MONETARY MALPRACTICE : BIS & IMF Issue warnings to Global Central Bankers
As we reported last month, Global Economic Risks have taken a noticeable and abrupt turn downward over the last 60 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggested the global economic condition is at a Tipping Point. Though we stated "Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses" nothing has occurred even after the 19th disappointing EU Summit to address the EU Crisis. Some event is soon going to push the global economy over the present Tipping Point. The IMF recently warned and reduced Global growth to 3.5%. This is just marginally above the 3% threshold that marks a Global recession. This would be the first global recession ever recorded.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY
MONETARY MALPRACTICE : Moral Hazard, Unintended Consequences & Dysfunctional Markets - Monetary Malpractice has had the desired result of driving Investors into becoming Speculators and are now nothing more than low-odds Gamblers. There is a difference between investing, speculating and gambling. At one time these lines were easy to comprehend and these distinctive groups separated into camps with different risk profiles in which to seek their fortunes. Today investing has become at best nothing more than speculating and realistically closer to outright gambling.
The reason is that vital information is either opaque, hidden or manipulated. Blatant examples such as: the world of off balance sheet debt, Contingent Liabilities, Derivative SWAPS, Special Purpose Vehicles (SPV), Special Purpose Entities (SPE), Structured Investment Vehicles (SIV) and obscene levels of hidden leverage make a mockery out of public Financial Statements. Surely if we get our ego out of this for a moment we can see that stockholders are now nothing more than gamblers? What is worse is that the casino is rigged. With Monetary Policy now targeting negative real interest rates, it is forcing the public out of interest bearing savings and investing, and into higher risk vehicles they would have shunned historically. They have no choice as the Monetary Malpractice game is played against them.
There is an old poker player adage: "when you look around the table and can't determine who the patsy with the money is, it is because it is you." 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
During the first phase of the euro crisis, private capital flowed out of the “peripheral” countries to the core of the eurozone, but this shift had no adverse impact on the euro.
Now, investors are taking their capital out of the eurozone altogether.
The euro threatens to fall further, possibly leading to serious concerns about a devaluation spiral.
Article Main Body
Since the beginning of May, the euro has lost around 5% of its value on a trade-weighted basis. Against the U.S. dollar, it has lost as much as 8%. This is a clear signal that the eurozone debt crisis has reached the currency markets. The euro threatens to fall further, possibly leading to serious concerns about a devaluation spiral.
In view of the way events have escalated in the eurozone over the last few years, what is surprising is not so much that the euro has shed its fundamental overvaluation, but rather that this correction did not happen sooner and was not a great deal more pronounced.
The answer lies in the pattern of this crisis, which is essentially a global debt crisis whose symptoms have been spreading for years – starting with the U.S. subprime sector, moving on to the banking sector, then to public finances – typically from the weakest link to a stronger one.
A similar process is at work in the eurozone: During the first phase of the euro crisis, substantial volumes of private capital flowed out of the “peripheral” countries. However, these capital outflows had no adverse impact on the euro’s exchange rate, because they merely represented shifts of capital within the eurozone – from Spain to Germany, for example. (Figure 1 shows private capital outflows from Spain.) Several months ago, these capital outflows from the periphery prompted a worldwide debate about the significance of the balances of the European payments system known as Target2, as the Eurosystem – particularly the Deutsche Bundesbank – took over the financing of these private capital outflows.
Now there are growing signs that the crisis of confidence in the eurozone has assumed a new dimension. For some weeks, it has been apparent that capital is no longer simply flowing from the southern countries to the core countries of the eurozone, particularly Germany. Rather, the falling euro is a sign that the eurozone as a whole is experiencing a net outflow of capital. Whereas initially investors fled to the safety of the eurozone’s core, now they are taking their capital out of the eurozone altogether.
In this context, it is worth noting that, since May, the Swiss National Bank (SNB) has been actively selling Swiss francs in exchange for euros on the Swiss currency market to maintain the maximum rate of 1.2 Swiss francs against the euro, which it set last September. According to SNB statistics, in May and June, Switzerland accumulated currency reserves of more than CHF 60 billion, so that the SNB’s currency reserves excluding gold are now equivalent to more than 60% of Swiss GDP, as Figure 2 shows.
The currency market interventions by the Swiss National Bank reinforce the downward pressure on the euro, as the SNB puts some of the purchased euros back on the foreign exchange market, offering them in exchange for dollars, yen and other hard currencies, to keep the composition of its currency reserves stable. In addition, the SNB invests the purchased euros mainly in high-quality eurozone government bonds, which tends to accentuate the downward pressure on yields in the eurozone core countries that still have triple-A ratings. The SNB is not the only institution that has been forced to take extraordinary measures: In July, the Danish central bank lowered the interest rate on its deposit facility to a negative level – minus 0.2 percent – to counter the upward pressure on the Danish krone. In other words, banks must now pay for the “privilege” of depositing money with the Danish central bank.
Domestic and foreign investors seem to be steadily losing confidence in the Economic and Monetary Union (EMU), and so are increasingly looking for safe havens for their money outside the eurozone. In the interest of safety, i.e., preserving capital, they are even prepared to accept negative interest rates. And with confidence in the EMU shaken, there is the danger of this capital outflow turning into a self-perpetuating process, further accelerating the tension within the system.
When storm clouds gathered over “little” Greece at the end of 2009, it seemed unthinkable that the debt crisis and the flight of capital would shake European monetary union – once proclaimed as “irreversible” – to its very foundations. Now, though, another storm could be about to break.
1- EU Banking Crisis
SPANISH BANKS - ECB Borrowing To Handle Capital Flight
Even as the Spanish (and Italian) sovereign bond market foundered in July, hitting record yields following stark realizations just how insolvent Spain is, a more sinister development was taking place: Spanish banks, completely disconnected from the funding needs of the sovereign, were receiving a daily bailout from the ECB to the tune of over €1 billion. As the Bank of Spain released hours ago, in July Spanish banks borrowed a record €375.5 billion from the ECB, a new record, and a €38 billion increase from June. Sadly, as the red line in the chart below demonstrates, the parabolic increase in Spanish bank borrowings from what is effectively Germany, continues unabated. Indicatively this is comparable to the US banking system obtaining a roughly $500 billion rescue in one month for the 8th month running. Year to date, Spain has received €257 billion in ECB "borrowings" which we put in quotes as this money will obviously never be repaid, which means simply that Europe continues to be entrenched in the most diabolical version of Stockholm syndrome, where the hostages and the kidnappers have now realized they can only exist as long as the other is alive. If there was any good news, it is out of Italy, whose ECB bank borrowings rose by "only" €2 billion in July to €283 billion, and leaving Spain far ahead in the direct borrowing insolvency race. Of course, this was offset by the far more complicated ponzi scheme where banks can and continue to issue government-backed bonds. In fact, as reported yesterday, Italian sovereign debt rose to a new all time high. Because at the end of the day remember: sovereign or financial debt - it doesn't really matter in Europe, an asset-starved continent where the two terms are now effectively synonymous, and where the law of fungible funding and communicating vessels in the context of debt has never been more in your face. Spain and Italy relative funding needs:
Greece managed to sell EUR4 billion short-dated bills this morning at remarkably low yields - not exactly the kind of thing that incentivizes political leaders to request aid - but how did they do it? Who bought it? Well, we suspect you know the answer but Mark Grant's clarifying response to Santelli's question concluded simply that the ECB-to-Greek-Banks-to-The-Bank-Of Greece-to-ECB circle-jerk is "in a sense, a kind of Ponzi scheme." Santelli's response that "it really is a rigged game" and that our reflexive response to the signaling of bond yields is remarkable given the manipulation; Grant agrees adding that "the real money guys are either out of Europe, getting out of Europe, or have cut back as much as they can" since simple math shows you that at some point Europe will have it's 'moment'.
Rick Santelli and Mark Grant discuss in more detail in the short clip below - Santelli and Grant take over at 3:40...
A PONZI SCHEME: ECB Lends Cash to > Greek Banks Buy > Greek Government Bills > Greek Banks Pledge Bills to ECB > ECB Give Cash to Greek Banks
"Way too Much Debt and Not Enough Debt to Guaranttee them"
Previously we explained on at least two occasions (here and here) why the upcoming death of the US money market industry is not greatly exaggerated: quite simply, as we wrote back in 2010, the Group of 30, or the shadow group that truly runs the world (see latest members) decided some time ago that it would rather take the "inert" $2.6 trillion held in money markets, and not used to boost the fractional reserve multiplier, and instead have it allocated to such more interesting markets as bonds and stocks. As a reminder, Europe already achieved this last month when it cut its deposit rate to zero leading to a sequential shuttering of money market funds. The Fed, however, has to be far more careful to not impair the overnight General Collateral repo market which as everyone who understands the nuances of Shadow Banking knows is where all the bodies are buried, and as such has been far more careful in implementing such a shotgun approach. Instead, Ben, the SEC, and the Group of 30 have adopted a far more surgical approach to destroying money markets: they want investors themselves to pull their money by implementing such terminally destructive measures as floating NAV, redemption restrictions and capital requirements, which will achieve one thing - get the end user to pull their money from MM and put the cash either into either deposits, where it can then proceed to be "fractionally reserved" into the banking system, or to boost AMZN's 250+ P/E. After all the number under observation is not modest: at $2.6 trillion, this is almost 20% of the market cap of the US stock market. So it was only a matter of time before major money market institutions, in this case Federated first, but soon everyone else, starts screaming and warning that money markets are about to die (which they are).
Of course, at the end of the day, whatever the Group of 30 wants, the Group of 30 gets: goodbye money market funds (more here). It was nice knowing you.
Dear Financial Professional,
Over the past 40 years, money market funds have become a staple of the US economy, used by millions of investors, businesses, state/local governments and non-profit organizations as a stable, efficient and liquid cash management vehicle. Unfortunately, if Securities and Exchange Commission Chairman Schapiro has her way, that may not be the case for much longer, as the SEC is poised to consider a set of proposals that would be the death knell for money market funds.
Federated has been very active in the battle to save money market funds and I am pleased to report that we are not alone. In addition to a host of financial services companies, hundreds of corporations, business groups, state/local governments and non-profits have written to the SEC to express their support for money market funds and to oppose Chairman Schapiro’s proposals.
There are three proposals being promoted by Chairman Schapiro and other Washington regulators – a floating NAV, redemption restrictions and capital requirements – each of which would destroy the very foundations that make money market funds so effective and popular.
Replacing the stable $1.00 net asset value, which has been the hallmark of money funds, with a floating rate NAV would create accounting nightmares for all users, requiring the tracking and reporting of fractional changes in share price each time shares are bought or sold.
Instituting redemption restrictions would prohibit money fund users from having full access to their investments when they want it or need it. Such a freeze would also cripple sweep accounts, check-writing and a number of others features that money market fund users depend on.
Requiring money market funds to maintain “capital buffers” or reserves would further limit the attractiveness of money market funds, particularly in the current low interest rate environment.
It is crunch time. The SEC is getting ready for a public meeting on these proposals. We need the help of everyone who knows the benefits of money market funds and their importance to the economy. Federated has developed a website that provides you the ability to contact the SEC and other officials to let your voice be heard in support of money market funds. You can visit www.savemoneymarketfunds.org to tell the Washington regulators not to destroy money market funds.
I truly appreciate our relationship and your consideration of helping Federated and money fund users everywhere in this important matter.
J. Christopher Donahue
President and Chief Executive Officer
Federated Investors, Inc.
The medium-term outlook for the U.S. economy will hinge largely on how much farther the deleveraging cycle has to run.
T he good news for U.S. households is that the most intense phase of the deleveraging cycle is over. The bad news is that hopes that the deleveraging cycle will come to an end within the next couple of years are unduly optimistic.
Housing debt, which accounts for four-fifths of all household debt, currently stands at about 60% of the value of the residential housing stock, still well above the pre-bubble level of 40%. Also, the pace of public sector deleveraging is likely to intensify, especially at the federal level. Moreover, the paradox of thrift continues to reign supreme: the current household saving rate is still below what one would expect given the present ratio of household net worth-to-disposable income. This means households will continue to try to save more, which will likely only serve to depress spending and aggregate incomes.
Adding to the trouble is the fact that labor compensation as a share of GDP has sunk to a post-war low. Indeed, for all the talk about how U.S. consumers have been living beyond their means, the reality is that even during the housing boom, personal consumption as a share of GDP excluding healthcare expenditures was below where it was in the 1950s.
Bottom line: While household deleveraging will be less of a drag going forward, economic growth likely will stay subdued for the foreseeable future.
STANDARD OF LIVING
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - August 12th - August 18th, 2012
Central Bank Policy Implementation and the ECB's Plan
In order to avoid the appearance that its plan to buy bonds of peripheral governments does indeed amount to 'funding of governments by the printing press', the ECB has tied the plan to the condition that it has to happen in parallel with EFSF/ESM rescues. However, that was not all – there was another stipulation mentioned by Mario Draghi during the press conference. We briefly remarked on this already in our summary and analysis of the ECB decision last week.
The other part of the plan, which is supposed to make the operation more akin to a 'monetary policy' type intervention, is to concentrate the buying on the short end of the yield curve. The thinking behind this is that in 'normal times', the central bank is mainly aiming to manipulate overnight rates in the interbank funding markets as well as other very short dated interest rates rates. Hence intervention in the short end of the curve closely resembles this 'normal' implementation of monetary policy. With this, the ECB probably also tries to differentiate its actions from those of the Fed and BoE.
Usually, the central bank determines a 'target rate' for overnight funds, and whenever credit demand wanes and interbank rates drift below this target, it is supposed drain liquidity. Whenever credit demand threatens to push interbank rates above the target rate, it will add liquidity.
During boom times, very little 'draining' tends to happen. As a rule, central bank target rates will be too low, and as speculative demand for short term credit keeps increasing during a boom, its liquidity injections – which provide banks with the reserves required to keep the credit expansion going – will aid and abet the growth in credit and money supply initiated by the commercial banks.
In the euro area, this method of overnight rate targeting has produced roughly a 130% expansion of the true money supply in the first decade of the euro's existence – about twice the money supply expansion that occurred in the US during the 'roaring twenties' (Murray Rothbard notes in 'America's Great Depression' that the US true money supply expanded by about 65% in the allegedly 'non-inflationary' boom of the 1920's).
This expansion of money and credit is the root cause of the financial and economic crisis the euro area is in now. This point cannot be stressed often enough: the crisis has nothing to do with the 'different state of economic development' or the 'different work ethic' of the countries concerned. It is solely a result of the preceding credit expansion.
Since long term interest rates are essentially the sum of the expected path of short term interest rates plus a risk and price premium, the central bank's manipulation of short term rates will usually also be reflected in long term rates.
In the euro area's periphery, the central bank has lost control over interest rates since the crisis has begun. The market these days usually expresses growing doubts about the solvency of sovereign debtors by flattening their yield curve: short term rates will tend to rise faster than long term ones. This in essence indicates that default (or a bailout application) is expected to happen in the near future. It is possible that this effect has also influenced the ECB's decision to concentrate future bond buying on the short end of the yield curve. However, as is usually the case with such interventions, there are likely to be unintended consequences.
The Rollover Problem
Recently the bond maturity profile of Italy and Spain looked as depicted in the charts below. Note that the charts are already slightly dated (this snapshot was taken at the beginning of the year), so there may have been a few changes in the meantime, but they probably still represent a reasonably good overview of the situation. There has been an enormous shift in the maturity schedule of the debt of both governments when we compare these charts to the situation as it looked in May of 2010, when the following snapshots were taken:
ITALY: As of mid 2010, Italy had €168.2 billion of debt coming due in 2012. At the beginning of 2012, this had increased to € 319.6 billion – a near doubling. In Spain, the change is even more extreme:
SPAIN: In Spain, the change is even more extreme. As of mid 2010, Spain had €61.2billion of debt coming due in 2012. At the beginning of 2012, this had increased to € 142.2 billion –nearly 2.5 X
What accounts for this enormous change? When interest rates began to rise sharply, the governments of Spain and Italy ceased to issue long term debt, opting to shorten the maturity spectrum of their debt instead. This was done because long term interest rates had become too high for their taste. It was no longer considered affordable to finance the government at these rates when they exceeded 6% and later temporarily even 7%.
Thus panic began to set in when short term interest rates began to rise sharply as well in November of 2011 and again from March 2012 onward.
Now we can already see what the problem with the ECB's plan is: it will tend to shorten the average maturity of peripheral debt even further once it is implemented. In fact, it already has this effect even before the ECB has bought a single bond, as rates on the short end of the curve have recently fallen sharply in reaction to the announcement.
“European Central Bank President Mario Draghi’s bid to bring down Spanish and Italian yields may spur the nations to sell more short-dated notes, swelling the debt pile that needs refinancing in the coming years.
“In a way what the ECB has done is making the situation worse,” said Nicola Marinelli, who oversees $160 million at Glendevon King Asset Management in London. “Focusing on the short-end is very dangerous for a country because it means that every year after this they will have to roll over a much larger percentage of their debt.”
The average maturity of Italy’s debt is 6.7 years, the lowest since 2005, the debt agency said in its quarterly bulletin. The target this year is to keep that average at just below seven years, according to Maria Cannata, who heads the agency. In Spain, where the 10-year benchmark bond yields 6.94 percent, the average life is 6.3 years, the lowest since 2004, data on the Treasury’s website show.
“Driving down the short-dated yields provides a little bit of comfort and encourages Spain and Italy to issue more at the short-end,” Marc Ostwald, a strategist at Monument Securities Ltd. in London, said. “The problem is that you are building up a refinancing mountain.”
Even if the ECB buys the bonds of Italy and Spain, they will still have to repay them and regularly roll them over at maturity. By inducing them to shorten the average maturity of their debt further, the ECB creates new risks, especially as the economic downturn remains in full swing and is likely to worsen the fiscal situation of both countries in the short to medium term.
Interestingly, a similar shortening of average debt maturities can be observed in the euro area's 'core' countries. France is certainly considered a 'core' country and is currently treated as a 'safe haven' by bond investors. However, this is a tenuous situation, as it can still not be ruled out that the government will eventually be called upon to bail out the country's banks. At the moment all is quiet on that front, but it was only in November last year when the market was extremely worried about the risk these banks face in view of their enormous balance sheets and potential funding problems.
By now it is no secret that the primary beneficiary of the over $7 trillion pumped by global central banks into the financial system in just the past 4 years, and countless other trillions in miss-spent fiscal stimuli has been the stock market. But what about the global economy: after all five years after BNP Paribas stopped withdrawals from their investment funds - the unofficial start of the Great Financial Crisis - whose primary beneficiaries have been corn, gold, silver and brent - we should have seen at least some sustained impact in the economy if all Econ 101 teaches us about the virtuous business cycle is true, and if any of this countless money out of ZIRP air actually made its way into the economy instead of just the stock market. Well, let's take a look shall well. Courtesy of Bridgewater we present a chart of coordinated interventions and their impact not on the stock market, but on the economy. What we find is that it was, is, and will be a centrally planned world after all.
The three contractions in global growth that have occurred since the financial crisis were offset by heavy blasts of fiscal and monetary stimulation by global governments and central banks. But each wave of support has also had less impact on global conditions than the previous wave. We remain concerned that the ability of those policy responses to stabilize the situation is diminishing. The third wave stabilized global growth after last summer’s dip and allowed for the bounce in global conditions and markets over the early part of this year – but its impact on global conditions was more modest than that of earlier waves of stimulation. As the third wave has ended, global growth has again rolled over.
The scariest thing about the above chart? The ever lower global growth bounce as a result of ever increasing, or exponential, central bank intervention.
In other words, not only is conventional economics wrong about virtually everything, but the impact of whatever the real underlying story is, certainly not one that can be captured by econometric models which continue to falsely model out what is essentially a system of infinite complexity and soaring fragility, has increasingly diminishing returns.
Also, when we get to the point on the chart above where global growth is at or below zero irrelevant of how much "money" is pumped into the system, that will be the moment to shut the lights out, because it is then that the central planning fat finger which has to date mostly impacted various intraday inflection points in the S&P, will simply press CTRL-P. And not let go.
By this analysis, adjusted retail sales ex gasoline was up 0.7% in July from the previous month and up a modest 2.9% year-over-year. However, it's down 8.5% from its all-time high in June 2005.
The Great Recession of the Financial Crisis is behind us, but a close analysis of retail sales suggests that the recovery has been weak and had been showing signs of contraction. Let's hope that the July improvement is the beginning of a sustained reversal of the recent trend. But the more sobering reality is that, in "real" terms — adjusted for population growth and inflation — consumer sales remain at the level we saw in around the midpoint of the last recession.
Total Revenues: -$475 million (-10.1%)
Income Tax: $12 million (0.4%)
Sales Tax: -$295 million (-33.5%)
Corporate Tax: $57.1 million (27.4%)
Compared to 2011
Total Revenues: -$468.8 million (-10%)
Income Tax: $156.2 million (5%)
Sales Tax: -$390.7 million (-40%)
Corporate Tax: -$26.4 million (-9.1%)
What the Numbers Tell Us
Typically, July is a month when California revenues go on vacation, as the month accounts for about one dollar of every $20 deposited in the General Fund. (Only October has lower revenue volume.)
Despite those low expectations, July’s revenues were $475 million, or 10.1%, below estimates.
Some of that variance may be due to timing, as a fund transfer expected in July will now be made in August (in the range of $100 million). Most of the shortfall was attributable to sales tax, which dropped $295 million, or 33.5%, below estimates.
Partially offsetting these revenue losses, the state’s other major revenue sources — income and cor-porate taxes — performed above estimates.
Corporate taxes rose $57.1 million (27.4%) above estimates. This reverses an eight-month trend of corporate tax revenue underperforming estimates. This could have been helped by a drop in corporate refunds in July, $54.6 million below July of last year.
Personal income taxes came in just above estimates by $12 million in July. The stability of this month’s personal income tax could be attributed to the modest recovery being made in the labor markets. California added 38,300 nonfarm payroll jobs in June, which followed a gain of 45,900 jobs in May.
July’s sales tax performance is harder to explain as it is unclear whether consumer activity has slowed or if this is an issue of timing. The missed amount this month can certainly be made up in the near future. While sales taxes were only projected to hit $882 million in July, the Budget expects the State to collect $2.3 billion in sales tax in August.
Total General Fund Disbursements also went out faster than originally projected. Table 2 shows Local Assistance payments in July totaling $1.7 billion over the budget’s estimates. Most of that was caused by a $1.5 billion school payment scheduled for September, but instead issued in July.
Sales taxes collections off 33.5% vs. budget and 40% from a year ago is not a "timing issue". Either California data is extremely messed up, or retail sales nationally will be revised sharply lower
19 - Slowing Retail & Consumer Sales
INVESTOR SENTIMENT - A Lost Deccade & Not Returning Soon
There is a segment of the Baby Boomers that will never return to investing in equities because the last 12 years has produced a lack of returns with relentless volatility and scary headline news. BofAML's Mary Ann Bartels notes that equity holdings as a percentage of financial assets peaked in 2000 and have been declining ever since. This same behavior occurred last time the market traded sideways from 1966-1984 (16 years) and we clearly face the risk of more years of sideways trading to come as cumulative bond and equity flows show no sign of letting up at all.
Despite the majestic efforts at jawboning 'markets' higher with constant reassurance that infinite QE will come 'we promise', it seems the real economy - full of small businesses and job creators - hasn't got the message. As while equities trade at multi-year highs, small business optimism just printed at its lowest in 9 months. Trickle-down QE doesn't seem to be taking hold among the dismal reality in which we all actually live - as opposed to the vacuum tune hyperplane that stocks exist on.
33 - Public Sentiment & Confidence
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
We often hear that the central banks printing money in order to keep the stock market inflated and broke countries afloat for just a few days longer is nothing to worry about. The reason we are given, is that even though the central banks are pumping trillions into the economy, inflation isn't an issue. And after all, the velocity of money has actually declined. That's the message from the "smart" people anyway. This chart shows that as M2 grows (Red), so does inflation ie: CPI (Green) - yes, this is the government's calculation, we'll leave it there for this chart's purpose. Also of note is the monetary base without the banking ponzi scheme of fractional reserve banking (Blue).
So as you can see, inflation actually follows M2 growth, even as the velocity of money (below) declines. Don't be fooled by those who tell you that printing money isn't causing inflation, because it is doing just that each and every day.
There are those who believe that velocity of money is a product of fast growing inflation (not a cause). Inflation has been rising consistently with the growth in money supply, but the velocity of money has declined. You can imagine what happens once velocity of money actually starts to turn (hint: something ZH has been warning about for years).
EARNINGS - Q2 Recap
Q2 earnings seasons is now (with 93% of firms reporting) over, and it is time for post mortem. The bottom line for those strapped for time is the following: In order to salvage the 2012 earnings consensus for the S&P, the sell side crew and asset managers, as wrong but hopeful as ever, are now expecting Q4 2012 earnings to grow 15% versus 4Q 2011, which is more than twice as fast as any other quarter. Indicatively, Q2 2012 earnings rose at a rate of 3% compared to Q2 2011. Elsewhere, revenues came 2% lower than consensus estimates at the start of the earnings season.
And the kicker: The S&P 500 bottom-up consensus EPS estimate for 3Q fell 4% during the past five weeks and management guidance has been more negative than usual. Consensus expectations imply no earnings growth for the S&P 500 versus 3Q2011. This number will certainly drop more and will be the first Y/Y EPS decline since the Lehman failure.
In other words, the entire year is now a Hail Mary bet that in Q4, the time when the presidential election, its aftermath, as well as the debt ceiling and fiscal cliff acrimony will hit a peak, a Deus Ex Machine will arrive and lead to a 15% rise in earnings. Why? Because global central bankers will have no choice but to step in and thus lead to a surge in EPS multiples even if the underlying earnings are collapsing. With the presidential election around the corner making Fed QE before 2013 now virtually impossible, with Spain (and Italy) refusing to be bailed out and cede sovereignty thus precluding ECB intervention, and with China spooked by what may be a surge in food costs, this intervention, and any hope that the Hail Mary pass will connect, all look quite impossible.
As the chart below shows, in this bizarro market, the lowest 2012 consensus earnings to date can only be matched by the highest PE multiple. Brilliant.
2Q earnings results disappointed across the globe. In the US and Europe, P/E multiples have expanded more than fund managers might realize because earnings estimates are too high. The divergence between trends in earnings and valuation is likely to become more pronounced as profit forecasts continue to be reduced in the coming months. In the US, our 2Q earnings season takeaways are: (1) disappointing sales; (2) in-line earnings; (3) margins are still declining; (4) 3Q estimates imply no growth while 4Q estimates imply significant growth; (5) earnings estimates are falling, driven by Energy and Materials.
2Q Results by Geography
For the US, sales disappointed more than earnings. 18% of ex-Financials and Utilities companies have posted positive revenue surprises by beating consensus sales expectations by at least one standard deviation, half the historical average. The number of firms that missed sales estimates was twice the historical average. Sales surprises were the worst since 1Q2009. The frequency of earnings beats and misses are largely in line with history.
In Europe, earnings season misses were driven by margins not sales. 239 companies, 54% of market cap, have reported. So far, the frequency of earnings beats, a surprise of 5% or more, is below the three-year average (33% vs. 43%), and misses are slightly higher (40% vs. 37%). Sales results have been modestly positive. Analysts significantly revised down Banks earnings. FY2012 estimates are down 9% over the past month.
In Japan, companies reported further earnings declines. 90% of TOPIX companies (95% of market cap) have reported earnings. Results so far have been disappointing especially in context of the April-June 2011 quarter. Last year, supply chain problems following the March 2011 earthquake resulted in a weak earnings season. Yet operating earnings for the April-June 2012 quarter are down 7.4% year over year. Revisions and guidance have remained muted, which our Japanese strategists see as a sign of caution in the face of macro uncertainty going into 2H.
Across Asia, Consumer Discretionary companies posted stronger results relative to consensus estimates. Similar to results in the United States, Energy and Materials posted the weakest results relative to consensus estimates. Singapore posted the strongest results relative to consensus while Taiwan was weaker.
In the US and Europe, P/E multiples have expanded more than fund managers might realize because earnings estimates are too high.
1. Global EPS forecasts are too high. Our top-down, full-year earnings forecasts imply further downside to consensus estimates in the US, Europe and Japan. In each region, the difference between our top-down 2012 EPS growth forecast and bottom-up consensus growth is about 3pp. Our MSCI Asia Pacific ex-Japan earnings growth estimate is in line with consensus.
2. In the US and Europe, P/E multiples have expanded more than fund managers realize. The strong rally in global equity markets during the past five weeks means portfolio managers have re-rated stocks based on policymaker promises rather than fundamentals. On consensus NTM EPS, the S&P 500 P/E multiple expanded from 12.6X to 12.9X. The Stoxx multiple rose from 10.0X to 10.7X over that same period of time.
3. Consensus earnings estimates declined in all regions over the last month. Full-year 2012 estimates fell 4% for the Stoxx 600 while Topix (FY) and MSCI AP ex Japan forecasts each fell 3%. S&P 500 estimates fell 1%.
4. Meanwhile, despite weak earnings season, the S&P 500 is up 3.6% since July 6. Other global indices have also rallied sharply with Stoxx up 6.2% and MSCI Asia Pacific ex Japan up 4.0%. TOPIX is down 2.6%.
Details of 2Q Earnings Results for S&P 500
A total of 456 firms in the S&P 500 have now released 2Q 2012 results representing 93% of the equity cap. Below we highlight our takeaways:
1. Sales disappointed. Realized sales are 2% lower than consensus estimates at the start of the season. 2Q2012 sales for S&P 500 (excluding Financials and Utilities) grew by 3% year over year.
2. Earnings in line with expectations. S&P 500 realized 2Q EPS is tracking at $25.49, a 2% positive surprise versus the consensus estimate at the start of reporting season. On a quarterly basis, 2Q2012 EPS will post year over year growth of 3% vs. 2Q2011. Telecommunication Services and Financials EPS grew by 26% and 14%, respectively. On a trailing four-quarter basis, 2Q2012 will establish a new EPS peak of $99.
3. Margins beat, but LTM margins are declining. With earnings beats and sales misses, 2Q quarterly margins are 20bp higher than expected (9.1% vs. 8.9%). Year over year, quarterly margins are flat to negative in most sectors. The trailing-four-quarter net margin for the S&P 500 is tracking at 8.8%.
4. Earnings expectations are falling and 3Q estimates imply no growth. The S&P 500 bottom-up consensus EPS estimate for 3Q fell 4% during the past five weeks and management guidance has been more negative than usual. Consensus expectations imply no earnings growth for the S&P 500 versus 3Q2011. Energy and Materials are the most significantly negative.
5. Over half of consensus 2012 EPS growth is from strong 4Q forecasts. 4Q earnings are expected to grow 15% versus 4Q2011, more than twice as fast as any other quarter. 4Q2011 growth was about half that of the other 2011 quarters, which explains some of the growth discrepancy between quarters in 2012. Analysts forecast a sudden jump in LTM margins to a new peak of 9.0% in 4Q2012 while we forecast further slippage to 8.7%.
TECHNICALS & MARKET ANALYTICS
EARNINGS - Earnings follow US$ which follows QEIII Expectations
While many argue that corporate profitability in the US knows no bounds as cost-cutting amid 'slow' growth will fill the gap, we offer this quite compellingly nerve-jangling chart of the increasing dependence of S&P non-financial operating profits and the weakness of the US Dollar. The negative correlation between macro-level EPS and the U.S. dollar is both theoretically and empirically clear. As Citi points out, profits earned abroad are reported in depreciating or appreciating terms, boosting or reducing profits; and as the negative correlation between the USD and global growth can result in 'double counting' of earnings influences - this leads to too much hope at 'turning points'. What is more critical is the trend higher in the USD - whether due to EUR break-up fears and safe-haven flows OR courtesy of Draghi's EUR weakening QE/LTRO promises - is tending to push Bernanke's hand to act to weaken the USD (do NEW QE) to 'strengthen' corporate profits and the economy.
However, with inflation-expectations now high and macro data stabilizing, his justification is far from clear - no matter how high the hopes and dreams have become. Without the Fed's NEW QE, the Q4 hockey-stick of hope in earnings is finished thanks to implicit USD strength. The irony is that time inflation is supply constrained - due to food limitations (global warming notwithstanding) - and adding QE 'demand' to that fire will only have potentialy violent repurcussions.
US corporate profitability has become increasingly dependent on USD weakness (implied by the Fed's QE actions)
... and as US macro surprises remain weak but have tended to stabilize/improve recently... It seems like a much tougher call from the Fed to plunk down another $500billion at this time. Source: Citi
CORPORATOCRACY -CRONY CAPITALSIM
CRONY CAPITALSIM - Enriching the Financial Sector Through Monetary Policy
Easy monetary policy enriches the financial sector at the expense of the wider society.
When the central bank engages in monetary policy, the financial sector gets the new money first and so receives an ex nihilo transfer of purchasing power (the Cantillon Effect).
FIRST: The effects of quantitative easing (monetary base expansion) on equities (S&P500 Index), corporate profits and employment.
While quantitative easing has dramatically reinflated corporate profits, and equities, it has not had a similar effect on employment (nor wages). However there are lots other factors involved (including government layoffs), and employment (and wages) is much stickier than either corporate profits or equities. It will be hard to fully assess the effects of quantitative easing on employment outcomes without more hindsight (but the last four years does not look good).
SECONDLY: Following QE, financial sector profits have rebounded spectacularly toward the pre-2008 peak, while nonfinancial sector profits have not:
THIRDLY: This disparity has not been driven by growth in the monetary base, which lagged behind until 2008. Instead it has been driven by other forms of money supply growth, specifically credit growth.
FOURTHLY: As interest rates have been lowered credit creation has spiked, and vice verse:
This is the relationship between financial sector asset growth, and growth of the money supply:
Growth of the money supply inversely correlates with changes in the Federal Funds rate:
FIFTH: The easing of credit conditions (in other words, the enhancement of banks’ ability to create credit and thus enhance their own purchasing power) following the breakdown of Bretton Woods — as opposed to monetary base expansion — seems to have driven the growth in credit and financialisation. It has not (at least previous to 2008) been a case of central banks printing money and handing it to the financial sector; it has been a case of the financial sector being set free from credit constraints.
Monetary policy in the post-Bretton Woods era has taken a number of forms; interest rate policy, monetary base policy, and regulatory policy. The association between growth in the financial sector, credit growth and interest rate policy shows that monetary growth (whether that is in the form of base money, credit or nontraditional credit instruments) enriches the recipients of new money as anticipated by Cantillon. This underscores the need for a monetary and credit system that distributes money in a way that does not favour any particular sector — especially not the endemically corrupt financial sector.
GLOBAL FINANCIAL IMBALANCE
STANDARD OF LIVING
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