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
CURRENCY WARS: The Fighting Resumes - The "Race to the Bottom" Monetary Policy Programs Accelerates
THE "UNLIMITED" & "UNCAPPED" SALVO - The macroprudential policy strategy of Financial Repression reached a seminal point last month with the announcement of the Federal Reserve's "Unlimited" QEIII/Operation Twist and the ECB's "Uncapped" OMT. We have moved into the outer limits of Monetary Policy which now forces the accelerated currency debasement of the developed economies against its Asian & BRIC competitors. The 'race to the bottom' has entered another phase which now sets the battle lines for the next set of conflicts.
In case you haven't been keeping score, here is how the "Race to Debase" currently stands. (see right) 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 Technical Analysis coverage available this month.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & EXECUTIVE BRIEF
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
European Union leaders meet here Thursday and Friday for talks that aren't expected to yield any big breakthroughs, but that will likely shed light on deep divisions within the 27-member bloc over decisions due in coming months—from
Establishing a single banking supervisor and creating a banking union
Introducing a central euro-zone budget.
The trenches for battle over these issues are being set up. The meeting comes as
Spain is signaling it is prepared to ask for a broader assistance package on top of a bailout it has secured for its banking sector,
euro-zone leaders and the International Monetary Fund are still trying to square the circle of keeping Greece afloat without giving it additional aid.
EU leaders might discuss the situation in these two countries at the margins of the summit and issue a brief, general statement on Greece, but no specific decisions are expected, officials said.
A BANKING UNION & A SINGLE BANKING SUPERVISOR
The most contentious part of the agenda will be the timing of launching a single bank supervisor under the European Central Bank for the 17 euro-zone countries, plus any non-euro countries that are interested in joining.
At least five euro-zone countries, led by Germany, are campaigning to push back an end-of-year deadline, indicating that they want the talks to focus on the quality of the project, rather than speed.Still, a draft of the summit's conclusions—traditionally prepared in advance but subject to change—reiterated the goal of completing the work on the supervisor "as a matter of priority" by year-end.
The timing of the launch of the banking supervisor could determine how soon the European Stability Mechanism, the bloc's bailout fund, would be able to directly recapitalize banks.
At their previous summit in June, EU leaders had agreed that the ESM would be able to directly recapitalize banks once a joint bank supervisor is in place.
Spain, Ireland and other countries that stand to benefit from this facility because they hold bank-bailout debt on their books are pushing for a swift implementation of that June decision.
Italian Prime Minister Mario Monti also urged a rapid move to direct bank recapitalization by the ESM in a speech last week—a view supported by the French, according to EU officials.
Germany and other wealthy euro-zone nations have indicated the plan shouldn't apply to countries that are already under a bailout program.
Another thorny issue is the creation of some form of central budget for the euro-zone countries. This is one of the proposals included in a report by European Council President Herman Van Rompuy due to be finalized in December. Mr. Van Rompuy's report will be the centerpiece of the discussions over the next two days, and officials say Germany and France back his proposal for a euro-zone "fiscal capacity"—a common pool of funds for the 17 countries.
The money could be used to help countries deal with asymmetric shocks—crises that affect some but not others—and to provide financial incentives to members that commit to reforms.
But the plan is still unclear, one euro-zone government official said, adding that a debate was already starting over how to seed and use such funds.
Separately, Germany, the union's paymaster, is expected to try to get support for a proposal of its own to create a budget czar within the European Commission, a "currency commissioner with a high level of autonomy," according to a senior aide to German Chancellor Angela Merkel.
A similar idea was previously blocked by France and other countries loath to giving up sovereignty over their budgets.
Ms. Merkel, in a speech in Berlin Thursday, said Europe has come a long way, but now was the time for new, bold steps. She called on Europe to create robust powers for a monetary commissioner with the ability to veto national budgets that threaten the stability of the euro.
"We still have more to do," she said. "We must ensure that we have real rights of intervention in national budgets."
EU countries outside the euro also are expected to express concerns at the summit, in particular over how to reconcile banking supervision by the ECB's governing council—on which they have no representation—and the role of their own national supervisors.
EU leaders, their finance ministers and experts will have until the next summit in mid-December to reach a compromise on some of these issues.
Mr. Van Rompuy will present a final version of his report on the future of the euro zone at that meeting.
"December will decide how many of these ideas actually fly," one senior euro-zone official said.
It just refuses to get any better in Spain, whose banks are now aggressively marking down real estate to something resembling fair value. Last month we reported that Spanish bad loans jumped by the most ever, rising by over 1% to just under 10%. Today, last month's number was revised even higher to 10.1%. But the worst news is that the August bad loan total just hit a fresh record of €178.6 billion, or 10.5% of the total €1,698.7 billion in bank loans. Making things worse is that the primary bank funding lifeline - deposits - continues to flow out. That both Spain, and its banking sector are utterly insolvent, is clear to anyone but Oliver Wyman and those who have bought SPGBs (although granted the latter are merely hoping for a quick flip). And the ECB of course. Indicatively, as a % of GDP, this would be equivalent to roughly $2.7 trillion in US bank loans going sour (for more on the collapse of Spanish banking, and the laughable stress test whose worst case has already become the baseline, read here). The chart summarizing this staggering statistic is below.
As for that other marginal peripheral country, Italy, things aren't any better on ther ground there either.
The Italian banking association ABI said overall deposits and bank bonds had risen 0.57 percent year-on-year in September. Deposits held by Italian residents jumped 4.7 percent while bonds bank sold to retail clients fell 6.8 percent.
The data showed deposits held by foreigners continued to fall, although at a slower pace than in previous month. In August they declined by 15.4 percent compared with a 17 percent fall a month earlier.
Higher overall deposits did not translate in increased bank lending. Loans to non-financial businesses and families fell 2.6 percent, the fifth straight monthly decline and the worst deterioration in at least two years.
Also, bad loans rose due to Italy's recession. In September, they totalled nearly 116 billion euros, up 15.6 percent from a year earlier.
In other news, the European recovery is here. Or something.
2- Sovereign Debt Crisis
GLOBAL MACRO - - Government Debt Dynamics Interactive Model
While it is easier to listen to the narrative from world leaders and feel numb to the reality of it all, The Economist has decided enough is enough. The Economist provides this handy 'be your own global macro strategist' tool to comprehend just what magic the markets believe will occur going forward to keep debt levels under control across the world's governments... (e.g. all things equal, Spain would need to grow by 7.7% a year, or nominal bond yields to fall to a Teutonic 0.5% to stabilize government gross debt at its 2011 level of 70% of GDP).
ALL EYES are on Spain ahead of the European Council's two-day meeting in Brussels beginning on October 18th. In just three short years, the country's horrendous housing bust and subsequent recession have caused government debt to increase from a sustainable 40% of GDP in 2008 to 70% of GDP in 2011. Despite brutal government spending cuts, by the end of this year the IMF forecasts government debt will reach 90% of GDP. The question of whether Spain will seek a bail-out preoccupies markets and policymakers alike.
Our interactive graphic above shows the IMF's latest forecasts (updated in October 2012) for government gross debt as a percentage of GDP through to 2017. It also allows you to input your own long-term assumptions to project the likely path of debt to 2020.
There are two things that matter in government-debt dynamics: the difference between real interest rates and GDP growth (r-g), and the primary budget balance as a % of GDP (ie, before interest payments). In any given period the debt stock grows by the existing debt stock (d) multiplied by r-g, less the primary budget balance (p).
The simple r-g assumption is one of the most important in debt dynamics: an r-g of greater than zero (when interest rates are greater than GDP growth) means that the debt stock increases over time. An r-g of less than zero causes it to fall.
Our interactive model uses the nominal interest rate (i) approximately equivalent to the ten-year bond yield and allows you to input your own inflation rate, ?. Inflation helps reduce the total debt stock over time, by reducing the real value of debt. In our model and using approximations, r-g becomes i - ? - g. The greater the inflation rate, the lower r-g becomes.
The second consideration is the primary budget balance. A primary budget surplus causes the debt stock to fall, by allowing the government to pay off some of the existing debt. A primary deficit needs to be financed by further borrowing. As European peripheral countries have found out to their cost, interest rates increase when governments run large budget deficits, and as they do it becomes increasingly difficult to reduce r-g to a sustainable level.
In reality, these variables are all related. When inflation rises, for instance, bondholders will expect a higher nominal interest rate on new debt. If a country runs a larger primary surplus, the interest rate it is forced to pay may fall. Adjustments in countries' deficits will also affect their growth rates. To keep matters simple, we have ignored these interactions. Our calculator shows the evolution of a government's debt stock based directly on the values for inflation, growth, interest rates and the primary deficit that you determine.
Spain has lots of work to do.
Keeping all things equal, the country would need to grow by 7.7% a year, or nominal bond yields to fall to a Teutonic 0.5% to stabilise government gross debt at its 2011 level of 70% of GDP.
Fat chance: the IMF forecasts GDP growth to average just 0.5% a year and bond yields of 7.7% between 2012 and 2017. A bail-out for Spain it seems, is not a case of if, but when.
GMTP A11, R11
2- Sovereign Debt Crisis
SENTIMENT - Morgan Stanley's Business Conditions Index
We are currently experiencing a pre-election surge in all economic metrics; and then comes the hangover as can be confirmed by looking at hiring plans. Morgan Stanley's Business Conditions Index (a multi-factor real-time bottom-up economy tracker) has tumbled this month, giving back most of the very recent gains but it is the 'outlook for hiring' that is the most worrisome. Despite the stronger than expected employment report for October, both hiring indices fell to multi-year lows. The hiring index dropped 10 points to 44%, its lowest since December 2009, and the hiring plans index sunk 13 points to 44%, lowest since August 2009. Due to its leading indicator nature, this means that imminent payrolls may not stop rising; but in a few short months will post the first sequential decline since 2010. What this means for the unemployment rate is self-explanatory - but by then the election will be decided.
Evidence continues to pour in that the U.S. consumers and the U.S. businesses are experiencing the economy very differently. Specifically, the consumer has been feeling more confident thanks to emerging bullish trends like the rebound in home prices. Meanwhile, businesses are becoming increasingly cautious as the fiscal cliff looms.
Morgan Stanley just published its October read on its proprietary Business Conditions Index and it collapsed to 41% from 55% in September.
"Optimism surrounding supportive monetary policy has faded while fiscal cliff and election uncertainty have steadily risen," wrote Morgan Stanley economist Dane Vrabac. "The stronger than expected employment report did little to boost enthusiasm.
"Reports of uncertainty created by the fiscal cliff continue to increase. In October, 51% (versus 49% last month) of analysts responded that companies have downgraded business conditions as a result of cliff-related issues."
The most worrying component of the report was the stunning drop in hiring plans:
Despite the stronger than expected employment report for October, both hiring indices fell to multi-year lows. The hiring index dropped 10 points to 44%, low since December 2009, and the hiring plans index sunk 13 points to 44%, low since August 2009. To put this into perspective, in August 2009 the unemployment rate was at 9.6%, still on its way to maxing out at 10% two months later. By that December, it had only recovered 0.1% to 9.9%. Given the volatility of the component indices, it’s too early to make a strong call, but these indices warrant close attention in the coming months.
Meanwhile, we learned today that the NAHB homebuilder index climbed to a six-year high. According to Deutsche Bank's Joe LaVorgna, this means housing starts could double within just six months. This could be bullish for the U.S. consumer.
Hopefully, Washington will soon address these fiscal cliff issues. The consumer is coming back. But as you see above, persistent business uncertainty surrounding the fiscal cliff could eventually hit the consumer through a higher unemployment.
You know the drill: please point out on this chart, which shows the yearly change in average hourly earnings for all US private workers, just where is this so-called "recovery", which an additional $6 trillion in public debt, and 5 quantitative easing episodes, have allegedly created out of thin air. For those confused, like us, we bring attention to the fact that in the past two months we have seen the smallest Y/Y increase in avg hourly earnings. Ever.
HOUSING - Potentially Increasing Supply v Demand Problem
Supply is outpacing Demand.
In the wake of yesterday's huge housing starts report, Wall Street Examiner's Lee Adler noted that starts appeared to be outpacing sales.
TD Securities economist Millan Mulraine, who remains bullish on housing, also pointed to similar warning signs in a research note today.
"The exceptionally strong surge in residential construction activity and building permits approval in September has caused us to question whether homebuilding activity is beginning to edge too far ahead of the market’s capacity to absorb the new supply," wrote Mulraine. "Particularly given the current weak economic outlook in the medium term.
"The key risk is that prices in this segment of the market could come under pressure in the near term unless demand for new homes pick up more meaningfully in the coming months, justifying the optimism among builders."
Check out the spread between housing completions and new home sales:
...the non-annualised pace of new home completion has outpaced sales activity in this segment of the market every month this year. Up to the end of August, the accumulated gap between completion and sales this year has widened to 144K, and at the current pace so far this year, the gap appears likely to widen to around 200K. While this is not a particularly worrying level of inventory, the acceleration in the pace of starts in September, if sustained, will push the level of new homes supply well over twice the current pace of sales activity. To close this gap, new home sales will need to double from the current pace of 373K.
Another problem for the new homes market is the attractiveness of the existing homes market:
The Achilles’ heel for the new homes sector continues to be the competition from the massive supply of distressed properties still to be worked off in the market. With prices for existing homes still down 33% from their peak compared to new home prices (which are now within striking distance of their pre-crisis peak), the preference for new homebuyers will continue to be for the bargains to be had from the existing homes market, until this premium falls back to historical norms.
The analysts at Goldman Sachs have been among the most pessimistic people to talk about the fiscal cliff — the tax cuts and spending programs that will expire automatically at the end of the year and slash GDP by around 4 percentage points.
Goldman's David Kostin has warned that fiscal "brinksmanship" will cause the S&P 500 to tumble to 1,250 by the end of the year. In various surveys and anecdotes, U.S. businesses have indicated that uncertainty surrounding the fiscal cliff is preventing them from pursuing any major investments for growth.
Bottom line: the fiscal cliff is increasingly becoming a worry for the U.S. economy as the end of the year approaches.
Lately there has been an amusing and very spurious, not to mention wrong, argument among both the "serious media" and the various tabloids, that US households have delevered to the tune of $1 trillion, primarily as a result of mortgage debt reductions (not to be confused with total consumer debt which month after month hits new record highs, primarily due to soaring student and GM auto loans).
The implication here is that unlike in year past, US households are finally doing the responsible thing and are actively deleveraging of their own free will. This couldn't be further from the truth, and to put baseless rumors of this nature to rest once and for all, below we have compiled a simple chart using the NY Fed's own data, showing the total change in mortgage debt, and what portion of it is due to discharges (aka defaults) of 1st and 2nd lien debt. In a nutshell: based on NYFed calculations,
there has been $800 billion in mortgage debt deleveraging since the end of 2007. This has been due to $1.2 trillion in discharges (the amount is greater than the total first lien mortgages, due to the increasing use of HELOCs and 2nd lien mortgages before the housing bubble popped).
In other words, instead of actual responsible behavior of paying down debt, the primary if not only reason there has been any "deleveraging" at all at the US household level, is because of excess debt which became insurmountable, not because it was being paid down, the result of which is that more and more Americans are simply handing their keys in to the bank and walking away, and also explains why the US banking system is now practicing Foreclosure Stuffing, as defined first here, as the banks know too well, if all the housing inventory which is currently in the default pipeline were unleashed, it would rip off any floor below the US housing "recovery" which is not a recovery at all, but merely a subsidized bounce, as millions of units are held on the banks' books in hopes that what limited inventory there is gets bid up so high the second housing bubble can be inflated before the first one has even fully burst.
Naturally, two concurrent housing bubbles can not happen, Bernanke's fondest wishes to the contrary notwithstanding, especially since as shown above,
US households do not delever unless they actually file for bankruptcy,
and in the process destroy their credit rating for years, making them ineligible for future debt for at least five years. It is thus safe to say that all the other increasingly poorer US households (who are not getting paid more as we showed this morning with the chart showing Y/Y change in US household earnings) are merely adding on more and more debt in hopes of going out in a bankrupt blaze of glory just like everyone else: from their neighbors, to all "developed world" governments.
And why not: after all this behavior is being endorsed by the Fed with both hands and feet.
Just when we thought we may finally get one decent economic data point which even we could get excited about, we decided to look at the Non-Seasonally Adjusted September retail sales data. After all the $4.7 billion seasonal increase in headline retail sales was the second highest ever (in absolute terms, second only to 2004). Turns out our curiosity was an enthusiasm-dowsing mistake, as a number which on the surface looked good, was hardly validated by the Not-Seasonally Adjusted number, which plunged by $31.9 billion. How does this September sequential change compare to previous years? See the chart below and decide for yourselves if the massive NSA plunge in September 2012 merits the second best seasonally adjusted retail sales increase in history.
If anything, the 2012 spread of SA vs NSA retail change is most comparable to that from September 2007. As a reminder, this is 2 months before the 2nd Great Depression officially started.
Rail traffic trends continue to weaken as this week’s intermodal traffic report came in at 3.8% year over year growth. This is up slightly from last week’s reading of 2.5%, but brings the 3 month moving average down to 3.8% from 4%. I continue to see this as being consistent with an economy that is growing, but only marginally. Here’s more from the AAR:
“The Association of American Railroads (AAR) today reported mixed weekly rail traffic for the week ending October 6, 2012, with U.S. railroads originating 283,440 carloads, down 6.3 percent compared with the same week last year. Intermodal volume for the week totaled 251,113 trailers and containers, up 3.8 percent compared with the same week last year.
Ten of the 20 carload commodity groups posted increases compared with the same week in 2011, with petroleum products, up 46.1 percent; farm products excluding grain, up 30 percent, and lumber and wood products, up 11.2 percent. The groups showing a decrease in weekly traffic included coal, down 18.1 percent; iron and steel scrap, down 17.9 percent, and waste and nonferrous scrap, down 11.5 percent.
Weekly carload volume on Eastern railroads was down 7.9 percent compared with the same week last year. In the West, weekly carload volume was down 5.3 percent compared with the same week in 2011.
For the first 40 weeks of 2012, U.S. railroads reported cumulative volume of 11,325,845 carloads, down 2.6 percent from the same point last year, and 9,462,377 trailers and containers, up 3.7 percent from last year.”
profoundly pessimistic about the ability of companies operating in the U.S. to compete in the global economy and to pay high wages to U.S. workers,
a survey of more than 6,800 Harvard Business School alumni found.
Some 58% of the respondents expect the U.S. to weaken on one or both of these two dimensions of competitiveness over the next three years.
Only 25% expect the country to improve on one or both but decline on neither.
"It's not that the sky is falling," said Jan Rivkin, a Harvard professor overseeing the project with competitiveness guru Michael Porter.
"We've got great strengths, but the strengths are weighed down by weaknesses that are getting worse."
The survey is one piece of a broader effort by a group of Harvard Business School professors to rally executives to encourage business and government to pursue policies that will improve U.S. living standards and bolster the U.S. economy's competitiveness.
One bright spot in the new survey: Respondents were less pessimistic about prospects for the U.S. than they were in a similar survey last year. "We are sinking more slowly," Prof. Rivkin said. That appears to reflect a deterioration of the outlook for Europe and Asia rather than improvements in the U.S.
"The perception of the rest of the world has slipped," Mr. Porter said. "The sense of doom is a little bit less." Indeed, the decline in pessimism about the U.S. was sharper among Harvard alumni abroad than those in the U.S.
Unlike some other efforts to diagnose the competitiveness of the American economy, the Harvard project emphasizes both making U.S. companies more competitive, which could be achieved by cutting wages, as well as making the U.S. economy more competitive, so it can deliver rising wages.
The Harvard alumni are less gloomy about the former than the latter. Some 34% said companies in the U.S. would be less able to compete in the global economy over the next three years; 28% said they would be more able.
52% said the U.S. would be less able to pay high wages and benefits; only 20% said it would be more able. The remainder in each case said "neither more or less."
The Harvard professors found particularly strong support among the alumni for encouraging more immigration of highly skilled individuals, for rewriting the corporate tax code to lower rates and eliminate loopholes and for making the federal budget more "sustainable" with spending cuts and revenue increases.
A parallel survey of 1,025 Americans found them far less pessimistic than the business-school alumni. That survey found, to the surprise of the professors, strong support among the public for corporate tax reform.
Both surveys also found enthusiasm for a multiyear effort to invest more in communications and transportation infrastructure.
The alumni survey attempted to identify political leanings of executives by soliciting their views on two policies seen as conservative—right-to-work laws and the budget crafted by Rep. Paul Ryan (R., Wis.)—and two seen as liberal—clean-energy incentives and the so-called Buffett tax on the highest-income earners.
Just as in recent polls of the public, liberal business-school alumni are more upbeat about the future of the American economy than conservatives.
The alumni survey was conducted by Abt SRBI and the online survey of the public by GfK, which maintains a statistically representative panel of Americans.
INDICATORS CYCLE CONFIDENCE
33 - Public Sentiment & Confidence
BUSINESS CONDITIONS - Weakening Over the Last Year
The Aruoba-Diebold-Scotti business conditions index is designed to track real business conditions at high frequency. Its underlying (seasonally adjusted) economic indicators (weekly initial jobless claims; monthly payroll employment, industrial production, personal income less transfer payments, manufacturing and trade sales; and quarterly real GDP) blend high- and low-frequency information and stock and flow data. Both the ADS index and this web page are updated as data on the index's underlying components are released.
The average value of the ADS index is zero. Progressively bigger positive values indicate progressively better-than-average conditions, whereas progressively more negative values indicate progressively worse-than-average conditions. The ADS index may be used to compare business conditions at different times. A value of -3.0, for example, would indicate business conditions significantly worse than at any time in either the 1990-91 or the 2001 recession, during which the ADS index never dropped below -2.0.
The vertical lines on the figure provide information as to which indicators are available for which dates. For dates to the left of the left line, the ADS index is based on observed data for all six underlying indicators. For dates between the left and right lines, the ADS index is based on at least two monthly indicators (typically employment and industrial production) and initial jobless claims. For dates to the right of the right line, the ADS
index is based on initial jobless claims and possibly one monthly indicator.
Today's just announced revenue and EPS misses from both megacaps McDonalds and GE (in addition to MSFT, GOOG, INTC, IBM and everyone else) merely adds to what has so far been an abysmal earnings season, and one which is set to continue for far more weakness into Q4 (why? Hint: China, and its unwillingness to ease, and thus provide the much needed demand oomph US corporates need). Yet, the pundits will claim, economic conditions in the US have improved. How does one reconcile this disconnect? Simple: as Bloomberg Brief shows in two simple charts, what we are undergoing is not the first, but second case of annual deja vu, as the economy supposedly picks up in Q3 and Q4, courtesy of the latest and greatest artificial sugar high from the Fed, only to slide promptly back into decline once the initial euphoria fizzles. However, this time there is a major difference:
Corporate Y/Y revenue (and in many cases EPS) comps have turned negative, which means that unlike before when corporations would be the silver lining in a dreary macro environment once the economic downward trend resumed, this time around there won't be a convenient Deus Ex to provide a last gasp reason to hold on to the myth that things are getting better.
This, in turn means, that with "dividend" assets no longer attractive,
the investing/trading crowd will rush into hard assets like crude (recall the $125/barrell Brent barrier for economic decline)... and gold. But that is a story for another day.
From Bloomberg Economics Brief by Joseph Brusuelas:
Recent growth data and a number of positive economic surprises are following an eerily familiar pattern that has repeated over the past three years. Inthis pattern, indicators point to possible improvement in the economy in the fourth quarter of each year, only to disappoint when the roughly 2 percent growth trend (2.2 percent since recovery) reasserts itself in subsequent quarters.
Will this year follow the pattern, or represent a breakout?
Some developments in the economy do point to signs that this time may be different, especially if policy makers successfully avoid the fiscal cliff.
The lagged impact of past fiscal and monetary policy may be gaining traction, supporting auto sales that are 50 percent above recession lows and home purchases that are up 9.3 percent on a year-over-year basis. A mid-cycle improvement in auto sales and housing starts, areas that traditionally lead the economy, is a welcome development.
The 35 percent year-over-year increase in housing starts will probably be sustained due to real demand for rentals of multi-family dwellings as new entrants to the workforce start households and homeowners transition to renter status.
Other positive factors appear to be more temporary. Pent-up demand for consumer goods, and the ability of upper income households to access credit to purchase them, can help support temporary bumps in spending in the latter parts of the year when new consumer products such as the iPhone and iPad are released. This support for the economy is likely transitory and insufficient to move the economy back toward its long-term growth trend of 2.5 percent.
Personal income continues to stagnate. Disposable personal income is up 1 percent on a year ago basis, half the 2 percent average posted during the previously cyclical expansion.
And new bookings of capital orders excluding non-defense aircraft are down 5 percent year-over-year, with total manufacturing orders off 2.5 percent and durable goods orders down 7.2 percent.
While the housing story is encouraging, and a recovery in housing is an essential component of a sustained expansion, total residential investment accounts for only 2.3 percent of GDP, down from 6.3 percent at the peak of the housing boom. The U.S. economy is undergoing a structural change from an overreliance on household consumption to a growth model based on value-added manufacturing, technology and energy.
Those hoping for the old growth model to reassert itself in the wake of the housing collapse, financial shock and ensuing Great Recession may as well be waiting for Godot.
With that said we want to reiterate what we said earlier: until and unless China resumes a major monetary easing episode (and it has so far sternly refrained from doing so due to fear of food price shocks and imported inflation), the latest episode of macro optimism will end in tears far sooner than all expect. And this time the Fed will truly be exposed as the naked emperor it is.
US INDICAOTRS CYCLE GROWTH
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
You can’t go below zero. But man, it’d sure be nice if you could. That’s the conclusion of a new report from two economists at the Cleveland Fed, who say that the downturn in 2009 called for Fed interest rates to actually be negative — if only that were possible.
This is the main dilemma for central banks during deep recessions like the one from which we’re currently emerging. In normal times, if a slump is coming, the Fed and its counterparts in other countries will slash interest rates. If the rate was 5 percent and the Fed slashed it to 2, that reduces banks’ incentive to hoard money and encourages lending, which in turn boosts the economy.
But what happens when interest rates are already extremely low, and that’s not enough to take the economy out of its slump? The Fed’s rate is currently set at a range of 0 percent to 0.25 percent. You can’t go much lower than that without things getting real weird. Negative interest rates basically mean that the bank is charging you money to stash your savings with them. In that situation, many people would just hold cash, which at least has a 0 percent return.
There are some situations where this isn’t practical. Large companies aren’t going to go all “Breaking Bad” and just keep big piles of $100 bills around. Indeed, Sweden has tried a negative 0.25 percent interest rate on bank reserves, with encouraging results, suggesting the impediments to holding cash are big enough for negative rates to work.
But there are workarounds. Kenneth Garbade and Jamie McAndrews at the New York Fed warned earlier this year that negative interest rates would lead to “special purpose banking,” in which companies offer effectively sky-high returns by promising to just keep peoples’ money in the form of cash. Garbade and McAndrews also envision people delaying depositing checks, knowing that if they put it in their bank account immediately, it’ll start losing value. To avoid these problems altogether, you’d need to take a drastic step like abolishing paper currency. While some, like Citigroup’s Willem Buiter, have proposed just that, it doesn’t seem in the offing for any countries anytime soon.
Which is too bad, since the data suggest that we really needed negative interest rates in 2009. I did some back of the envelope math a while back showing that under popular policy rules for determining interest rates, rates should have reached close to -4 percent in 2009. Now, two economists at the Cleveland Fed, Ellis Tallman and Saeed Zaman, argue that, if anything, that’s too timid. They believe rates should have reached -5 percent:
The red line is the actual policy the Fed has taken, and the blue line is the policy which Tallman and Zaman estimate would have been taken if the Fed followed past patterns for changing rates. The rate, if the Fed followed past policies, would have dipped to -5 percent in mid-2009, and still be around -2 percent today. What’s more, the results are statistically significant at a 90 percent level, as you can see from the fact that even the upper 90 percent confidence bound is negative until the start of 2011.
The Fed has tried to get around this through quantitative easing, and fiscal stimulus as implemented by the American Recovery and Reinvestment Act is another way of getting around the “zero lower bound.” Some, like Columbia’s Michael Woodford, have suggested getting around it by making promises about how long interest rates will stay at zero, an approach which the Fed has also adopted in a limited form and appears set to embrace wholesale.
But as Tallman and Zaman show, one wouldn’t even need to get that creative if the Fed were able to go negative. And given that the Fed acts faster to change interest rates than to do more exotic things like QE, and that Congress acts much more slowly than the Fed ever does, that could have sped up the recovery.
Entering the final quarter of the year, Lacy Hunt and Van Hoisington (H&H) describe domestic and global economic conditions as extremely fragile. Across the globe, they note, countries are in outright recession, and in some instances where aggregate growth is holding above the zero line, manufacturing sectors are contracting. Of course, new government initiatives have been announced, particularly by central banks, in an attempt to counteract deteriorating economic conditions.
These latest programs in the U.S. and Europe are similar to previous efforts. While prices for risk assets have improved, governments have not been able to address underlying debt imbalances. Thus, nothing suggests that these latest actions do anything to change the extreme over-indebtedness of major global economies. To avoid recession in the U.S., the Federal Reserve embarked on open-ended quantitative easing (QE3). Importantly, in their view, the enactment of QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth.
H&H go on to break down every branch that Bernanke rests his QE hat on from the Fed's inability to create demand, to the de minimus wealth effect, and most importantly the numerous unintended consequences of the Fed's actions.
Can all the trillions of dollars of reserves being added to the banking system move the economy forward enough to eventually create a higher level of aggregate spending? Our analysis of the aggregate demand curve and its determinants indicate they cannot. The unintended consequence of these Federal Reserve actions, however, is to actually slow economic activity.
The unintended consequences of QE3 could also serve to worsen and undermine global economic conditions already under considerable duress. When the Fed actions lead to higher food and fuel prices, the shock wave reverberates around the world, with many foreign economies being hit adversely. When prices of basic necessities rise, the greatest burden is on those with the lowest incomes since more of their budget is allocated to the basic necessities such as food and fuel. Thus, a jump in daily essentials has a more profound negative impact on living standards in economies with lower levels of real per capita income.
Three studies show that the impact of wealth on spending is miniscule—indeed, “nearly not observable.” How the Fed expects the U.S. to gain any economic traction from higher stock prices when rising commodity prices are curtailing real income and spending is puzzling.
The other element that is required for the Fed to shift the aggregate demand curve outward is the velocity or turnover of money over which they also have no control. During all of the Fed actions since 2008 the velocity of money has plummeted and now stands at a five decade low.
The consequence of the Fed’s lack of control over the money multiplier and velocity is apparent. The monetary base has surged 3.3 times in size since QE1. Nominal GDP, however, has grown only at an annual rate of 3%. This suggests they have not been able to shift the aggregate demand curve outward. Nor, with these constraints, will they be any more successful in shifting that curve under the present open-ended QE3
Increased aggregate demand and thus rising inflation is not on the horizon.
As the IMF meetings close in Tokyo this weekend, it is obvious that governments are struggling to find the correct balance between controlling public debt, which now exceeds 110 per cent of GDP for the advanced economies, and boosting the rate of economic growth. The former objective requires more budgetary tightening, while the latter requires the opposite. Is there any way around this?
One radical option which is now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely.
This option has always been viewed as extremely dangerous on inflationary grounds, and has never been publicly discussed by senior central bankers, as far as I am aware . However, Adair Turner, the Chairman of the UK Financial Services Agency, and reportedly a candidate to become the next Governor of the Bank of England, made a speech last week that said more unorthodox options, including “further integration of different aspects of policy”, might need to be considered in the UK.
Two separate journalists (Robert Peston of the BBC and Simon Jenkins of The Guardian) said that Lord Turner’s “private view” is that some part of the Bank’s gilts holdings might be cancelled in order to boost the economy. Lord Turner distanced himself in public from this suggestion on Saturday. However, the notion will now be widely discussed. It is easy to see how the idea could appeal to a finance minister facing the need to tighten fiscal policy during a recession in order to bring down the public debt ratio.
Why is this such a radical idea? No one in the private sector would lose out from the cancellation of these bonds, which have already been purchased at market prices by the central bank in exchange for cash. The loser, however, would be the central bank itself, which would instantly wipe out its capital base if such a course were followed. The crucial question is whether this matters and, if so, how.
In order to understand this, we need to ask ourselves why governments finance their deficits through the issuance of bonds in the first place, rather than just asking the central bank to print money, which would not add to public debt. Ultimately, the answer is the fear of inflation. When it runs a budget deficit, the government injects demand into the economy. By selling bonds to cover the deficit, it absorbs private savings, leaving less to be used to finance private investment. Another way of looking at this is that it raises interest rates by selling the bonds. Furthermore the private sector recognises that the bonds will one day need to be redeemed, so the expected burden of taxation in the future rises. This reduces private expenditure today. Let us call this combination of factors the “restraining effect” of bond sales.
All of this is changed if the government does not sell bonds to finance the budget deficit, but asks the central bank to print money instead. In that case, there is no absorption of private savings, no tendency for interest rates to rise, and no expected burden of future taxation. The restraining effect does not apply. Obviously, for any given budget deficit, this is likely to be much more expansionary (and potentially inflationary) than bond finance.
This is not, however, what has happened so far under QE. Fiscal policy, in theory at least, is set separately by the government, and the budget deficit is covered by selling bonds. The central bank then comes along and buys some of these bonds, in order to reduce long-term interest rates. It views this, purely and simply, as an unconventional arm of monetary policy. The bonds are explicitly intended to be parked only temporarily at the central bank, and they will be sold back into the private sector when monetary policy needs to be tightened. Therefore, in the long term, the amount of government debt held by the public is not reduced by QE, and all of the restraining effects of the bond sales in the long run will still occur. The government’s long-run fiscal arithmetic is not impacted.
Note that QE under these conditions does not directly affect the wealth or expected income of the private sector. From the private sector’s viewpoint, all that happens is they hold more liquid assets (especially commercial bank deposits at the central bank), and fewer illiquid assets (ie government bonds). Because this is just an temporary asset swap, it may impact the level of bond yields, but otherwise its economic effects may be rather limited. (See pages 8-13 of this Fulcrum Research paper for a description of the debate over the size of these effects.)
Now consider what would happen if the bonds held by the central bank were cancelled, instead of being one day sold back into the private sector. Under this approach, the long-run restraining effect of bond sales would also be cancelled, so there should be an immediate stimulatory effect on nominal demand in the economy. If done without amending the path for the budget deficit itself, this would increase the expansionary effects of past deficits on nominal demand, and would also reduce the outstanding burden of public debt associated with such deficits.
The central banks have now purchased so much government debt that the effects of such an action could be large. This is the situation in the UK, where the Bank of England holds 25 per cent of all outstanding government debt:
And this is the situation in the US, where the Fed holds 10 per cent of outstanding Treasury debt:
Furthermore, the effects would be increased even more if, instead of just cancelling past debt, the central bank were to co-operate with the government, agreeing to directly finance an increase in the budget deficit by printing money. We would then be genuinely in the world of “helicopter money”, with no pretence of separation between fiscal and monetary policy .
Outside of wartime, developed economies have not been normally been willing to contemplate any such actions. The potential inflationary consequences, which are in fact signalled by the elimination of central bank capital which this strategy involves, have always been considered too dangerous to unleash.
For me, that remains the case. But others are more worried about deflation than inflation. This genie might soon be leaving the bottle.
 Samuel Brittan makes the case that part of the budget deficit should be money financed in this column. Martin Wolf makes a similar case in this column. Both argue that money financing of deficits is preferable to “everlasting austerity and slump”.
TECHNICALS & MARKET ANALYTICS
Q3 EARNINGS - Earnings Watch
Here Is Why GOOG Has Plunged By 10% (So Far) While everyone knows that GOOG is halted and may or may not resume trading before market close (and no, RRD merely reported the facts, if only early, and as everyone knows the market has a revulsion to reality peeking during trading hours), few are aware just why it is that everyone dumped the stock which soared to all time highs a few short weeks ago. Here it is, in its full visual splendor - Google's Operating Income, which was expected to come in at $3.536 billion printed at $2.736 billion, a 23% miss!
For BofA, Crisis Hits Keep Coming Bank of America's third-quarter profit dropped 95% and revenue tumbled 28% as the lender continues to struggle with crisis-era fallout.
Nestlé Sales Beat Expectations Swiss food giant Nestlé reported a better-than-expected increase in nine-month sales and said it continues to grow even in developed markets hit by poor consumer confidence. Nestlé Adding Two China R&D Centers Nestlé, the world's largest food company by sales, is opening two new research and development centers in China, adding to the two it already operates there.
Bank of America, PepsiCo, and Halliburton all report Q3 earnings before the opening bell. Consensus EPS estimates are for $0.05, $1.16, and $0.68, respectively. Click here for BofA's earnings results >
As market participants ponder the disappointing post-QEtc. performance on their 'Bernanke/Draghi-Put'-floored equities, perhaps these three charts will help in comprehending just how much hope there is in the world's equity markets. The disconnect from macro-fundamental is not unique, but has had significant and extremely rapid repercussions in the past. It seems, however, that just like AAPL, everyone believes everyone else to be the greater fool - and this time is different.
Germany's DAX 'disconnected' from economic reality in 2007 (to the euphoric side) and in 2011 (to the dysphoric side). It seems once again that hope has taken over...
The S&P 500 also exhibits the same disconnect - though even more significantly...
While as Bloomberg reports the EPS beat to miss ratio so far is 68%:32%, the scariest statistic of the day goes to Deutsche Bank who said that "The beat-to-miss ratio... is running 41%:59% for revenue." This means nearly 50% more misses than beats in the earnings season so far. DB continues: "Recall that Q2 was also one where we saw better EPS beat but weaker revenue performance so it seems that companies have been eking out earnings by squeezing costs and wages."
REAL DISPOSABLE INCOME
Now as every entry level analysts, Treasurer and CFO knows, there are 1001 ways to boost ESP cut corporate overhead (and those exclude accounting gimmicks, ahem all banks and GE), chief among them of course is laying people off and replacing them with part-timers and temps (something that has been going on in the US for 3 years now as we first showed in 2010), there is precisely zero way to hide the fact that there is simply less demand for products and services at the very top level in a world in which 2% growth, formerly known as stall speed, is the New Killing it, and in which real disposable income just turned negative once again, not to mention the endless collapse in average hourly earnings.
There is little doubt that asset prices have responded to Central Bank promises and actions. Even as bottom-up fundamentals are fading, top-down index 'nominal prices' rise on the back of magical multiple expansion - which is defended from on high by sell-side strategists the world over on the back of 'recovery' is just around the corner. The trouble is there's a limit and it seems - from QE2 and LTRO - that we are rapidly approaching that limit; and with earnings outlooks being revised lower, perhaps we are at peak P/E for this cycle of QE?
Each line is the normalized gain in P/E from the onset of expectations for Central Bank largesse: (QE2 - green; LTRO - red; QEtc. - Orange)
Adapted from Bloomberg Chart of the Day
PATTERNS -- Over-Exuberance at 'Reflation"
Inversion of the 10Y-30Y Inflation Breakeven term structure (implying a front-loading of reflationary concern relative to long-term - or over-exuberance at reflation) has occurred at 2 previous important times... will third time be lucky?
The plunge-plunge-linear-ramp pattern in S&P futures...
For those who missed it earlier, Intel reported results that were just slightly better than expected, and yet the stock tumbled over 3% after hours. The reason is because despite a weak quarter which had been pre-guided down by the sellside community every so effectively, the semiconductor manufacturer saw even more weakness in Q4.
Those who wish to read the details can do so here. For everyone else who is more of a visual learning bent, we present the following chart which shows the year-over-year change in Intel revenue, which shows that for the first time in 12 quarters, INTC reported a decline in annual revenue. Furthermore, there is virtually no question that Q4 will also see a revenue decline: the only question is whether it will be greater than Q3's 5.5% Y/Y drop.
Why is this notable? Because the last time Intel posted two, or even one, consecutive declines in Y/Y revenue, the recession was found to have already been in place for nearly a year, starting in December 2007.
Intel is held by many as the canarie in the coalmine of the ever so critical tech sector, which is also a proxy for high-margin electronics products, and from there marginal demand in the economy as a whole. One can hope that the central planners have this latest recessionary confirmation under control (and with China sternly refusing to join the easing party the conclusion so far is they absolutely do not), or else the market will find itself at such a disconnect between the synthetic, correlation driven and implied value from the ES and SPY relative to cash flow intrinsics that not even QE?+1 will be able to save the policy vehicle that is the market, let alone the economy.
The period from 2003 to 2008 has been nicknamed 'The Great Moderation' as credit spreads collapsed close to zero, free-wheeling securitizations flooded the market with liquidity which repressed every credit instrument and forced investors to reach down in quality and out the curve for every extra tick of yield or carry. The period from the lows in 2009 could well be nicknamed 'The Great WTF' as credit spreads collapsed back down, and free-wheeling central banks flooded the market with liquidity which repressed every credit instrument and forced investors...blah blah blah... It would appear from the analog below that while markets do not repeat, they sure like to echo. We just remind those bulls looking for the next 18% lift that the analog period is when reality started to come out from behind the curtain - beginning in 2007...The Great Realization.
It is by now well-known that the general level of the stock market no longer has any impact on retail flows in or out of stocks, having become a one way street out of equities beginning roughly six years ago, with the proceeds invested into fixed income (a paradox much to the chagrin of the Fed which keeps hoping positive equity dividend yields will prove a sufficient motive for investing in a world where interest income is now zero and has taken away $400 billion in purchasing power each year) and only institutions, mostly Primary Dealers and other entities "close" to the Fed's freshly printed money, and central banks are propping up the stock market.
However, one place where the S&P level still does have a modest influence is the number of shorts in the market, which are strategically used by repo desks and custodians (State Street and BoNY), to force wholesale short squeezes at given inflection points, usually just when the bottom is about to drop out. The problem is that even short squeezes are increasingly becoming fewer and far between, for the simple reason that the Fed has managed to nearly anihilate shorters as a trading class with its policy of Dow 36,000 uber alles. This was demonstrated with the latest NYSE Group short interest data, which tumbled to 13.6 billion shares short as of the end of September, or the lowest since early May, just as the market was swooning to its lowest level of 2012 to date.
Since the Fed desperately needs inexperienced, "weak-hand" shorts to reenter stocks to facilitate its "transmission mechanisms" (all of which can be summarized in two words: "stock ramps"), and since the only time shorts re-enter the market, even against their and everyone else's better judgment, is just after major market tumbles, expect the Fed to prepare for some more stock market acrobatics whose sole purpose is to get a fresh batch of shorts in, just so the squeeze trap can be replayed over and over, as it has been for the past 4 years.
Presented with little comment, except to say - it seems, as Boaz at EminiAddict points out, that the S&P 500 likes to travel around 808 points from swing low to swing high. Extending the analog suggests a drop to 565 on the S&P 500 by mid-2014.
and using EminiAddict's channel projection... suggests a 565 swing low to come...
This week our Percent Buy Index (PBI) for the S&P 500 dropped below its 32-EMA and generated a sell signal. The PBI tracks the percentage of stocks in a given index that are on intermediate-term buy signals, and it is one of many indicators that we follow. The PBI does not currently affect our primary timing model (which is still on a buy signal), but it does offer an early warning of possible problems ahead.
The chart below shows the SPX PBI over a three-year period. Obviously, its crossover signals are not infallible, but downside crossovers at overbought levels are generally bad news. Additionally, notice the negative divergence -- lower PBI tops against higher price tops.
For the Nasdaq 100 Index, the PBI sell signal was generated over two weeks ago, and the negative divergence is much more severe. This reflects that the smaller-cap stocks in the index are fading and that larger-cap stocks are holding the index aloft. This is not a good thing, but it can persist longer than we might think.
It is possible that prices will behave indecisively (move sideways) until after the election, but the PBIs are giving signs that, no matter who wins, the market is likely to head lower.
Today, Barron's goes out on a limb again with a bullish cover story titled "Almost There" in reference to the Dow Jones Industrial Average being 6 percent from an all-time high.
Here's a sample of what author Andrew Bary says:
The Dow Industrials are more reasonable now than at the 2007 peak, when the index traded for 16 times the then-current 2008 earnings estimates. That projection turned out to be way too high, as did even more bullish 2009 projections at that time, as the financial crisis and recession savaged earnings.
It's bullish that U.S. stocks have done well without much participation by retail investors, who continue to prefer bonds despite historically low rates on Treasuries, mortgage securities, high-grade corporate debt, and junk bonds. The average junk-bond yield of 6% is only three percentage points higher than dividend yields on scores of high-quality, dividend-paying stocks. Junk bonds probably can't go much higher, although they could go a lot lower. If retail investors ever warm to stocks, the Dow could go much higher.
Bary's story includes quotes from Jim Paulsen of Wells capital Management and Blackstone's Byron Wien who both point to a stronger-than-expected U.S. economy.
"With a bevy of reasonably priced stocks, the Dow industrials look poised to set a new record, if not this year then next, and investors can get a nice 2%-plus yield along the way," writes Bary.
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DISCLOSURE Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.