STALL SPEED : Any Geo-Political, Economic or Financial Event Could Trigger a Market Clearing Fall
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 unless major globally coordianted policy initiatives are undertaken. 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. The World Bank is "unpolitically'projecting 2.5%. The situation is now deteriorating so rapidly, as to be impossible to hide anylonger.
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.
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TIPPING POINT or 2012 THESIS THEME
HOTTEST TIPPING POINTS
PEOPLE HAVE IT ALL WRONG & UPSIDE DOWN - Here is why QE infinity is needed.
QEX - Unlimited Quantitative Easing Arrives
“...if we do not see substantial improvement in the outlook for the labor market, we will continue the MBS purchase program, undertake additional asset purchases, and employ our policy tools as appropriate until we do.”
In the past, when the Fed has tried QE, it's always come with precise limits on size. So the Fed will say that it will buy $600 billion worth of Treasuries and mortgage-backed securities, but then nothing more.
But the hot buzz in economics these days is that it's not the size of the program, but the commitment on the part of the Fed to keep money easy until the economy is well on the road to recovery.
That's where unlimited QE comes in. The idea would be that the program would be open-ended, with ongoing bond buying until that point at which the Fed was satisfied that the economy was strong.
The program is thus transformed from being a program about bond buys to a program that seems to commit the Fed to future actions.
The big question is, what conditions the Fed attaches to ending the bond buying.
It probably won't be an explicit Nominal GDP target or even something specific like an Evans Rule (no tightening until 7 percent unemployment or 3 percent inflation). It will likely be something softer, and more along the lines of "robust data." (Read: Tim DuyDeutsche Bank)
FEDERAL RESERVE - Balance Sheet Growth Projections
Imminently, the Fed's Open Markets Operations desk will commence buying $40 billion in MBS per month, or about $10 billion each week. Concurrently, the Fed which is continuing Operation Twist, will still purchase $45 billion in "longer-term" Treasurys, sterilized by the $45 billion or so in 1-3 years Bonds it will sell until the end of the year at which point it runs out of short-term paper to sell.
End result: every month through the end of 2012, the Fed's balance sheet expands by $40 billion in MBS.
Beginning January 1, 2013 the Fed will continue monetizing $40 billion in MBS each month, and will continue Operation Twist, however it will adjust the program so that it continues to increase its long-term holdings at $85 billion per month, without sterilized as it will no longer have short-term bonds to sell. It will also need to extend its ZIRP language "through the end of 2016" so all bonds 1-3 years are essentially risk free, as they are now, in effect eliminating the need to sell them.
End result: every month in 2013 the Fed will increase its balance sheet by $85 billion, consisting of $40 billion in MBS, and $45 billion in 10-30 year Treasurys, or the natural monthly supply of longer-dated issuance. The Fed will therefore monetize roughly half of the US budget deficit in 2013.
Putting it all together, the Fed's balance sheet will increase from just over $2.8 trillion currently, to $4 trillion on December 25, 2013. A total increase of $1.17 trillion.
This is what the Fed's balance sheet will looks like:
Another way of visualizing this is how many assets as a percentage of US GDP the Fed will hold on its books. Currently, this number is 18%. By the end of 2013, the Fed's historical flow operations will be accountable for 24% of US GDP.
Why is this important? Simple: when the time comes for the Fed to unwind its balance sheet, if ever, the reverse Flow process will be responsible for deducting at least 24% of US GDP at the time when said tightening happens. If ever.
What is scariest, is that as of this moment, all of this is priced in. Any incremental gains in the stock market will have to come from additional easing over and above what Bernanke just announced.
And finally: Fed's DV01 at December 31, 2013: ~$4 billion
There is one big problem with the Fed's announcement of Open-Ended QE moments ago: it effectively removes all future suspense from FOMC announcements. Why? Because the Fed has as of this moment exposed its cards for all to see from here until the moment it has to start tightening the money supply (which may or may not happen; frankly we don't think the Fed tightens until hyperinflation sets in at which point what the Fed does is meaningless). It means easing is now effectively priced into infinity. Now rewind back to that one certain paper by the New York Fed, which laid it out clear for all to see, that if it wasn't for the expectation of easing in the 24 hour period ahead of the FOMC meeting, the market would be 50% or lower than where it is now, and would have been effectively in negative territory in the aftermath of the Lehman collapse. What Bernanke did is take away this key drive to stock upside over the past 18 years, because going forward there is no surprise factor to any and all future FOMC decisions, as easing the default assumption. It also means that Bernanke may have well fired his last bullet, and it, sadly, is all downhill from here, as soaring input costs crush margins, regardless of what revenues do, and send corporate cash flow to zero. Unfortunately, not even in the New Normal can companies operate without cash flow.
This is the chart.
Than you Fed for telling us what comes next.
QEx to INFINITY - The Implementation of Financial Repression
There are several major differences between QE3 now and past QE. The one that is least remarked on is that the world outside the US is much less attractive now than in March 2009 or August 2010 when previous QEs were announced. In earlier QEs, EM was much more attractive, having shrugged off the debt crisis, there was an attractive destination for the liquidity the Fed was injecting into the global economy. Now the term ‘global leadership’ is linked to the US with its 2% (plus or minus) growth rate, and pessimism over Chinese, Brazilian, Indian and other major EM economies. So the downside risk is that the new liquidity sloshes around the banking system rather than being used for investment abroad. The outcome would change if China embarked on a major stimulus programme, though for now investors are not positioning themselves for such an expansion.
In addition, we are struck by the somewhat skeptical reaction of investors and colleagues to the Fed’s analysis of the benefits from past rounds of QE. In particular the Fed’s benefit calculation explicitly assumes that the level of stimulus is a function of the size of the Fed’s balance sheet, so keeping the Fed’s balance sheet fixed would not result in any diminution of stimulus. Most clients and traders feel that rates would back up significantly if the Fed were to stop expanding the balance sheet. In that world, subsequent rounds of QE just keep rates where they are rather than lower them and the cumulative benefits are much less pronounced. There is a strong view in markets that 1) the Fed have to do a big QE, given the expectations that have been built up, and 2) the added liquidity will have a marginal effect. Taken together this raises the risk that the assets that will benefit are those sensitive to liquidity, such as money substitutes and Treasuries, rather than assets that are sensitive to real business cycle expansion.
Two things here: Citi has finally figured out that the Fed will be unable to herd cats and instead of investors positioning to buy the assets that the Fed demands they should buy, i.e., stocks with a 100X P/E, a far simpler trade will be the one that has worked for years - to simply frontrun the Fed in what it will buy, as explained here months ago, when we showed why the performance of the long-bond has surpassed that of the S&P by a factor of almost 200%.
Second, and more imporantly, let's recall that "money substitutes" = gold. So... Citi basically said that tomorrow Ben Bernanke is about to (again) become a goldbug's best friend.
PEOPLE HAVE IT ALL WRONG & UPSIDE DOWN - Here is what is really happening
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - Sept 9th- Sept. 15th, 2012
When the ECB announced its new plan to buy peripheral government debt in Europe (for the purpose of reducing yields) there was some concern over the fact that the purchases were going to be "sterilized."
In theory what this means is that if, say, the ECB goes out and buys 50 billion EUR worth of sovereign debt, then somewhere else it will remove 50 billion EUR from the system so as to avoid inflation (and placate the Germans).
Some people wondered: What assets will the ECB sell in order to finance these purchases.
But the market was clearly not worried about this sterilization news, as evidenced by the big market surge on Thursday and Friday, as investors realized that "sterilization" is mostly for show, with little real impact on the amount of money in the system.
In a note from last December, JPM's Greg Fuzesi explained how the ECB engaged in bond sterilization (this was in reference to the old SMP program, but the gist is the same.
When the ECB purchases peripheral government bonds through its Securities Markets Programme (SMP), it pays for these by creating new bank reserves (i.e., through the modern form of printing money). In terms of its balance sheet, both assets and liabilities increase. The purchased peripheral bonds are held as assets in the SMP category and are matched on the liability side by a larger amount of bank reserves. In the first instance, the new reserves are added to the current accounts that commercial banks hold at the ECB. In this form, the reserves are fully liquid as they count towards meeting banks’ reserve requirements and they can be used to settle interbank payments.
The way the ECB has chosen to sterilize these reserves balances is to encourage banks to shift them from the fully liquid current accounts into fixed term deposits, which are just another form of reserves. The ECB could offer these at any maturity but has chosen a short maturity of just one week (likely for operational reasons). The deposits are auc- tioned through a tender procedure, which requires banks put in bids, stating the amount they are willing to tie down for the one week period and the interest rate at which they are willing to do so. The maximum interest rate that the ECB is willing to pay is the main policy interest rate, and it be- gins by picking the cheapest bids until it has met its target level.
So basically, the "sterilization" just means that banks commit to keep some cash at the ECB for a fixed period of time, so it doesn't technically enter the system. And since that money at the ECB is liquid and guaranteed it's not a problem.
As for whether the sterilization really matters, the answer is: Not really.
First, it does not shrink the ECB’s balance sheet back to its original size, as would be the case if the ECB sold other assets to finance its SMP purchases. It is of course debatable whether a larger central bank balance sheet is a source of concern per se (e.g., of the inflationary sort). But, even if it is, the sterilization method used by the ECB clearly does not address this concern.
Second, viewed from the perspective of the banking system, purchases of peripheral government bonds by the central bank remove a risky asset and replace it permanently with highly liquid reserves (whether these are subsequently sterilized or not). In addition, the sterilization operation ties the funds down for only a very short one-week period and these can still be used as collateral at other ECB refi- nancing operations. Hence, the sterilization itself does not neutralize the impact on the banking system’s balance sheet, which has become permanently more liquid. Whether this, in itself, encourages banks to lever up in other ways (e.g., by making other risky investments or aggressively growing their loan books) is debatable. But, in any case, the sterilization does not fully reverse the changes.
So it's just technical accounting stuff. The ECB can buy unlimited volumes of sovereign debt, provided the country whose debt its buying remains in good compliance with reforms.
The National Bureau of Economic Research has published a new paper analyzing 138 years of economic history in 14 advanced economies, which proves that high levels of private debt cause severe recessions.
Through a series of tests run on a sample of 14 advanced economies between 1870 and 2008, Mr Taylor establishes a link between the growth of private sector credit and the likelihood of financial crisis. The link between crisis and credit [i.e. private debt] is stronger than between crises and growth in the broad money supply, the current account deficit, or an increase in public debt.
Over the 138-year timeframe Mr Taylor finds crisis preceded by the development of excess credit, as in Ireland and Spain today, are more common than crisis underpinned by excessive government borrowing, like in Greece. Fiscal strains in themselves do not tend to result in financial crisis.
The study shows that excessive private debt is a much more accurate and consistent predictor of financial crisis than the amount of public debt. (However, high levels of public debt exacerbate the problems caused by massive private debt, since governments which are already “in the red” have little ammunition left with which to help out the economy.)
[Consumers certainly rang up too much debt.] But that ignores the really massive runup: financial corporations’ debts. Starting at a little over 10% of GDP in 1970, they hit almost 80% by 2000, and when the crash hit they were over 120% of GDP — a 10x, order-of-magnitude increase over 40 years.
The basic story is very simple. It goes like this (in my words):
• Banks (and shadow banks) make money by lending. Bankers have every incentive to increase their loan books, even by extending questionable loans, because bankers don’t personally bear the eventual, down-the-road losses from loan defaults — they’ve gotten their money already.
• When banks run out of real, productive enterprises to lend to — enterprises that can pay back loans and interest from the production and sale of real goods that humans can consume — they start lending to speculators (gamblers) who are buying financial assets in hopes that their prices will rise.
• That lending — extra money being pumped into the system — does indeed drive up the price of financial assets, far beyond the value of the real assets that (according to most economists you listen to) supposedly underpin those financial assets’ value.
• Eventually people realize that the value of financial assets far exceeds the value of real assets — and far exceeds the capacity of the real economy to service the loans that drove up those financial asset prices. Prices of financial assets plummet, borrowers default because there just ain’t enough real income to service the loans, financial-asset prices plummet some more, all in a downward spiral — with all sorts of collateral damage to the real economy.
There’s your (economy-wide) Ponzi scheme. Households and nonfinancial businesses definitely participate (the financial industry makes it almost irresistible not to), but it’s driven by the financial industry, and a huge proportion of the takings go to players in the financial industry.
a piecemeal, open-ended QE program, with set economic thresholds that if unmet will force Bernanke to keep hitting CTRL-P until such time as Goldman is finally satisfied
First thing this morning we tweeeted:
It is early for the Hilsenrumor. Those usually appear in the last 20 minutes of trading
We were off by 14 minutes, as today's "Hilsenrumor" appeared at 3:26 pm, giving the market its closing oomph.
By now everyone knows that the WSJ's Jon Hilsenrath is spoon-Fed information directly by the Fed. Even the Fed. Which is why everyone expected the Fed to ease last time around per yet another Hilsenrath leak, only to be largely disappointed, invoking the term Hilsen-wrath.
Sure enough, it took the market only a few hours to convince itself that "no easing now only means more easing tomorrow", and sure enough everyone looked to the August, then September FOMC meetings as the inevitable moment when something will finally come out.
So far nothing has, as the Fed, like the ECB, have merely jawboned, since both know the second the "news" is out there, it will be sold in stocks, if not so much in gold as Citi explained earlier.
Regardless, the conventional wisdom expectation now is that tomorrow the Fed will do a piecemeal, open-ended QE program, with set economic thresholds that if unmet will force Bernanke to keep hitting CTRL-P until such time as Goldman is finally satisfied with their bonuses or unemployment drops for real, not BS participation rate reasons, whichever comes first.
As expected, this is what Hilsenrath 'says' to expect tomorrow, less than two months from the election, in a move that will be roundly interpreted as highly political, and one which as Paul Ryan noted earlier, will seek to redirect from Obama's economic failures, and also potentially to save Bernanke's seat as Romney has hinted on several occasions he would fire Bernanke if elected. Here is what else the Hilsenrumor says.
In the past, it has announced programs with big numbers and fixed completion dates — like a $1.25 trillion mortgage-buying program that stretched 12 months through March 2010 and a $600 billion Treasury bond-buying program that stretched eight months through June 2011.
The activist wing of Fed officials, which support aggressive responses to high unemployment, want a large and open-ended commitment to bond buying. For instance, the Fed could announce it would buy at least a certain amount of bonds over a specified time period and signal they could buy more later if the economy doesn’t pick up.
Announcing an opening allotment over several months would blunt the ability of Fed policy hawks, who are skeptical of easing actions, to quickly call for the program to end. The hawks don’t want another round of QE, but if there is going to be one, they would want a small up-front commitment to bond buying and the opportunity to pull the plug on the program if the economy picks up quickly.
A four-month opening allotment would get the Fed past the election and through a Dec. 11-12 policy meeting, at which point it could consider whether to continue. A five month commitment could get it to a January press conference and another round of forecast updates. A seven-month opening allotment would get it through the first quarter of 2013 and to a March 19-20 policy meeting. If it decides to make decisions on a meeting-by-meeting basis, the next meeting is Oct. 23-24, two weeks before the election.
It’s hard to say how big a program the Fed would launch, here are some guideposts:
The Fed is already purchasing $45 billion in long-term Treasury securities every month through the Operation Twist program and it plans to buy a total of $267 billion by year-end. That marks the lower bound of what Fed purchases will be for the rest of the year.
If the Fed doubles the size of its current program by matching Treasury purchases with mortgage purchases, that would get its monthly purchases to $90 billion.
Its controversial QEII program launched in November 2010 was smaller at $75 billion per month.
Its first round of mortgage and Treasury purchases took place largely in 2009 and was designed to be immense to address the financial crisis. It amounted to more than $140 billion per month, an amount that seems likely to be far beyond the ambitions of what Fed officials are prepared to do now.
–WHAT TO DO WITH TWIST: Officials must decide what to do about the “Operation Twist” program if they launch a new bond-buying program. The Fed is funding the Twist purchases with money it gets by selling short-term Treasury securities. The Fed has two options:
It could suspend the Twist program and replace it with a new bond-buying program in which it buys both Treasury securities and mortgage-backed securities, and funds those purchases with money that the Fed prints — rather than with proceeds from short-term securities sales. This would be more like the QE programs the Fed launched in March 2009 and November 2010.
The Fed could continue the Twist program and launch a mortgage-bond-buying program by its side in which it buys mortgage bonds with newly printed money but continues to fund long-term Treasury purchases with sales of short-term securities.
In either case, the Fed would be launching a program which it considers to be more powerful than Operation Twist alone. One question for officials is which of these two complex approaches would be easiest to explain to the public? Another is which approach entails less risk of public backlash? Many critics worry that the Fed’s money printing will someday cause inflation or another financial bubble. Many officials don’t agree, but they’re sensitive to the argument. The second option would involve less money printing and might help to blunt that criticism.
–COMMUNICATION: How the Fed describes its impetus for action, and its criteria for even more in the future, could matter a lot. Is it responding to a darkening outlook? Or has it decided to take more aggressive action because its patience with slow growth and high unemployment is running out and it has a new commitment to changing that?
If it emphasizes the former, it might just depress investors, households and businesses more and backfire. If it emphasizes new resolve, it could spur the public to change behavior in ways that lead to more economic growth but also risk more inflation.
Fed officials have long believed that their communications about monetary policy and the economy are as important as the actions they take, but they’ve struggled to strike the right message.
In a widely debated paper presented at the Fed’s Jackson Hole meeting last month, Columbia University economist Michael Woodford argued that the Fed should signal more strongly that it is committed to an easy money policy until the economy meets benchmarks for more output. The Fed seems to be moving tentatively in this direction. Its discussion about open-ended bond buying is one potential example.
Another: Minutes of the July 31-Aug. 1 policy meeting showed officials considered offering a new assurance that short-term interest rates will stay low even after the recovery progresses.
–WHETHER TO LOWER ANOTHER RATE: The Fed now pays banks 0.25% interest on reserves they keep with the central bank. The Fed could reduce the rate it pays on reserves that aren’t required of banks (known as excess reserves) a little bit to try to give banks more impetus to lend. However many officials are reluctant to do so because they’re afraid pushing the rate any lower would disrupt short-term lending markets. It’s unclear whether the Fed will do anything on this front, especially with so many other hard decisions on the table.
Much has been written on the fading efficacy of the Fed/ECB grand-monetization schemes over the past few years. The following chart clarifies the market's apparent 'getting-religion' moment and that since QE1 - and the wake-up call that indeed the Central Banks of the world will inflate their way out of this mess - the market has increasingly front-run (and therefore removed) much of the actual balance sheet expansion efforts of the monetary overlords. One thing is sure, the latest ramp in stocks is absolutely front-running 'something' big from the Fed/ECB and for now, they are late!
Fed and ECB balance sheet - upper pane - clearly its not the stock
3-month rate of change - middle pane - but the flow correlates (with a market lead) as we have long suggested...
as the market - lower pane - has switched from 'not getting it' to now front-running everything...
Does the Fed need to re-instill some discipline in order to regain its omnipotence?
QE3 - First Addition At A Market High -- Extremely Questionable
"The reaction function of the FOMC seems to have changed. In my simple terms, QE has never always come with the stock market down YTD -- now, it appears we’ll receive it with S&P up 14%."
That's from a Goldman desk note send around earlier today, and it's a great point.
This chart from Doug Short shows it nicely, that all previous QEs and Twists came during periods when the market was at a low.
So will we wee QE3 on Thursday? We argued NO. John Carney at CNBC says YES.
Carney is correct that the weak state of the economy probably complies with the Fed's previously stated preconditions for easing. That being said, the new twist is the potential ECB gamechanger that could be a real boon in the next few months.
For that reason, a punt 'til December seems likely.
JPM says 77% of investors expect with be a NEW QE round (mostly MBS) between $200 and $500 billion in QE, the world is, also in the words of JP Morgan, drowning in liquidity. In other words, according to the central planners, not only is debt the fix to record debt, but liquidity is about to be unleashed on a world that is, you guessed it, already drowning in liquidity. The bad news: everything being tried now will fail, as it did before, because nothing has changed, except for the scale, meaning the blow up will be all that more spectacular.
From JPM's Michael Cembalest:
It has been a strange year. If you were concerned about the global economy this year, you were right:
Leading indicators of manufacturing, such as new orders, are weakening just about everywhere
Chinese, Korean and Taiwanese exports are slowing sharply; China may be growing at only 6%
European growth is ~0%, with the periphery in recession. Germany business surveys also fading
Last week’s US jobs report was weak across the board (payrolls, work week, labor force participation and wages)
US capital spending trends are slowing (e.g., capital goods orders ex-aircraft)
Countries like Brazil are showing signs of industrial fatigue due to an overly strong currency in 2010-2011
The US election does not look like it will bring clarity to the US fiscal/debt ceiling divide (polls show Democrats keeping the White House and Republicans keeping the House of Representatives)
US housing is staging a modest recovery, but it’s not a game-changer given its smaller contribution to employment
Corporate profits are high, but the trend in EPS revisions is negative and profits growth is slowing
However, global equity markets have done well, up 13% so far in 2012. The bottom line: with the world drowning in liquidity, the right portfolio moves this year have been to take advantage of low equity valuations, look through all the economic weakness and expect that continued monetary stimulus will eventually bear fruit. We have done some of that but not as much as we might have, and as things stand now, global equity markets have outperformed what I had expected. The world’s Central Banks have made it clear that inflating their way out is preferable to the alternatives, an environment that is conducive to risky assets that are priced very cheaply, until and unless they lose control of inflation.
For those confused, Cembalest only added "unless" out of political courtesy, because as even the Fed itself admitted last night, first via St. Louis Fed's James Bullard and soon everyone else, the Fed has finally been exposed as being nothing but a puppet tool of politicians, who in turn have always been sponsored muppets of Wall Street (Who can possibly forget Chuck Schumer telling Bernanke to "get to work Mr. Chairman"). In other words, we now know politicians run not only fiscal, but monetary policy. How to hedge against this apocalyptic proposition? Simple. Cue Kyle Bass:"Buying gold is just buying a put against the idiocy of the political cycle. It's That Simple."
TECHNICALS & MARKET ANALYTICS
SECTOR POSITIONING - Morgan Stanley Research Goes Negative
BofAML's Michael Hartnett has an excellent note answering the question: Why is the equity market up so much?
Hartnett chalks it up to the 3 P's: Policy, production, and positioning.
Policy, of course, refers to the actions taken by the ECB (and possibly the Fed) to crank back up the monetary stimulus.
Production refers to the quality of the data, which is no longer surprising to the downside. Weak data is no longer failing to incite treasury buying, as it did not longer ago.
Positioning refers to the fact that investors have been caught on the wrong side of this risk trade. Numerous investors have missed this rally.
And it's for this last point that there seems to be a desire to want to hear that this can go on longer.
All the big analysts are being asked this how much longer question, and they're generally answering that it can go a bit higher.
Here's Goldman's Dominic Wilson
With the summer rally extending, the key question is whether markets can still move higher. On balance, we think they can, but the risks are rising. The rally so far has been driven mostly by policy and its impact on compressing risk premia. While there is more event risk as decisions shift from the ECB to governments, we expect OMTs to be activated in the next few weeks and we anticipate a shift to QE3 this week. These moves are likely to keep the forces for easy financial conditions in place. What will now be needed is more evidence of cyclical improvement from the US and global data. News there has been more disappointing. Our view is that it will look somewhat better over the coming weeks. If that occurs alongside the policy tailwind, we think markets should move higher even from current levels. Without it, we doubt they can.
The fundamental backdrop, in the shape of economic lead indicators and earnings momentum, has been deteriorating: manufacturing PMIs for the US, China, Japan, Korea, the Euro zone, and the UK are all now sub-50, and consensus earnings growth estimates for 2012 have been halved in recent months. What has this meant for Global Equities? Well, as UBS notes, in the last three months, very little. The MSCI AC World index is up more than 12% from the 4 June low. That markets have rallied while fundamentals have deteriorated in this manner is unusual. Historically, equity market rebounds have tended to coincide with a trough in PMIs and earnings momentum – that is, when PMIs have stopped going down and the pace of earnings downgrades slows (waiting for PMIs to recover to 50 or for earnings momentum to turn positive is usually too late). Markets now appear to be taking their cues from central bankers: potential policy actions are becoming a sort of ‘lead indicator of the lead indicators’, if you will. Given the recent rally, in addition to underlying macro weakness, policy action - and effective action at that – has become increasingly important for investors. Without it this recent rally could end up looking more like a false start than a head start.
UBS: PMIs and Global Equities…
We have taken a long-run series of selected manufacturing PMIs from around the world (US, Euro zone, China, Japan and Korea). The vast bulk of the early history comes from the US, with some countries’ data not starting until the 1990s or even later. We have simply weighted by current GDP weights – this will only give us an estimate, but our composite measure does seem to move closely with the US ISM over the last decades.
We have circled the nine periods that we think were major turning points in the indicator since 1973 (trying to reduce some of the noise in mid-cycle volatility).
Historically, the trough in Global Equities performance has tended to coincide with the trough in the PMIs (chart 2).
But this time round the rally has occurred ahead of the turn (chart 3).
And earnings momentum has been sharply negative (and worsening) over the last three months as markets rallied. June, July, and August all saw deteriorating momentum (Chart 6),
the result of which has been a near-halving of 2012 consensus earnings growth estimates (Chart 7).
Of course, if policymakers do follow through with drastic actions that reduce Euro zone break-up risk or drive an acceleration in US or Chinese economic growth, then PMI and earnings stabilisation will follow. If this is the case then equity markets will have gotten a nice head start in the last few months. However, given the recent rally, in addition to underlying macro weakness, policy action - and effective action at that – has become increasingly important for investors. Without it this recent rally could end up looking more like a false start than a head start.
Since The Dreme (Draghi Scheme) began shortly after the EU Summit, the P/E multiple on the S&P 500 has risen by a faith-defining 2x. This is the largest three-month rise in this indicator-of-indifference-to-reality since the initial burst rally off the March 2009 lows. Meanwhile, the actual earnings consensus is being marked down further, heading for an earnings recession as we pointed out last week. It seems investors are too afraid not to believe in P/E miracles or perhaps it is just faith that central banks have it all under control and their 'promises' are as good-as-gold.
The S&P 500 seems 'managed' to a certain level - no matter what that means for EPS or P/E multiples, the spice must flow market must rise... (a 2x multiple increase since Draghi's initial utterances post EU Summit
As if the divergence was not enough, the 3 month rise in the S&P's P/E ratio (lower pane) is its highest since the initial V-bottom recovery in 2009...
Charts: Bloomberg and JPMorgan
CANARIES - Particpation Index Suggests Consolidation or Pull Back Ahead
For a month we have been waiting for a news event to trigger a break up or down out of the narrow, miserable trading range. Thursday brought "positive" news regarding new plans to deal with the European debt crisis. It was the kind of news we refer to in shorthand as pure BS. Or as Macbeth said: "It is a tale told by an idiot, full of sound and fury, signifying nothing."
Specifically, a debt problem cannot be solved until the debtor begins running a budget surplus that allows him to begin retiring the debt. Period. Printing money ain't going to do it, but the geniuses who run the world know better. So the market is constantly on edge, waiting for the next bright idea for ending the crisis with no pain. The news comes, triggers a brief rally (a lot of short-covering). Then reality sets in again. On the chart below we can see the effect these swings between fantasy and reality have had on price.
On Thursday we got a nice market rally, and the Participation Index-UP reached climactic levels. The Participation Index (PI) measures short-term price trends and tracks the percentage of stocks pushing the upper or lower edge of a short-term price trend envelope. The PI has no breadth or volume component -- it is strictly derived from price movement. In this article we will only be addressing Participation-UP.
Climactic activity on the PI is generally in the 60 to 80 range, and climaxes generally signal that the immediate advance is ending and that there will be a period of consolidation or correction -- a pause to refresh, so to speak. There are instances where price just keeps rising after indicators climax, but that kind of price power is normally associated with the beginning of a new bull market. Thursday's climax is more likely a signal that the news-induced advance is nearly over.
Conclusion: The S&P 500 has advanced about 13% since the June low, but it has been a choppy ride because the news suffered from a lack of sustainability. Climaxes of the Participation-UP have been occurring at or near short-term tops, and I think that will prove to be the case this time as well.
CANARIES - Hong Kong Profit Warnings & US Market Volume Tell the Story
COMMODITY CORNER - HARD ASSETS
CORPORATOCRACY -CRONY CAPITALSIM
CRONY CAPITALISM - It Starts With the Federal Reserve System
Does the Federal Reserve benefit the nation, or just the banks?
Cui bono--to whose benefit?--is a skeptic's scalpel that cuts through the fat of propaganda and political expediency to the hard truth. Since the world has been trained (in Pavlovian fashion) to hang on every word issued by America's privately owned central bank, the Federal Reserve, it's appropriate to ask a simple but profound question:
Who benefits from the Fed's existence and its policies of loaning "free money" to banks at 0% and ZIRP (zero interest rate policy)? The Status Quo's answer is "the American people," of course, a deliciously juicy layer of "Big Lie" propaganda and obfuscation.
Let's start by considering the object of the Fed's loving largesse: the world's "too big to fail" banks, which have received $16 trillion from the Fed. (I first saw this chart on Chartist Friend from Pittsburgh.)
Recall that the entire gross domestic product (GDP) of the U.S. is around $15 trillion, and all residential mortgages in the U.S. total about $10 trillion.
Only the U.S.A. has a privately owned central bank with broad powers that are independent of (and thus exceed) those of the elected government:
The Federal Reserve System has both private and public components, and was designed to serve the interests of both the general public and private bankers. The result is a structure that is considered unique among central banks.
Progressive Democrats favored a reserve system owned and operated by the government; they believed that public ownership of the central bank would end Wall Street's control of the American currency supply.
Needless to say, the Progressives didn't get a government-owned central bank. Silly Progressives! That would have inhibited the Fed's only real purpose, which is consolidating wealth and power in the banks.
The stated purpose of the Fed is to "even out" the business cycle by never ever allowing "bank panics," in which banks failed because they were over-leveraged and burdened with bets that soured.
This has been sold as a policy of avoiding recessions and turning those few that slip through the cracks into short, shallow affairs with no lasting consequence.
Banks fail when credit has been over-extended and minimal collateral has been overleveraged. In the old days, depositors were wiped out along with the bank's owners and managers. But the FDIC deposit insurance eliminuated the threat of depositors being wiped out when banks failed, and this did not require a central bank.
So we're back to the original question: who benefits from the existence and policies of the Fed? Here are two more charts to ponder:
It certainly doesn't appear that a central bank helps maintain competition in the banking sector.
See that little blip around 2008? That was the global financial crisis. It sure is nice to have a "lender of last resort" who can loan you $16 trillion at 0% interest when you're about to lose your financial empire:
What is the fundamental basis of bank wealth and power? The financialization of the entire economy. And what are the primary mechanisms of financialization? Ever-expanding credit (debt) and leverage based on phantom collateral in phantom assets.
And what is the primary purpose of the Fed's policies? To expand debt and leverage. These are the essential mechanisms of increasing the banking sector's wealth, power and control over the economy and the machinery of governance. Expand debt and leverage and you expand banking profits and thus the banks' political power.
As noted yesterday in The Federal Reserve's Cargo Cult Magic: Housing Will Lift the Economy (Again), the interest on skyrocketing debt drains income and capital from potentially productive investments to pay for unproductive debt-based spending on consumption, fraud, friction and malinvestments. "Free money" loans create moral hazard, which means that those who can borrow money for almost nothing and never have to pay it back act entirely differently from those paying market rates for money and backing their loan with real collateral that is at risk.
Banks borrow from the Fed at 0%, students borrow from the banks at 7%. Banks never have to actually pay back their "free money" from the Fed, while students are indentured for life to the banks.
Widely distributed prosperity for the citizenry results from increases in real income that flow from productive investments and higher productivity that's passed on to workers. The Fed's model of "prosperity" is to enrich the banks and incentivize workers to take on more debt to boost their consumption and their purchase of phantom assets in stock bubbles, housing bubbles, etc.
The banking sector's solvency is entirely dependent on officially sanctioned over-valuation of phantom assets. How do you keep phantom assets inflated? You allow banks to mark assets to fantasy rather than market, you keep interest rates at zero to encourage marginally qualified borrowers to take on more debt than is prudent, turning the borrowers into debt-serfs, and you buy dodgy debt (such as impaired mortgages) from the banks to clear the bed debt from their books. And of course the one thing you never do is loan money directly to citizens or buy their dodgy mortgages. That wouldn't serve the banks.
These are all the policies of the Federal Reserve. Let's return to our original question: who benefit from the existence of the Fed and its policies? Answer: the banking sector.
The financial sector ran wild in the 2000s, running on a model of systemic fraud and "the Fed's got our back" speculation. This frenzy of financialization ended when the pyramid of instability and over-reach imploded.
Any healthy political and financial system would have broken the fraud-based system and dismantled the failed banks en masse in an orderly fashion. One institution stopped this from happening: the Federal Reserve. Instead of allowing a failed system to collapse and establish a new one based on prudent lending, market-set interest rates, competitive banks and transparent regulatory structure, instead we have a failed system that has become even more politically powerful even as its Fed-backed excesses have increased systemic fragility.
The Fed exists to serve the banks. Everything else is propaganda. Ever-expanding debt leaves America a nation of wealthy banks and increasingly impoverished debt-serfs. Cui bono, baby.
New video: Gordon Long and I discuss "Inequality Precedes Social Unrest":
Continuing with the theme of the secular shift in the labor pool (not cyclical, as the Fed still mistakenly believes: it will take it at least one more year to understand it has been wrong about this aspect of the New Normal economy too, just as it was wrong for decades about the Flow vs Stock debate), it is not only men who are fresh out of luck. As a reminder, we observed earlier that the labor force participation rate for men has just dropped to an all time low. It turns out there is another class of workers whose participation rate is at the lowest in series history: that of "25 year olds with a Bachelor's degree and higher", i.e. college grads. At 75.5%, it is the lowest since this data has been kept by the BLS. But not all is abysmal in America's labor force. While the share of workers with a college degree has plunged to all time lows, a bright spot can be found when observing the labor force participation rate of those who never bothered with college, and for whom high school was their last known degree-granting institution. At 59.9%, the participation rate is well of its 2012 lows of 59.0% and steadily rising, in fact, to borrow a term from the housing bulls, it may well have "bottomed". Now there is some truly great news for the future of America's highly educated workforce.
None of the above, however, matters to hordes of young, impressionable wannabe college grads for whom college is the only hope out there, no matter the cost. Sadly, the cost is rising exponentially, and as we showed recently, total Federally-funded student loan debt outstanding is now at all time highs.
Luckily, the cost of the debt is at record lows. Sadly, the principal will still need repayment, as cohort after cohort of unemployed students will soon find out, and also find out that there is no discharge of student debt in bankruptcy: it is, indeed, the proverbial gift that keeps on taking.
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