COMING UNGLUED: Market Fragility and Credit Market risk indicators are now at post-Lehman levels.
Global Economic Risks have taken a noticeable and abrupt turn downward over the last 30 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggest the global economic condition is at a Tipping Point. Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses.
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MORAL METASTASIS : Malfeasance, Manipulation & Malpractice - Metastasis is the spread of a disease from one organ or part to another non-adjacent organ or part. Cancer occurs after a single cell in a tissue is progressively genetically damaged to produce a cancer stem cell possessing a malignant phenotype. These cancer stem cells are able to undergo uncontrolled abnormal mitosis, which serves to increase the total number of cancer cells at that location. The moral fiber of our society is going through this same process as it breaks down, spreads and metastasis. We are presently in the process of Moral Metastasis that will prove fatal if not immediately operated on and surgically removed. Sadly, however it has gone undetected too long and the damage it has caused is now irreparable. 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.
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
Financial advisors often recommend international stocks as a way to diversify their porfolios. However, you only benefit from diversification if the correlation between those international stocks have low correlation with domestic stocks. After falling from recent highs, correlations seem to be back on the rise. Here's a chart of cross-country equity correlation courtesy of Reuters chart guru Scott Barber
3 - Risk Reversal
RISK - Corporations Reducing EU Risk Exposure (aka: Bank Runs)
Even as the ECB is desperately doing its best to stick a finger in every hole in the leaking European dam, in which just like in the US failed monetary policy is a substitute for sound fiscal one, and in which the pattern of interventions and cause and effect will now follow that of Japan until the bitter end, others are not waiting around to see the results. Reuters reports that Royal Dutch Shell is pulling some of its funds out of European banks "over fears stirred by the euro zone's mounting debt crisis, The Times reported on Monday." And shell is not the only one: more and more institutional are actively preparing to lock up their cash on a moment's notice, an eventuality which can be seen best at the ECB itself, where deposits with the ECB (collecting 0.00%), dropped to just €300 billion the lowest since 2011, while the ready for withdrawal current account saw holdings rise to a record €550 billion overnight, a €20 billion increase overnight. And so the cycle repeats anew, and Gresham's law rises to the surface, as bad money pushes out good money, and in return the situation deteriorates once more, until the next time much more than just harsh language out of the ECB will be needed just to preserve the status quo.
The company's chief financial officer Simon Henry told the newspaper that Shell is cutting back its exposure to European credit risk in the worst-hit economies and putting a higher price on doing business with the region's peripheral nations.
"There's been a shift in our willingness to take credit risk in Europe. The crisis has impacted our willingness to afford credit," Henry is quoted as saying.
Henry is cited as saying that the Anglo-Dutch oil major would rather deposit $15 billion of cash in non-European assets, such as U.S. Treasuries and U.S. bank accounts.
The firm is forced to keep some money in Europe to fund its operations, but is keeping the bulk of its reserve liquidity out of the euro zone to avoid growing macroeconomic risk, the report said.
And what Shell is doing, everyone else can't be far behind - certainly not the head of a Greek bank who decided to pull his money out of Greece and "launder" it via London real estate: just as so many others are doing.
A political row has erupted in Athens after the former head of a big Greek state bank admitted to transferring €8m of personal savings abroad to buy a London property months before his Agricultural Bank headed towards insolvency.
Theodoros Pantalakis, former chief executive of Greece’s Agricultural Bank (ATEbank), strongly denied any wrongdoing, telling Realnews, a Greek website, that he had declared the transaction to authorities in 2011 and had paid tax on the amount transferred.
“I’m on holiday and I don’t plan to say anything more until I come back to Athens,” Mr Pantalakis told the FT from his villa on the Aegean island of Paros. He is expected to testify on his three years at the helm of ATEbank before a parliamentary committee at the end of August, said a person with knowledge of the dispute.
And that, in a nutshell is Europe: do as I say, and "believe" what I say... Just not what I do.
3 - Risk Reversal
ANALYTICS - Deutsche Bank Warns of 5 -10% Market Correction
June and July’s sub 50 US Mfg. ISM and continued commodity price and FX EPS headwinds, make it very likely that 3Q12 EPS will be down sequentially and vs. last year, which is rare outside of recessions. Given the continued weakness in global PMIs this week and still no certainty in decisive policy actions, we fear that investors are unlikely to calmly wait for 2H macro improvement. We think the S&P is likely to sell-off 5-10% in the near-term from today’s price.
Still, Bianco's year-end target remains 1,475 and his 12-month target continues to be 1,500.
Wages need to rise to keep up with inflation, especially since the value of the dollar has been trashed:
Wages need to rise to keep up with inflation, especially since the value of the dollar has been trashed:
7 - Chronic Unemployment
US EMPLOYMENT - Recovery Rate Comparisons
The latest jobs report came out today with the Labor Department reporting that nonfarm payrolls (jobs) increased by 163,000 in July. Today's chart puts the latest data into perspective by comparing nonfarm payrolls following the end of the latest economic recession (i.e. the Great Recession -- solid red line) to that of the prior recession (i.e. 2001 recession -- dashed gold line) to that of the average post-recession from 1954-2000 (dashed blue line). As today's chart illustrates, the current jobs recovery is much weaker than the average jobs recovery that follows the end of a recession. Today's chart also illustrates that the jobs market continues to improve at a fairly steady pace -- a pace very similar to what occurred following the recession of 2001.
7 - Chronic Unemployment
CONSUMER CREDIT - Biggest Monthly Contraction Since April 2011
Just like every other aspect of the global economy and capital markets, the sudden, rapid moves in every times series are becoming increasingly more pronounced: today's case in point - consumer credit. Instead of rising by the expected $10.25 billion in June, following the whopper of a May bounce when it grew by $17 billion, in June, credit rose by only $6.46 billion. On the surface this was not a big miss and was the 10th consecutive increase in a row, driven exclusively by non-revolving credit - i.e. student and GM subprime loans. However, looking below the surface shows that following May's biggest monthly surge in revolving credit since November 2007 (+$7.5 billion), consumers have again expressed a revulsion to credit, with revolving credit sliding by $3.7 billion: this was the biggest monthly contraction in revolving credit since April 2011, and before that since February 2009. Did Americans developed a sudden taste for credit funded consumption in May, only to puke it all up and then some in June? It sure appears that way based on recent retail sales numbers. The July retail sales number will simply confirm if the re-icing of US consumers has continued for another month.
Finally the reason why the overall credit number posted an expansion in June is simple. Of the $6.2 billion in NSA increase in consumer credit, $5.8 billion came from one source. Take a will guess which one (the hint is highlighted in the chart below).
You hear a lot about how companies may pull back on investment due to the fiscal cliff, and that's clearly an issue, but... The data suggests that the consumer is a big worry spot. Today's consumer credit number came in way weaker than expected, and revolving consumer credit (credit cards) actually shrunk sequentially. Here's a chart of the year-over-year change in non-seasonally adjusted revolving credit. As you can see, the year over year growth rate is still positive, but the growth is shrinking fast.
And to drive home the point that this is a trouble spot, here's a look that same YOY change in consumer credit number vs. the year-over-year growth rate in retail sales. Both are deteriorating.
CYCLES - CONSUMPTION
16 - Credit Contraction II
US FEDERAL WELFARE - 110,000 on Food Stamps, Medicaid
A new chart set to be released later today by the Republican side of the Senate Budget Committee details a startling statistic: "Over 100 Million People in U.S. Now Receiving Some Form Of Federal Welfare."
"The federal government administers nearly 80 different overlapping federal means-tested welfare programs," the Senate Budget Committee notes. However, the committee states, the figures used in the chart do not include those who are only benefiting from Social Security and/or Medicare.
Food stamps and Medicaid make up a large--and growing--chunk of the more than 100 million recipients. "Among the major means tested welfare programs, since 2000 Medicaid has increased from 34 million people to 54 million in 2011 and the Supplemental Nutrition Assistance Program (SNAP, or food stamps) from 17 million to 45 million in 2011," says the Senate Budget Committee. "Spending on food stamps alone is projected to reach $800 billion over the next decade."
The data come "from the U.S. Census’s Survey of Income and Program Participation shows that nearly 110,000 million individuals received a welfare benefit in 2011. (These figures do not include other means-tested benefits such as the Earned Income Tax Credit or the health insurance premium subsidies included in the President’s health care law. CBO estimates that the premium subsidies, scheduled to begin in 2014, will cover at least 25 million individuals by the end of the decade.)"
This is not just Americans, however. "These figures include not only citizens, but non-citizens as well," according to the committee.
According to a Wall Street Journal analysis of recently released Federal Reserve data, households with annual incomes of $94,535 to $205,335 saw the biggest jump in the percentage with student-loan debt from 2007 to 2010
That group also saw a sharp climb in the amount of debt owed on average.
The Journal's analysis defined upper-middle-income households as those with annual incomes between the 80th and 95th percentiles of all households nationwide.
Among this group, 25.6% had student-loan debt in 2010, up from 19.5% in 2007.
For all households, the portion with student loan debt rose to 19.1% in 2010 from 15.2% in 2007.
The amount borrowed by upper-middle-income families, meanwhile, has soared. They owed an average of $32,869 in college loans in 2010, up from $26,639 in 2007, after adjusting for inflation
The typical low-income family receives grants and scholarships totaling 36% of the cost, while for higher-income families such packages total 21%.
More than three million households now owe at least $50,000 in student loans, up from about 794,000 in 2001 and fewer than 300,000 in 1989, after adjusting for inflation.
The upper-middle-income households now repaying student loans spend 3.2% of their monthly incomes on debt payments
Even after adjusting for inflation, the average sticker price of four-year colleges has more than doubled since 1985
A July 26 report from Moody's Investors Service noted that reductions in net worth, lackluster job growth and stagnant incomes have "created the stiffest tuition price resistance that colleges have faced in decades."
More than one-third of parents with incomes of $95,000 to $125,000 with a child who entered college in 2011 didn't save or invest for that child's education
On average, upper-middle-income households' median net worth fell 19%, to $369,320, in 2010 from three years earlier
Among families earning $100,000 or more, students paid 23% of their college costs in 2012 through loans, income and savings, according to Sallie Mae, up from 14% in 2009; the share covered by parents fell to 52% from 61%.
As Jeff Kleintop of LPL Financial writes, the average holding period of a stock has fallen from eight years in the 1960s to around five days today.
Much of this is due to the advent of ETFs and high-frequency trading. But there's little doubt that the average investor is also holding stocks for much shorter periods.
And that comes with consequences.
Here's a chart and commentary from Kleintop's latest Weekly Market Commentary:
One of the consequences of such a short investment time horizon is that investors have begun to fear short-term market events and volatility as much or more than the factors that shape prospects for long-term economic and profit growth that drive stocks over the longer term.
33 - Public Sentiment & Confidence
MACRO News Items of Importance - This Week
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
Last week we explained why while endless promises of Fed intervention may be enough to confuse the market and force endless rounds of short covering as weak hands are flushed out of positions under threat (but never action) of central planning, banks are no longer in a position to delay indefinitely the moment they have all been waiting for: a $500+ billion reserve injection which will allow them to go hog wild in investing in risk assets or plug capital shortfalls (off the books of course), and otherwise continue their lives in a ZIRP environment which makes net interest margin existence impossible. We also showed that for the first time after nearly 4 years, the Fed conducted a regular (not reverse) repo last Friday. As we explained, regular repos are liquidity injecting, and while the Fed may promise these are merely test runs, everyone knows they are anything but, and are merely a telegraphing to the banks of what is in store. Today, the day after the last repo expired, we just got a new 3 day repo, only not for $210 million this time, but one for $600 million, including not only Treasury, but also Agency and MBS securities. The result: S&P above 1400 for the first time in months.
Simone Foxman explained here that Mario Draghi had essentially made European leaders a promise. If they get their act together on activating their various bailout funds and moving more towards fiscal union, then the ECB as a matter of policy will work to depress short-term borrowing costs in Italy and Spain.
This is actually much more powerful than mere bond buying. After all, last year the ECB engaged in sovereign bond buying, via a program called the SMP, but the program wasn't that affective since it didn't seem unlimited. It seemed temporary and only marginally helpful.
What's key is that Mario Draghi has been hinting at this kind of deal for several months now.
What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.
Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.
This word "sequencing" is everything. If European leaders agree to budget controls, then the ECB will do stuff. Now Mario Draghi, by talking about short-term bond buying is spelling out what those "other elements" that "might follow" are.
If the Euro is going to survive, everyone knows it needs at least two elements: Some kind of ceding of budget control, and a willingness by the ECB, with its printing press, to be the backstop for the other thing. Maybe we're getting closer.
Draghi set forth criteria that EU political leaders must abide by in order to receive monetary policy assistance, while at the same time promising that EU countries like Spain and Italy won't fail in the short term.
In other words, he sent the following message: "If you do that, then I will do this."
This is a divergence from earlier policy, which was unpredictable and reactive.
For example, the ECB revved up its bond purchase program (SMP) last summer only once tensions in Europe neared unbearable levels. The move felt rushed and panicked, nobody trusted it, and so it became less of a bazooka and more of a squirt gun.
Even the central bank's more effective three-year long-term refinancing operations (LTROs)—two massive liquidity operations that stoked bank lending and pulled down borrowing costs—came as a surprise to investors. They only believed Draghi might be using his leverage to force European leaders to action after the fact.
Now, however, Draghi is clearly spelling out his demands and the rewards, somewhat tyrannically forcing EU leaders to move forward.
This diminishes some uncertainty in the real economy.
The ECB will purchase shorter-term debt and attempt to push down the front end of the yield curve.
EU leaders will resolve concerns about official sector creditors as de facto senior bondholders and they will start using the European bailout funds to purchase sovereign bonds.
Not to mention that the central bank has also confirmed it will make reducing sovereign borrowing costs (at least at the short end) a matter of clear policy.
Draghi is essentially holding a bullet to the heads of country leaders, explicitly refusing to do anything beyond preserve the situation until EU leaders earn the long-term reward.
By focusing SMP on shorter term end of the yield curve, ECB will indeed lower shorter-term borrowing costs for Italy and Spain (3-5 year max maturity), while steepening 10 year instruments costs to discourage, relatively, longer term borrowings. This means Italy and Spain should get an added incentive - growing over time as overall maturity profile of their debt starts to shorten as well - to enact long-term reforms. At the same time, ECB will be buying (assuming it does go through with the threat) shorter-term instruments, implying that unwinding these assets will be a natural process of maturity. ECB will not commit to sacrificing long-term flexibility of its policy tools by expanding SMP on the longer end of the yield curve, thus reducing overall risks to the monetary policy in the future.
These latest moves show that Draghi has European leaders over a barrel. The ECB has typically been more proactive than EU leadership, and this amounts to little less than a power play.
That's not to say that these latest announcements will necessarily be good for financial markets. Draghi's plan confirms that he will push EU leaders to the brink before he does anything, and such pressure typically leads to losses in equities.
However, in the real economy, Draghi's promises to act are invaluable. Such clarity could give investors faith enough to invest in the real economy, despite continued volatility in the markets.
This tyrannical but—for now—positive structure does have one fatal flaw, however. Should Draghi underestimate market angst and should EU leaders fail to deliver appropriate reforms in time, the ECB chief will have to wage a speedy retreat to save the financial system even without his demands fulfilled.
Thus, there's chance that EU leaders could call Draghi's bluff.
We have argued in the past that the next step in the escalation of the ECB response would be outright purchases of private assets.
This would allow purchases of unsecured bank debt and corporate debt, enabling NCBs to ease private-sector financial conditions where such support is most needed."
Why would the ECB do this: "A natural objection to outright purchases of assets issued by the private sector is that they involve the assumption of too much credit risk by the ECB. But substantial risk is already assumed via credit operations." In other words, the only thing better than a little global central banker put is a whole lot global central banker put, and when every central planner is now all in, there is no longer any downside to putting in even more taxpayer risk on the table. Or so the thinking goes.
Mitt Romney says the Federal Reserve shouldn’t use new stimulus measures to boost the still-sluggish economy. The Republican presidential hopeful says he doesn’t think another round of stimulus would help the economy, arguing that previous measures didn’t work. Romney tells CNN’s ‘‘State of the Union’’ in an interview scheduled to air Sunday morning that business incentives are preferable to more government intervention. The Fed held off last week on taking further action to boost economic growth, but indicated those measures could be announced in the near future. The Fed also opted to keep interest rates near zero in an attempt to keep borrowing costs low. Romney also doubled down on his vow to create 12 million new jobs during his first term, calling that goal realistic and achievable.
TECHNICALS & MARKET ANALYTICS
ANALYTICS - High Stock Correlations A Worry - Part II
The move from the early June lows for U.S. stocks has come with increasing correlations across a wide array of asset types and industry sectors. That's unusual, because rising markets over the past three years more commonly bring lower correlations. For example, the rally from January to early April of this year saw industry correlations within the S&P 500 drop from +95% to 75-80% as the index went from 1270 to 1420 (a 12% return). Conversely, the move from 1278 to 1400 (early June to present day) has come with increasing industry correlations – 82% in May to 86% currently. To us, that's an important "Tell" about what's been taking us higher – hopes for further Federal Reserve liquidity at the next FOMC meeting in September and ECB liquidity to support the euro. The rest of August will likely feature the kind of light-volume tape that loves to drift higher, but increasing correlations represent a flashing yellow light signifying the need for caution in trading over the balance of the month.
When correlations fall, it is a sign that global markets may be getting back to something akin to the old model of capital markets. Good stocks go up, bad ones go down. Precious metals do their own thing. Fixed income trades somewhat independently. And when correlations rise, it’s because all the stocks are essentially lost and looking for direction wherever they can find it.
The last 4 days have been the lowest volume for a non-Xmas holiday week since 2007 in futures and NYSE volumes are just remarkably bad compared to even normal cyclical seasonal dips. The range-compression in equity markets is very reminiscent of last April/May's top. The last 2 days have seen the lowest range since April of last year and NYSE volume is dismal compared to the last five years - even adjusted (below) for seasonal weakness...
As Securities Technology reports, the NYSE Euronext reports daily volume of trading stocks down 16.9% from a year ago (and down 17.8% YTD compared to last year) and down 9.9% from June alone. Trading in stocks on its exchanges in Europe were also down 12.3%. This plunge in stock trading has knocked into the derivative markets which have seen a massive 15.8% cliff-dive worldwide from June to July.
One more nail statistic in the coffin of CNBC's audience is a 29.7% drop in ETF transactions year-over-year and NYSE/Arca/MKT's share of trading in NYSE-listed stocks is down 34.3% from a year ago as the dark pools rise.
With volumes collapsing it is only likely that we will see far more 'incidents' such as Knight - where companies whose top-line explicitly stems from flow trading - increasingly find themselves redundant; whether or not this is due to a self-inflicted algo, or other, potentially more sinister, reasons.
Each successive up leg within the push from early June has occurred with slightly lesser upside momentum...This chart, which we published Monday (July 30), shows the percentage of S&P stocks above their 10-day moving average. By this measure, the most recent rise from July 24 has been the weakest so far.
... Groupon is now offering a 97% off "four day online stock-trading course." While not nearly as big as the discount we have all grown to expect from Whitney Tilson's Value Investing Congress, this offer demonstrates just how much interest the retail investing public has regarding stocks. And why any administration, whether the current or the future one, that believes it can delude the general public into ignoring the broad economy and focusing only on the Russell 2000 as proof of "how good it is" will have its work cut out.
The SP 500 has rallied to a post June 4th high of 1409 this week, about 13 points shy of the Bull Market cycle highs of 1422 earlier this year. The rally has overlapped along the way, forming a series of “3′s” which are sometimes found in impulsive bullish moves, but usually found at the end of bull cycles whether they be short term or long term cycles.
To wit, the first 11 trading days off the 1267 SP 500 lows saw a 97 point rally, again in only 11 trading days. The last 34 trading days we have only been able to move up about 44 further points, indicating the rally is getting long in the tooth and a bit tired at that. So 11 days, 97 points… 34 more days, only 44 further points. Another 10 trading days would mark a 55 fibonacci trading day cycle, so we should be alert to potential rally highs between August 13th and August 22nd as a window for a top.
A few days ago I discussed we may see a continual sloppy drift up to 1425-1445 ranges, with 1434 a key pivot line to watch. Although the count doesnt really fit for me, if this rally from the June lows is a 5th and final wave up… then a 5th wave rally to complete a larger cycle often is characterized by a series of 3′s.
The first leg of the rally was a 3 wave rally to 1363, about 97 points in 11 days. We have continued with overlapping 3′s. This final stage of the rally is likely going to be 5 waves or ABCDE in nature to complete the entire cycle up from 1267 That cycle high should come within the Aug 13th-22nd window and in the 1425-1445 ranges.
ELLIOTT WAVE COUNT
EARNINGS - Analysts Delusional About Margin Growth
You've probably heard how negative companies are right now as one after another has slashed forward earnings guidance throughout this earnings season, preparing for a tougher second half of the year. However, sentiment toward the outlook for 2013 is surprisingly positive. So positive, in fact, that expectations are for profit margins to have their largest increase ever next year – by a mile. Morgan Stanley chief U.S. equity strategist Adam Parker presents a chart in his latest monthly strategy presentation, showing that 86 percent of the top 1500 companies in the U.S. are expected to post increases in profit margins next year:
The highest ratio of companies increasing margins to companies not increasing margins is around 60 percent, and that level has been tested continuously over the past 40 years – so 86 percent may be a bit much to expect.
David Bianco, Deutsche Bank's Chief U.S. Equity Strategist, is just the latest to publish a defense. Rather than just talking about stock market returns, he looks at profits. From his note to clients today:
Higher S&P 500 profits relative to GDP can be attributed to sustainable causes
Some investors take concern with elevated S&P 500 profits relative to GDP vs. history. We believe this is secularly sustainable owing to: 1) lower interest rates and debt usage, 2) a higher proportion of S&P 500 profits from abroad, and 3) Technology sector gains. We also remind investors that the profitability of Energy and most Industrial and Materials companies was depressed in the 1990s owing to weak commodity prices and limited global infrastructure investment. Financial sector profits were high in the mid 2000s, but not now.
David Bianco told Business Insider that "S&P 500 profits by region" was one of the most important charts in the world
SENTIMENT - False Expectations of Central Bank Effectiveness
The US stock market is up about 9% since June 1 despite weakening fundamentals for US companies and weakening economies around the world, including in Europe. Morgan Stanley's Adam Parker thinks the reason for the rally is investors’ dream that macro policy in the US and Europe will prove to be more effective this time around than in the recent past.
Perhaps the incessant calls of market participants that things must be good given the performance of the market in the face of weakness are simply investors exhibiting the 5 Kubler-Ross stages of grief at a new reality that doesn't cognitively fit with their hopes and dreams...
Is Everyone A Contrarian Bull?
Underneath the market rally there has been some abnormal micro structure, including the fact that mega-caps have outperformed in an up tape, high beta has underperformed, and in the last month energy was the best-performing sector while materials was the worst, despite the 0.83 correlation between the two over the past 40 years.
Our stock selection strategy this year has been fairly defensive, focused on mega-caps, and has done pretty well so far despite the market’s rally. A few weeks ago we recommended trimming exposure to expensive defensives and to buy laggards or bombed out cyclicals, and we think there is more to go in that trade. After all, we gained a full year of returns from 10-year government bonds in just one day of equity market trading.
Sentiment is the key to the market outlook. I don’t really care that much about the prime brokerage data, the retail investor data, or the put/call ratio, as none of these is really effective at predicting the market’s subsequent return historically. Everyone talks about being pessimistic, but what I hear from my conversations with investors is generally optimism. Most people seem to think earnings are holding up pretty well, that the estimate reductions are a healthy reset, that macro policy will be more effective going forward. I have been told that if the market has held up this well despite all the bad news, just think how well it can do when the news improves. My response to all this optimism is to remind investors that analysts and investors tend to want to be optimistic and that the market runs on a buy-the-dream mentality. I am wary when people claim to be a contrarian bull today. They should not pretend they are alone on an island in their bullishness.
With 86% of the S&P 500’s market cap reported, 2Q earnings growth has been negative, with profits down 1.6% excluding Financials. This marks the first quarter of year-on-year profit declines since 2009. Moreover, while EPS surprises have been positive, they have been the weakest of the current recovery cycle, and revenue surprises have been negative. Following 2Q announcements, companies have issued weak guidance, resulting in increasingly rapid downward revisions to analyst estimates. At present, consensus expectations are for earnings to decline by 1.5% in 3Q. This implies further deterioration in margins. While UBS believe margins will hold up better than expected, their revised economic outlook suggests top-line expectations may be too high - and along with the FX impact we noted last night, those miraculous multiples will have to extend to magnificent levels to maintain this haughty market valuation.
As earnings growth is negative for the first time since the recession...
and revenue growth is the slowest since then too...
with earnings and revenue surprises now at cycle highs - with more top-line negative surprises than we have seen since Q2 2009...
In a world of slow stagnating growth, foreign exchange variations can have a dramatic impact on top and bottom lines - especially in a market where hedges are flummoxed by government-influenced gap-after-gap and mismatch. As Goldman notes the headwinds of FX into Q2 are acute and have been painful for multi-nationals - with several high-profile companies missing and or adjusting down forecasts due to the rise of the US dollar. In spite of all the focus on Q2 earnings, we remind investors that Q3 and Q4 will also see significant currency headwinds - an impact we (and Goldman) believes is far from priced in for many companies in the market - a total top-line drag of over 5% YoY.
The year-over-year impact of FX rates has become a drag on growth for the typical multinational in 2012
YOY changes assuming current spot rates of 1.23 USD/EUR, 1.56 USD/GBP and JPY/USD 78.60 hold through the rest of the year
Via Goldman Sachs:
Our model estimates that FX boosted the top line of a typical multi-national company by nearly 2.5% in 2011, but that the yoy changes should result in close to a 2.6% headwind this year – a total expected yoy drag of more than 5%.
We emphasize the continuation of the FX drag as we enter 3Q, where we model relative 7% yoy deterioration due to FX, based on current spot rates.
During the on-going 2Q reporting season several multi-national companies have cited FX as a considerable headwind.
STUDY FUNDAMENTALS EARNINGS
ANALYTICS - Market Rise Added By Stealth Short Squeeze
Exactly one year ago, the short-interest in SPY (the S&P 500 ETF) reached epic heights at over 536mm shares. At the same time, short-interest in QQQ (the Nasdaq ETF) also short-term peaked at over 116mm shares short. While QQQ has seen a gentle drift lower in general (somewhat reflective of trading volumes in the last few years), since July of last year SPY has seen a 62% drop in short-interest and QQQ 59%. QQQ short-interest is now its lowest since October 2000 and SPY short-interest its equal lowest since October 2007 and so ammunition for charging this market higher seems to be running out. This is even more highlighted by the 45% and 30% plunge in QQQ and SPY short-interest in the last six weeks alone.
The chart below shows the updated counts of profit warnings for July and August (month to date). The count for July has no doubt broken any past records, pointing to difficult environment in which these companies are operating in. On top of that, we plot Hang Seng Index (HSI) along side. As Credit Suisse noted, the number of profit warnings peaked on March 2009, which happened to be the month when the index bottomed out.
ANALYTICS - Canaries Singing but Few are Listening - TSE Halted
Earlier today the Spanish stock exchange was down for nearly 5 hours - the reason is unclear: perhaps as a form of precrime punishment to all those felons who would even consider selling stocks in the future. Now, the SkyNet self-awareness wave goes East just as Japan opens and takes down all Tokyo derivative trading:
Tokyo Stock Exchange Stops Derivative Trades, Cites System Error - BBG
Tokyo Stock Exchange Group stopped trading of Topix futures, JGB futures and options from around
9:20 a.m. because of a systems error.
Co. spokesman Naoya Takahashi spoke in phone interview
In the aftermath a series of events such as the FaceBook IPO collapse, Knight, IBEX, this was only logical and expected. Tomorrow, any stock market that even thinks of a red candle will be halted indefinitely.
ANALYTICS - Removing the Analysts' Estimates Charade - A Subtle Leading Indicator
While Mario Draghi has done wonders to expose his total and utter lack of credibility - no matter how much spin is pushed at us - it seems that equity analysts still (somewhat remarkably) move markets and remain credible in the eyes of what we assume is an entirely cognitively dissonant self-perpetuating market-structure in need of 'excuses'. To wit, the following chart, from Strategas, which illustrates perfectly the herd-like upward-biased and constant shift in year after year of S&P 500 earnings expectations that quickly and inexorably smashes lower in the face of the reality of a crushed credit cycle and 'whocouldanode' recessions/stagnations. It seems we (as investors) and they (as shills analysts) will never learn - or maybe we all will this time (as it's never different!).
Decision Point publishes a daily Tracker report of our 152 Blue Chip list. This list is composed of the stocks in the S&P 100 Index, the Dow 65, and some large-cap Nasdaq stocks. We also track the Top 10 stocks in ths list, ranked by relative strength measured by Decision Point’s proprietary PMO (Price Momentum Oscillator).
I have observed this list over a long period of time, and my impression has been that the top stocks do exceptionally well during a bull market, and extremely poorly in a bear market; however, I wanted to develop a more objective way to measuring the performance of these top stocks.
To do this I constructed a “Blue Chip Top 10 Index”. This is done by calculating the daily change of the Index as being the daily average percent change of the securities in the Blue Chip Top 10 list. Stocks are tracked from the day after they enter the Top 10 list through the day they drop off the list.
The Top 10 Index is equally weighted, so theoretically one could only replicate the performance of the list with real money by reallocating an equal amount to each stock each day (and somehow avoid transaction fees in the process). More to the point, the Top 10 list are a good place to look for securities that will out-perform the market, but it will be impossible for you to duplicate the Index. You could also lose a ton of money if you are long these top ranked securities during an extended market decline.
The primary purpose of the 152 Top 10 Index (BC Top 10) is to how see well these top ranked large-cap stocks are doing in relation to the broader market. Specifically, in a bull market or extended rally we expect the Index to out-perform the broad market. This is because, when stocks reach the top of the list, they tend to stay on top due to persistent upward momentum. This is a healthy condition. In an unhealthy market, stocks tend to rotate through the Top 10 rather quickly, and the performance of the index poor in relation to the broad market.
Comparing three-year charts of the SPX and BC Top 10 Indexes we can see that the Top 10 have been underperforming for the entire time. Since the June low the BC Top 10 has advance only 5.9% versus 9.5% for the SPX. And while the SPX has been trending up for the period shown, the BC Top 10 has been trending down since the February 2011 top.
Conclusion: In spite of upward movement of the SPX, the Blue Chip Top 10 Index tells us that the leadership of the market has been rotating too rapidly, which suggests confusion and weakness. By the time a stock reaches the Top 10, it loses momentum and drops right back out again. This is evidence that for a long time the internal condition of the market has been turbulent and confusing, in spite of generally rising market prices.
FINANCIAL REPRESSION - Why It Won't Work & Ends Badly
Anyone who has been following US fiscal policy over the past three years, which by implication means US monetary policy since Congress and the president have dumped everything in the lap of the Fed, which by implication means the Fed's guide to investing in the Russell 2000, knows too well that it can be summarized in two words: financial repression. Read the attempt to force everyone out of "riskless" assets such as Treasurys and mortgages and into risky assets such as Amazon and its 200+ P/E. All else equal, there has been one huge error with this policy which is akin to the Fed attempting to herd cats: instead of pushing investors into other asset classes, all the Fed has achieved is to get everyone to front run it in buying whatever bonds the Fed has not committed to monetizing just yet as we showed before. The other problem is that all else is not equal, and as SocGen shows Financial Repression, even by construct assuming practice and theory were the same, will not be sufficient due to the following three reasons.
Firstly, countries that currently benefit from financial repression still have primary deficits that are inconsistent with debt stabilisation.
Secondly, the demographic time bomb means that a further deterioration of the primary surplus will appear in the future unless reform is undertaken.
Thirdly, we believe there is a limit to how far central bank asset purchases can go. If this were not the case, the government could in extremis stop collecting taxes and just let the central bank buy all the bond issuance required to cover public spending! This is reminiscent of the story of German hyper-inflation under the Weimar Republic (albeit not the only historical episode of hyper-inflation).
And assuming we ever get across the chasm, there is the other side to consider: what happens when central bank balance sheets have to be unwound:
Managing exit strategies from asset purchase programmes will be a challenge and will in our opinion ultimately carry either a growth and/or an inflation price tag. Inflation expectations are key in this respect and for the present remain fairly well anchored.
The most immediate channel from QE to inflation is the currency channel. The credit channel is an additional factor; at some point economic agents may seek to lock in what is perceived to be exceptionally low interest rates – this can be helpful for the initial stages of recovery, but left untamed a new credit bubble could well prove inflationary not to mention destabilising for the economy. Ultimately, inflation expectations are a question of credibility and here government actions become important. Should economic agents lose confidence in the ability of governments to manage public finances, inflation expectations could soar.
In other words: damned if you do and damned if you don't. That's a great corner you have pegged yourselves into, dear central planners.
CORPORATOCRACY -CRONY CAPITALSIM
FREE MARKETS - People Now Feel This Sort of Video Is Required
In a genuinely free market, rich corporations people have both the resources and incentive to corrupt the government in order to make the market less free. In other words, Capitalism only works in a world in which people have integrity and are accountable to others and themselves - which is the weakest link. And so you end up with? America. In short: "there ain't no such thing as a free market" - which is not to say that we shouldn't try. The following clip points out that even seemingly pro-business legislation is not beneficial to society or businesses themselves broadly with the analogy that "what's good for GM may not be good for America after all"; which begs the question: do humans doom capitalism by default?
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Tipping Points Life Cycle - Explained Click on image to enlarge
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