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.
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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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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
Investors pulled nearly $10.6 billion from U.S. stock mutual funds last week. That brings the total 2012 outflow to more than $100 billion. Investors have been bailing out of the stock market all year, but the exodus picked up considerable speed last week. U.S. stock mutual funds bled nearly $10.6 billion during the week ended Oct. 3, the most since the week in August 2011 when Standard and Poor's downgraded the U.S. credit rating following the debt ceiling brawl in Washington, according to data from the Investment Company Institute. That brings the total 2012 outflow from U.S. mutual funds to more than $100 billion. By comparison, those funds lost around $57 billion during the first nine months of 2010, and $80 billion during the first nine months of 2011.
3 - Risk Reversal
RESIDENTIAL REAL ESTATE - Fundamentals For a Sustained Recovery Are Not In Place
For nearly 30 years, two of the world's largest economic nations (China and the US) have continually debauched debased the purchasing power of their currency. For the last 12 years, the rest of the world joined in. So who is winning the race to debase now? It appears globalization was really all about currency debasement and exporting inflation (i.e. loss of FX value) with debt being the inflation buffer (i.e. borrow to afford or vendor-financing - see AMZN). The problem now is the entire world is saturated with debt and so there is no-one left to export inflation to anymore. We do indeed live in interesting times.
Source: Goldman Sachs
and as a bonus chart - the following chart shows how massivley active China has been to 'manage' its currency. The green line is the USDCNY exchange rate and the red and blue lines indicate the direction of exchange rate pressure driven by the market and the CCP/PBoC's wishes. What is extremely evident is that from the end of LTRO to the start of QEternity (note - they stopped 2 days before the FOMC meeting) - China's government was a massive seller of USD to maintain their CNY stability... (while market expects CNY depreciation)
Economists, market analysts, journalists and investors alike are all talking about it quite openly, generally in a calm and reserved tone that suggests that - to borrow a phrase from Bill Gross – it represents the 'new normal'. Something that simply needs to be acknowledged and analyzed in the same way we e.g. analyze the supply/demand balance of the copper market. It is the new buzzword du jour: 'Financial Repression'.
The term certainly sounds ominous, but it is always mentioned in an off-hand manner that seems to say: 'yes, it is bad, but what can you do? We've got to live with it.'
But what does it actually mean? The simplest, most encompassing explanation is this: it describes various insidious and underhanded methods by which the State intends to rob its citizens of their wealth and income over the coming years (and perhaps even decades) above and beyond the already onerous burden of taxation and regulatory costs that is crushing them at present.
It is as though a highway robber were not only content with robbing you at gunpoint on the street, but were emptying your bank account by having his associates hack into it at the same time and then visiting you at home to break into your wall safe for good measure.
One would think that people should be up in arms over it and do everything to avert it instead of merely calmly discussing it with a proverbial shrug.
How and why has it come to this? Why is there this sudden need for the State to not only openly grab the vast bulk of what its citizens produce, but add to the loot by robbing them by thinly disguised stealth methods as well? There are two main reasons for this: the legacy of the past and the unwillingness to shrink the power and size of the State.
Time Preferences and Obstacles to Reform
In democracies (especially when they are using a fiat money system) time preferences tend to be much higher than they would otherwise be. This is most pronounced in the case of the political class: the average politician cares not one whit about the long term health of his nation's capital stock - it doesn't belong to him after all. However, he is in a position to dispose of other peoples' wealth and will almost always do so in a manner that 'buys' the maximum of votes in the next election. Note that this tendency to maximize the income obtained by political instead of economic means raises the time preferences of nearly everyone in society – this is so because it diminishes the prospective return on capital for everyone, including of course those whose wealth is diminished by taxation. Long term economic growth suffers accordingly (for readers who want to know more about this particular topic, Hans-Hermann Hoppe has written extensively about it).
Ever more promises were made to ever more people, ever more privileges were extended and ever more costly welfare and warfare programs were initiated. It was seemingly easy to pay for it all: tax revenues were high and what could not be obtained by means of taxation was simply borrowed and/or printed. It has been perfectly clear for a long time that the funding of all these programs would not be sustainable in the long run. Even the governments own 'watchdogs' like the 'GAO' ('government accountability office') in the US and similar offices elsewhere have continually made a compelling case that spending needs to be reined in.
Alas, in the long term 'we're all dead' as Keynes maintained, so why worry? To the politicians of the day, the long term has always been something someone else would eventually have to deal with.
We have now arrived at the edges of this long dreaded moment, the time when the piper will have to be paid. The moment that could always be put off in the past has clearly been reached in the euro area for instance, where the limitations on government financing imposed on the supra-national central bank have unmasked the truth about government finances in a number of countries.
The past cannot be undone. In many cases it has become impossible to get rid of so-called 'entitlement spending' short of declaring national bankruptcy – it has become part of so-called 'mandatory spending' (we have to use quote marks here because a sufficiently motivated political leadership could deal with it if it wanted to). Moreover, politicians are loath to cut discretionary spending as well: no matter what type of spending is cut, there will be 'blowback' from the vested interests that are denied their place at the trough. Any spending cuts or economic reforms that really make a difference are a sure way to lose elections.
As an example, consider Gerhard Schröder's actually not overly radical welfare state and labor market reforms in Germany. He undertook them in light of the economic pressures German reunification had produced. They went against the grain of what his party (the social democrats) stood for. They most certainly led to his electoral defeat. And yet, today it is widely acknowledged that Germany's economy would have continued to stagnate and could never have become Europe's 'economic locomotive' without them. The positive effects arrived far too late to save Schröder's political career – he actually made policy for the long term, a rare exception.
Leviathan Doesn't Want to Shrink
Apart from the legacy of the past – which consists of the already accumulated outstanding public debt and the many promises to continue spending – there is a desire to keep the State's bloated size intact at all costs. Every single bureaucracy within the State is eager to keep growing and amass more powers over time. No ministry wants to be the one that bears the brunt of prospective spending cuts.
Regular readers know that we have focused our criticism of EU-style 'austerity' on this point: governments that are reluctantly forced to reduce their deficits and debts in the euro area tend to do so in a manner that aims to keep the size of government unaltered – the main focus is on raising taxes even further, not on slimming down the bloated State. The banking industry – which is the industry enjoying the biggest of all privileges, namely the power to create money ex nihilo – is likewise taboo. Apparently there cannot possibly be too many banks or any banks not worth saving at tax payer cost. Meanwhile, the system's ability to obtain profits by denying savers a return on their savings is couched in propaganda about the alleged necessity for central banks to manipulate rates to zero, and in some cases even below zero, to 'save the economy'.
Numerous ways to avoid spending cuts and to diminish the value of outstanding debt have been thought up. This is where financial repression comes in.
It can take many forms – higher taxation, capital controls (either open or disguised), the imposition of negative real interest rates, regulations that force investment into government-desired channels, selective defaults, credit dirigisme, monetary inflation and so forth. We cannot accuse the political and bureaucratic classes of a lack of creativity in these areas. Nor can we accuse them of hiding their desire to impose additional oppressive taxation.
Below is a clip that shows Austria's minister of the interior holding forth in parliament not long ago. Consider in this context that the total tax burden imposed on the country's citizens amounts to 60% at this time (you'll have to use Google translation, the article is in German). It is also a country in which political corruption and waste of tax payer funds have attained what are often stunning proportions (to no detriment to the perpetrators, as the ministry of justice can stop any and all investigations at will). Here is the clip (her rant begins at 0:38)
Austria's interior minister Johanna Miki-Leitner, talking about the need for a new 'solidarity tax'.
Here is a translation of what she said:
“…and when the rip-off artists and speculators among the top income earners are asked to pay up, and they have the feeling that we are ripping them off, then I can only say, they have anyway no sense for the collective good, for our community. Then I simply say to them: Fork over the dough! Fork over the millions! Fork over the loot!”
This by the way is a 'conservative' politician. Consider also that there really are no 'speculators' in Austria. Neither are there many rich people and most of the known 'rip-off artists' are as a rule members and/or friends and relatives of the political class. What they are ripping off are tax payer funds. In fact, Austria's small handful of 'rich' people consists of utter financial midgets compared to e.g. the rich in the US. Under the guise of 'taking from the rich' (who somehow automatically seem to be deserving of opprobrium, because what else can they be if not 'rip-off artists and speculators'), Mrs. Miki-Leitner's rant indicates that taxes will be raised further on everyone. When is it going to be enough? As noted above, the tax burden on the middle class already amounts to 60% of its income if calculated correctly.
We don't want to pick specifically on Austria as it were – it merely serves as an example of the hubris and shamelessness of the modern-day political class when it comes to the forcible appropriation of other peoples' property. It is roughly the same in virtually all of Europe.
Below we bring a few recent examples of 'financial repression' activities on the part of governments that show the many guises which the policy is taking apart from the well-known fact that central banks are inflating all out.
Recent Examples of Financial Repression
One example is the US 'FATCA' Act, a thinly disguised attempt to introduce capital controls through the backdoor by making it nigh impossible for US citizens to hold funds abroad. The reporting and compliance requirements the law imposes on foreign financial institutions are so complex and costly that many of these institutions have simply ceased to do business with US clients. This has created undue hardship for US citizens residing in foreign countries. A recent article at BC Business describes the problems faced by banks and credit unions as well as their clients in Canada as a result of this law. A few highlights follow below. First an example of what it can do to private citizens who try to comply with the regulations:
“New U.S. laws targeting overseas tax cheats have not only left a million Canadians facing the potential of financial ruin, but have put local credit unions in an impossible bind.
Maury Williams, a 68-year-old history professor at UBC’s Okanagan campus, was born in Australia, moved to the U.S. with his family as a child and acquired U.S. citizenship at age 15, when his mother decided to become a U.S. citizen. He moved to Canada in August 1973 to take a teaching position at the now-defunct Notre Dame University in Nelson, and became a Canadian citizen in 1986.
That seemingly benign history has created a nightmare. In May 2011 Williams and his wife Linda realized that their status as U.S. citizens requires them to file U.S. income tax returns. The rule has been in place for several decades, although it is rarely enforced by the U.S. Internal Revenue Service. Wanting to do the right thing, Williams and his wife plunged into the Byzantine world of American tax compliance by entering the Offshore Voluntary Disclosure Program — a program designed to give U.S. tax cheats a chance to come clean without facing criminal charges. He has since discovered that it is not the way to go for anyone whose only transgression was not knowing the U.S. requirement for expatriates to catch up on tax filing.
As of this summer, the adventure has cost the couple $28,000 in accounting fees and nearly $18,000 in back taxes owed to Uncle Sam. And it’s not over. At press time, the Williamses were awaiting a response from the IRS on all the paperwork filed through the Offshore Voluntary Disclosure Program in December 2011 on their “catch-up” with filing requirements. The IRS could assess late-filing penalties that would add tens of thousands more to what they’ve already paid, putting them at risk of financial ruin.
Put aside the cost for a moment, and consider what this has done emotionally, psychologically and physically to this ordinary Canadian family whose only “crime” was that at one time they were U.S. citizens. Asked about the impact, Williams said, “Nightmare, unfairness — it goes further for me. I’m not quite sure how to put this, but my wife has an arthritic condition, and it’s gotten a lot worse. We’re both convinced that the stress associated with this has had some impact. It’s affecting our health. Linda and I have gotten to the point where we don’t talk about this anymore.”
However, that is not all. As the article points out, the requirements of the FATCA act actually clash with Canada's own privacy laws. The US is asking Canadian institutions to do something in terms of client data collection they are not allowed to do. This creates a legal bind for them that goes well beyond the mere costs of compliance (the same problem is faced by institutions in many other countries as well).
“FATCA, which was passed into law in 2010, demands that every financial institution in the world identify all account holders who are “U.S. persons” — defined by the IRS as anyone who is a U.S. citizen, or even a U.S. landed immigrant or green-card holder — and report directly to the IRS on the status and balances in those accounts. Intended to catch U.S. tax cheats stashing money abroad, this huge net threatens to sweep up, along with a handful of tax cheats, those six to seven million U.S. expatriates living ordinary lives in other countries.
One significant challenge for Canadian financial institutions is the fact that Canadian and provincial right-to-privacy legislation prohibits them from sending financial information to a third party (like the IRS) without the consent of the account holder. While Canada’s major banks have taken strong positions on FATCA, the country’s credit unions are also caught up in the controversy and are actively pushing for changes. Collectively, they are not happy.
“I’ve never touched a file before in which there is absolutely no public policy benefit, no benefit for Canada, no benefit for a Canadian credit union,” says Gary Rogers, vice-president of financial policy at Credit Union Central of Canada, the association that represents the country’s credit unions. “The burden to follow some rules imposed by a foreign government is quite disgusting. I’ve been trotting out that phrase from the 1960s — ‘Yankee Imperialism.’ I launched that with our board, and got a chuckle. But it is accurate.”
The end result, quite predictably, is this:
“None of the credit union officials would speculate on what their ultimate policy decisions will be — perhaps because the options are not very palatable. One of those options, and it’s one already being employed in other countries, is to simply get rid of all account holders with American ties, and refuse to open accounts for anyone with American connections. As draconian as that sounds, it is already happening in Asia and in Europe. If a financial institution can purge itself of all accounts with American connections, it won’t have any compliance issues with the U.S., and it won’t have to report anything to the IRS.”
Or to put it bluntly: the law effectively amounts to the introduction of capital controls through the backdoor.
Forcing Pension Funds to Buy Government Debt
Another example we have come across are laws and regulations that force pension funds to buy sovereign debt whether they like it or not. People are coerced into buying the debt of what are de facto, if not yet de iure, bankrupt governments. After all, without the ability to print money, many governments would have been forced into outright default already. Avoiding default by printing money is of course nothing but default by another name. As the FT reports:
“Pension funds will be forced to buy chunks of the trillions of US, UK and EU long-dated sovereign bonds to be issued over the next few years – but with disastrous consequences, experts say.
Solvency II-type regulations and financial repression – in which governments are pressing institutional investors to buy debt – will push pension funds to invest in government bonds. The problem, however, is that government bonds offer low-to-negative real returns that will eat into pension funds and increase those funds’ growing deficits. While financial repression can help governments to shrink debt, this type of policy is definitely not favourable to pension funds, says Jerome Booth, head of research at Ashmore.
“Financial repression works well, as it did after the second world war, but it is distortionary,” he says. “Whilst it’s good for the taxpayer, as a saver I think it’s outrageous. Anyone who invests money in sovereign bonds has got some explaining to do.”
Recent monetary policy in developed markets has already pushed down government bond yields, but experts say the situation could get worse. One concern is that over the long term, a period of high inflation or strong currency moves would lead to a great reversal of government bond prices.
Mr Booth adds: “In markets, risk is always moving. It’s not acceptable to shove people’s money into deposits or government bonds.”
'Acceptable' or not, it is being done. As the article notes, a veritable 'tsunami' of government debt issuance lies dead ahead, with the US alone expected to issue an estimate $5 trillion in new debt by 2017.
As Ludwig von Mises notes in 'Human Action' regarding investment in government bonds, there is no such thing as a 'risk free' investment that is independent of the wealth generated on the free market. Furthermore, over time, the government is forced to begin paying for all the capital that has been squandered in the past.
“Now, the irredeemable perpetual public debt presupposes the stability of purchasing power.Although the state and its compulsion may be eternal, the interest paid on the public debt could be eternal only if based on a standard of unchanging value.In this form the investor who for security's sake shuns the market, entrepreneurship, and investment in free enterprise and prefers government bonds is faced again with the problem of the changeability of all human affairs. He discovers that in the frame of a market society there is no room left for wealth not dependent upon the market. His endeavors to find an inexhaustible source of income fail.
There are in this world no such things as stability and security and no human endeavors are powerful enough to bring them about. There is in the social system of the market society no other means of acquiring wealth and of preserving it than successful service to the consumers. The state is, of course, in a position to exact payments from its subjects and to borrow funds. However, even the most ruthless government in the long run is not able to defy the laws determining human life and action. There are in this world no such things as stability and security and no human endeavors are powerful enough to bring them about.
If the government uses the sums borrowed for investment in those lines in which they best serve the wants of the consumers, and if it succeeds in these entrepreneurial activities in free and equal competition with all private entrepreneurs, it is in the same position as any other businessman; it can pay interest because it has made surpluses. But if the government invests funds unsuccessfully and no surplus results, or if it spends the money for current expenditure, the capital borrowed shrinks or disappear entirely, and no source is opened from which interest and principal could be paid. Then taxing the people is the only method available for complying with the articles of the credit contract. In asking taxes for such payments the government makes the citizens answerable for money squandered in the past. The taxes paid are not compensated by any present service rendered by the government's apparatus. The government pays interest on capital which has been consumed and no longer exists. The treasury is burdened with the unfortunate results of past policies.”
Mises put these words to paper in the late 1940's. Although he didn't use the term 'financial repression', it is evidently precisely what he deemed the ultimate outcome of the vast accumulation of government to be.
The Transaction Tax
Euro area governments are pushing ahead with the introduction of the 'transaction tax', which will will do untold harm to European capital markets and further diminish the shrinking incomes of citizens depending on their savings and investments. As numerous studies have shown, the tax will destroy far more revenue than it can ever hope to bring in. The reaction of Europe's political class: Let's do it anyway!
“Finance ministers from 11 European Union countries agreed at a meeting in Luxembourg on Tuesday to support a tax on financial transactions, hoping to discourage risky trading while simultaneously raising revenue.
Germany and France, the EU's two largest economies, have long supported the idea of the tax, while countries like the Netherlands, Sweden and the United Kingdom remained staunchly opposed out of fears the tax could harm the competitiveness of their financial markets.
Sweden imposed a similar tax in the 1980s, only to lose much of its trading activity to London. Stockholm later repealed the law. "We still think that the financial transaction tax is a very dangerous tax," Swedish Finance Minister Anders Borg said ahead of the meeting. "It will have a negative impact on growth."
There are still few details on how the tax — referred to as the "Tobin tax" after the Nobel laureate American economist James Tobin who first proposed it in 1972 — would work and how its revenue would be used. The European Comission, the EU's executive branch, has proposed taxing trades in bonds and shares at a rate of 0.1 percent per transaction and taxing trades in derivatives at 0.01 percent.
Some have proposed the revenue be put into a fund that would help struggling banks, while others — particularly Brussels — want the money to beef up the EU's budget. Austrian Finance Minister maria Fekter said that a model for how the tax might work would be presented by the end of the year in the hopes that it could be installed by 2014.
Talks on the tax are one element of European Union efforts to create banking rules that could help prevent a repeat of the debt crisis which continues to ravage euro-zone finances.”
Let us simply ignore Sweden's experience! Who cares about 'growth'? We must 'rein in risky trading'! This is such appallingly uninformed nonsense that one doesn't know where to begin. Have they no better things to do? Of course the officially intended 'victims' of the tax, namely financial institutions and the ever-present 'evil speculators' (on whose activities the market economy depends, a fact that has not once been mentioned or considered by the eurocrats as a result of their economic illiteracy) are definitely not the ones who will pay for this newest burden. Everybody else certainly will – first and foremost the proverbial widows and orphans. The tax will severely impair market liquidity, thereby raising spreads and diminishing the prospective investment returns of pension funds, mutual funds and other investment vehicles. The banks will simply pass the cost on to their customers – they are not going to pay a single cent. Speculators will decamp to more welcoming shores, which should permanently increase the equity risk premium in the countries imposing the tax, which in turn will make it more expensive for companies to raise capital. Meanwhile, anyone who actually believes that the financial crisis could have been averted by means of imposing such a tax urgently needs to have his head examined.
Negative Interest Rates, Inflation
Banks have begun to impose penalties on those who seek to escape the risks associated with the euro by fleeing into the currencies of Denmark and Switzerland. This is a result of the central banks in these countries attempting to discourage capital inflows by imposing negative deposit interest rates.
“State Street Corp. (STT) and Bank of New York Mellon Corp., two of the world’s biggest custody banks, will charge depositors to hold Danish kroner and Swiss francs as customers seek refuge from the crisis-stricken euro.
State Street will apply a negative interest rate of 0.75 percent annually to krone deposits starting Nov. 1, with a separate charge for francs, according to a note to clients last week. That means money managers, insurance companies and pension funds must pay the bank to hold their cash. BNY Mellon started charging for krone deposits last month, a person with knowledge of the matter said. The lender isn’t charging for francs.
Denmark and Switzerland have cut interest rates close to or below zero to keep the krone and franc from rising as investors flee the euro for safer havens, reflecting concern that the currency may break up. While negative rates may drive off some customers, global lenders want to restore the profit margin between what they pay for deposits and what they earn on investments.
“It does look customer-unfriendly, but since State Street’s mainly dealing with institutions I would think that people would be more understanding,” said Richard Herring, a professor of international banking at the University of Pennsylvania. “The overall problem is the distortions that are caused by the monetary policies that are being pursued in the major countries.”
Of course 'negative interest rates' are a liable to create even worse economic distortions than merely 'suppressed' interest rates. In the real world there can be no such thing as a 'negative interest rate'. The natural interest rate must always be positive – it expresses the discount of future goods against present goods. It is simply not possible for future goods to be worth more than present goods. Time preferences may in theory rise to something approaching 'infinity': for instance, imagine the hypothetical case that we find out that a comet will collide with the earth and destroy it within a week's time. Obviously there would no longer be any incentive to provide for the future and time preferences would increase accordingly.
However, it is logically impossible for time preferences to become 'negative'. And yet, a number of central banks have manipulated their administered interest rates into negative territory and several others are reportedly considering taking the same step. How that can result in anything other than even more misallocation of scarce resources remains unexplained by the bien pensants leading these institutions.
Der Spiegel on the Pernicious Effects of Inflation on Savings
Interestingly, the normally somewhat left-leaning German news magazine Der Spiegel has devoted its recent cover story to a report on the havoc inflationary policies inflict on savings and wealth. In fact, the cover gets it exactly right with its title:
Recent Spiegel cover: 'Attention, inflation! How Germans are dispossessed by stealth.'
Germans are avid savers, which is one of the chief reasons for the German economy's success. Moreover, the country's private sector is not plagued by the 'deleveraging' issues that are regarded as such a big problem in many other nations these days, as Germany's citizens tend to eschew debt. Not surprisingly, Germans are very concerned about the recent machinations of the ECB.
“Central banks are currently flooding cash-strapped industrialized nations with money. This may help governments reduce their debt load, but it also erodes the value of people's savings. A massive redistribution of wealth is threatening to take place in Germany and Europe — from the bottom to the top.
Germany's central bank, the Bundesbank, has established a museum devoted to money next to its headquarters in Frankfurt. It includes displays of Brutus coins from the Roman era to commemorate the murder of Julius Caesar, as well as a 14th-century Chinese kuan banknote. There is one central message that the country's monetary watchdogs seek to convey with the exhibit: Only stable money is good money. And confidence is needed in order to create that good money.
The confidence of visitors, however, is seriously shaken in the museum shop, just before the exit, where, for €8.95 ($11.65) they can buy a quarter of a million euros, shredded into tiny pieces and sealed into plastic. It's meant as a gag gift, but the sight of this stack of colorful bits of currency could lead some to arrive at a simple and disturbing conclusion: A banknote is essentially nothing more than a piece of printed paper.”
We are astonished and delighted to come across such a frank and correct assessment of the situation in a mainstream news magazine. Already in the first paragraph one of the chief problems of the inflationary policy is correctly identified: “A massive redistribution of wealth is threatening to take place in Germany and Europe — from the bottom to the top.”
The article also has a chapter on 'financial repression' where this train of thought is explored in more detail. Interestingly, it even includes a fairly harsh critique of the manner in which the banking system and governments have become intertwined to the vast detriment of citizens and savers. Obviously in Germany the issue of financial repression is not glossed over so easily.
As the article notes:
“This is how the trick works: The central bank buys government bonds, thereby pushing the interest rates to levels below the rate of inflation. This means that inflation is greater than the growth in interest rates, so that real interest rates become negative. Put differently, inflation consumes assets. Or, to put it even more bluntly: Saving becomes pointless.”
A history of administered interest rates and 'CPI inflation' in Germany, via Der Spiegel
Do we really want 'saving to become pointless'? Central bankers continue to insist that this is 'necessary' in order to 'support the economy'. But how can the economy possibly be 'supported' by a policy that consumes capital? As Frank Shostak recently pointed out in this context:
“Regardless of psychological disposition, if the ability to generate final goods and services diminishes, it is not possible to boost overall demand for goods and services. We could convince individuals that the Fed's monetary pumping is going to revive the economy and therefore that it is in their own interest to start buying more goods and services. However, if the backup is not there — i.e., if there isn't an increase in the production of real wealth (final consumer goods and services) — it is not going to be possible to expand the overall demand.”
We hold that it is a fallacy to suggest that Bernanke's monetary pumping has prevented the US economy from falling into a severe depression. What Bernanke's policy has done is to prevent the removal of various non-productive, wealth-destroying activities that emerged on the back of previous loose monetary and fiscal policies.
Obviously, if Bernanke hadn't stepped in with massive pumping, a large amount of bubble activities would have been liquidated by now. This would have provided more real wealth to wealth generators and would have set in motion a genuinely solid economic expansion. This would have strengthened the economy's ability to generate real wealth.
By introducing another massive monetary-pumping scheme Bernanke is running the risk of inflicting more damage to the process of real wealth generation. Consequently, this raises the likelihood that we could remain in depressed economic conditions over a prolonged period of time.
It must be realized that the damage inflicted on the economy by reckless monetary and fiscal policies cannot be fixed by further aggressive monetary pumping and by lifting people's confidence in the Fed's policies.”
Amen to that – as we always point out, one cannot possibly 'print one's way to prosperity'. The exact opposite is in fact true: the policy diminishes the economy's ability to generate true wealth.
If anything, “we” are printing ourselves into the poorhouse.
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK -Oct 7th- Oct 14th, 2012
Companies are taking advantage of investors' appetite for yield—and fear of riskier bets—by issuing more long-term bonds, aiming to reduce their refinancing needs in coming years, when interest rates are likely to be higher.
Investment-grade companies have sold more 30-year bonds in the U.S. so far in 2012 than in any full year since 1995, according to data provider Dealogic.
The $91.9 billion of 30-year bonds sold in 166 offerings this year, is about 26% more than the $73.2 billion sold in 145 deals during all of 2011.
Issuers are being drawn to the longer maturities by low interest rates, the result of the Federal Reserve's loose monetary policy and the global economy's continuing weakness. For investors, the longer maturities provide better returns than shorter-term debt without the default worries associated with the high-yielding debt of some of Europe's troubled economies.
However, more long-term debt issuance now could limit the supply of bonds in the future, meaning investors will need to find other places to put their cash. For corporations, there is a sense that now is as good a time as any to raise debt, particularly as the near-term economic outlook dims.
That view helped make
September the second busiest month for 30-year issuance this year, with 24 companies raising $12.3 billion.
"No treasurer or CFO wants to be the one treasurer or CFO who didn't get cheap long-term money when it was available," says Mark Gray, an analyst with Moody's Investors Service.
UPS: Among those tapping the market was United Parcel Service Inc. UPS -1.00% On Sept. 24, UPS refinanced $1.75 billion of five-year bonds coming due in January 2013 through a three-part bond deal, including $375 million of 30-year bonds that paid 3.625% annually. The timing of the deal "was a combination of the current credit market and looking at avoiding fourth-quarter uncertainty," said UPS spokeswoman Susan Rosenberg. Ms. Rosenberg said that there was seven times the demand for the bonds than the amount available. She added that the company wanted to raise the funds ahead of any disruption to the economy caused by government negotiations over tax and spending cuts.
GE: The corporate-debt market is enticing many companies that haven't issued long-dated bonds for years. General Electric Co. GE -1.03% jumped in on Oct. 1, selling $7 billion of bonds, including $2 billion of 30-year bonds. Although GE's finance arm, GE Capital, is a frequent bond issuer, the recent offering was the first by the parent company in five years. The company plans to use part of the proceeds to refinance $5 billion of debt coming due in February 2013. A GE spokesman said the issuance was consistent with its strategy of being "opportunistic in accessing markets and prefunding maturities, particularly with interest rates at historically low levels."
COMCAST: On Sept. 28, Comcast Corp. CMCSA -1.77% sold $1 billion of 30-year bonds for its NBCUniversal subsidiary, with a 4.45% rate, compared with rates ranging between 6.5% and 7% for 30-year bonds Comcast sold in past years. That difference represents an annual interest-payment savings of roughly $20 million on $1 billion of debt.
SPREAD: Investor demand for corporate bonds has narrowed their spread with benchmark 30-year U.S. Treasurys. The spread measures how risky investors consider the bonds relative to U.S. Treasurys, which are considered among the safest investments. On Thursday, the spread between 30-year Treasurys, which yielded 2.89%, and 30-year corporate debt was 1.83 percentage points, the lowest since Aug. 10, 2011, according to S&P Capital IQ's Leveraged Commentary & Data unit. The tighter spread suggests investors see less risk in corporate bonds.
The low yields present a problem to investors, because they are buying bonds at historically high prices that will fall if the Fed begins raising interest rates. Bond prices move in the opposite direction of interest rates. However, bond-fund managers have little choice but to buy the debt, if they can, especially when highly regarded issuers like GE re-enter the market.
Investment-grade companies have been very stable lately. Moody's Mr. Gray said that only four companies have suffered ratings downgrades since July, "which speaks to the fact that things are pretty stable out there." He added that the long-term issuance is a positive for companies.
"If a company can lock in cheap long-term money for a refinancing, it takes maturity risk out of the equation for a long time. Over the near term it gives a company breathing room," Mr. Gray said. The demand is making it easy for companies to come to market, particularly those with the higher ratings. "Whether you're mid-BBB or mid-A, if you're a solid, large market cap company in a noncyclical industry, you've got very, very good access," said one investment-grade bond banker.
CREDIT / BONDS / SPREADS / YIELDS
6- Bond Bubble
FISCAL CLIFF - Congress Bying Time Before the Inevitable
BASICALLY A "STALL PROGRAM" before the inevitable arrives.
With US Federal tax (mostly) and spending (far less) policy having become two of the key issues of the ongoing presidential debate, we wish to present to our readers 111 years of US revenue and spending data, both in absolute terms, and as a percentage of GDP.
Two things to observe:
Between the passage of the 16th Amendment, which ushered in the modern Federal income tax, in 1913, and the end of WW I, the US somehow managed to exist with only 2% of Federal tax revenue as a % of GDP. Then the war ended, and it was all downhill from there, with Federal tax as a % of GDP first flatlining around 5-6% of GDP, and then after WW II, it found a new home just shy of 20%. One wonders what the new benchmark support for US Federal tax will be after the next global war.
Spending, unlike taxes, have been far more erratic, and far larger on average, than Tax revenues. In fact, in the 82 years after 1930, there have been only 14 budget surpluses. Of note: the four years of Clinton budget surpluses between 1998 and 2001 were the first time Federal tax revenues surpassed spending since 1969. Judging by the recent explosion in government spending, which we doubt will ever be reduced to historical trendline again, the US can kiss the concept of budget surplus goodbye for ever.
Federal tax and spending in absolute dollars - 1900-2011:
Federal tax and spending as % of GDP - 1900-2011:
13 - Global Governance Failure
GLOBAL GROWTH - IMF Cuts Growth from 3.9% to 3.6%and Increases Deficit Multiplier by 100 to 200%
The IMF now believes economic output will expand by 3.6 per cent in 2013, down from its July estimate of 3.9 per cent. But this assumes the US Congress will take action to avoid the “fiscal cliff” – the automatic expiry of tax cuts and introduction of spending reductions next year – and that eurozone governments will follow the European Central Bank’s plan to buy sovereign debt by committing to economic reform and closer integration.
“A key issue is whether the global economy is just hitting another bout of turbulence in what was always expected to be a slow and bumpy recovery or whether the current slowdown has a more lasting component,” the IMF said. “The answer depends on whether European and US policy makers can deal proactively with their major short-term economic challenges.”
Economic uncertainty would continue to weigh on output in both advanced and emerging markets, the fund added, though it remained comparatively upbeat on the outlook for China.
CHINA: Growth estimates for China for this year and next were revised downwards by a fifth of a percentage point to 7.8 per cent and 8.2 per cent respectively, but the IMF believed there would be a soft landing for the world’s second-largest economy, along with the rest of the region. “The outlook is for a modest pick-up in growth on the back of recent policy easing,” the IMF said.
UK: The IMF slashed its forecast for the UK economy this year from growth of 0.2 per cent to a contraction of 0.4 per cent. The fund now expects growth of 1.1 per cent next year, down from an estimate of 1.4 per cent. The new forecasts are broadly in line with those of private sector economists.
The fund points to new analysis showing that governments’ assumptions about the trade-off between fiscal consolidation and growth had been too favourable, and cutbacks would do more damage to output than their economic forecasts predicted.
The IMF said that evidence from 28 countries shows that so-called fiscal multipliers, used by governments to assess the impact on growth of fiscal cutbacks, have underestimated the damage to the economy. “The multipliers used in generating growth forecasts have been systematically too low since the start of the great recession,” the IMF said. A smaller multiplier implies fiscal consolidation is less costly.
Olivier Blanchard, chief economist, indicated on Tuesday that the analysis had influenced the Fund’s policy prescriptions for countries under IMF programmes. Mr Blanchard cited the troika’s recent relaxation of Portugal’s deficit target for 2013 to 4.5 per cent of gross domestic product from 3 per cent, saying: “When the case is fair, we have to get ready to adjust targets given that fiscal multipliers are so large.”
According to the IMF, policy documents seen by fund officials suggest that governments are commonly using fiscal multipliers of about 0.5 to calculate the impact of austerity on growth. A multiplier of 0.5 would mean that for every $1 lost in government spending, 50 cents is wiped from output.
“Our results indicate that multipliers have actually been in the 0.9 to 1.7 range since the great recession,” the fund said.
Mr Blanchard said fiscal multipliers were substantially larger than usual because the impact of fiscal cutbacks could not be offset by looser monetary policy. “We are in a period where many countries are in a liquidity trap and monetary policy is much more constrained than in normal times,” he said.
The chief economist said Spain and Italy should receive financial assistance in the form of direct bank recapitalisations and lower borrowing costs, once they followed through with adjustment plans.
The IMF called for the European Stability Mechanism, the eurozone’s permanent bailout fund, to be made operational as soon as possible to inject capital directly into banks based in the periphery. Funds to ensure sovereigns could borrow “at reasonable cost” could be channelled through either the ESM or the European Financial Stability Facility, the bloc’s temporary rescue vehicle.
17 - Shrinking Revenue Growth Rate
GLOBAL GROWTH - IMF Cuts Advanced Economies Growth by 25% from 2.0% to 1.5%
The IMF has cut global growth expectations for advanced economics from 2.0% to only 1.5%. Quite sadly, they see two forces pulling growth down in advanced economies: fiscal consolidation and a still-weak financial system; and only one main force pulling growth up is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general. A general feeling of uncertainty weighs on global sentiment. Of note: the IMF finds that "Risks for a Serious Global Slowdown Are Alarmingly High...The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO. For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area." And yet probably the most defining line of the entire report (that we have found so far) is the following: "Central bank capital is, in many ways, an arbitrary number." And there you have it, straight from the IMF.
Global growth is too weak to bring down unemployment and what little momentum exists is coming primarily from central banks, the International Monetary Fund said in its World Economic Outlook, released ahead of its twice-yearly meeting, which will be held in Tokyo later this week.
The keyword is momentum. Or rather lack thereof:
Policy tightening in response to capacity constraints and concerns about the potential for deteriorating bank loan portfolios, weaker demand from advanced economies, and country-specific factors slowed GDP growth in emerging market and developing economies from about 9 percent in late 2009 to about 5¼ percent recently. Indicators of manufacturing activity have been retreating for some time (Figure 1.3, panel 1). The IMF staff’s Global Projection Model suggests that more than half of the downward revisions to real GDP growth in 2012 are rooted in domestic developments.
Growth is estimated to have weakened appreciably in developing Asia, to less than 7 percent in the first half of 2012, as activity in China slowed sharply, owing to a tightening in credit conditions (in response to threats of a real estate bubble), a return to a more sustainable pace of public investment, and weaker external demand. India’s activity suffered from waning business confidence amid slow approvals for new projects, sluggish structural reforms, policy rate hikes designed to rein in inflation, and flagging external demand.
Real GDP growth also decelerated in Latin America to about 3 percent in the first half of 2012, largely due to Brazil. This reflects the impact of past policy tightening to contain inflation pressure and steps to moderate credit growth in some market segments—with increased drag recently from global factors.
Emerging European economies, following a strong rebound from their credit crisis, have now been hit hard by slowing exports to the euro area, with real GDP growth coming close to a halt. In Turkey, the slowdown has been driven by domestic demand, on the heels of policy tightening and a decline in confidence. Unlike in 2008, however, generalized risk aversion toward the region is no longer a factor. Activity in Russia, which has benefited various economies in the region, has also lost some momentum recently
IMF isn't happy about Europe:
Notwithstanding policy action aimed at resolving it, the euro area crisis has deepened and new interventions have been necessary to prevent matters from deteriorating rapidly. As discussed in the October 2012 Global Financial Stability Report (GFSR), banks, insurers, and fi rms have swept spare liquidity from the periphery to the core of the euro area, causing Spanish sovereign spreads to hit record highs and Italian spreads to move up sharply too (Figure 1.2, panel 2). Th is was triggered by continued doubts about the capacity of countries in the periphery to deliver the required fi scal and structural adjustments, questions about the readiness of national institutions to implement euro-area-wide policies adequate to combat the crisis, and concerns about the readiness of the European Central Bank (ECB) and the European Financial Stability Facility/ European Stability Mechanism (EFSF/ESM) to respond if worst-case scenarios materialize.
These concerns culminated in questions about the viability of the euro area and prompted a variety of actions from euro area policymakers. At the June 29, 2012, summit, euro area leaders committed to reconsidering the issue of the seniority of the ESM with respect to lending to Spain. In response to escalating problems, Spain subsequently agreed on a program with its European partners to support the restructuring of its banking sector, with financing of up to €100 billion. Also, leaders launched work on a banking union, which was followed up recently with a proposal by the European Commission to establish a single supervisory mechanism. Leaders agreed that, once established, such a mechanism would open the possibility for the ESM to take direct equity stakes in banks. This is critical because it will help break the adverse feedback loops between sovereigns and banks. Moreover, in early September, the ECB announced that it will consider (without ex ante limits) Outright Monetary Transactions (OMTs) under a macroeconomic adjustment or precautionary program with the EFSF/ESM. The transactions will cover government securities purchases, focused on the shorter part of the yield curve.
Importantly, the ECB will accept the same treatment as private or other creditors with respect to bonds purchased through the OMT program. (ZH: not really - especually not when the ECB has to see its bonds incur losses - see Greece)The anticipation of these initiatives and their subsequent deployment set off a relief rally in financial markets, and the euro appreciated against the U.S. dollar and other major currencies. However, recent activity indicators have continued to languish, suggesting that weakness is spreading from the periphery to the whole of the euro area (Figure 1.3, panel 2). Even Germany has not been immune.
.. or the US:
The U.S. economy also has slowed. Revised national accounts data suggest that it came into 2012 with more momentum than initially estimated. However, real GDP growth then slowed to 1.7 percent in the second quarter, below the April WEO and July WEO Update projections. The labor market and consumption have failed to garner much strength.
Could have fooled the BLS and the brand spanking news "7.8% unemployment rate."
The IMF concludes there is little to worry about as a result of global QEternity, an observation that certainly explains the following statement: "Central bank capital is, in many ways, an arbitrary number." ... right.
Risks related to swollen central bank balance sheets
The concern is that the vast acquisition of assets by central banks will ultimately mean a rise in the money supply and thus inflation (Figure 1.5, panel 3). However, as discussed in previous WEO reports, no technical reason indicates this would be inevitable. Central banks have more than enough tools to absorb the liquidity they create, including selling the assets they have bought, reverting to traditionally short maturities for refinancing, raising their deposit rates, and selling their own paper. Furthermore, in principle, central bank losses do not matter: their creditors are currency holders and reserve-holding banks; neither can demand to be paid with some other form of money. The reality, however, may well be different. A national legislature may see such losses as a symptom that the central bank is operating outside its mandate, Central bank capital is, in many ways, an arbitrary number, as is well illustrated by the large balance sheets of central banks that intervene in foreign exchange markets (Figure 1.5, panel 4). which could be of concern if it led to efforts to limit the central bank’s operational independence. A related concern is that economic agents may begin to doubt the capacity of central banks to fight inflation. Two scenarios come to mind:
Public deficits and debt may run out of control, causing governments to lean on central banks to pursue more expansionary policies with a view to eroding the real value of the debt via inflation. Similarly, losses on holdings of euro area, Japanese, and U.S. (G3) government securities may cause emerging market economies’ central banks or sovereign wealth funds to buy fewer G3 government assets, investing instead in better opportunities at home and triggering large depreciations of G3 currencies.
Policymakers may falsely perceive central bank balance sheet losses to be damaging to their economies. Such perceptions may make central banks more hesitant to raise interest rates, because doing so would decrease the market value of their asset holdings. The mere appearance of such hesitation may lead private agents to expect an increase in inflation
And some absolute profundity:
Risks related to high public debt levels
Public debt has reached very high levels, and if past experience is any guide, it will take many years to appreciably reduce it (see Chapter 3). Risks related to public debt have several aspects. First, when global output is at or above potential, high public debt may raise global real interest rates, crowding out capital and lowering output in the long term.3 Second, the cost of debt service may lead to tax increases or cutbacks in infrastructure investment that lower supply. Third, high public debt in individual countries may raise their sovereign risk premiums, with a variety of consequences—from limited scope for countercyclical fiscal policies (as evidenced by the current problems in the euro area periphery) to high inflation or outright default in the case of very large increases in risk premiums.
Simulations with the GIMF suggest that an increase in public debt in the G3 economies of about 40 percentage points of GDP raises real interest rates almost 40 basis points in the long term (Box 1.2). This simulation and discussion necessarily abstracts from the potential long-term benefits of fiscal stimulus. The 2009 stimulus, for example, was likely instrumental in averting a potential deflationary spiral and protracted period of exceedingly high unemployment, macroeconomic conditions that general equilibrium models such as the GIMF are not well suited to capture. Bearing this in mind, the simulation suggests that in the long term the higher debt lowers real GDP by about ¾ percent relative to a baseline without any increase in public debt. This is because of the direct effect of higher interest rates on investment and the indirect effect via higher taxes or lower government investment. The GIMF simulations indicate that within the G3 the negative effects would be larger, with output 1 percent below baseline projections. The loss of output over the medium term would be even larger if, for example, savings were to drop more than expected because of aging populations in the advanced economies or if the consumption patterns of emerging market economies with very high saving rates align more quickly than expected with those of advanced economies.
Scenarios that involve very high levels of debt and high real interest rates may not only result in lower growth but may also involve a higher risk of default when fiscal dynamics are perceived to be unstable. This combination of high debt and high real interest rates can lead to bad equilibriums, when doubt about the sustainability of fiscal positions drives interest rates to unsustainable levels.
In other words, according to the IMF's brain trust, soaring debt, and exploding interest rates may lead to default. And that is why they get paid the big SDRs.
Risks for a Serious Global Slowdown Are Alarmingly High
The WEO’s standard fan chart suggests that uncertainty about the outlook has increased markedly (Figure 1.11, panel 1). The WEO growth forecast is now 3.3 and 3.6 percent for 2012 and 2013, respectively, which is somewhat lower than in April 2012. The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO.
The IMF staff’s Global Projection Model (GPM) uses an entirely different methodology to gauge risk but confirms that risks for recession in advanced economies (entailing a serious slowdown in emerging market and developing economies) are alarmingly high (Figure 1.12, panel 1). For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area.
As we have painstakingly pointed out, rising equity markets in 2012 have mostly been a function of rising multiples applied to relatively stagnant earnings.
While JPMorgan's CIO Michael Cembalest would have given odds no better than 1 in 4 of a 17% advance in the S&P this year, he does note that forecasting annual equity returns is an entirely treacherous (and we add foolish) exercise as real return variation has completely swamped industry expectations for the last 60 years.
The traditional Graham-Dodd/Shiller valuation model makes equities look expensive currently, but Cembalest notes, valuations might not be the driving factor at this point.
The debasement of money by the Fed has altered the calculus of investing for many participants, and not necessarily for the better (as he notes ongoing work that hints at since the Greenspan/Bernanke era of negative real interest rates began, stock market volatility is even higher than before the creation of the Fed in 1913).
Of course, by driving interest rates down and promising to keep them there, a 7% nominal equity earnings yield (i.e., a 14 P/E) is transformed into a more compelling investment - but critically (especially for social and political reasons) the 'value' of this adjusted earnings yield is questionable given the earnings boom is derived from extraordinarily weak labor compensation and potentially unsustainable demand from Europe/China.
The growth of corporate profits has delinked from nominal GDP growth, a departure from past cycles.
This is unfamiliar territory for investors, since it suggests that you should just ignore weak domestic growth concerns and watch profits keep rising. The political and social risks of this trend are self-evident.
21 - US Stock Market Valuations
EARNINGS ESTIMATES - First Earnings Decline in 11 Months of - 1.34%
For the first time in 11 quarters, companies in the Standard & Poor's 500-stock index are likely to show a decline in profits, overall
Estimates from S&P Capital IQ call for a 1.34% decline, while in the second quarter, earnings managed to cling to positive territory with a 0.81% growth rate.
The consensus forecast for aggregate third-quarter earnings on S&P 500 companies is now $25.01 a share, down 4.5% from June 30, according to FactSet Research SystemsFDS +0.22% . FactSet notes, however, that the decline is only a touch bigger than the average downward revision over the past 10 years of 4.3%.
Paying particular attention to the number of earnings warnings compared with the number of upbeat announcements. He pegs the ratio at 4-to-1, the highest since the third quarter of 2001, when the economy was lumbering after the bursting of the technology-stock bubble. Mr. Bohnsack said the combined weakness of the second and third quarters is significant, a bearish sign for stocks over the long term, even if the Fed helps prop up the market initially.
declining revenue and shrinking profit margins, would signify a serious deterioration in corporate health that could undermine any stock-market gains over the long haul.
"This foreshadows a prolonged deceleration in earnings". Strategas, which counts itself in the "defensive" camp on stocks, expects 2012 S&P 500 earnings to come in at $100.50 per share, compared with a FactSet consensus forecast of $103.24.
21 - US Stock Market Valuations
EARNINGS ESTIMATES - 4.3 Up versus Down Revisions Highest Since 2001
Downward EPS revisions have outnumbered upward revisions for 22 weeks
For the S&P 500 companies, there have been 91 negative pre-announcements versus 21 positive
The 4.3x negative-to-positive pre-announcement ratio is the highest since 2001
Of the S&P 500 companies that have reported thus far (25 total), only 52% have exceeded expectations (long-term average is 63% and last four quarters average 67%)
Overall Q3 earnings are expected to fall 2.5%
And as a reminder - Via Citi:
When investors consider the earnings expectations for the next several quarters, it must be noted that a few sectors seem to have an abundance of optimism that may or may not be warranted. For example, the Materials sector is showing a big bounce in 1H13 earnings projections that may require much more clarity on global economic reacceleration, while Financials are expected to rise sharply as well. Hence, these two areas might require some ratcheting down of forecasts and management teams may begin to do so in the next few weeks.
We have highlighted some of current measures of complacency, which may not be entirely appropriate in the very near term (next couple of months) given the US elections and the related fiscal cliff, recent European social unrest and the need to curtail some of the profit growth enthusiasm. In the medium term (2013), many of the analytical models we use still argue for overall market gains, and thus we believe weakness should be seen as a buying opportunity.
Companies in the S&P 500 had $1.5 trillion parked outside the U.S. for which they hadn't accrued tax expense in 2011, more than double the amount five years earlier.
When companies park cash overseas indefinitely, they are essentially saying there is a pool of profit that is out of the reach of shareholders. This also means part of a company's "free" cash flow may be anything but. So these profits essentially become "look, but don't touch earnings," Jack Ciesielski, editor of the Observer, argued late last month at a Senate hearing examining offshore profit shifting and the U.S. tax code. Of course, a company can decide to bring the profits back to the U.S. But if it chose not to take an expense for future taxes when the overseas profit was first generated, this would result in a potentially enormous hit to earnings.
Goldman's equity strategist David Kostin has been very quiet for the past year, having not budged on his 2012 year end S&P target of 1250 since late 2011. Today, he finally released a revised forecast, one that curious still leaves the year end forecast unchanged at a level over 200 points lower in the S&P cash, and thus assuming a ~15% decline. The reason: the same fiscal cliff (which would otherwise deduct 5% in GDP growth) and debt ceiling debate we have warned will get the same market treatment as it did in August of 2011 when the only catalyst was a 15% S&P plunge and a downgrade of the US credit rating. However, one the fiscal situation is fixed, Kostin sees only upside, with a 6 month target of 1450 ("We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed."), and a year end S&P target of 1575, calculated by applying a 13.9 multiple to the firm's EPS forecast of 114. Of course, this being bizarro Goldman Sachs it means expect a continued surge into year end, then prolonged fizzle into the new year. Why? Because there is not a snowball's chance in hell the consolidated S&P earnings can grow at this rate, especially not if the Fiscal Cliff compromise is one that does take away more than 1% of GDP thus offsetting all the "benefit" from QE.
Simply said, companies who have already eliminated all the fat, and most of the muscle, and are desperate for revenue growth to generate incremental EPS increase, have not invested in CapEx at nearly the rate needed to maintain revenue growth (see How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement) having dumped all the cash instead in such short-sighted initiatives as dividends and buybacks. Also, recalling that revenues are now outright declining on a year over year basis, and one can see why anyone assuming a 14% increase in earnings in one year, is merely doing all they can to make the work of their flow desk easier.
Equities are attractive for long-term investors but face near-term risks. We forecast S&P 500 will reach 1575 at year-end 2013 based on our new 2014 EPS estimate of $114 and a fair value P/E of 13.9X. The FOMC’s open-ended easing program allows investors to look past current stagnant economic growth and focus on corporate fundamentals. So far QE has reduced the equity risk premium but not yet improved growth expectations. However, in the near-term we apply a valuation discount due to fiscal policy uncertainty. Our year-end 2012 price target remains 1250
Downside risk through year-end stems from ‘fiscal cliff’ uncertainty Investors are too complacent that Congress reaches compromise on the divisive issues of taxes and spending during the six weeks between the Nov 6 election and Jan 1 when $576 billion of fiscal contraction starts.
New QE policy supports rising EPS in 2014 and the market will follow Although Congress may stumble, we assume it reaches agreement in early 2013 to delay full impact of the ‘fiscal cliff’. Open-ended QE has eased financial conditions and will continue to support GDP growth. We raise our 2013 S&P 500 EPS estimate to $107 and introduce a 2014 estimate of $114.
S&P 500 will establish a new high of 1575 at year-end 2013 We forecast S&P 500 will reach 1575 by year-end 2013, 9% above current and 1% above the 2007 peak. Once policy risks are addressed investors can focus on the trajectory of EPS growth, high ROE, and valuation metrics.
We apply a valuation discount to S&P 500 through year-end due to fiscal policy risks but see attractive upside over the medium-to long-term. Open-ended QE allows investors to look past current stagnant economic growth and assign valuation consistent with strong fundamentals. We introduce a 2014 EPS estimate of $114 and a year-end 2013 S&P 500 target of 1575 but maintain our 2012 year-end target of 1250.
Two of the three pillars of our 2012 framework for analyzing the US equity market have stood firm, but one has not – valuation. US GDP growth has been below trend at 2% and our top-down 2012 S&P 500 EPS estimate has remained unchanged at $100 since the start of the year. Meanwhile, consensus sales and earnings estimates have dropped by 1% and 5%, respectively, since early 2012. Despite that, valuation is notably higher.
Our expectation that S&P 500 valuation would remain flat in 2012 in the face of stagnating economic and earnings growth has been incorrect. Investor response to Fed and ECB policy actions since June 2012 was far more dramatic than we anticipated. The forward P/E multiple has expanded by 15% to 13.4x and S&P 500 has advanced by 15% YTD, reversing the pattern of 2011 when EPS rose by 15% but S&P 500 ended flat at 1258.
We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed. The FOMC’s commitment to pursue a loose monetary policy until unemployment falls should allow investors to look through the current period of stagnation and assign a valuation multiple consistent with corporate fundamentals, once fiscal policy risk abates.
Our S&P 500 price targets are 1250 at year-end, 1450 in 6 months and 1575 at yearend 2013. Those estimates suggest returns of -14%, 0%, and +9% over those time periods. Our year-end 2012 forecast is below our estimate of fair value due to high uncertainty from the impending December 31 ‘fiscal cliff’.
Our baseline assumption is that fiscal issues will be resolved during 1Q 2013 but they remain the largest medium-term risk to US equity performance and economic growth. Our US Economists expect $193 billion of fiscal consolidation out of the potential $576 billion total, representing a drag of about 120 bp on 2013 GDP.
Although we forecast a rising stock market in 2013, numerous headwinds remain for equity performance that policy action must overcome: Consensus 2013 EPS estimates remain too high despite sales and EPS revisions that have been consistently negative in 2012; S&P 500 margins have declined for three quarters; US GDP growth continues to stagnate near 2%; China economic growth has been reduced ahead of an important political transition in November; and political and policy uncertainty remains high in Europe along with risk to Euro area growth. The major near-term policy risk relates to possible 1Q 2013 fiscal consolidation of roughly 4% of GDP under a worst case outcome.
Our S&P 500 EPS, revenue and ROE estimates remain largely unchanged as QE was already an element of our US GDP forecasts. We expect S&P 500 will earn $100 per share in 2012, $107 in 2013 and $114 in 2014, with revenue growth of approximately 5% in each year. Our ROE forecasts remain 17.5% for 2012 and 17.3% for 2013 for the S&P 500 due to weak Financials ROE but 19.7% and 20.7% on an ex-Financials basis.
Slow growth, low inflation and high unemployment justify additional easing. Goldman Sachs US Economics forecasts real US GDP growth of 2.2% in 2012 and 1.9% in 2013. They forecast benign core PCE inflation below 2% and expect the US unemployment rate will remain above 8%. Our forecasts are modestly more conservative than the FOMC central tendency outlook as well as consensus expectations. We assume GDP growth of 2.5% in 2014 as an input in our top-down sales, margin, and EPS.
We revise our 2013 S&P 500 earnings estimate to $107 (from $106) and introduce a 2014 EPS forecast of $114 per share. Our new estimates imply EPS growth of 4% in 2012, 7% in 2013, and 6% in 2014. Our EPS estimates are below current bottom-up consensus EPS estimates in 2012, 2013 and 2014 of $102, $115 and $128, respectively (see Exhibit 1).
Our regression-based model of sales and net margins for each sector drives our earnings forecasts for individual sectors and for the overall S&P 500. Variables included in our sales and margin models encompass US GDP growth, world GDP growth, 2-year and 10- year US Treasury rates, Brent crude oil, core inflation, and the tradeweighted US Dollar (see Appendix A for our macroeconomic assumptions).
The level of sales is highly correlated with nominal economic growth. We assume the nominal size of the US economy will grow by 3.7% in 2013 and by 4.6% in 2014. Given more than 30% of aggregate revenues of S&P 500 companies take place outside of the US, our model forecasts S&P 500 sales will rise by 4.4% in 2013 and 4.7% in 2014, respectively.
Our revenue growth forecast is in-line with consensus expectations. We forecast trailing four quarter net margins will return to the previous peak of 8.9% by 2013 before rising to a new peak of 9.0% in 2014. Higher labor costs and decelerating margin expansion in the Information Technology sector are headwinds to further margin expansion at the index-level (see Exhibit 4). Consensus expects aggressive margin expansion of 60bp in both 2013 and 2014. Bottom-up consensus forecasts S&P 500 margins will reach new peak levels by 1Q 2013.
To summarize: Goldman rejoins the sellside groupthink. It will be wrong once again.
21 - US Stock Market Valuations
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
One of the most egregious aspects of the Great Moderation was the issuance of large amounts of grossly mispriced extremely 'junky' debt at the peak as investors stymied by the lack of spread (return) pushed further and further out the credit risk spectrum. The driver at the time was the liquidity flood triggered by large-scale securitizations (and that ended well eh?); this time it is central banks providing the fuel for investors to seek yield through leverage (either through fundamental leverage in riskier firms or technical leverage through riskier instruments). To wit, the last few weeks have seen a resurgence of issuance of PIK-Toggle bonds.
These extreme junk credit-rated bonds with very high default risk offer 'attractive' yields relative to the financially repressed idiocy of the rest of the capital markets but the Pay-In-Kind nature means simply - do not expect coupons and principal return in cash, but we promise to pay that principal back by offering you more 'junky' bonds (extending maturity for example).
Issuance of PIKs has re-surged once again
The last time we saw a surge like the current one was during the ECB's LTRO fiasco, and once again with QEternity on the table, that excess liquidity 'forces' money to work in these over-leveraged and under-compensated (risk-wise) instruments. With rates held low and IG and HY spreads technically compressed, we suspect we will see more PIK-Toggle, Cov-Lite, Junior-Mezz CLOs - and suspect this won't end well.
and CNBC's Gary Kaminsky pointing out the junkiness of these deals..."This is Junk, This is Bad!"
MONETARY POLICY - Focused on Avoiding US Debt Insolvency
The first shows S&P earnings vs. what S&P earnings had been expected to be by analyst 12 months previous going back to 1991. For the most part, the lines have been close.
But what's really interesting is the second chart showing the relationship as a spread. For basically 20 years, Wall Street earnings forecasters have been habitually over-optimistic, and S&P earnings almost always miss, with just a few tiny exceptions.
It may come as a surprise (until very recently) to many who watch the flashing red headlines spewed forth by Bloomberg and Reuters terminals as each and every firm manages to coincidentally report earnings within a smidge of guidance (and maintain their 'near-perfect' records of 'sustainable' growth) when all around the signals seem to point to an economy in malaise. However, earnings quality - that ephemeral view of just how manipulated the end number really is - remains critical (in the medium-term, if not the short-term thanks to the headline-reading algos). To wit, Bloomberg notes a recent paper (below) that finds 20% of CFOs will "manage earnings to misrepresent economic performance" with 93.5% admitting it is to influence the stock price. 'Red flag's include EPS inconsistent with cash-flows, unusual accruals, or an industry outlier. Amid pressure to maintain stock prices (and keep a career going), 60% of earnings 'management' is to increase income and of course 66% of CFOs hope for fewer accounting rules going forward.
93.45% of CFOs responded the motivation to cheat (our word) was to influence the stock price!!.. and 88.62% to increase their own compensation!!!
So the next time a CEO/CFO says anything - and it is heralded as something other than self-serving tripe - please read this report one more time!!
S&P 500 EPS is forecast by consensus to decline 2% both sequentially and YoY in 3Q12 driven by net margin compression. As Morgan Stanley's Adam Parker notes, it appears (for now) that we can have an earnings recession without an economic recession; but the disconnect may be a lag as opposed to a decouple. Roughly 50% of companies are expected to experience YoY contraction in net margins but - and this is the 'funny' segment of this post - consensus expects an 18.2% incremental margin expansion in 2013 (from a 7.2% rise in 2012 which is down from 13.1% rise in 2011); and while 3Q EPS is expected to be negative, the following three quarters EPS growth are expected to rise dramatically (double that of 2012 on average). It seems investors (and analysts) are still willing to believe in miracles.
This is one of Morgan Stanley's chief concerns. Currently, the consensus embeds very optimistic 2013 incremental margin expectations, accelerating at a time when a potential fiscal cliff is imminent and profit margins are already at record levels.
We doubt that companies can drop through 18 cents for every dollar they grow revenue in 2013.
Remember, earnings are declining for the entire S&P500 right now!
but are expected rise dramatically in the quarters to come - again by some miracle - even after 3Q2012 EPS has been reduced notably already - with 4Q12 EPS dropping to wher 3Q12 was 7 months ago...
Priced In? Only if you think Fed-driven multiple-expansion is the 'alter-ego' of reality...
The following two slides come from Alcoa's earnings presentation. The first looks at demand growth from industrial end markets. The second looks at demand growth based on regional end markets. One stat that stands out is the huge decline in truck and trailer production in China, which confirms the warning that truck engine maker Cummins gave tonight.. As you can see in the second slide, demand in much of the world is expected to have decelerated in the second half.
Cummins Lowers 2012 Revenue and EBIT Guidance. Company Also Announces Necessary Actions to Respond to Global Economic Slowdown.
“We continued to see weak economic data in a number of regions during the third quarter increasing the level of uncertainty regarding the direction of the global economy.
Demand in China has weakened in most end markets and we have also lowered our forecast for global mining revenues. EBIT margins will also be below our previous guidance primarily due to the sharp reduction in revenues.”
CMI is down over 7% after-hours (to three-month lows) as it seems the 16% cut expectations in Aluminum demand that Alcoa just announced can no longer be ignored. Reality is that Cummins is slashing guidance and cutting jobs in "response to the weakening global economy."
*CUMMINS TO CUT UP TO 1500 JOBS, LOWERS YEAR REV, EBIT FORECASTS
*CUMMINS SEES YEAR EBIT ABOUT 13.5%, SAW 14.25%-14.75% :CMI US
*CUMMINS PRELIM 3Q REV. ABOUT $4.1B, EST. $4.425B :CMI US
*CUMMINS SEES 2012 REV. $17B, SAW $18B, EST. $18.11B :CMI US
CORPORATOCRACY -CRONY CAPITALSIM
GLOBAL FINANCIAL IMBALANCE
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