falls short of a 20% decline. Anything beyond that is a bear market. A correction tends to be caused by falling valuation multiples (P/Es), triggered by fears that earnings will drop. If earnings remain stable or continue to rise, contrary to expectations, then the P/E rebounds and the bull market resumes. If earnings do fall, then P/Es may continue to do so too, resulting in a bear market. So corrections are panic attacks that aren't validated by the fundamentals. We had a nasty correction two years ago and another one last year. It is happening again this year:
(1) During 2010, the S&P 500 forward P/E dropped 22% from a high of 14.7 on January 11 to a low of 11.4 during August 26. However, forward earnings rose all year. So the 16% correction in the S&P 500 from April 23 to July 2 was reversed by the end of the year, with the P/E ending at 13.1.
(2) During 2011, the P/E fell 25% from 13.6 on February 18 to 10.2 on October 3. Forward earnings rose during the first half of the year and remained mostly flat during the second half at a record high. So once again, the market recovered and closed higher by the end of the year with the P/E rebounding to 11.7.
(3) During 2012 so far this year, the P/E peaked at 13.0 on March 26. It was down 11% to 11.6 yesterday, just about matching the 2010 low, which was 11.4. The S&P 500 is down 9% from its high on April 2, which is still just a garden-variety correction. Meanwhile, forward earnings rose to a new all-time record high of $111.27 during the week of May 31. At this level, a retest of last year’s panic low P/E of 10.2 would push the S&P 500 down to 1135, which would be a 20% decline from the year’s high on April 2.
As you can see in our Earnings & Valuation: S&P 500 Blue Angels, the market’s volatility is attributable almost entirely to the volatility in the P/E. Earnings expectations tend to change more slowly and smoothly. The one exception is during recessions, when both variables take a dive. During the bear market from October 9, 2007 through March 9, 2009, the P/E plunged 32% from 15.1 to 10.2, with forward earnings diving 29%. The P/E actually bottomed at 8.9 on November 20, 2008.
ANALYTICS - No Volumes - AGAIN! - Caution Warranted
The S&P 500 gained over 3.5% this week (with a dip-and-rip today on dismal volume). This is the best week of the year amid the lowest volume of the year (ex-holiday weeks). Gold, Stocks, Treasury yields, and the USD all recoupled from last Friday's decoupling and limped higher, ending at the top of the day's range today. Financials and Tech outperformed - up over 1.1% - with the majors best as financials won on the week +4.8%. Treasuries close to close were dull but intraday saw rather notable vol as 30Y yields dropped over 10bps before round-tripping back to its high yields of the day. All-in-all, broad risk assets did leak higher today but nothing like as exuberantly as stocks which was somewhat surprising into a weekend likely full of equity dilution for Spanish banks (and more burden for Spain) - or none at all. The USD rallied into the European close and sold off after for the fifth day in a row. HYG outran stocks on the day and maintained the bid (ES closed at overnight highs) but IG and HY credit lagged on the day - though are al better on the week. Cross asset-class correlations dropped notably into the close, as implied correlation dropped and VIX was very stable given the rally into the close, holding above 21% - even as S&P 500 e-mini futures ended the day more than 2 sigma above VWAP (as we suspect futures roll effects kept some out into the weekend). Lastly, this push higher today in stocks saw a major drop in average trade size - certainly not offering the kind of follow through to yesterday's (or the week's) gains that one would expect on a new bull leg.
S&P 500 rose over 3.5% on the week, best week in six months, as volume lagged dramatically...
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - June 3rd - June 9th, 2012
There were so many disturbing elements to the May jobs data that we're not sure we can do justice to the litany of disappointments (with some help from our friends at the Investor's Business Daily):
The share of long-term unemployment is at its highest level since the Great Depression (42%).
Fully 54% of college degree graduates under the age of 25 are either unemployed or underemployed.
45 million Americans are on food stamps — one in seven residents.
47% of Americans are on some form of government assistance.
The employment-to-population ratio for 25-54 year olds is now 75.7%, lower than it was when the recession supposedly ended in June 2009.
The number of people not in the labour force has swelled eight million since the recession ended; absent that effect, the unemployment rate would be 12% right now (about the same as President Obama's election chances would be).
The number of people confident enough to leave their jobs fell 11% in May
for the second month in a row to 891k, the lowest since November 2010.
The ranks of the unemployed who have been looking fruitlessly for work for at least 27 weeks jumped 310k in May, the sharpest increase since May 2011.
The unemployment rate for males aged 16-19 is 27% and for males between 20 and 24 it is 13%. Draw your own conclusions from a social (in)stability standpoint.
One in seven Americans are either unemployed or underemployed.
Only one in six of the youth are working full-time and three-in-five are living with their folks or another relative (as per the NYT).
A mere 16% of the 2009-2011 graduating class has found full-time work, while 22% are working part-time. Even those hired from 2006-08, just 23% are working full-time.
According to a poll cited in the NYT, just 14% of high-school grads today believe they will have a more successful financial future than their parents Line of the day, as depressing as it is, comes from an 18-year old: "Thank God I had a buddy at Burger King who could help me out". Fast-food has emerged as the fast-growing industry in a country once led by technology. Even tech now is fuelled more by companies that produce nifty consumer gadgets and feed our narcissistic needs than those who focus on improving the nation's capital stock which is the ultimate trailblazer for productivity growth and durable gains in our standard-of-living.
10 - Chronic Unemployment
GETTING ELECTED - Priority #1 is to Stop Markets From Falling
The relentless build-up of foreign reserves by China and Asia's export Tigers has become a threat to financial stability and risks setting off inflation across the region, the Bank for International Settlements has warned.
"The expansion of the central banks' balance sheets has created dangers that require attention," the BIS said in its quarterly report.
"Serious consideration should be given to capping and then shrinking the size of central bank balance sheets."
The "bank of central bankers" said the rising powers of Asia – excluding Japan – have boosted their holdings of foreign bonds and gold from $1.1 trillion (£715bn) to $6.4 trillion over the last decade.
The reserves are mostly in dollars and euros. They top 100pc of GDP in Hong Kong and Singapore, and 50pc in China, Malaysia and Thailand.
The BIS said reserve accumulation on this scale distorts the credit system.
In China it has led to negative real interest rates and growth of a "shadow banking system" that is hard to control. It causes banks to boost lending beyond safe levels and can "push the expansion of monetary liabilities beyond the ability of the financial system to absorb them".
While countries have mostly managed to choke the inflation effects so far, the BIS cited a history of "hyperinflation episodes" where governments tried to "override fiscal constraints".
The process may be going into reverse at last. Global reserves peaked in April and have since been declining as a string of countries start selling reserves to prop up their own currencies, though this has happened for short periods before.
Bank of America said traders saw heavy selling of euro bonds by central banks in May.
Early evidence suggests that the great rotation from dollars into euros over recent years may have run its course, heralding a weaker euro.
Central bank experts say excess reserves are not a sign of strength. They usually stem from a misaligned currency and a distorted economic system.
While the policy may flatter a country's profile for a while, it stores up a host of problems.
China has amassed $3.3 trillion, or more than 5pc of global GDP. Professor Michael Pettis from Beijing University said this was what the US did in the 1920s, and Japan in the 1980s. Both episodes ended badly.
The combined reserves of Asian powers and oil exporters now exceed €11 trillion.
This money is recycled into the global economy through bonds – making credit too cheap, and fuelling asset bubbles – and may have been a key cause of the global crisis in 2008-2009.
The BIS said Asian states began to build up a war chest of reserves to avoid repeating the disastrous crisis in 1998. More recently it is the result of a deliberate policy to hold down currencies.
While the bank is careful not to ruffle feathers, the inference is that these countries are pursuing mercantilist strategies to promote exports and gain market share.
The strategy is self-defeating in the end if it stokes internal wage inflation and erodes competitiveness.
Deleveraging is back with a vengeance. In Q1 the US Household sector saw its total debt decline by $81 billion, or the most since Q1 of 2011, to $12.85 trillion. That this happened even as overall net worth supposedly soared by $2.8 trillion as noted in the previous article is truly disturbing, and confirms what everyone knows: not only is nothing fixed in the US economy, but the deleveraging wave.
Growth of the world money supply has dropped to the lowest level since the financial crisis of 2008-2009, heralding a severe economic slowdown later this year unless authorites rapidly take action. The latest data show that the real M1 money supply – cash and overnight deposits – for China, the eurozone, Britain and the US has been contracting since the early Spring. Any further falls risk a full-blown global recession.
Real M1 for the G7 economies and leading E7 emerging powers peaked at 5.1pc in November and has since plunged to 1.6pc in April. The data explain why commodity prices are falling hard, with Brent crude down to a 16-month low of under $97 a barrel.
LAST BASTION OF STRENGTH - The New York Institute of Supply Management said its ISM business index – a proxy for business demand – flashed a "screeching halt" in May, crashing to 49.9 from 61.2 in April, where anything below 50 denotes contraction.
Central bank governors and finance ministers from the G7 bloc are to hold an emergency teleconference call on Tuesday to grapple with Europe's escalating crisis
China's money data are falling at the fastest pace since records began. The gauge – six-month real M1 – gives advance warning of economic output half a year ahead. "Europe needs to start quantitative easing [QE] immediately and China must ease policy,"
The Americans may act first. Goldman Sachs expects Federal Reserve chair Ben Bernanke to open the door for QE in testimony on Thursday.
20 - Credit Contraction II
CREDIT - Its All Government Sponsored Non-Revolving Student Loans & GMAC
That the just released consumer credit update for April missed expectations of a $11 billion increase is not much of a surprise. As noted earlier, the US consumer has once again resumed deleveraging: April merely saw this trend continue with:
Revolving Credit DECLINING by $3.4 billion,
Non Revolving Credit EXPANDING: Now traditional increase in student and subprime government motors car loans, which increased by $10 billion.
In other words, following a modest increase in revolving consumer credit in March, we have another downtick, and a YTD revolving credit number which is now negative. Obviously the government-funded student loan bubble still has a ways to go.
What was very surprising is that as noted in the earlier breakdown of the Z1, the entire consumer credit series was revised, with the cumulative impact resulting in a major divergence from the original data series. Why did the Fed feel compelled to revise consumer credit lower? Simple: as debt goes down, net worth goes up, assuming assets stay flat. Which in the Fed's bizarro world they did! Sure enough, if one compares the pre-revision Household Net Worth data (which can still be found at the St. Louis Fed but probably not for long) with that just released Z.1, one notices something quite, for lack of a better word, magical. Ignoring the March 31 datapoint which does not exist for the pre-revision data set, at December 31, household net worth magically grew from $58.5 trillion in the original data set to $60.0 trillion in the revised one! And that, ladies and gentlemen, is how you "create" $1.5 trillion in net worth in this wonderfully wacky fiat world, with the wave of a magic wand, or the push of a revision button. We hope all of you feel $1.5 trillion wealthier as of this post.
"By law, the federal government can't tell the truth," says accountant Sheila Weinberg of the Chicago-based Institute for Truth in Accounting
Retirement programs are not legal obligations. Retirement programs should not count as part of the deficit because, unlike a business, Congress can change what it owes by cutting benefits or lifting taxes.
The typical American household would have paid nearly all of its income in taxes last year to balance the budget if the government used standard accounting rules to compute the deficit.
Under those accounting practices, the government ran red ink last year equal to $42,054 per household — nearly four times the official number reported under unique rules set by Congress.
A U.S. household's median income is $49,445, the Census reports.
The big difference between the official deficit and standard accounting: Congress exempts itself from including the cost of promised retirement benefits. Yet companies, states and local governments must include retirement commitments in financial statements, as required by federal law and private boards that set accounting rules.
The deficit was $5 trillion last year under those rules. The official number was $1.3 trillion.
Liabilities for Social Security, Medicare and other retirement programs rose by $3.7 trillion in 2011, according to government actuaries, but the amount was not registered on the government's books.
Contrasting deficits The federal government calculates the deficit in a way that makes the number smaller than if standard accounting rules were followed (in trillions).
Social Security had the biggest financial slide.
The government would need $22.2 trillion today, set aside and earning interest, to cover benefits promised to current workers and retirees beyond what taxes will cover. That's $9.5 trillion more than was needed in 2004.
Deficits from 2004 to 2011 would be six times the official total of $5.6 trillion reported.
Federal debt and retiree commitments equal $561,254 per household. By contrast, an average household owes a combined $116,057 for mortgages, car loans and other debts.
25 - Pension - Entitlement Crisis
FOOD STAMPS - 46,405,204 Indivduals, 22,257,647 Households below Poverity Line
Last month, when the USDA released the latest foodstamps numbers for the month of February, there was some hope that following a third month of declines, we may just have seen the peak of US foodstamp usage and going forward we would only see the number decline. Sadly, the latest numbers refutes this: in March a total of 46,405,204 persons were at or below poverty level and thus eligible for foodstamps, a 79K increase in the month. Yet while many individuals have learned to game the system, and this numbers at the peak may fluctuate, when it comes to the far more comprehensive and difficult to fudge "households on foodstamps" number, there was no confusion: at 22,257,647, the number of US households receiving the "SNAP treatment" rose to an all time high, even as the benefit per household dropped to the second lowest ever. At least all these impoverished believers in hope and change have FaceBook IPO profits to look forward to. Oh wait.
25 - Pension - Entitlement Crisis
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
CRACKS APPEAR - Will There NOW Be Central Bank Intervention?
Individual manufacturing PMI readings across Europe continue pointing toward a deeper recession in the currency union with the overall euro zone PMI slipping to 45.1 in May. Germany’s safe-haven status hasn’t prevented the country’s manufacturing sector from slowing in tandem with its neighbors. Germany’s May’s PMI print declined to 45.2 from 46.2 a month prior, its lowest reading since June 2009. PMI’s for France and Italy, declined to 44.7 and 44.8 in May, respectively. Following the 2008 financial crisis the overall euro zone manufacturing PMI bottomed in February 2009 at 33.5.
What it shows is: The year-over-year change in Social Security Income as a share of total personal income. Not surprisingly, during recessions (which are shaded in grey), Social Security payments as a share of total income spike. It's very consistent. We're seeing another freak spike again. Uh-oh.
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
RUMORS FLY - Will There NOW Be Central Bank Intervention?
Greek elections June 17th—will they exit the Euro or will they stay?
June FOMC meeting June 19-20th—QE3 or no QE3?
Supreme Court decision on ObamaCare
1- ECB INTEREST RATE REDUCTIONS
NOMURA: The main event today is the ECB meeting, and we expect it to leave its policy rate unchanged at 1.0% (12:45 BST, Consensus: 1.0%, Previous: 1.0%), but indicate that it is prepared to cut rates and thereby increase expectations for a rate cut as early as July. We do not expect any significant announcement regarding liquidity, and we see only a 30% probability of a 25bp rate cut on Wednesday.
The WSJ's Jon Hilsenrath -- whom Cardiff Garcia has dubbed "Fedwire" - Reports that more Fed action is now officially on the table due to the slew of weak incoming data. There's no gaurantee that it will happen, or that if it did happen it would be at the June 20 meeting, but the presses are being warmed up.
Top Fed officials have said that they would support new measures if they became convinced the U.S. wasn't making progress on bringing down unemployment. Recent disappointing employment reports have raised this possibility, but the data might be a temporary blip. Moreover, the Fed's options for more easing are sure to stir internal resistance at the central bank if they are considered. Their options include doing nothing and continuing to assess the economic outlook—or more strongly signaling a willingness to act later if the outlook more clearly worsens. Fed policy makers could take a small precautionary measure, like extending for a short period its "Operation Twist" program—in which the Fed is selling short-term securities and using the proceeds to buy long-term securities. Or, policy makers could take bolder action such as launching another large round of bond purchases if they become convinced of a significant slowdown.
As always, it will be hard to pinpoint exact tipping points for a move - but I suspect that if we see a combination of the DXY (dollar index) at 86/88, and the spoo (S&P) at 1200/1225, the Fed will jump into action. I do not think we need to talk about the PCE or the U-rate when it comes to the Fed - the real triggers are in liquid market prices. And, in particular, if these levels in the DXY and spoo are breached, any sensible forecasts for forward looking employment and inflation that enter into a Taylor rule will plummet - hence accommodation follows!! In fact, take a look at a DXY chart since early 2008 - the 88 level was a good indicator for QE1 and QE2.
3- EUROPEAN BANKING UNION or DEPOSIT GAURANTEE SCHEME
Banking union and the euro’s future 06/06/12 FT - Perhaps the best way out now is to sever the link between the sovereign and the banking system by moving to a eurozone-wide banking union. This would involve moving the supervision and support of banks away from national to European regulators.
It would require an agency with the authority and capacity to restructure or close failing banks, including the ability to write down bondholders.
There would also need to be a pan-European deposit insurance scheme backed, at least initially, by the rescue funds. True, this would involve a substantial pooling of sovereignty, albeit less than what would be required for full fiscal union. But it should be sufficient to stabilise the currency area.
It would, for instance, make it easier to let over-indebted states such as Greece default within the eurozone rather than be forced out.
Voters would still retain the choice of whether to move to the next level of integration, which would be to mutualise eurozone governments’ sovereign debt. There is a case for this, although it would move the eurozone a long way towards full fiscal federalism – which would require real consent if it were to be made to stick.
Issuing eurozone bonds would help over-indebted countries to get over the transition period while structural reforms were taking effect. The debt sustainability of the currency area would be beyond doubt. Banks would have a “safe”, euro-wide class of assets in which to invest.
But politically this is much less realistic, and there may not be a will for it. Banking union is the more important goal. If the eurozone cannot resolve these issues, there is no point in adding another storey to the structure
The business cycle shifted into the Contraction phase of Goldman's 'Swirlogram' framework. The latest observations in their Global Leading Indicator (GLI) as well as the way we entered this Contraction phase suggest this could be a much more severe downturn. In their own words: "We do not yet see clear reasons for optimism in the data, and our GLI framework still suggests that the current phase of the cycle is in a challenging one." Goldman's Global Leading Indicator, month-on-month, has turned negative...
but the angle at which we entered this Contraction phase is notably steep...
which has negative implications for forward 12-month S&P 500 returns...
We have quite vehemently reminded readers of the dismal drop in US (and global) macro data over the past few months. These disappointing economic surprises and the ensuing global growth weakness will, Morgan Stanley believes, lead to a global policy response (rate cuts where rates can be cut and QE where they can't) and while they expect this monetary policy to work in many important emerging economies, they are doubtful as to whether it will make a material difference to growth in developed economies. Certainly, there are obvious risks to growth (Euro rupture and US fiscal cliff) that could counteract any QE effect but they rather critically note that:
"Unconventional policy is effective when the issue is systemic stress; it is less so when growth is the concern"
The QE2 rally was largely due to better macro data, which coincidentally started right after Bernanke hinted at QE2. If macro data stays weak, they expect any 'Pavlovian' QE3 rally to last hours or days, not weeks or months. The bull case for a tradable rally is one of simple observation that prior central bank action has coincided with important market turning points but the more skeptical MS strategists suspect this more correlation than causation as they point to the muted effect monetary policy has in an extended deleveraging to stimulate activity.
Morgan Stanley - Pavlovian Policy or 'Doggy' Markets
Global macro weakness seems set to trigger another round of global monetary easing. Prior aggressive policy action has coincided with risk asset rallies. However, those policy actions also corresponded with improving macro data, which we think was the critical factor. There will be a Pavlovian reaction from markets if we get further easing, particularly QE3 from the Fed. But if macro stays weak, expect any QE3 rally to last hours or days, not weeks or months.
Macro news is falling short of expectations almost everywhere
Our sense is that investors are split on the significance of this, but many see monetary easing as a potential catalyst for a tradable rally, even if they – like us – doubt its ability to significantly improve the macro outlook. The bull case is based in part on the simple observation that prior central bank action has coincided with important market turning points (Exhibit 2).
Fed balance sheet expansion and US equities were, for a while, correlated (Exhibit 3).
Other central banks’ balance sheets and equity indices show little correlation.
Our view is that the apparent effect of policy easing was more correlation than causation. However, note two qualifications:
First, policy easing has a much greater chance of working in EM, where credit systems still function and the economies are not burdened by the structural baggage now weighing on developed economies.
Second, we are not arguing that monetary policy has been unimportant over the past few years. Unconventional policy has been, at several points, critical to avoiding systemic stress leading to systemic collapse. Central bank liquidity can lubricate a private sector in seizure. This was most obvious after the collapse of Lehman’s. The ECB’s long term repo operation was also important last year. When risk assets, rightly, were affected by the tail risk of systemic implosion, reducing that risk triggers (and warrants) a risk rally.
What’s at issue now is whether unconventional policy either works to stimulate activity, or can directly boost risk asset prices. We’re skeptical on the first point. Deleveraging cycles mute the effect of monetary policy on growth. Unconventional monetary policy may be an effective shield – can defend against systemic breakdown – but not a good sword: broadly unable to encourage a return to normal credit creation, where monetary policy can work to stimulate growth.
Having said that, the important issue for many investors is whether further unconventional easing can trigger a tradable rally in risk assets, even if there is little or no effect on the macro outlook. We’re doubtful. When growth is the concern, as now, tradable rallies require better macro news. That macro was critical in the QE2 rally is most obvious from looking at bond markets. Whatever else QE2 did, buying bonds should have affected Treasuries - but as the chart shows, the commencement of QE2 – as with QE1 (large scale asset purchases) and operation twist – coincided with rising Treasury yields. And, as an aside, Fed selling Treasuries (as it did in late 2007) coincided with falling yields.
Of course, we don’t know what would have happened otherwise – perhaps yields would have moved even higher. But that is beside the point. If the Fed’s action were designed to encourage a shift to risky assets by lowering the yield on safe assets, the point is that its actions coincided with rising yields. Moreover, yields fell as LSAP and QE2 ended.
This shows that not even the Fed can dominate the pricing of the world’s largest, most liquid, asset market. What explains the seemingly perverse reaction of Treasury markets to the Fed’s actions? Simple: it was the swing in macro data (Exhibit 5). The swing in macro likewise explains much of the swing in equities through the past few years, as suggested by Exhibit 6. We think Mr. Bernanke got lucky with QE2: macro data improved almost from the moment it was flagged at Jackson Hole in August 2010. That improvement, not QE2, was in our view the key to the subsequent rally.
Growth concerns, not systemic risk, are now unsettling markets. Investors, rightly in our view, are increasingly skeptical about the ability of unconventional policy to boost growth in developed economies. Certainly, it seems unlikely to counteract fiscal tightening, now under way in Europe and UK, and in prospect in the US. Further easing may trigger an initial market response – there are too many investors who think it works to think otherwise. But without macro improvement, that risk asset rally will be short-lived, in our view.
BEAR MARKETS - 2008 Comparisons to All Time Worst Bear Markets
For decades we have argued about education’s merits and ills, real or imagined. But while there was still a positive return, demand grew and we were able to educate our nation and workforce. We have now reached a tipping point. The ROI of education has diminished for all and become negative for many. We have lost the ubiquitous positive financial return on education.
Further, for the first time in the history of our country, the majority of unemployed Americans attended college. There are now more people without jobs who went to college than those who did not.
And for those college graduates lucky enough to have jobs “forty percent… are mal-employed, meaning they’re working at jobs that don’t require [their] college degrees,” says Andrew Sum, a professor of economics and the director of the Center for Labor Market Studies at Northeastern University.
Higher education has always had a positive financial return. But, like the unraveling of the fabled housing market that “only ever goes up,” education has reached its breaking point.
But to say education is a bubble is too simple an analog.
The housing bubble was a function of financing and price. But the underlying product—homes—was still sound. We still like homes and they serve our needs well. Bad debt had to be unwound, and prices adjusted, but solving the crisis didn’t demand that we invent a new kind of home to live in.
And therein lies the drastic difference with the education crisis.
Education is broken. It has been for a long time. The underlying product has survived intact since the industrial revolution. Resolving this crisis is not simply a matter of financing and price. We must address the underlying model of education and reinvent it for a new era.
At the heart of the problem is the degree itself.
TIME magazine writes, “The tight connection between college degrees and economic success may be a nearly unquestioned part of our social order. Future generations may look back and shudder at the cruelty of it… It is inefficient, both because it wastes a lot of money and because it locks people who would have done good work out of some jobs.”
Universities do not have a monopoly on learning—only credentialing. There isn't a single job that actually requires a degree. People simply require knowledge and skills to perform jobs successfully.
Mark Cuban recently wrote, “As an employer I want the best prepared and qualified employees. I could care less if the source of their education was accredited by a bunch of old men and women who think they know what is best for the world. I want people who can do the job. I want the best and brightest. Not a piece of paper.”
The diploma was a fitting credential for an economy requiring knowledge to be stockpiled early in one’s career. Now, learning is increasingly happening “just in time” and from a diversity of sources, both formal and informal. Today, there are more ways to learn—many better suited to the demands of our technology driven, knowledge economy.
Harvard and MITx recently announced edX, several top Stanford professors just left to start Udacity, and Coursera offers courses from Princeton, Stanford, U. of Michigan, and Penn, all online and for free. General Assembly and Dev Bootcamp are examples of new, offline course providers enjoying great demand.
With the advent of these new ways to learn, a new form of credentialing is emerging. Degreed validates and scores users’ lifelong education from any source, both formal, like Harvard, and informal, like Udacity, facilitating a course-by-course, ad hoc, lifelong model of education.
Fast Company wrote in 2009, “Why can’t we take robotics at Carnegie Mellon, linear algebra at MIT, law at Stanford? And why can’t we put 130 of these together and make it a degree? These are the kinds of innovations waiting to happen.”
Now, it seems that the required ingredients are finally coming together to make that vision a reality just as the financial pressures have finally stoked a heat hot enough to catalyze the change required of education
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